Universitas Jenderal Soedirman

Nama : Muhammad Faishal

NIM : C1H017037
Financial Management I
Ratio Analysis
Ratio analysis is the process of examining and comparing financial
information by calculating meaningful financial statement figure
percentages instead of comparing line items from each financial
statement. Managers and investors use a number of different tools and
comparisons to tell whether a company is doing well and whether it is
worth investing in. The most common ways people analysis a
company’s performance are horizontal analysis, vertical analysis, and
ratio analysis. Horizontal and vertical analyzes compare a company’s
performance over time and to a base or set of standard performance
numbers.

What Does Ratio Analysis Mean?

Ratio analysis is much different. Ratio analysis compares relationships

between financial statement accounts. This means that one income
statement or balance sheet account is being compared to another.
These relationships between financial statement accounts will not only
give a manager or investor an idea of the how healthy the business is
on a whole, it will also give them keen insights into business operations.

Example

Take inventory turns for example. Inventory turnover is the ratio

between cost of goods sold and average inventory. Inventory turnover
tells managers and investors not only how much inventory the
company maintained, it also tells them how efficient the company was
with its inventory. A high inventory turnover ratio means that the
company is lean and is able to move its inventory quickly. This could
indicate proper management and thoughtful inventory purchasing.
The opposite is true about a low inventory turnover. A low inventory
turnover usually means either that companies buy too much inventory
or they have problems selling it. Neither of these facts indicate a
healthy business.

Managers and investors use a ton of different ratios in this analysis.

Here are a few:

- Current Ratio

- Acid Test Ratio

- Accounts receivable turnover

- Inventory turnover

- Total asset turnover

- Debt-to-equity ratio
Current Ratio
The current ratio is a metric used by the finance industry to assess a
company's short-term liquidity. It reflects a company's ability to
generate enough cash to pay off all debts should they become due at
once. While this scenario is highly unlikely, the ability of a business to
liquidate assets quickly to meet obligations is indicative of its overall
financial health.

Components Of The Current Ratio

Current Assets

Current assets are located on the balance sheet and represent the
value of all assets that can reasonably expect to be converted into cash
within one year. The following are examples of current assets:

- Cash and cash equivalents

- Marketable securities
- Accounts receivable
- Prepaid expenses
- Inventory

Current Liabilities

Current liabilities are a company's debts or obligations that are due

within one year, appearing on the company's balance sheet. The
following are examples of current liabilities:

- Short-term debt
- Accounts payables
- Accrued liabilities & other debts
How To Calculate The Current Ratio

The current ratio shows the proportion of current assets to current

liabilities is calculated by the following formula:

Example Of The Current Ratio

Below are the current assets and current liabilities for Microsoft
Corporation (MSFT) as stated on the company's balance sheet at the
end of 2017.

To determine Microsoft's current ratio, we divide current assets by

their current liabilities:

Current ratio = $159,851,000 ÷ $64,527,000 = 2.48

Investors and analysts would consider Microsoft's current ratio of 2.48

to be financially healthy, meaning the company is easily capable of
paying off its obligations.
Acid Test Ratio
The acid-test ratio, also known as the "quick ratio," is used to highlight
the short-term liquidity and solvency of an organization. Investors and
lenders use the acid-test ratio as a more severe version of the current
ratio, often looking for a "pass" or "fail" value. All of the information
necessary to calculate the acid-test ratio can be found on the
company's most recent balance sheet.

The basic formula for the acid-test ratio is: ATR = (Cash + Accounts
Receivable + Short-term Investments) / Current Liabilities.

Short-term investments include marketable securities that can be

liquidated quickly. The current liabilities portion of the balance sheet
includes items such as accounts payable, accrued liabilities and short-
term debts. Unlike other capital ratios, the acid-test ratio does not take
the value of existing inventory into consideration.

It is easy to compare acid-test ratios among publicly listed companies

within the same industry, because generally accepted accounting
principles (GAAP) reporting is required by the Securities and Exchange
Commission (SEC). Cash on hand and accounts receivable are listed
under the assets section of the balance sheet. The company's accounts
payable, accrued expenses payable and short-term notes payable are
all listed under liabilities. Since capital needs vary among industries, it is
best to compare any working capital ratios among like companies or
across time with the same firm.

Companies are expected to have a ratio of at least 1.0, which means

they have enough existing liquid assets to cover their bills. Several
factors can impact this figure; the timing of asset purchases, timing of
raised capital, allowances for bad debt and accounts receivable
management policies are all significant determinants of the acid-test
ratio.

Account receivable turnover

Accounts receivable turnover is the number of times per year that a
business collects its average accounts receivable. The ratio is intended
to evaluate the ability of a company to efficiently issue credit to its
customers and collect funds from them in a timely manner. A high
turnover ratio indicates a combination of a conservative credit policy
and an aggressive collections department, as well as a number of high-
quality customers. A low turnover ratio represents an opportunity to
collect excessively old accounts receivable that are unnecessarily tying
up working capital. Low receivable turnover may be caused by a loose
or nonexistent credit policy, an inadequate collections function, and/or
a large proportion of customers having financial difficulties. It is also
quite likely that a low turnover level indicates an excessive amount of
bad debt. It is useful to track accounts receivable turnover on a trend
line in order to see if turnover is slowing down; if so, an increase in
funding for the collections staff may be required, or at least a review of
why turnover is worsening.

