Financial Statement Analysis

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 $2,591
Total liabilities and owners’ equity $3,588
Prufrock Corporation 2008 Income Statement ($ in millions)
Sales 2311
Cost of goods sold 1344
Depreciation 276
Earnings before interest and taxes 691
Interest paid 141
Taxable income 550
Taxes (34%) 187
Net income 363
Dividends 121
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.

Current ratio=

*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?

Debt-equity ratio=

Times interest earned=

  • It measures how well a company has its interest obligations covered. Are we generating enough income to make out interest payments?

Asset management or turnover ratios

Turnover ratios measure asset use efficiency.

Inventory turnover=

*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=

Profitability ratios

Operating margin=

Profit margin=

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.)


Price-earnings ratio=

Market-to-book ratio=


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