F

ANDRIAMAHENINTSOA LALAINA

MCCA 323

BOTOJANINA JENNY

MCCA 324

RALAHINOMENJANAHARY LIANTSOA

MCCA 330

RANDRIANARIJAONA MIKOLO

MCCA 336

RASANDIMANANA JOHARY

MCCA 339

RATSARAVOLA FRANCELLE

MCCA 341

RASOAMAMPIANINA SANDRA

MCGAO 260

RAZAFINIMPANANA NALY

MCGAO 266

RATSIRESY ANTSA

MCGAO 263

A
N
C
I
A
L
Mr RAKOTOARIVELO JEAN BAPTISTE

R
A
T
I
O

INTRODUCTION
It is difficult to manage a company. It is essential to earn profit, to attract investors and to
satisfy all the shareholders. To show the strength and the health of the enterprise, the use of
financial ratio is crucial. It is used by Bankers, investors and venture capitalists.
It is important to crunch and to analyze numbers from the financial statements which
considers the general factors of the company (qualitative) and tangible and measurable factors
(quantitative). The ratio analysis is not just comparing numbers against previous years or
other enterprises or the economy in general. Ratio looks at the relationships between
individual values and relates them to how the company has performed in the past and how it
might perform.
This presentation will help us to make more informed choices as investors and to analyze
financial reports.We will try to present 19 basic fundamental analysis ratios to help us get
started. The ratios are presented in a simplified manner to make them easier to understand.

I. GENERALITIES
1- Definitions
Ratio
Relationship between two related or interdependent items, expressed in arithmetical terms is
called a ratio.
According to R.N. Anthony "A ratio is simply one number expressed in terms of another. It
is found by dividing one number into the other."
Ratios are simply a means of highlighting in arithmetical terms the relationship between
figures drawn from the financial statements.

Accounting ratios
Ratios based on financial statement are called 'Financial Ratios' or 'Accounting Ratios.'
Accounting ratio is thus, an arithmetical relationship between two accounting variables.
According to J. Betty, "The term accounting ratio is used to describe significant relationship
which exist between figures shown in a Balance Sheet or in a Profit and Loss Account or in a
budgetary control system or in any part of the accounting organization."
In short, accounting ratios indicate a quantitative relationship which the financial analyst may
use to make a qualitative judgment about various aspects of the financial position and
performance of a business enterprise.

Ratio analysis
Ratio analysis is a process of computing, determining and presenting the relationship of items
or group of items of financial statements to provide a meaningful understanding of the
performance and financial position of a business concern.
Ratio analysis is a tool or a technique to present figures of financial statements in simple,
concise, intelligible and understandable manner.
According to Myers, "Ratio analysis is a study of relationship among various financial factors
in a business."
2

Hence, Ratio Analysis is a technique of analyzing the financial statements by computing

accounting ratios and interpreting it to draw meaningful conclusions.

2- Methods of Expressing Accounting Ratios

Accounting ratios can be expressed in the following forms:
Percentage Method:
In this method, a quotient obtained by dividing one figure with another figure is
multiplied by one hundred and it becomes the percentage form of expression
example: Profitability ratios
Rate Method:
Here a quotient obtained by dividing one figure with another figure is taken as unit of
expression of how many times a figure is in comparison to another figure. This method is
used when figures are related to a fixed period of time e.g., Activity ratios.
Proportionate Method
It express relationship of two items is directly in proportion. It is also known as Ratio
Method or Pure Ratio or Simple Ratio. E.g. Liquidity Ratios
Fraction:
Sometimes ratio relationship is expressed in fraction. Sometimes ratio relationship
may be expressed in terms of months or days.

