Microsoft Office Tutorials and References
In Depth Information
Financial Statements and Ratios
By adding the Average Collection Period to the Average Age of Inventory, the total days to
convert inventory into cash can be computed. This is the Operating Cycle and is computed as follows:
=Average_collection_period+Average_age_of_inventory
Solvency ratios
Whereas liquidity ratios compute a company’s ability to pay short-term debt, solvency ratios
compute its ability to pay long-term debt. The Debt Ratio compares total assets with total liabilities:
=Total_Assets/(Total_Current_Liabilities+Long_Term_Debt)
The Debt-to-Equity Ratio divides total liabilities by total equity. It’s used to determine whether a
company is primarily equity financed or debt financed:
=(Total_Current_Liabilities+Long_Term_Debt)/(Common_Stock+Additional_Paid_
in_Capital+Retained_Earnings)
The Times Interest Earned Ratio computes how many times a company’s profit would cover its
interest expense:
=(Net_Income__Loss+Interest_Expense)/Interest_Expense
Profitability ratios
As you might guess, profitability ratios measure how much profit a company makes. Gross Profit
Margin and Net Profit Margin can be seen on the earlier common size financial statements
because they are both ratios computed relative to sales. The formulas for Gross Profit Margin and
Net Profit Margin are
=Gross_Margin/Revenue
=Net_Income__Loss/Revenue
The Return on Assets computes how well a company uses its assets to produce profits:
=Net_Income__Loss/((Total_Assets+LastYear_Total_Assets)/2)
The Return on Equity computes how well the owners’ investments are performing:
=Net_Income__Loss/((Total_Equity+LastYear_Total_Equity)/2)

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