# Ratios and Formulas in Customer Financial Analysis

Using the following financial statements for Eagle Company, compute the required ratios:

EAGLE COMPANY BALANCE SHEET AS OF December 31 (IN MILLIONS)

2007 2008 2009

Assets

Cash $2.6 $1.8 $1.6

Government securities 0.4 0.2 0.0

Accounts and notes receivable 8.0 8.5 8.5

Inventories 2.8 3.2 2.8

Prepaid assets 0.7 0.6 0.6

Total current assets $14.5 $14.3 $13.5

Property, plant, and equipment (net) 4.3 5.4 5.9

Total assets $18.8 $19.7 $19.4

Liabilities and shareholders' Equity

Notes payable $3.2 $3.7 $4.2

Accounts payable 0.9 1.1 1.0

Total current liabilities $6.9 $8.5 $9.3

Long-term debt, 6% interest 3.0 2.0 1.0

Total liabilities $9.9 $10.5 $10.3

Shareholders' equity 8.9 9.2 9.1

Total liabilities and shareholders' equity $18.8 $19.7 $19.4

Income Statement for the Year Ended December 31 (in millions)

Net sales $24.2 $24.5 $24.9

Cost of goods sold (16.9) (17.2) (18.0)

Gross margin $7.3 $7.3 $6.9

Selling and administrative expenses (6.6) (6.8) (7.3)

Earnings (loss)before taxes $0.7 $0.5 $(0.4)

Income taxes (0.3) (0.2) 0.2

Net income $0.4 $0.3 $(0.2)

Required

A. What is the rate of return on total assets for 2009?

B. What is the current ratio for 2009?

C. What is the quick (acid-test) ratio for 2009?

D. What is the profit margin for 2008?

E. What is the profit margin for 2009?

F. What is the inventory turnover for 2008?

G. What is the inventory turnover for 2009?

H. What is the rate of return on stockholders' equity for 2008?

I. What is the rate of return on stockholders' equity for 2009?

J. What is the debt-equity ratio for 2009?

#### Solution Preview

I have attached a word file with all of the formulas for these and other ratios as well as sample calculations to use to calculate the answers to the questions on your own. You may want to print off this page to keep for future use as a reference.

Ratios and Formulas in Customer Financial Analysis

Financial statement analysis is a judgmental process. One of the primary objectives is identification of major changes in trends, and relationships and the investigation of the reasons underlying those changes. The judgment process can be improved by experience and the use of analytical tools. Probably the most widely used financial analysis technique is ratio analysis, the analysis of relationships between two or more line items on the financial statement. Financial ratios are usually expressed in percentage or times. Generally, financial ratios are calculated for the purpose of evaluating aspects of a company's operations and fall into the following categories:

? liquidity ratios measure a firm's ability to meet its current obligations.

? profitability ratios measure management's ability to control expenses and to earn a return on the resources committed to the business.

? leverage ratios measure the degree of protection of suppliers of long-term funds and can also aid in judging a firm's ability to raise additional debt and its capacity to pay its liabilities on time.

? efficiency, activity or turnover ratios provide information about management's ability to control expenses and to earn a return on the resources committed to the business.

A ratio can be computed from any pair of numbers. Given the large quantity of variables included in financial statements, a very long list of meaningful ratios can be derived. A standard list of ratios or standard computation of them does not exist. The following ratio presentation includes ratios that are most often used when evaluating the credit worthiness of a customer. Ratio analysis becomes a very personal or company driven procedure. Analysts are drawn to and use the ones they are comfortable with and understand.

Liquidity Ratios

Working Capital:

Working capital compares current assets to current liabilities, and serves as the liquid reserve available to satisfy contingencies and uncertainties. A high working capital balance is mandated if the entity is unable to borrow on short notice. The ratio indicates the short-term solvency of a business and in determining if a firm can pay its current liabilities when due.

? Formula

Current Assets - Current Liabilities

Acid Test or Quick Ratio:

A measurement of the liquidity position of the business. The quick ratio compares the cash plus cash equivalents and accounts receivable to the current liabilities. The primary difference between the current ratio and the quick ratio is the quick ratio does not include inventory and prepaid expenses in the calculation. Consequently, a business's quick ratio will be lower than its current ratio. It is a stringent test of liquidity.

? Formula

Cash + Marketable Securities + Accounts Receivable / Current Liabilities

Current Ratio:

Provides an indication of the liquidity of the business by comparing the amount of current assets to current liabilities. A business's current assets generally consist of cash, marketable securities, accounts receivable, and inventories. Current liabilities include accounts payable, current maturities of long-term debt, accrued income taxes, and other accrued ...

#### Solution Summary

This solution contains a selection of ratios and financial analysis formulas along with an explanation of each which will be helpful to accounting students that need a better understanding of them. Ratio and formulas covered include the following: Working Capital, Acid Test or Quick Ratio, Current Ratio, Cash Ratio, Net Profit Margin or Return on Sales, Return on Assets, Operating Income Margin, Return on Investment, Return on Equity, Du Pont Return on Assets, Gross Profit Margin, Total Debts to Assets, Capitalization Ratio, Debt to Equity, Interest Coverage Ratio, Long-term Debt to Net Working Capital, Cash Turnover, Sales to Working Capital or Net Working Capital Turnover, Total Asset Turnover, Fixed Asset Turnover, Days' Sales in Receivables, Accounts Receivable Turnover, Accounts Receivable Turnover in Days, Days' Sales in Inventory, Inventory Turnover, Inventory Turnover in Days, Operating Cycle, Days' Payables Outstanding, Payables Turnover, and Payables Turnover in Days. Additional ratios include, Altman Z-Score, Bad-Debt to Accounts Receivable Ratio, Bad-Debt to Sales Ratio, Book Value per Common Share, Cost of Credit, Current-Liability Ratios, and the Rule of 72.