3- History
There is majority of evidence prove that ratio analysis since the late 1800s has been
widely used in the analysis and valuation of published financial data such as security analysis
firms (e.g., Dun & Bradstreet) have published, and presumably have profited from publishing,
listings of annual financial ratio values for various firms and industries. In addition, the use of
ratio analysis is emphasizing in the literature on financial statement analysis.
The first attempt to present an historical review of ratio analysis was made by Horrigan
(1968) followed by Barnes (1987) and Salmi and Martikainen (1994).
3

The historical development of ratio analysis can be divided broadly into four phases. The first
phase began approximately in 1870. We have seen a spurt in the ratios development for
managerial and credit analysis. During this period, current ratio has been the most important
ratio. It still draws the attention of the analysts.
However, the proliferation of ratios created problems for discerning the right kind of ratios in
business analysis. Attempts were made to resolve the problem by developing a coherent
system of ratios. In 1919, the du Pont RoI chart developed by bliss is the first such attempt
and during the same period the emergence of industry-wise ratios were also found. Wellknown business schools and credit agencies have begun publishing these ratios on a regular
basis.
In the second phase in 1930, attempts were made to understand the statistical nature
and empirical basis of financial ratios. A considerable volume of literature was produced on
the subject but the empirical findings of major researchers were found to be more
contradictory than corroborative. The statistical approach to ratio analysis also led to the
development of ratio models for predicting corporate bankruptcy. Most important among
those works are those of Merwin (1942) and Beaver (1967), Altman (1968) and Ohlson
(1980). While emphasis on empirical research enriched the discipline of ratio analysis it
retarded the development of a comprehensive theory of ratios.
In the third phase in the later part of the 1960s, rigorous scientific investigation was
made into the information content of financial ratios with the help of Entropy Law and
decomposition theory. The problem of aggregation and consequent information loss was
investigated with the help of sophisticated mathematical tools but the findings remained
inconclusive. However, these studies revealed for the first time that accounting does not really
have a satisfactory conceptual framework. The research on understanding the statistical nature
of ratios, particularly for the purpose of predicting the health of a business, continued
unabated during this period and is also being carried forward to the present.
Since 1980 the discipline has entered into its fourth logical phase where the search of a
theory of financial ratios has begun. Serious attempts are being made to find a comprehensive
testable theory of financial ratios. This discipline is now ripe enough to give birth to its own
theory.

4- Objective
Ratio analysis is useful for manager to make decision too. Using ratio analysis helps manager
to evaluate the firm performance such as financial health, profitability and operational
efficiency over a period of time.
These ratios have following objectives:
Measuring the profitability:
Profitability is the profit earning capacity of the business. This can be measured by Gross
Profit, Net Profit, Expenses and Other Ratios. If they fall we can take corrective measures.
Determining operational efficiency:
Operational efficiency of the business can be determined by calculating operating / activity
ratios.
Measuring financial position:
Short-term and long-term financial position of the business can be measured by calculating
liquidity and solvency ratios. In case of unhealthy short or long-term position, corrective
measures can be taken.
Facilitating comparative analysis:
Present performance can be compared with past performance or with other competitive firms
to discover the positive and negative points.
Indicating overall efficiency:
Profit and Loss Account shows the amount of net profit whereas Balance Sheet shows the
amount of various assets, liabilities and capital. We can also obtain the profitability by
calculating the financial ratios.
Budgeting and forecasting:
Ratio analysis helps in financial forecasting and planning. Ratios calculated for a number of
years work as a guide for the future.

II. DIFFERENT TYPES OF FINANCIAL RATIOS

There are many financial ratios but we have gathered the ratios into groups

1- LIQUIDITY ANALYSIS RATIOS

Liquidity Analysis Ratios measure a companys ability to pay its short term debt obligations
when they fall due and its margin of safety through the calculation of metrics including the
current ratio, quick ratio, Net working capital ratio and cash ratio.
In other words, a company should possess the ability to translate its short term assets into
cash. The liquidity ratios attempt to measure this ability of a company.
The liquidity ratios are a result of dividing cash and other liquid assets by the short term
borrowings and current liabilities. They show the number of times the short term debt
obligations are covered by the cash and liquid assets. If the value is greater than 1, it means
the short term obligations are fully covered.
Generally, the higher the liquidity ratios are, the higher the margin of safety that the company
possesses to meet its current liabilities. Liquidity ratios greater than 1 indicate that the
company is in good financial health and it is less likely fall into financial difficulties.

a) The current ratio

The current ratio is balance-sheet financial performance measure of company liquidity.
The current ratio indicates a company's ability to meet short-term debt obligations. The
current ratio measures whether or not a firm has enough resources to pay its debts over the
next 12 months. Potential creditors use this ratio in determining whether or not to make shortterm loans. The current ratio can also give a sense of the efficiency of a company's operating
cycle or its ability to turn its product into cash.
The current ratio is called current because, unlike some other liquidity ratios, it incorporates
all current assets and liabilities.