To calculate receivables turnover, add together beginning and ending

accounts receivable to arrive at the average accounts receivable for the
measurement period, and divide into the net credit sales for the year.
The formula is as follows:
Net Annual Credit Sales ÷ ((Beginning Accounts Receivable + Ending
Accounts Receivable) / 2)

For example, the controller of ABC Company wants to determine the

company's accounts receivable turnover for the past year. In the
beginning of this period, the beginning accounts receivable balance was
$316,000, and the ending balance was $384,000. Net credit sales for
the last 12 months were $3,500,000. Based on this information, the
controller calculates the accounts receivable turnover as:

$3,500,000 Net credit sales ÷ (($316,000 Beginning receivables +

$384,000 Ending receivables) / 2)

= $3,500,000 Net credit sales ÷ $350,000 Average accounts receivable

= 10.0 Accounts receivable turnover

Thus, ABC's accounts receivable turned over 10 times during the past
year, which means that the average account receivable was collected in
36.5 days.

Here are a few cautionary items to consider when using the receivables
turnover measurement:

Some companies may use total sales in the numerator, rather than net
credit sales. This can result in a misleading measurement if the
proportion of cash sales is high, since the amount of turnover will
appear to be higher than is really the case.

A very high accounts receivable turnover number can indicate an

excessively restrictive credit policy, where the credit manager is only
allowing credit sales to the most credit-worthy customers, and letting
competitors with looser credit policies take away other sales.
The beginning and ending accounts receivable balances are for just two
specific points in time during the measurement year, and the balances
on those two dates may vary considerably from the average amount
during the entire year. Therefore, it is acceptable to use a different
method to arrive at the average accounts receivable balance, such as
the average ending balance for all 12 months of the year.

A low receivable turnover figure may not be the fault of the credit and
collections staff at all. Instead, it is possible that errors made in other
parts of the company are preventing payment. For example, if goods
are faulty or the wrong goods are shipped, customers may refuse to
pay the company. Thus, the blame for a poor measurement result may
be spread through many parts of a business.

The accounts receivable turnover ratio can be used in the analysis of a

prospective acquiree. When the ratio is excessively low, an acquirer can
view this as an opportunity to apply more vigorous credit and collection
practices, thereby reducing the working capital investment needed to
run the business.

Inventory Turnover
What Is Inventory

Inventory is the account of all the goods a company has in its stock
including raw materials, work-in-progress materials, and finished goods
that will ultimately be sold. Inventory typically includes finished goods,
such as clothing in a department store. However, inventory can also
include raw materials that go into the production of the finished good,
called work-in-progress. For example, the cloth used to make the
clothing would be inventory for the clothing manufacturer.
What Is Inventory Turnover & How Is It Interpreted?

Inventory turnover is the number of times a company sells and replaces

its stock of goods during a period. Inventory turnover provides insight
as to how the company managing costs and how effective their sales
efforts have been.

The higher the inventory turnover, the better since a high inventory
turnover typically means a company is selling goods very quickly and
that there’s demand for their product.

Low inventory turnover, on the other hand, would likely indicate

weaker sales and declining demand for a company’s products.

Inventory turnover provides insight as to whether a company is

managing its stock properly. The company may have overestimated
demand for their products and purchased too many goods as shown by
low turnover. Conversely, if inventory turnover is very high, they might
not be buying enough inventory and may be missing out on sales
opportunities.

Inventory turnover also shows whether a company’s sales and

purchasing departments are in sync. Ideally, inventory should match
sales. It can be quite costly for companies to hold onto inventory that
isn’t selling. This is why inventory turnover can be an important
indicator of sales effectiveness but also for managing operating costs.

Alternatively, for a given amount of sales, using less inventory to do so

will improve inventory turnover.

Calculating Inventory Turnover

Like a typical turnover ratio, inventory turnover details how much
inventory is sold over a period of time. To calculate the inventory
turnover ratio, cost of goods sold is divided by the average inventory
for the same period.

Cost of Goods Sold ÷ Average Inventory Or Sales ÷ Inventory

Average inventory is used in the ratio because companies might have

higher or lower inventory levels at certain times in the year. For
example, retailers like Best Buy Co Inc (BBY) would likely have higher
inventory leading up to the holidays in Q4 and lower inventory levels in
Q1 following the holidays.

Cost of goods sold (COGS) is a measurement of the production costs of

goods and services for a company. COGS can include the cost of
materials, labor costs directly related to goods produced, and any
factory overhead or fixed costs that are directly used in the production
of goods.

Days Sales of Inventory (DSI) or Days Inventory

Days Sales of Inventory (DSI) measures how many days it takes for
inventory to turn into sales. DSI is also known as days inventory, is
calculated by taking the inverse of the inventory turnover ratio
multiplied by 365. This puts the figure into a daily context, as follows:

(Average Inventory ÷ Cost of Goods Sold) x 365

A lower DSI is ideal since it would translate to fewer days needed to

turn inventory into cash. However, DSI values can vary between
industries. As a result, it's important to compare the DSI of a company
with its peers. For example, companies that sell groceries like Kroger
supermarkets (KR) have lower days inventory than companies that sell
automobiles like General Motors Co (GM).

Example

For the fiscal year ended Jan. 2017, Walmart Inc (WMT) reported
annual sales of $485.14 billion, year-end inventory of $43.04 billion,
and an annual cost of goods sold (or cost of sales) of $361.25 billion.

Walmart's inventory turnover for the year equals:

$361.25 billion ÷ $43.04 billion = 8.39

Its days inventory equals:

(1 ÷ 8.39) x 365 = 43 days

This indicates that Wal-Mart sells its entire inventory within a 43-day
period, which is quite impressive for such a large, global retailer.