FINANCIAL RATIO

ANALYSIS
Lutfi lutfi@perbanas.ac.id
STIE Perbanas Surabaya
Financial Analysis: A Creditor Perspective
 The ultimate creditor’s objective is to determine the
borrower’s capability to pay off the principal and
interest of the loan
 The question that arises in credit analysis :
 What is the purpose of credit application?
 What is the company's capital structure? How much is
currently outstanding debts? How is the company's ability
to pay the debts in the past?
 What is the source of paying off the loan? How well
companies manage working capital? Do the company
generates enough cash from operations?

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 Financial Analysis Tools
RATIO COMPARATIVE
ANALYSIS (TREND)
ANALYSIS

Financial COMMON-SIZE
Analysis Tools ANALYSIS

COMPANY CASH FLOWS

VALUATION ANALYSIS

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 Key Financial Ratios
RATIO
ANALYSIS

Liquidty Activity Solvabilty Profitability

Ratios Ratios Ratios Ratios

Comparative Ratio Ratio Trend

Analysis Analysis

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 Balance Sheet
BALANCE SHEET, December 200X
ASSETS 2005 2004 LIABILITIES & EQUITY 2005 2004
Current Asset Current Liabilities
Cash 4,061 2,382 Account Payable 14,294 7,591
Marketable Securities 5,272 8,004 Notes Payable 5,614 6,012
Account Receivables 8,960 8,350 Current Proportion of LT Debt 1,884 1,516
Inventory 47,041 36,769 Other Current Liabilties 5,669 5,313
Prepaid Expenses 512 759 Total Current Liabilities 27,461 20,432
Total Current Asset 65,846 56,264 Long Term Debt 21,902 17,610
Non Current Asset Total Liabilties 49,363 38,042
Fixed Aset 40,607 26,507 Equity Capital
Accum. Depreciation (11,528) (7,530) Equity Share 4,803 4,594
Fixed Asset - Net 29,079 18,977 Excess Paid in Capital 957 910
Other Assets 373 668 Retained Earnings 40,175 32,363
Total Equity 45,935 37,867
TOTAL ASSET 95,298 75,909 TOTAL LIABILITIES & EQUITY95,298 75,909

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 Income Statement
INCOME STATEMENT AS OF DECEMBER
2005 2004
Net Sales 215,600 153,000
Cost of Good Sold 129,364 91,879
Gross Profit 86,236 61,121
Operating Exepenses
Genaral Adm. Expenses 45,722 33,493
Marketing Expenses 14,258 10,792
Depreciation Expenses 3,998 2,984
Maintenance Expenses 3,015 2,046
Operating Profit 19,243 11,806
Other Income (Expenses)
Interest Income 422 838
Interest Expenses (2,585) (2,277)
Profit Before Taxes 17,080 10,367
Taxes 7,686 4,457
Net Profit 9,394 5,910 6

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 Liquidity Ratio: Short-term Solvency

Current Assets
Current ratio
Current Liabilities

Current Asset – Inventory

Quick ratio Current Liabilities

Cash + Marketable Securities

Cash ratio Current Liabilities
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 Liquidity Ratios: Short Term
 Current Ratio: It is commonly used to evaluate the
company ability to pay off its obligation in the short run.
2005 2004 Industry
Current Assets 65,846 56,264
= 240% = 275% 190%
Current Liabilities 27,461 20,432

 In general, the company’s ability to repay the debt when it comes due
deteriorates
 The relatively high current ratio compared to the industry average may
suggest that (1) the company is over liquid, or (2) the main sources of its
liquidity may come from inventory, a component of current assets that is
illiquid (it takes long time for the company to liquidate the inventory, or
the company has to offer some discount to sell the inventory)
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 QUICK (ACID-TEST) RATIO
 The pitfall of current ratio is to include components of current assets that are
not liquid enough, such as inventory and prepaid expenses.
 Quick (Acit-test) ratio is a better short-term solvency measurement as it
includes only quite liquid assets
2005 2004 Industry
Current Asset – Inventory – Pre 65,846 – 47,041 – 512 56,264 – 36,769 – 759
Paid Expenses -------------------------- ------------------- -------
------------------------------------------ 27,461 20,432 125%
Current Liabilties = 67% = 92%