The current ratio is calculated by dividing current assets by current liabilities:

Current ratio = Current Assets / Current Liabilities

The higher the ratio, the more liquid the company is. Commonly acceptable current
ratio is 2; it's a comfortable financial position for most enterprises. Acceptable current ratios
vary from industry to industry. For most industrial companies, 1.5 may be an acceptable
current ratio.
Low values for the current ratio (values less than 1) indicate that a firm may have difficulty
meeting current obligations. However, an investor should also take note of a company's
operating cash flow in order to get a better sense of its liquidity. A low current ratio can often
be supported by a strong operating cash flow.
If the current ratio is too high (much more than 2), the company may not be using its current
assets or its short-term financing facilities efficiently. This may also indicate problems in
working capital management.
All other things being equal, creditors consider a high current ratio to be better than a
low current ratio, because a high current ratio means that the company is more likely to meet
its liabilities which are due over the next 12 months.

b) The quick ratio

The quick ratio is a measure of a company's ability to meet its short-term obligations
using its most liquid assets (near cash or quick assets). Quick assets include those current
assets that presumably can be quickly converted to cash at close to their book values. Quick
ratio is viewed as a sign of a company's financial strength or weakness; it gives information
about a companys short term liquidity. The ratio tells creditors how much of the company's
short term debt can be met by selling all the company's liquid assets at very short notice.

The quick ratio is calculated by dividing liquid assets by current liabilities:

Quick ratio = (Current Assets - Inventories) / Current

Liabilities
Calculating liquid assets inventories are deducted as less liquid from all current assets
(inventories are often difficult to convert to cash).
7

Alternative and more accurate formula for the quick ratio is the following:

Quick ratio = (Cash and cash equivalents + Marketable securities +

Accounts receivable) / Current Liabilities
The formula's numerator consists of the most liquid assets (cash and cash equivalents) and
high liquid assets (liquid securities and current receivables).
The higher the quick ratio, the better the position of the company. The commonly acceptable
quick ratio is 1, but may vary from industry to industry. A company with a quick ratio of less
than 1 cannot currently pay back its current liabilities; it's a bad sign for investors and
partners.

c) Net working capital ratio

Net working capital is the amount of current assets that is in excess of current liabilities.
Working capital is frequently used to measure a firm's ability to meet current obligations. It
measures how much in liquid assets a company has available to build its business.
Working capital is a common measure of a company's liquidity, efficiency, and overall health.
Decisions relating to working capital and short term financing are referred to as working
capital management. These involve managing the relationship between an entity's short-term
assets and its short-term liabilities.
Net working capital is the difference between current assets and current liabilities.
Net working capital = Current Assets - Current Liabilities

Net working capital ratio is calculated by dividing net working capital by total assets:

Net working capital ratio = Net working capital/ Total

assets
If a business has a positive working capital, this indicates that it is able to pay off its
short-term liabilities almost immediately. In general, companies that have a lot of working
capital will be more successful since they can expand and improve their operations. A
negative working capital indicates that a company is illiquid.

d) Cash ratio
Cash ratio is a refinement of quick ratio and indicates the extent to which readily available
funds can pay off current liabilities. Potential creditors use this ratio as a measure of a
company's liquidity and how easily it can service debt and cover short-term liabilities.
Cash ratio is the most stringent and conservative of the three liquidity ratios (current, quick
and cash ratio). It only looks at the company's most liquid short-term assets cash and cash
equivalents which can be most easily used to pay off current obligations.
Cash ratio is calculated by dividing absolute liquid assets by current liabilities:

Cash ratio = Cash and cash equivalents / Current

Liabilities
Cash ratio is not as popular in financial analysis as current or quick ratios; its usefulness is
limited. A cash ratio of not less than 0,2 is considered as acceptable. But ratio that is too high
may show poor asset utilization for a company holding large amounts of cash on its balance
sheet.

