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Financial Ratio analysis

Financial ratios define the relationships between different bits of financial information (financial data). Ratios is simply one number divided by another. Ratios eliminate the size problems, because in calculation of the ratios the sizes are divided out. Financial ratios are traditionally grouped into following categories: 1. 2. 3. 4. 5. Short-term liquidity (solvency) ratios Long-term liquidity (solvency) ratios (or financial leverage ratios) Asset turnover ratio (Asset management ratios) Profitability ratios Market value ratios

Short-term Liquidity Ratio (Short-term Solvency Measures) As the name of these ratios expresses, short-term liquidity ratios (or solvency ratios) provide information about a firms short-term liquidity status. These ratios are sometimes called short-term liquidity measuring. The purpose of calculating short-term liquidity ratios is to assess the firm's ability to pay its bills in short run without stress and problem. Consequently, short-term liquidity ratios focus on current assets and current liabilities of the firms. Short-term liquidity ratios are interesting to short-term creditors. They are the banks and other short-term lenders. 1) Current ratioA liquidity ratio that measures a company's ability to pay short-term obligations. The Current Ratio formula is:

For a short-term creditor, as for example for a supplier, the higher the current ratio, the better is it for him. To the firm, a high current ratio indicates high liquidity, but it also indicates an inefficient use of cash and other short-term assets. Normally, we would expect to see a current ratio of at least 1. It means that the current assets just cover the current liabilities. A current ratio, which is less than 1, means that the current assets are not sufficient to cover the current liabilities. This is very unusual in a healthy firm.

Generally, the higher the ratio, the more liquid the company is. This means the company would have a better short-term financial standing to meet its debt obligations. However, an investor should also take note of a company's operating cash flow in order to get a better sense of its liquidity. A low current ratio is can often be supported by a strong operating cash flow. On the other hand, if a company is able to operate with a low current ratio, it means that the company is more efficient about using its capital. Therefore, a low current ratio can lead to higher return of assets. 2) Quick ratioInventory makes some times the book values least reliable, because it is not measured in market value and the quality of the inventory isn't considered. Some of the inventory may later turn out to be damaged, obsolete, or lost. Moreover, relatively large inventories are often a sign of short-term trouble of the firm. The firm may have overestimated sales and overbought or overproduced. In this case, the firm may have a substantial portion of its liquidity tied up in slow moving inventory. An indicator of a company's short-term liquidity. The quick ratio measures a company's ability to meet its short-term obligations with its most liquid assets. The quick ratio is calculated as: Quick Ratio = (Current Assets - Inventories) / Current Liabilities

The higher the quick ratio, the better the position of the company. The current ration of Prufrock was 1.53 times, which means that the current asset is 1.31 times the current liabilities. In other words, it means that Prufrock nothing worry about its liquidity. On the other hand, the quick ratio of Prufrock says that it only .53 times. It means that if the inventory is not worth (consists of unmarketable goods), then Prufrock is to concern about liquidity. 3) Cash ratioCash ratio is the ratio of cash and cash equivalents of a company to its current liabilities. It is an extreme liquidity ratio since only cash and cash equivalents are compared with the current liabilities. It measures the ability of a business to repay its current liabilities by only using its cash and cash equivalents and nothing else. Cash ratio is calculated using the following formula: Cash + Cash Equivalents Current Liabilities Cash equivalents are assets which can be converted into cash quickly whereas current liabilities are those liabilities which are to be settled within 12 months or the business cycle. Cash Ratio =

A cash ratio of 1.00 and above means that the business will be able to pay all its current liabilities in immediate short term. Therefore, creditors usually prefer high cash ratio. The cash ratio of Prufrock is .18 times. In other word, only .18% of the current liabilities of Prufrock are covered by cash. But businesses usually do not plan to keep their cash and cash equivalent at level with their current liabilities because they can use a portion of idle cash to generate profits. This means that a normal value of cash ratio is somewhere below 1.00.

4) Networking capital ratioNet Working Capital (NWC) is fact the short-term liquidity of a firm. So, it is significant to know the relationship between Total Asset and Net Working Capital, because Net Working Capital Ratio to Total Asset expresses the relative liquidity of a firm to its total asset. A relatively low value of Net Working Capital Ratio to Total Asset indicates that the firm uses only a small portion of its total Asset for operation of the firm: Net Working Capital Net Working Capital Ratio = Total Assets The ratio of Net Working Capital to Total Asset indicates that only 4.7% of the total asset of Prufrock is used for direct equity increasing operation of the firm. 5) Interval measureSuppose, a firm faces a strike and its liquidity began to dry up. So, the management of the firm is eager to know how long could firm sustain with present liquidity. This can be calculated by the following ratio: Current assets Interval measure = Average daily operating costs The current asset is given in the balance sheet. Only the daily operating cost has to be calculated. We know that the annual operating costs equal the cost of goods sold. So, dividing the Cost of goods sold by 365 the daily operating could be calculated. The interval measure for Prufrock is 192.3 days, which means that Prufrock can hang on for 192.3 days.

Long term ratio Profitability ratio Asset turnover ratio 1) Current asset turnover ratio Inventory turnover ratio Inventory turnover days Receivable turnover ratio Receivable turnover days Payable turnover ratio Payable turnover days Networking capital sustainability Networking capital sustainability days 2) Fixed asset turnover ratio 3) Total asset turnover ratio 4) Networking turnover ratio.