Financial Performance Evaluation: Understanding Financial Ratios and Their Importance, Slides of Fundamentals of E-Commerce

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Contemporary Financial

Management

Chapter 3:

Evaluating and Forecasting Financial

Performance

Introduction

This chapter introduces financial statementanalysis techniques that are used to evaluate acompany’s performance.

Words of Caution

Ratios are only as good as the information onwhich they are based.

Ratios become most valuable when: - Compared to the ratios of a peer group - Analyzed over time - Ratios are symptoms, not causes. - Ratios should cause one to ask questions; rarelydo they provide answers themselves - When comparing ratios among different firms,ensure the ratios are calculated using the samemethod.

Types of Ratios

Liquidity

Asset management - Financial leverage - Profitability - Market-based - Dividend policy

Abbreviations Used in the Chapter

EBIT – Earnings Before Interest & Taxes - ROI – Return on Investment - ROE – Return on Equity - P/E Ratio – Price to Earnings Ratio - EAT – Earnings After Tax - r – Return on total capital - k – Cost of capital

Liquidity Ratios

Used to indicate the ability of the firm to fund itsliabilities as they come due.

Higher ratio normally preferred to a lower ratio - High ratio may indicate poor asset management. - Low ratio may indicate difficulty meeting short-termfinancial obligations Current Assets Current Ratio = Current Liabilities

Asset Management Ratios

Indicates number of days that, on average, it takes tocollect an account receivable. - Long collection period may indicate problems withcredit quality or credit granting procedures. - The collection period should always be compared tothe firm’s stated credit policy.

÷ Accounts Receivable Collection Period = Annual Credit Sales 365 Docsity.com