2- PROFITABILITY ANALYSIS RATIO

As we know, the profitability of a company is vital for both the survivability of the company
as well as the benefit received by the shareholders.
This section of the presentation discusses about the different measures of corporate
profitability and financial performance. These profitability analysis ratios give users a good
understanding of how well the company utilized its resources in generating profit and
shareholder value. The first three ratios covered in this section - Return on Assets, Return on
Equity and Return on Common Equity - detail how effective a company is at generating
income from its resources.
The second part of this presentation-Earning per share-Profit analysis Margin-Pretax
Profit Margin- details the ratios that a company should consider in relation with his capital
and shares.

a) Return on Assets (ROA):

This ratio indicates how profitable a company is relative to its total assets. The return
on assets (ROA) ratio illustrates how well management is employing the company's total
assets to make a profit. The higher the return, the more efficient management is in utilizing its
asset base. The ROA ratio is calculated by comparing net income to average total assets, and
is expressed as a percentage, as his formula shows:

Return on assets = Net Income / Average Total Assets

The need for investment in current and non-current assets varies greatly among
companies. In the case of capital-intensive businesses, which have to carry a relatively large
asset base, will calculate their ROA based on a large number in the denominator of this ratio.
And non-capital-intensive businesses (with a small investment in fixed assets) will be
generally favored with a relatively high ROA because of a low denominator number.
It is precisely because businesses require different-sized asset bases that investors need
to think about how they use the ROA ratio. For the most part, the ROA measurement should
be used historically for the company being analyzed. If peer company comparisons are made,
it is imperative that the companies being reviewed are similar in product line and business
type. In other terms, being categorized in the same industry will not automatically make a
company comparable with the return on Assets.

b) Return on equity (ROE):

This ratio indicates how profitable a company is by comparing its net income to its
average shareholders' equity. The return on equity ratio (ROE) measures how much the
shareholders earned for their investment in the company. The higher the ratio percentage, the
more efficient management is in utilizing its equity base and the better return is to investors.
As his definition, the formula to calculate the Return on equity is:

Return on Equity = Net Income/ Average Shareholders Equity

Usually used by investors, the ROE ratio is an important measure of a company's
earnings performance. The ROE tells common shareholders how effectively their money is
being employed. Peer Company, industry and overall market comparisons are appropriate;
however, it should be recognized that there are variations in ROEs among some types of

10

businesses. In general, financial analysts consider return on equity ratios in the 15-20% range
as representing attractive levels of investment quality.
While highly regarded as a profitability indicator, the ROE metric does have a
recognized weakness. Investors need to be aware that a disproportionate amount of debt in a
company's capital structure would translate into a smaller equity base. Thus, a small amount
of net income (the numerator) could still produce a high ROE off a modest equity base (the
denominator).

c) Return on common equity (ROCE):

The return on capital employed (ROCE) ratio, expressed as a percentage, complements
the return on equity (ROE) ratio by adding a company's debt liabilities, or funded debt, to
equity to reflect a company's total "capital employed". This measure narrows the focus to gain
a better understanding of a company's ability to generate returns from its available capital
base. By comparing net income to the sum of a company's debt and equity capital, investors
can get a clear picture of how the use of leverage impacts a company's profitability.
Financial analysts consider the ROCE measurement to be a more comprehensive
profitability indicator because it gauges management's ability to generate earnings from a
company's total pool of capital.
To calculate the ROCE, we use the following formula:

Return on Common Equity = Net Income / Average Common

Stockholders Equity*

*Average Common Stockholders Equity = (the beginning Common Stockholders Equity +

Ending Common Stockholders Equity)/2
The return on capital employed is an important measure of a company's profitability.
Many investment analysts think that factoring debt into a company's total capital provides a
more comprehensive evaluation of how well management is using the debt and equity it has at
its disposal. Investors would be well served by focusing on ROCE as a key, if not the key,
factor to gauge a company's profitability.

11

In addition to that, the ROCE tells common stock investors how effectively their
capital is being reinvested. A company with high return on equity (ROE) is more successful in
generating cash internally. Investors are always looking for companies with high and growing
returns on common equity. However, not all high ROE companies make good investments.
The better benchmark is to compare a companys return on common equity with its industry
average. The higher the ratio, the better the company.

d) Earnings Per Share

Earnings per share concerns listed company or not but especially the listed company has
to represent it. It serves as an indicator of a companys profitability and also considered to be
the single most important variable in determining a shares price and company value.
Furthermore, it is a major component to calculate the price to valuation ratio earning. There
are earnings per share called basic earnings per share and diluted earnings per share.
Earnings Per Share (EPS) are the portion of a companys profit allocated to each outstanding
share of common stock.

