Module Four: Analyzing Financial Statements (II)

This module will teach us more ratios and calculations for analyzing financial statements. Here are the topics for this module:

Long-term analysis ratios

• Coverage ratios
• Leverage ratios
• Calculating return on investment (ROI)
• Calculating return on investment (ROI)

Our first topic in this module is calculating the long-term analysis ratio.

 

Long-Term Analysis Ratios

The long-term analysis helps determine how well the company will perform over time regarding its financial obligations. These are the formulas for calculating long-term performance.

Ratio Calculation - Formula - Result

Current Assets to Total Debt - Current Assets = Current Assets to Total Debt Ratio Current + Long-Term Debt.

This ratio determines the degree of protection linked to short- and long-term Debt. More net working capital protects short-term creditors.

 

Stockholders' Equity Ratio - Stockholders' Equity = Stockholders' Equity Ratio Total Assets.

This ratio determines the relative financial strength and long-run liquidity.

 

Total Debt to Net Worth - Current + Deferred Debt = Total Debt to Net Worth Ratio Tangible Net Worth.

This ratio measures the organization's total liabilities against its tangible

Coverage ratios show how many times a company's earnings can cover the fixed-interest payments on its long-term Debt. The Times Interest Earned Ratio calculates this, and the formula is the following:

EBIT = Time Interest Earned Ratio

EBIT is earnings before interest and taxes

I am the interest amount payable on the

Leverage Ratios

Leverage ratios calculate the proportion of the owner's contribution and the contribution from creditors. Three formulas help you calculate ratios:

Ratio Calculation - Formula - Result

Equity Ratio - Common Shareholders' Equity = Equity Ratio Total Capital Employed

This ratio shows how much of the total capitalization comes from the owners.

 

Debt to Equity Ratio - Debt + Preferred Long-Term = Debt to Equity Ratio Common Stockholders' Equity

With this ratio, a high ratio means less protection for creditors. Conversely, a low ratio means more protection for creditors.

 

Debt Ratio Current + Long-Term Debt = Debt Ratio Total Assets

This ratio determines how much of the assets are financed.

 

Calculating Return on Investment (ROI)

Calculating the return on investment (ROI) helps determine if an investment is worth the effort. This calculation takes the project return the investment promises and subtracts the cost of the investment, leaving either a gain or a loss. That figure is then divided by the cost of the investment.

If the calculation produces a large percent or whole number, then the investment would be good. But, of course, this would have to be approved by an authorized agent within your company. On the other hand, if the calculation produces a small percentage, then it would not be an excellent investment. 

A zero means the investment would break even. Here is the formula:

• ROI = (Gain from the investment – the cost of investment) / cost of investment

Whenever you need to make a purchasing decision, determining the return on investment is always a good practice. Presenting this before the purchase to your manager would make you look wise. In addition, taking the time to calculate the ROI demonstrates that you care about the organization. 

There are other return calculations you can use. Here are a few:

• Return on assets (ROA)
• Return on capital employed (ROCE)
• Return on equity (ROE)
• Return on gross invested capital (ROGIC)
• Return on investment capital (ROIC)

Lesson Summary

This module covers analyzing financial statements through measuring several key ratios. These include:

• Long-term analysis ratios: Current Assets to Total Debt, Stockholders' Equity Ratio, Total Debt to Net Worth
• Coverage ratios: Times Interest Earned Ratio
• Leverage ratios: Equity Ratio, Debt to Equity Ratio, Debt Ratio
• Return on investment (ROI): Return on assets (ROA), Return on capital employed (ROCE), Return on equity (ROE), Return on gross invested capital (ROGIC), Return on investment capital (ROIC)

It provides the formula for each calculation and an explanation of how to calculate the return on investment, including when to make the calculation and how it can make a purchasing decision more effective.