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)