Basic EPS = Net Income Preferred Dividends / Weight Average

Common Shares Outstanding
There is not any earning paid to preferred shareholders as a cash dividend, so they are
subtracted from income, because the ratio here applies only to common shareholders. The net
income used in this formula is the consolidated result which means the net income for group
but not for the minority shareholders.
For example, with a basic earnings per share $ 0,8, it means that one action creates $ 0,8
The evolution of the number of shares in connection with financial transactions such as
capital increase, share buyback or acquisition merger leads to dilution phenomena.
Fully diluted shares are the total number of shares that would be outstanding if all possible
sources of conversion, such as convertible bonds and stock options, are exercised. This
number of shares is very important for companys earnings per share because its use may
increase the number of shares used in earning per share calculation and reduce the amount
earned per share of common stock. Normally diluted earnings per share value is lower than its
basic earnings per share.
12

Fully Diluted Shares = (Total Income Preferred Dividends) /

(Outstanding Shares+ Diluted Shares)
e) Profit Margin Analysis
Profit margin analysis uses the percentage calculation to provide a comprehensive
measure of a company's profitability on a historical basis and in comparison to peer
companies and industry benchmarks. Basically, it is the amount of profit (at the gross,
operating, pretax or net income level) generated by the company as a percent of the sales
generated. The objective of margin analysis is to detect consistency or positive/negative
trends in a company's earnings. Positive profit margin analysis translates into positive
investment quality. To a large degree, it is the quality, and growth, of a company's earnings
that drive its stock price.
There are four levels of profit or profit margins in the income statement which are:
- gross profit margin;
- operating profit margin;
-pretax profit margin and
-net profit margin.
Each level provides information about companys profitability. So, we are going to analyze
one by one these levels.
Gross Profit Margin
It is a financial metric used to assess a companys financial health and business model by
revealing the proportion of money left over from revenues after accounting for the cost of
goods sold. In addition, this ratio allows analysts to compare business models with
quantifiable metric. Its value varies from company and industry. Industry characteristics of
raw material costs, particularly as these relate to the stability or lack, have a major effect on a
company's gross margin. Generally, management cannot exercise complete control over such
costs. Companies without a production process (ex., retailers and service businesses) don't
have a cost of sales exactly. In these instances, the expense is recorded as a "cost of
merchandise" and a "cost of services", respectively. With this type of company, the gross
13

profit margin does not carry the same weight as a producer-type company. To get this ratio,
we use the following formula:

Gross Profit Margin = Gross Profit / Net Sales (Revenue)

Gross profit = revenues - cost of goods sold
In fact, if we have an adequate gross margin, the percentage of this ratio will increase, that
means that a company is able to pay for its other costs and debt obligations. In general, a
companys gross profit margin should be stable unless there have been changes to the
companys business model.
Operating Profit Margin
This ratio is a measurement of what proportion of a companys revenue is left after paying for
variable costs of production (wages, raw materials). This ratio shows a companys efficiency
at controlling costs. To calculate operating profit margin, the manager needs operating profit
and net sales or revenue. This operating income refers to the profit that a company retains
after removing operating expenses and depreciation or amortization.

Operating Profit Margin = Operating Profits / Net Sales

(Revenue)
Operating profit= operating revenues - operating expenses
This operating profit margin gives analysts an idea of how much a company makes before
interest and taxes on each dollar of sales. The higher a companys operating profit margin
is, the better off the company is. In fact, if companys margin is increasing, it is earning
more per dollar of sales.
For example, with an operating margin of 16% Company is earning about $ 0,16 for every
dollar of sales.

Pretax Profit Margin

Pretax profit margin is a companys earnings before tax as a percentage of total sales or
revenues. It is obtained by deducting all expenses from sales except for taxes and then
14

dividing by revenues. The trend of pretax the pretax profit margin is as important as the figure
itself, since it provides an indication of which way the companys profitability is headed.
Pretax Profit Margin =
Pretax profit= operating profit + financial products - financial expenses
As such, a high or increasing pretax margin is usually a positive sign, showing the
company is able to keep its operations costs low, while being able to pull in strong
earnings.

