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FinancialRatios!!!.doc

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FinancialRatios Financialratiosprovideasecondmethodforstandardizingthefinancialinformationontheincomestatementandbalancesheet. Aratiobyitselfmayhavenomeaning.Hence,agivenratioiscomparedto:(a)ratiosfrompreviousyears;or(b)ratiosofotherfirmsinthesameindustry. Ifthedifferencesintheratiosaresignificant,morein-depthanalysismustbedone. QuestionCategoryofRatiosUsed1.Howliquidisthefirm?Willitbeabletopayitsbillsastheybecomedue?Liquidityratios2.Howhasthefirmfinancedthepurchaseofitsassets?Capitalstructureratios3.Howefficienthasthefirm’smanagementbeeninutilizingitassetstogeneratesales?Assetmanagementefficiencyratios4.Hasthefirmearnedadequatereturnsonitsinvestments?Profitabilityratios5.Arethefirm’smanagerscreatingvalueforshareholders?Marketvalueratios 1.LiquidityRatios Liquidityratiosaddressabasicquestion:Howliquidisthefirm? Afirmisfinanciallyliquidifitisabletopayitsbillsontime.Wecananalyzeafirm’sliquidityfromtwoperspectives: Overallorgeneralfirmliquidity Liquidityofspecificcurrentassetaccounts Overallliquidityisanalyzedbycomparingthefirm’scurrentassetstothefirm’scurrentliabilities. Liquidityofspecificassetsisanalyzedbyexaminingthetimelinessinwhichthefirm’sprimaryliquidassets–accountsreceivableandinventories–areconvertedintocash. Theoverallliquidityofafirmisanalyzedbycomputingthecurrentratioandacid-testratio. CurrentRatio: CurrentRatiocomparesafirm’scurrent(liquid)assetstoitscurrent(short-term)liabilities. Forexample: Question:Whatisthecurrentratiofor2009Ifthecurrentassetsis$477andthecurrentliabilitiesis292.5? Answer: CurrentRatio=$477÷292.5=1.63times LiquidityRatios:QuickRatio(Acid-TestRatio) LiquidityRatios:QuickRatio(Acid-TestRatio):TheoverallliquidityofafirmisalsoanalyzedbycomputingtheAcid-Test(Quick)Ratio.Thisratioexcludestheinventoryfromcurrentassetsasinventorymaynotalwaysbeveryliquid. 1.3LiquidityRatios:IndividualAssetCategories Wecanalsomeasuretheliquidityofthefirmbyexaminingtheliquidityofindividualcurrentassetaccounts,includingaccountsreceivableandinventories.