SCHOOL OF ECONOMICS AND BUSINESS UNIVERSITY OF SARAJEVO

Ratio Analysis
Mirza Bahor 71225 Benjamin Milatovid 71218 Mirza rndid 71224

Goals of Ratio analysis

A tool used by individuals to conduct a quantitative analysis of information in a company's financial statements. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company. Ratio analysis is predominately used by proponents of fundamental analysis.
Ratios are used by:
Lenders to determine creditworthiness Stockholders to estimate future cash flows and risk Managers to identify areas of weakness and strength

The objective of ratio analysis is the comparative measurement of financial data to facilitate wise investment, credit and managerial decisions

Values for Ratios

The ratios have no financial theory behind them. Theory tells us what SHOULD BE the case (or value). With financial ratios, we have no way to identify a "theoretically best" value for any of the ratios. In fact, financial ratios are nothing more than common sense measures that have been developed and evolved over time. As such, they are imperfect measures and should be treated as such. There are two primary ways to use financial ratios:
Compare a ratio's value over several periods of time (trend analysis or timeseries analysis). If we see a deteriorating trend in any ratio's values over several quarters or years, we can investigate to find the cause. Compare the company's ratios to the industry average (cross-sectional analysis). A single ratio value by itself usually means nothing - we need a standard, or benchmark, to compare it to. This benchmark is usually the industry average (i.e., the ratio's average value for all firms in the industry).

Financial ratios have different meanings depending on the financial data used to calculate them, so there is no single answer as to whether it is good to have high or low financial ratios. High values are considered good for certain financial ratios and bad for others.

Examples
Net Profit Margin Net profit margin or simply profit margin is a financial ratio that is calculated by dividing net profit by total revenue. Net profit is a business's total revenue or sales minus all of its expenses. Net profit margin is a measure of a business's profitability -- it shows the proportion of total revenue that a company actually keeps after it pays its expenses. A high net profit margin means a company keeps a large proportion of its revenue as profit, so it is better to have a high net profit margin than a low or negative net profit margin. Debt-to-Asset Ratio Debt-to-asset ratio is a value that compares total assets and debt of a business. Debt-to-asset ratio is calculated by dividing total debt by total assets. Debt-to-asset ratio goes up as a company accrues debt and falls as a company gains assets. It is preferable to have a low debt-to-asset ratio, because a low ratio means a company has a low amount of total debt compared with the value of its assets.

Standardization
In general, a process of standardization is being achieved by the use of ratios. They can be used to standardize financial statements allowing for comparisons over time, industry, sector and cross-sectionally between firms and further facilitate the evaluation of the efficiency of operations and/or the risk of the firms operations regarding the scope and purpose of evaluation. Ratios measure a firms crucial relationships by relating inputs(costs) with output(benefits) and facilitate comparisons of these relationships over time and across firms.

Common-Size Statement Analysis

A common-size financial statement is simply one that is created to display line items on a statement as a percentage of one selected or common figure All three of the primary financial statements can be put into a commonsize format. (Balance sheet, Income statement, Cash flow) The key benefit of a common-size analysis is it allows for a vertical analysis by line item over a single time period, such as a quarterly or annual period, and also from a horizontal perspective over a time period The biggest benefit of a common-size analysis is that it can let an investor identify large or drastic changes in a firms financials. Rapid increases or decreases will be readily observable, such as a rapid drop in reported profits during one quarter or year. A common-size analysis can also give insight into the different strategies that companies pursue. For instance, one company may be willing to sacrifice margins for market share, which would tend to make overall sales larger at the expense of gross, operating or net profit margins. Ideally the company that pursues lower margins will grow faster.

Common-Base Year Analysis

A base year is the year used for comparison for the level of a particular economic index. The arbitrary level of 100 is selected so that percentage changes (either rising or falling) can be easily depicted In accounting and statistics, the expression of financial information in a given year as a percentage of an amount in an initial year. A company may treat the first year of its operations or the first year it made a profit as the base year, and express all financial information in those terms. For example, it may issue statements saying that profits in year five were 125% of year one's profits. Occasionally, governments or companies may change the base year to one that is more representative of "normal" performance. Base-year analysis of a company's financial statements is important to be able to determine whether a company is growing or shrinking. If, for example, a company is profitable every year, the fact that its revenues are shrinking year-over-year may go unnoticed. By comparing revenues and profits to those of a previous year, a more detailed picture emerges.

Liquidity ratios example

Does your enterprise have enough cash on an ongoing basis to meet its operational obligations? This is an important indication of financial health.
Current Ratio = Current Assets Current Liabilities (also known as Working Capital Ratio) Measures your ability to meet short term obligations with short term assets., a useful indicator of cash flow in the near future. A ratio less that 1 may indicate liquidity issues. A very high current ratio may mean there is excess cash that should possibly be invested elsewhere in the business or that there is too much inventory. Most believe that a ratio between 1.2 and 2.0 is sufficient. The one problem with the current ratio is that it does not take into account the timing of cash flows.

Leverage ratio example

To what degree does an enterprise utilize borrowed money and what is its level of risk? Lenders often use this information to determine a businesss ability to repay debt.

Debt to Equity =
Short Term Debt + Long Term Debt Total Equity (including grants)

Compares capital invested by owners/funders (including grants) and funds provided by lenders. Lenders have priority over equity investors on an enterprises assets. Lenders want to see that there is some cushion to draw upon in case of financial difificulty. The more equity there is, the more likely a lender will be repaid. Most lenders impose limits on the debt/equity ratio, commonly 2:1 for small business loans. Too much debt can put your business at risk, but too little debt may limit your potential. Owners want to get some leverage on their investment to boost profits. This has to be balanced with the ability to service debt.

Asset Utilization Ratios Example

When you are evaluating a business, how would you use the asset utilization ratio, and what do you look for?
Asset Utilization = Revenue Average Total Assets The asset utilization ratio measures management's ability to make the best use of its assets to generate revenue. This is particularly meaningful in a manufacturing, where fewer capital assets are used to produce products. The more effectively that the equipment is used, the more profitable the company will be. Rather than acquiring additional equipment and incurring additional production costs, make better use of existing capacity. For example, with an asset utilization ratio of 52%, a company earned $.52 for each dollar of assets held by the company. An increasing asset utilization means the company is being more efficient with each dollar of assets it has.

Profitability ratio example

How well is our business performing over a specific period, will your social enterprise have the financial resources to continue serving its constituents tomorrow as well as today? Percentage increase (decrease) in sales between two time periods. If overall costs and inflation are increasing, then you should see a corresponding increase in sales. If not, then may need to adjust pricing policy to keep up with costs. The retail industry, for example, typically experiences higher revenues and earnings for the Christmas season. Therefore, it would not be too useful to compare a retailer's fourthquarter profit margin with its first-quarter profit margin. On the other hand, comparing a retailer's fourth-quarter profit margin with the profit margin from the same period a year before would be far more informative.

Sales Growth = Current Period Previous Period Sales Previous Period Sales