 The calculation above shows that company liquidity is worsening (the liquidity
risk increase)
 Comparing the current ratio and quick ratio reveals that the high current ratio
can be caused by inventory piling up which means that the company's products are not
enough to sell in the market.
 Comparing to the industry average, it seems that the company’s ability to
repay its short liabilities using its liquid asset is worse than other forms in the
same industry.
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 CASH RATIO
 Cash Ratio it is the most stringent measure of liquidity due to it
consider cash and marketable securities only as the components of
current asset used to pay current liabilities.
2005 2004 Industry
Cash + Marketable Securities 4,061+ 5,272 2,382 + 8,004
-------------------------------- ---------------- = 34% ---------------- = 51% 56%
Current Liabilities 27,461 20,432

 The ratios above show that the firm’s cash ability to meet its short
term obligation is deteriorating and far below the other firm within
the industry
 Conclusion:
 The company ability to repay its debt is quite poor.
 The company relies on the piling up inventory that is not liquid
enough to support its liquidity
 Therefore, the liquidity risk of the company is quite high. 10

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 Activity Ratio
Sales (Credit)
Account Receivables
Turnover
Account Receivables
365 (days)
Average Collection
Period
Account Receivable Turnover
Cost of Good Sold
Inventory Turnover
Inventory
Sales
Fixed Asset
Turnover Fixed Asset
Sales
Total Asset
Turnover Total Assets 11

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 Account Receivables Turnover
 Account Receivable Turnover (ARTO) indicates how many
times receivable rotated in one year
 The quicker the turn over, the better account receivables
management in supporting firms sales.
2005 2004 Industry
Net Sales (Credit) 215,600 153,000
----------------------------- ----------- = 24.06 times ---------- = 18.32 times 25 times
Account Receivable *) 8,960 8,350
*) It may use the average of account Receivables
 The ratio above reveals that the firm account receivables
management improve compared to previous year.
 Comparing to the industry, however, the firm account
receivable management in supporting the sales is barely below
the other firms in the same industry 12

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 Average Collection Period
 Average collection period indicate the time needed to collect
trade credit given to customers

2005 2004 Industry

365 days 365 365
----------------------------- ----------- = 15 days ---------- = 20 days 14,6 days
Acc. Receivable Turnover 24,06 18,32

 In line with the account receivables turn over, the average

collection period shows an improvement in account receivable
management and the firm’s performance is quite similar to
other firms in the industry

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 Inventory Turnover
 Inventory turnover (ITO) measures the firm efficiency in
managing and selling its products
 It also measure the liquidity of firm’s inventory
2005 2004 Industry
Cost of Good Sold 129,364 91,879
----------------------------- ----------- = 2.75 times ---------- = 2.50 times 4 times
Inventory 47,041 36,769

*) It may use the average of inventory

 The ratios above show an improvement in the firm ability to
sell its product. The firm’s performance, however, is far below
the industry average
 It indicates the firm products are not well accepted by the
market 14

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 Fixed Asset Turnover
 Fixed asset turnover (FATO) and Total asset turnover (TATO)
are used to measure the effectiveness of a firm in selling its
products utilizing its assets
 Fixed asset turn over look at the utilization of fixed asset in
supporting the firm’s sales
2005 2004 Industry
Net Sales 215.600 153.000
----------------------------- ----------- = 7.41 times ---------- = 8.06 times 9 times
Fixed Asser 29.079 18.9779

 The above ratios indicate that the utilization of fixed asset to

support the sales is declining and its is well below the industry
 It indicates an idle capacity of the firms facility that may
suggest a worsening condition of firm’s sales performance 15
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 Asset Turnover
 Asset turnover (ATO) measures the firm’s efficiency in
utilizing its assets
 A decline in ATO indicate a poor utilization of asset
 However, if the decline is due to modernization of equipment
that increase assets, rather than decrease in sales, then this
condition can be accepted
2005 2004 Industry
Net Sales 215,600 153.000
----------------------------- ----------- = 2.26 times ---------- = 2.02 times 3.02 times
Total Assets 95,298 75.909
 The ratios show a reduction in the utilization of the firm’s
total asset, even though there is small improvement in 2005

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 Solvability Ratio: Long Term

Debt-equity Total Liabilities

ratio Total Equity

Debt-to-total Total Liabilities

asset Total Assets

Times interest Net Income + Interest Charge + Taxes

earned (TIE)
Interest Charge
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 DEBT to EQUITY RATIO & DEBT RATIO
 Debt to Equity ratio are Debt ratio are basically very similar.
They measure the firm’s degree of leverage (use of debt) and
they reflect the firm’s ability to repay all obligations in the
long run.
 The higher the ration, the higher the financial risk of the
company
 Debt is like a double-edged sword: (1) the debt is needed to
support the company’s growth, (2) on the other hand, a large
amount of debt will reduce the company's ability to repay the
obligations