The more the pretax profit margin increases, the more the company is

profitable.
Net Profit Margin
Net profit margin is the ratio of net profits to revenues for a company or business segment. It
shows how much of each dollar collected by the company is translated into profits. That
means how much net income a company makes with total sales achieved. It is one of the most
important indicators of a businesss financial health. It is mostly used to compare companys
results over time. To compare net profit margin, even between companies in the same
industry, might have little meaning. For example, if a company recently took a long term loan
to increase its production capacity, the net profit margin will significantly be reduced. That
does not mean necessarily that the company is less efficient than other competitors. While
undeniably an important number, investors can easily see from a complete profit margin
analysis that there are several income and expense operating elements in an income statement
that determine a net profit margin. It helps investors to have a comprehensive look at a
company's profit margins on a systematic basis.

Net profit Margin = Net Income / Net Sales (Revenue)

Moreover, it can give a more accurate view of how profitable a business is than its cash flow,
and by tracking increases and decreases in its net profit margin, a business can assess whether
or not current practices are working. Additionally, businesses can use it to forecast profits
base on revenues. So the higher of the net income increases the listed company value because
that attracts the investors.

15

3- ACTIVITY ANALYSIS RATIOS

Enterprises need to know how soon they can convert their assets into cash. They use activity
ratios to figure it out.
Activity ratios are financial analysis tools used to gauge the ability of a business to convert
various asset, liability and capital accounts into cash or sales. The faster a business is able to
convert its assets into cash or sales, the more efficient it runs. Activity ratios measure the
efficiency of the company in using its resources.
So we will try to explain three kinds of activities ratios which are the most common :
Assets Turnover
Accounts Receivable Turnover
Inventory Turnover

a) Assets Turnover
The Assets turnover ratio is an efficiency ratio that measures a company's ability to
generate sales from its assets by comparing net sales with average total assets. In other words,
this ratio shows how efficiently a company can use its assets to generate sales.
The asset turnover ratio calculates net sales as a percentage of assets to show how many sales
are generated from each dollar of company assets. So the total asset turnover measures the
return on each dollar invested in assets.

Assets Turnover = Net Sales / Average Total Assets

Net sales are the amount of sales generated by a company after the deduction of returns,
allowances for damaged or missing goods and any discounts allowed.
Average Total Assets = (Beginning Total Assets + Ending Total Assets) / 2
As mentioned above, this ratio measures how efficiently a firm uses its assets to generate
sales, so a higher ratio is always more prosperous. Higher turnover ratios mean the company
16

is using its assets more efficiently. Lower ratios mean that the company isn't using its assets
efficiently and most likely have management or production problems.
The indicator gives investors and creditors an idea of how a company is managed and uses its
assets to make products and sales. For instance, 1 in this ratio means that the net sales of a
company equal the average total assets for the year. Thus, the company is generating 1 dollar
of sales for every dollar invested in assets.

b) Accounts Receivable Turnover

Accounts receivable turnover is an efficiency ratio or activity ratio that measures how
many times a business can turn its accounts receivable into cash during a period. In other
words, the accounts receivable turnover ratio measures how many times a business can collect
its average accounts receivable during the year.
It is essential to remind that accounts receivable is the total amount of money due to a
company for products or services sold on an open credit account.
This ratio shows how efficient a company is collecting its credit sales from customers. In
some ways the receivables turnover ratio can be viewed as a liquidity ratio as well.
Companies are more liquid the faster they can convert their receivables into cash.

Accounts Receivable Turnover = Total Credits Sales / Average

Accounts Receivable
Total Credit sales establish a receivable, so the cash sales are left out of the calculation.
Average Accounts Receivable = (Beginning Accounts Receivable + Ending Accounts
Receivable) / 2
Since the receivables turnover ratio measures a business' ability to efficiently collect its
receivables, it only makes sense that a higher ratio would be more favourable. Higher ratios
mean that companies are collecting their receivables more frequently throughout the year.
For instance, 2 as a ratio shows that the company collects his receivables about 2 times a year
or once every six months. In other words, when the company makes a credit sale, it will take
six months to collect the cash from that sale.
17

Higher efficiency is favourable from a cash flow standpoint as well. If a company can collect
cash from customers sooner, it will be able to use that cash to pay bills and other obligations
sooner.
Moreover, accounts receivable turnover is an indication of the quality of credit sales and
receivables. A company with a higher ratio shows that credit sales are more likely to be
collected than a company with a lower ratio. Since accounts receivables are often posted as
collateral for loans, quality of receivables is important.

c) Inventory Turnover
The inventory turnover ratio is a good ratio that shows how effectively inventory is
managed by comparing cost of goods sold with average inventory for a period. It measures
how many times average inventory is "turned" or sold during a period. In other words, it
measures how many times a company sold its total average inventory dollar amount during
the year.
To get more profit a company should manage well its inventory as the money invested does
not earn a return until the product is sold.

