Financial Ratios
Financial ratios are useful indicators of a firm’s performance and financial situation. Most ratios can be calculated from information provided by the financial statements. Financial ratios can be used to analyze trends and to compare the firm’s financials to those of other firms. In some cases, ratio analysis can predict future bankruptcy.
SOURCES OF DATA FOR FINANCIAL RATIOS
Balance Sheet Income Statement Statement of Cash Flows Statement of Retained Earnings
PURPOSE AND TYPES OF RATIOS
Financial ratios can be classified according to the information they provide. The following types of ratios frequently are used: a. b. c. d. e. Liquidity ratios Asset turnover ratios Financial leverage …show more content…
Cost of Goods Sold Inventory Turnover = Average Inventory
The inventory turnover often is reported as the inventory period, which is the number of days worth of inventory on hand, calculated by dividing the inventory by the average daily cost of goods sold:
Average Inventory Inventory Period = Annual Cost of Goods Sold / 365
The inventory period also can be written as:
365 Inventory Period = Inventory Turnover
Other asset turnover ratios include fixed asset turnover and total asset turnover.
FINANCIAL LEVERAGE RATIOS
Financial leverage ratios provide an indication of the longterm solvency of the firm. Unlike liquidity ratios that are concerned with shorttermed assets and liabilities, financial leverage ratios measure the extent to which the firm is using long term debt. The debt ratio is defined as total debt divided by total assets:
Total Debt Debt Ratio = Total Assets
The debttoequity ratio is total debt divided by total equity:
Total Debt Debt Ratio = Total Equity
Debt ratios depend on the classification of longterm leases and on the classification of longterm debt or equity. The times interest earned ratio indicates how well the firm’s earnings can cover the interest payments on its debt. This ratio also is known as the interest coverage and is calculated as follows:
EBIT Interest Coverage = Interest Charges
Where EBIT

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