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Ratio Analysis Made Easy

Ratio Analysis Made Easy. John W. Nelson III CONSULTANCY. Statements Used in Ratio Analysis. Balance Sheet Profit & Loss. Statements Used. Remember A balance sheet is only a picture in time A P&L is a moving picture in time This difference must be reconciled

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Ratio Analysis Made Easy

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  1. Ratio Analysis Made Easy John W. Nelson III CONSULTANCY

  2. Statements Used in Ratio Analysis • Balance Sheet • Profit & Loss

  3. Statements Used • Remember • A balance sheet is only a picture in time • A P&L is a moving picture in time • This difference must be reconciled • The period of time from the last fiscal date in days must be computed • One year = 365 days • 1st quarter = 90 days • 3rd quarter = 270 days (and so forth)

  4. The banker’s easy method • Everything is broken down to a day, a dollar or a percent • Now they can be compared to like periods for the same business, i.e.. • This year to last year • This quarter to last quarter • Or compared to industry standards

  5. Ratio comparisons • Industry Standards • RMA • To get the NAICS number, go to: • http://www.census.gov/epcd/www/naics.html • For more industry comparisons, go to: • http://sbdcnet.utsa.edu/ • http://www.bizstats.com/ • Trade publications

  6. Financial Statements used in ratio analysis • Balance Sheet • Assets • Current • Fixed • Other • Liabilities • Current • Long Term • Net Worth or Equity

  7. What Your Balance Sheet Tells You • ASSETS • Current (turn to cash within 12 months) • Cash • Accounts Receivable • Inventory • Deposits & Pre-paid

  8. Balance Sheet Continues • Liabilities • Current Liabilities • Long Term Liabilities • Loans Due Affiliates or Owners • Net Worth • Common Stock or Equity • Paid In Capital • Retained Earnings • Owners Draw (Partnership, LLC or Proprietorship)

  9. Balance Sheet • CAPITAL, NET WORTH OR EQUITY • Assets minus the liabilities • Net book value of the business • How leveraged the business is • Treasury Stock for corporations • Value of the stock for a corporation • Owners equity for partnerships, proprietorships or LLC’s

  10. Statements used in ratio analysis • Operating Statement, a/k/a Income & Expense Statement, Profit & Loss Statement or just P&L • Revenue or sales • Less Cost of Goods Sold (none if a service business) • Beginning Inventory • Plus purchases • Less ending inventory • Equals Cost of Goods Sold • Equals Gross Profit

  11. P&L Continues • Less All Expenses • Operating Expenses • Administrative Expenses • Selling Expenses • Equals Net Income • Plus Other Income • Less Other Expenses • Equals Net Profit Before Taxes

  12. Operating Statement (P&L) & What It Shows You • How you are doing, your report card • If sales are up or down compared to last like period • Your Cost of Goods Sold • Your Gross Profit • All expenses • Profit or loss

  13. Ratio Analysis • Ratios take the temperature of a business • Ratios are computed by using the Balance Sheet & Operating Statement numbers • They will tell you how liquid a company is • They will tell you how it collects its money • They will tell you how they pay their bills • They will tell you how leveraged they are

  14. Liquidity Ratios • Current ratio = current assets/current liabilities • Current Assets $170,000 • Current Liabilities $150,000 • Equals 1.13 or $1.13 in current assets to pay for each $1 in current liabilities. Bankers like 2 or higher.

  15. Liquidity Assets (cont.) • Working Capital considers what’s left after paying current debt • Current Assets minus Current Liabilities • Current Assets $170,000 • Current Liabilities $150,000 • Equals $ 20,000 left • Bankers like a positive number.

  16. Liquidity Ratios (cont.) • Acid test or Quick Ratio considers that inventory is not saleable, therefore eliminated • Currents Assets – Inventory/Current Liabilities • Current Assets $170,000 • Minus Inventory $ 85,000 • Equals $ 85,000 • Divided by Current Liabilities of $150,000 • Equals .56 or $.56 in Current. Assets to pay for each $1 in Current Liabilities. • Bankers like 1 or higher.

  17. Asset Management Ratios • Accounts Receivable Turnover tells you how long it takes to collect them • Accounts Receivable times 365 days/Annual Sales (days must match period for which the ratio is being computed) • Accounts Receivable (from bal. sheet) $75,000 X 365 days = $27,375,000 (just a # to get to the answer) • Divided by Ann. Sales $900,000 • Equals 30.4 days to collect, say 30 days • Bankers like to see this at industry standards

  18. Accts. Rec. Turnover • Assume your client needs $9,000 in working capital and can’t borrow it. • Solution… • Accts. Rec. of $75,000 divided by 30 days (A/R turnover) = $2,250 per day • Collect the A/R in 26 days (4 days quicker) rather than 30 days • 4 days X $2,250 = $9,000 now in cash

  19. Inventory Turnover • Inventory Turnover Ratio tells how long it takes to sell the inventory • Inventory times 365 days/Cost of Goods Sold (days must match period for which the ratio is being computed) • Inventory (from bal. sheet) $85,000 X 365 days = $31,025,000 (just a # to get to the answer) • Divided by Cost of Goods Sold of $540,000 • Equals 57.5 or 58 days to sell • Bankers like to see this at industry standards

