Ratio Analysis Example
Prufrock Corporation Balance Sheet as of December 31,2008 ($ in millions)
Assets Liabilities and Owners’ Equity
Current assets Current liabilities
Cash $98 Accounts payable $344
Accounts receivable $188 Notes payable $196
Inventory $422 Total $540
Total $708 Long-term debt $457
Fixed assets Owners’ equity
Net plant and equipment $2,880 Common stock and paid-in surplus $550
Total assets $3,588 Retained earnings $2,041
Total liabilities and owners’ equity $3,588
Prufrock Corporation 2008 Income Statement ($ in millions)
Cost of goods sold 1344
Earnings before interest and taxes 691
Interest paid 141
Taxable income 550
Taxes (34%) 187
Net income 363
Addition to retained earnings 242
*Create common size balance sheet and common size income statement.
*Calculate ratios for Prufrock Corporation
Short-term solvency or liquidity ratios
Liquidity ratio measures the firm’s ability to pay its bills over the short run without undue stress.
*Do we have enough short-term liquid assets to cover our short-term debts?
Quick ratio (acid test ratio) =
*Do we have enough really liquid short-term assets to cover our short-term debts?
Long-term solvency, or financial leverage, ratios
Leverage ratio measures the form’s long-run ability to meet its obligations.
Total debt ratio=
What percentage of total assets is financed with either short- or long-term debt?
Times interest earned=
Asset management or turnover ratios
Turnover ratios measure asset use efficiency.
*On average, how many times per year do we go through our inventory? (Excess inventory is expensive!)
Day’s sales Outstanding=
Fixed Assets Turnover Ratio=
Total Assets Turnover Ratio=
Return on assets (ROA) =
*What is profit per dollar of asset?
Return on equity (ROE) =
*What is the rate of return for stockholders?
Return on equity (ROE) = Profit margin * Total asset turnover * Equity multiplier
Market value ratios
(We assume that Prufrock has 33 million shares outstanding and stock sold for $88 per share at the end of the year.)
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