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DEBT to EQUITY RATIO & DEBT to ASSET RATIO
 Debt to Equity ratio
2005 2004 Industry
Total Liabilities 49,363 38,042
----------------------------- ----------- = 107% ---------- = 100% 99%
Total Equity 45,935 37,867
 Debt to Asset ratio
2005 2004 Industry
Total Liabilities 49,363 38,042
----------------------------- ----------- = 51.8% ---------- = 50.1% 49%
Total Assets 95,298 75.909

 The ratios indicate an increase in the use of debt. It means the

company ability to repay its obligation is decline.
 The firm’s degree of financial leverage, however, is a little but
better than other firms within the industry 19

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 TIME INTEREST EARNED (TIE)
 TIE measure the firm’s ability to pay interest on debt using
income from its operation
 To be profitable in the use of debt and to enable the company
survive, then operating income should be higher than the cost
of financing (interest)
2005 2004 Industry
Net Profit + Taxes + 9.394+7.686+2.585 5.910+4.457+2.277
Interest Charge --------------------------- ---------------------------
8 times
----------------------------- 2.585 2.277
Interest Charge = 7,6 times = 5,6 times
 The Ratios indicate that the is an improvement in the firm’s
ability to repay its interest charge, and this ability is quite
similar to the other firms in the industry
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 Profitability Ratio
Gross Profit Gross Profit
Margin (GPM) Net Sales

Operating Profit Operating Profit

Margin (OPM) Net Sales
Net Prfot Margin Net Profit
(NPM) Net Sales
Return on Asset Net Profit
(ROA) Total Assets

Return on Equity Net Profit

(ROE) Total Equity
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 GPM, OPM, NPM
 GPM, OPM and NPM all indicate the firm’s ability to convert its
sales into profit, using various measure of profit.
 GPM relates sales to cost of good sold. It measures the firm’s
ability to control its inventory and production process as well as to
charge a higher price to its customer (reflecting better brand name)
 OPM measure the efficiency of operating (normal) activities of the
firm, considering all expenses related to the normal activity
 NPM measure the firm’s profitability that consider all income and
expenses, including the temporary component of income statement
 Beware of NPM!!! When NPM is good but OPM is poor. It
may suggest a poor quality of earnings.

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 GPM, OPM, NPM
 GPM 2005 2004 Industry
Gross Profit 86,236 61,121
---------------------- ----------- = 40% ---------- = 39.9% 40.7%
Net Sales 215,600 153,000

2005 2004 Industri

 OPM
Operating Profit 19,243 11,806
--------------------- ----------- = 8.9% ---------- = 7.7% 9.0%
Net Sales 215,600 153,000

 NPM 2005 2004 Industri

Net Profit 9,394 5,910
--------------------- ----------- = 4.4% ---------- = 3.9% 4.5%
Net Sales 215,600 153,000
 In general, there is no significant improvement in the firm’s
profitability. Comparing to the industry, however, the is also no
significant different in the profitability
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 ROA & ROE
 ROA measures the firm’s efficiency in managing its investment in all assets.
 ROE measures the firm ability to generate profit its shareholders
2005 2004 Industry
 ROA Net Income 9,394 5,910
--------------------- ----------- = 9.9% ---------- = 7.8% 10.4%
Total Assets 95,298 75,909

2005 2004 Industry

 ROE Net Income 9,394 5,910
--------------------- ----------- = 20.5% ---------- = 15.6% 26.6%
Total Equity 45,935 37,867

 The ratios above reveals a significant increase in the firm’s capability to

generate profit for its shareholders and in managing its assets
 In terms of the welfare of shareholders, however, the capability is below the
industry average
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 Conclusion on Credit
 In general, there is a decline in firm’s ability to repay its
obligation that comes due.
 Considering the improvement in firm’s profitability and the
profitability is quite similar to other firms in the industry,
there is still a possibility for and improvement in the future.
 If the bank provides credit, the credit is to support promotional
activities and product innovation
 The bank and the firms must pay closely attention to the very
low inventory turnover

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 lutfi@perbanas.ac.id
STIE Perbanas Surabaya