  20. Inventory Turnover Cont. • Maximize working capital thru inventory control • Inventory turns every 58 days & is $85,000 • 58 days into $85,000 = $1,466 per day • Inventory can be restocked in 30 days, therefore you only need a 30 inventory on hand • 58 days – 30 days = 28 days (less inventory needed) X $1,466 = $41,048 now in the checking account rather than in inventory

  21. Debt Management Ratios • Debt to Net Worth or Debt to Worth tells how leveraged a company is • Total Debt divided by Total Net Worth • Total Debt $204,000 • Total Net Worth $ 87,000 • Equals 2.34 or for each $1 in net worth, creditors have $2.34, leverage 2.34 to 1. Bankers like 3 or lower.

  22. Debt Management Ratios (cont.) • Accounts Payable Turnover tells how long a company takes to pay it’s bills • Formula is Accts. Payable times 365 days divided by Cost of Goods Sold • Accts. Payable $41,000 (from bal. sheet) X 365 days = $14,965,000 (a # just to get to the answer) divided by: Cost of Goods Sold (purchases)$350,000 • Equals 42.75 or within 43 days bills are pd • Bankers like to see this 30 to 45 days or less

  23. Accts. Payable Cont. • Accts. Payable of $41,000 divided by 43 days (turnover) = $953 per day owed • Usual terms due A/P are 2% 10 days, net 30 days, so lets see if we can pay in 10 days • 43 days – 10 days = 33 days X $953 (A/P per day) = $31,449 needs to be pd. to get to 10 days • Using the $41,048 saved in inventory, pay the payables down within 10 days & have $9,599 left for working capital, then take the 2% discount and save $7,000 (2% X $350K C of GS)

  24. Accts. Payable Cont. • Besides saving $7,000 taking the discounts consider this: • 2%, 10 days • Three 10 day period per month • 3 X 2% = 6% savings per month • 12 months X 6% = 72% • This assumes that you invest what you would have paid & the interest was figured like this.

  25. Summary of Savings • Dug $9,000 out of Accts. Payable • Dug $41,048 out of Inventory • Saved $7,000 from taking discounts • A total savings of $57,048 • Got a 72% ROI on amount saved

  26. Profitability Ratios • Profit margin or the percent of profit from sales • Net Profits divided by Net Sales • Net Profit $ 53,000 • Net Sales $900,000 • Equals .0588 or 5.9% net profit

  27. Profitability Ratios (cont.) • Debt Service Coverage or how much $ do you have to pay current loan payments • Formula is Net Profit plus Depreciation divided by Current Portion Long Term Debt (CPLTD) • Net Profit $53,000 + $25,000 Depreciation= $78,000 cash flow for this year • CPLTD is $6,000 (from bal. sheet) divided into $78,000 = 13.0 • Or you have $13 to pay every $l of term debt • Bankers like to see 2 or higher

  28. Complete Ratio Analysis -a • Liquidity Ratios: • Current ratio: • current assets/current liabilities • $170k/$150K = 1.31x or $1.13 • Working Capital • Current assets – current liabilities • $170k - $150k = $20K • Quick or Acid Test: • Current assets – inventory/Current liabilities • $170K - $85K/$150k = .56x or $.56 • Cash flow: • Net profit after taxes + depreciation + amortization • $55K +$25k + ? = $80k

  29. Complete ratio analysis cont. b • Asset Management Ratios • Accts. Receivable turn-over (A/R) • A/R X 365 days/Annual sales • $75k X 365 days/$900k = 30 days • Inventory turn-over (Inv) • Inv X 365 days/Cost of Goods Sold (CoGS) • $85k X 365 days/$540k = 58 days • Debt Management Ratios • Debt to Worth • Total liabilities/Net Worth or total Capital • $204k/$87k = (aka leverage) 2.34x or $2.34

  30. Complete Ratio Analysis Cont. c • Accts. Payable turn-over (A/P): • Accts. Payable X 365 days/CofGS (purchases) • $41k X 365/$350k = 57.5 or 58 days • Profitability Ratios: • Profit margin or net profit: • Net profit/net sales • $33k/$900k = .0588 or 5.9% • Debt service coverage ratio: • Net profit + deprec. + amort./Current part of long term debt (CPLTD) • $54k + deprec. ?/$6k = 13x OR $13.00

  31. Complete Ratio Analysis Cont. d • Return on Sales: (ROA) • Net profit/sales • $53k/$900k = .058 or 5.8% • Return on Investment: (ROI) • Net profit/net worth or capital • $53k/$87k = .61 or 61% • Return on Assets: • Net profit/Total assets • $53k/$291k = .19 or 19% • Sales to Assets: • Sales/Total assets • $900/$291k = 3.09 or $3.09

  32. The End – Thank Goodness • Thanks • For your time • For you attention • If you need further information: • John W. Nelson III Consultancy • 16 Park St. • Newport, RI 02840-2104 • Phone: 401-619-4588 • E-mail: jwn3rd@cox.net • For copies of my publications: www.newgroundpublications.com

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