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NOTES ON RATIO ANALYSIS

Definition:

Liquidity ratio:

Definition of 'Liquidity Ratios'

A class of financial metrics that is used to determine a company's ability to payoff its short-terms debts obligations. Generally, the higher the value of theratio, the larger the margin of safety that the company possesses to cover

short-term debts.

Investopedia explains 'Liquidity Ratios'

Common liquidity ratios include the current ratio, the quick ratio and theoperating cash flow ratio. Different analysts consider different assets to be relevant

in calculating liquidity. Some analysts will calculate only the sum of cash andequivalents divided by current liabilities because they feel that they are the

most liquid assets, and would be the most likely to be used to cover short-term debtsin an emergency.

A company's ability to turn short-term assets into cash to cover debts is of the utmost

importance when creditors are seeking payment. Bankruptcy analysts and mortgageoriginators frequently use the liquidity ratios to determine whether a company

will be able to continue as a going concern.

Liquidity ratio, expresses a company's ability to repay short-term creditors out of its totalcash. The liquidity ratio is the result of dividing the total cash by short-term borrowings. Itshows the number of times short-term liabilities are covered by cash. If the value is greaterthan 1.00, it means fully covered.

The formula is the following:

LR = liquid assets / short-term liabilities

Borrowing Ratio

Borrowing Ratio = Total Borrowings (Short-term and Long-term) / Total Equity

Current Ratio

Current Ratio = Current Assets / Current Liabilities

Net Working Capital Ratio

Net Working Capital Ratio = Net Working Capital / Total Assets

Where Net Working Capital = Current Assets - Current Liabilities

Net Working Capital Ratio


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Net Working Capital Ratio = Net Working Capital / Total Assets

Where Net Working Capital = Current Assets - Current Liabilities

Quick Ratio (Acid Test Ratio)

Quick Ratio = Quick Assets / Current Liabilities

Where Quick Assets = Current Assets - Inventories - Prepayments

Liquidity Ratios:

Liquidity Ratios are ratios that come off the the Balance Sheet and hence measure the

liquidity of the company as on a particular day i.e the day that the Balance Sheet wasprepared. These ratios are important in measuring the ability of a company to meet

both its short term and long term obligations.

FIRST LIQUIDITY RATIO

Current Ratio: This ratio is obtained by dividing the 'Total Current Assets' of a company by its 'Total Current Liabilities'. The ratiois regarded as a test of liquidity for a company. It expresses the 'working capital' relationship of current assets available to meetthe company's current obligations.

The formula:

Current Ratio = Total Current Assets/ Total Current Liabilities

An example from ourBalance sheet:

Current Ratio = $261,050 / $176,522

Current Ratio = 1.48

The Interpretation:

Lumber & Building Supply Company has $1.48 of Current Assets to meet $1.00 of its Current Liability

Review theIndustry Norms and Ratios for this ratio to compare and see if they are above below or equal to the others in thesame industry.

To use the Current Ratio Calculator Click hereclick here .

SECOND LIQUIDITY RATIO

Quick Ratio: This ratio is obtained by dividing the 'Total Quick Assets' of a company by its 'Total Current Liabilities'. Sometimes acompany could be carrying heavy inventory as part of its current assets, which might be obsolete or slow moving. Thus eliminatinginventory from current assets and then doing the liquidity test is measured by this ratio. The ratio is regarded as an acid test ofliquidity for a company. It expresses the true 'working capital' relationship of its cash, accounts receivables, prepaids and notesreceivables available to meet the company's current obligations.

The formula:

Quick Ratio = Total Quick Assets/ Total Current Liabilities

Quick Assets = Total Current Assets (minus) Inventory


Quick Ratio = $261,050- $156,822 / $176,522

Quick Ratio = $104,228 / $176,522

Quick Ratio = 0.59

The Interpretation:
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Lumber & Building Supply Company has $0.59 cents of Quick Assets to meet $1.00 of its Current Liability

Review theIndustry Norms and Ratios for this ratio to compare and see if they are above below or equal to the others in thesame industry.

To use the Quick Ratio Calculator Click hereclick here .

THIRD LIQUIDITY RATIO

Debt to Equity Ratio: This ratio is obtained by dividing the 'Total Liability or Debt ' of a company by its 'Owners Equity a.k.a NetWorth'. The ratio measures how the company is leveraging its debt against the capital employed by its owners. If the liabilitiesexceed the net worth then in that case the creditors have more stake than the shareowners.

The formula:

Debt to Equity Ratio = Total Liabilities / Owners Equity or Net Worth


Debt to Equity Ratio = $186,522 / $133,522

Debt to Equity Ratio = 1.40

The Interpretation:

Lumber & Building Supply Company has $1.40 cents of Debt and only $1.00 in Equity to meet this obligation

The current ratio is probably the best known and most often used of the liquidity ratios. Liquidity

ratios are used to evaluate the firm's ability to pay its short-term debt obligations such as accountspayable (payments to suppliers) and accrued taxes and wages. Short-term notes payable to a

bank, for example, may also be relevant.

This is obviously a good position for the firm to be in. It can meet its short-term debt obligations

with no stress. If the current ratio was less than 1.00X, then the firm would have a problem

meeting its bills. So, usually, a higher current ratio is better than a lower current ratio with regardto maintaining liquidity

Definition of 'Operating Cash Flow Ratio'A measure of how well current liabilities are covered by the cash flow generated from acompany's operations.

Formula:

Investopedia explains 'Operating Cash Flow Ratio'

The operating cash flow ratio can gauge a company's liquidity in the short term. Using

cash flow as opposed to income is sometimes a better indication of liquidity simply

because, as we know, cash is how bills are normally paid off.

Read more: http://www.investopedia.com/terms/o/ocfratio.asp#ixzz22fPZ9HwO

Dividend yield ratio is the relationship between dividends per share and the market

value of the shares.
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Share holders are real owners of a company and they are interested in real sense in the

earnings distributed and paid to them as dividend. Therefore, dividend yield ratio iscalculated to evaluate the relationship between dividends per share paid and the

market value of the shares.

Formula of Dividend Yield Ratio:

Following formula is used for the calculation of dividend yield ratio:

Dividend Yield Ratio = Dividend Per Share / Market Value Per Share

Example:

For example, if a company declares dividend at 20% on its shares, each having a paid

up value of $8.00 and market value of $25.00.

Calculate dividend yield ratio:

Calculation:

Dividend Per Share = (20 / 100) 8

= $1.60

Dividend Yield Ratio = (1.60 / 25) 100

= 6.4%

Significance of the Ratio:This ratio helps as intending investor is knowing the effective return he is going to get

on the proposed investment.

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