Inventory Turnover = Total Annual Sales or Cost of Goods Sold/

Average Inventory Cost

Average Inventories = (Beginning Inventories + Ending Inventories) / 2

Inventory turnover shows how efficiently a company can control its merchandise, so it
is important to have a high turn. It proves that the company does not overspend by buying too
much inventory and wastes resources by storing non-salable inventory. It also shows that the
company can effectively sell the inventory bought.
Furthermore, this measurement reveals investors how liquid a company's inventory is.
Think about it. Inventory is one of the biggest assets a retailer reports on its balance sheet. If
this inventory can't be sold, it is worthless to the company. This measurement shows how
easily a company can turn its inventory into cash.
18

Creditors are particularly interested in this because inventory is often put up as collateral for
loans. Banks want to know that this inventory will be easy to sell.

4- DEBT STRUCTURE ANALYSIS RATIO

Debt structure analysis ratio gives users a general idea of the companys overall debt load as
well as its mix of equity and debt. These ratios can be used to determine the overall level of
financial risk its company and its shareholders face.

a) Debt to equity ratio

Debt to Equity Ratio is a ratio used to measure a company's financial leverage, calculated
by dividing a companys total liabilities by its stockholders' equity. The debt to equity ratio
indicates how much debt a company is using to finance its assets relative to the amount of
value represented in shareholders equity.

Debt to equity ratio= Total Liabilities / Total Stockholders equity

Lower the percentages, the less leverage used and stronger the company is.

b) Interest coverage ratio

The interest coverage ratio (ICR) is a measure of a company's ability to meet its interest
payments. Interest coverage ratio is equal to earnings before interest and taxes (EBIT) for a
time period, often one year, divided by interest expenses for the same time period. The
interest coverage ratio is a measure of the number of times a company could make the interest
payments on its debt with its EBIT. It determines how easily a company can pay interest
expenses on outstanding debt.
Interest coverage ratio is also known as interest coverage, debt service ratio or debt service
coverage ratio.

Interest coverage ratio = EBIT / Interest expenses

A lower ICR means less earnings are available to meet interest payments and that the
business is more vulnerable to increases in interest rates. When a company's interest coverage
ratio is only 1.5 or lower, its ability to meet interest expenses may be questionable. An interest
coverage ratio below 1.0 indicates the business is having difficulties generating the cash
necessary to pay its interest obligations.
19

c) Capitalization ratio
The total debt-to-capitalization ratio is a tool that measures the total amount of
outstanding company debt as a percentage of the firms total capitalization. The ratio is an
indicator of the company's leverage, which is defined as using debt to purchase assets.
Companies need to manage debt carefully because of the cash flow needed to make principal
and interest payments.

Capitalization ratio = (long-term debt) / (long-term+

Shareholders Equity)

There is no standard or benchmark for setting the right or optimum amount of debt.
Leverage will depend on the type of industry, line of business and the stage of development of
the company and its products. However, it is commonly understood that low debt and high
equity levels in the capitalization ratio indicates good quality of investment

5- CAPITAL MARKET ANALYSIS RATIO

Capital market analysis ratios indicate a company's ability to win to the confidence of the
stock market. Capital Market Analysis Ratios deal with the equity securities portion of the
capital market. These ratios reveal the relationship between the elements in the companys
financial statements and the market price of the shares of the company.
We will use three ratios for that, which are:
Price earning ratio
Dividend yield
Dividend payout ratio

20

a) Price earning ratio

It is the most common measure of how expensive a stock is. The price-earnings ratio is the
ratio for valuing a company that measures its current share price relative to its per-share
earnings. Comparing this ratio is most valuable for companies within the same industry.
The P/E ratio is equal to a stock's market capitalization divided by its after-tax earnings over a
12-month period, usually the trailing period but occasionally the current or forward period.

