Ratio Analysis

Ratio analysis is used to evaluate relationships among financial statement items. The ratios are used to identify trends over time for one company or to compare two or more companies at one point in time. Financial statement ratio analysis focuses on three key aspects of a business: liquidity, profitability, and solvency.

Liquidity ratios

Liquidity ratios measure the ability of a company to repay its short-term debts and meet unexpected cash needs.

Current ratio. The current ratio is also called the working capital ratio, as working capital is the difference between current assets and current liabilities. This ratio measures the ability of a company to pay its current obligations using current assets. The current ratio*…show more content…*

If the credit period is 60 days, the 20X1 average is very good. However, if the credit period is 30 days, the company needs to review its collection efforts.

Inventory turnover. The inventory turnover ratio measures the number of times the company sells its inventory during the period. It is calculated by dividing the cost of goods sold by average inventory. Average inventory is calculated by adding beginning inventory and ending inventory and dividing by 2. If the company is cyclical, an average calculated on a reasonable basis for the company 's operations should be used such as monthly or quarterly. | | | | |

Calculation of Inventory Turnover | 20X1 | 20X0 | 20W9 | Cost of goods sold | $70,950 | $59,740 | | Inventory | 12,309 | 12,202 | $12,102 | Average inventory | (12,309+12,202)/2= | (12,202+12,102)/2= | | | 12,255.5 | 12,152 | | | | | | Inventory turnover | $70,950/$12,255.5= | $59,740/$12,152= | | | 5.8 times | 4.9 times | | |

Day 's sales on hand. Day 's sales on hand is a variation of the inventory turnover. It calculates the number of day 's sales being carried in inventory. It is calculated by dividing 365 days by the inventory turnover ratio. | | | | |

| 20X1 | 20X0 | Inventory Turnover | 5.8 times |

Ratio analysis is used to evaluate relationships among financial statement items. The ratios are used to identify trends over time for one company or to compare two or more companies at one point in time. Financial statement ratio analysis focuses on three key aspects of a business: liquidity, profitability, and solvency.

Liquidity ratios

Liquidity ratios measure the ability of a company to repay its short-term debts and meet unexpected cash needs.

Current ratio. The current ratio is also called the working capital ratio, as working capital is the difference between current assets and current liabilities. This ratio measures the ability of a company to pay its current obligations using current assets. The current ratio

If the credit period is 60 days, the 20X1 average is very good. However, if the credit period is 30 days, the company needs to review its collection efforts.

Inventory turnover. The inventory turnover ratio measures the number of times the company sells its inventory during the period. It is calculated by dividing the cost of goods sold by average inventory. Average inventory is calculated by adding beginning inventory and ending inventory and dividing by 2. If the company is cyclical, an average calculated on a reasonable basis for the company 's operations should be used such as monthly or quarterly. | | | | |

Calculation of Inventory Turnover | 20X1 | 20X0 | 20W9 | Cost of goods sold | $70,950 | $59,740 | | Inventory | 12,309 | 12,202 | $12,102 | Average inventory | (12,309+12,202)/2= | (12,202+12,102)/2= | | | 12,255.5 | 12,152 | | | | | | Inventory turnover | $70,950/$12,255.5= | $59,740/$12,152= | | | 5.8 times | 4.9 times | | |

Day 's sales on hand. Day 's sales on hand is a variation of the inventory turnover. It calculates the number of day 's sales being carried in inventory. It is calculated by dividing 365 days by the inventory turnover ratio. | | | | |

| 20X1 | 20X0 | Inventory Turnover | 5.8 times |

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