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Ratios
Assignment | Scoring Table | Diagnosis

Learning Activity

Financial Statement Analysis: Students use a mathematical model based on financial ratios to assess the financial health of a company.

Learning Objectives

1. Obtain a working knowledge of financial statements.
2. Understand the purpose of specific financial ratios and intrepret the meaning of calculated ratios.
3. Calculate financial ratios using an income statement and balance sheet.
4. Assess the financial condition of a company using financial ratios.

ASSESSMENT: Students will: (1) calculate five financial ratios for a company using its income statement and balance sheet, (2) using a model, assign points for each ratio based on the calculation, and (3) conclude with a "financial diagnosis" of the company.

FINANCIAL RATIOS

FINANCIAL RATIOS

 

PROFIT MARGIN %

DEFINITION:  Net Income, or profit, expressed as a percentage of sales.  For example, if a company has a profit margin of 10%, for every dollar of sales, 10% of those dollar sales represents profit.

ASSESSMENT:  Profit Margin is a primary measure of a companys profitability.

FORMULA:  Net Income / Sales = Profit Margin (%)

 

DEBT RATIO %

DEFINITION:  The degree (%) to which assets are purchased through debt (liabilities).  (Note:  Most companies finance their assets in one of two ways:  debt or stock)..

ASSESSMENT:  The Debt Ratio is a primary measure with which to gauge the degree a company is leveraged or financed through debt..

FORMULA:  Total Debt / Total Assets = Debt Ratio (%)

 

CURRENT RATIO #

DEFINITION:  The ratio of current assets to current liabilities represents the number of times a company can pay current debts through current assets such as cash.

ASSESSMENT:  The Current Ratio is a measure of a companys liquidity (how quickly a company can turn noncash assets into cash), and of a companys abiloity to meet future obligations (i.e., pay future debts)..

FORMULA:  Current Assets / Current Liabilities = Current Ratio (#)

 

RETURN ON ASSETS %

DEFINITION:  Net Income, or profit, expressed as a percentage of total assets.  For example, if a company has an ROAof 10%, the company will generate a net income equivalent to 10% of its assets.  In other words, as a percentage, what is the net income produced by a companys assets.

ASSESSMENT:  ROAis a measure of an assets or a companys efficiency and profitability.

FORMULA:  Net Income / Average Total Assets* = ROA (%)

 

INVENTORY TURNOVER #

DEFINITION:  The number of times a company sells its inventory in a year.

ASSESSMENT:  Inventory Turnover is the primary measure of a companys ability to sell or moveinventory.

FORMULA:  Cost of Goods Sold / Average Inventory** (%)

 

*Average Total Assets = (Current Year Total Assets + Prior Year Total Assets ) / 2

**Average Inventory = (Current Year Inventory + Prior Year Inventory) / 2