Market Price of Common Stock Per Share / Earnings Per Share

Companies with high P/E ratios are more likely to be considered "risky" investments than
those with low P/E ratios, since a high P/E ratio signifies high expectations.
The last year's P/E ratio would be actual, while current year and forward year P/E ratio would
be estimates, but in each case, the "P" in the equation is the current price.

b) Dividend yield
It is a financial ratio that indicates how much a company pays out in dividends each year
relative to its share price. Dividend yield is a way to measure how much cash flow you are
getting for each dollar invested in an equity position. In other words, it measures how much
"bang for your buck" you are getting from dividends. In the absence of any capital gains, the
dividend yield is effectively the return on investment for a stock. Dividend yield is
represented as a percentage.

Dividend yield = Annual Dividends Per Share / Price per Share

When companies pay high dividends to their shareholders, it can indicate a variety of things
about the company, such as that the company might currently be undervalued or that it is
attempting to attract investors. On the other hand, if a company pays little or no dividends, it
may indicate that the company is overvalued or that the company is attempting to grow its
capital.

21

c) Dividend payout ratio

The dividend payout ratio is the amount of dividends paid to stockholders relative to the
amount of total net income of a company. The amount that is not paid out in dividends to
stockholders is held by the company for growth. The amount that is kept by the company is
called retained earnings. This financial ratio highlights the relationship between net income
and dividend payments to shareholders.

Dividend Payout Ratio= Dividends / Net Income

Put another way, the dividend payout ratio shows whether the dividend payments made by a
company make sense given their earnings. If the number is too high, it may be a sign that too
small a percentage of the company's profits are being reinvested for future operations. This
casts doubt on the company's ability to maintain high dividend payments.

22

CONCLUSION
To conclude, evaluating progress is vital to any business's survival. One common
method is using financial ratios. They are numerical representations of a business's
performance. We can calculate such ratios by dividing one figure from the balance sheet,
income statement or cash-flow statement by another. There are liquidity ratios, profitability
ratios and leverage ratios. Liquidity ratios show how easily a company can pay its debts.
Profitability ratios can tell us how good a company is at making money. Finally, leverage
ratios can tell us how much debt the company is using to run the company and stay alive. We
must note that there are a lot of financial ratios and many different ways of using them.
Financial ratio analysis is a useful tool for users of financial statement. As advantages, we can
say that it simplifies the financial statements, helps in comparing companies in different size
between them, helps in trend analysis which involves comparing a single company over a
period and highlights important information in simple form quickly. A user can judge a
company by just looking at few numbers instead of reading the whole financial statements.
However, there are some important limitations of financial ratios that analysts should
be conscious of. Ratios are subject to the limitations of accounting methods. Different
accounting choices may result in significantly different ratio values. Continuous fluctuation in
price levels affect seriously the validity or comparison of accounting ratios; which are
calculated for different accounting periods and make such comparisons very difficult. At the
last, a company may have some good and some bad ratios. Consequently, it is not easy to
judge if its a healthy or weak company.

23

Table des matires

INTRODUCTION ............................................................................................................................................... 1
I.

GENERALITIES.......................................................................................................................................... 2

1-

Definitions ............................................................................................................................................... 2

Ratio ................................................................................................................................................................ 2
Accounting ratios ........................................................................................................................................... 2
Ratio analysis.................................................................................................................................................. 2
2-

Methods of Expressing Accounting Ratios .............................................................................................. 3

3-

History ..................................................................................................................................................... 3

4-

Objective ................................................................................................................................................. 5

II.

DIFFERENT TYPES OF FINANCIAL RATIOS ................................................................................................ 6

1-

LIQUIDITY ANALYSIS RATIOS ................................................................................................................... 6

2-

PROFITABILITY ANALYSIS RATIO ............................................................................................................. 9

3-

ACTIVITY ANALYSIS RATIOS ................................................................................................................... 16

4-

DEBT STRUCTURE ANALYSIS RATIO....................................................................................................... 19

5-

CAPITAL MARKET ANALYSIS RATIO ....................................................................................................... 20

CONCLUSION ................................................................................................................................................. 23

24