FINANCIAL STATEMENT
ANALYSIS – part 2
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Ratios
A ratio is a simple mathematical expression
of the relationship between one item and another.
Along with dollar and percentage changes,
trend percentages, and component percentages,
ratios can be used to compare:
Past performance to
present performance.
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Other companies to
your company.
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Uses and Limitations of Financial
Ratios
Uses
Limitations
Ratios help users
understand
financial relationships.
Management may enter
into transactions merely
to improve the ratios.
Ratios provide for
quick comparison
of companies.
Ratios do not help with
analysis of the company's
progress toward
nonfinancial goals.
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Ratio Categories

Liquidity Ratio
 assess
the ability of a company to meet its short term
liabilities

Solvency Ratio
 Measure
the ability of a company to meet its long-term
liabilities

Profitability Ratio
 Assess
management’s effectiveness in achieving
profitability

Activity Ratio
 Reflects

management’s ability in using the assets
Operating Ratio
 To
analyze the operations of a company
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Liquidity Ratio
Ratios
Current Ratio
Acid-Test
Ratio
(Quick Ratio)
Receivable
Turnover
Ratio
Receivable
Collection
Period
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Formula
Users
Comparing Standards
Basic Analysis
Creditors
Owners
Management
Creditors prefer higher
ratio for safety
- Normally 2 : 1
Owners prefer lower ratio
- Hotel 1.5 : 1 and Motel
for productivity
1 : 1 (less inventory)
Management try to satisfy
both
(Cash + Receivables + Creditors
Marketable Securities) Owners
Current Liabilities
management
Only consider the assets
that can be readily
Lower than current ratio
convert to cash.
and most quick ratios
are less than 1 : 1
Users’ opinion the same
as Current Ratio
Current Assets
Current Liabilities
Revenues
Average Receivable
365
Receivable Turnover
Ratio
Indicate how fast the
receivable can be
converted into cash
Creditors
Management
Creditors
Management
Credit Cards less than
10 days
Account Receivable
from 1 month – 3
months
How many days it takes
to collect receivables
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Solvency Ratio
Ratios
Formula
Total assets
to total
liabilities
(Solvency
Ratio)
Total Assets
Total Liabilities
Total
liabilities to
total assets
(Debt Ratio)
Total Liabilities
Total Assets
Total
liabilities to
total equity
(Debt Equity
Ratio)
Total Liabilities
Total Owner’s Equity
Number of
interest
earned
EBIT
Interest Expense
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Users
Creditors
Creditors
Comparing Standards
Creditors prefer to see
the ratio as high as
possible
2:1
Normally <50%
Hospitality Industry
usually 60% - 90%
Creditors prefer lower %
for less risk
Investors prefer higher %
for more profit
Creditors prefer lower
one for less risk
Investors prefer higher
one for more profit
Creditors
Creditors
Management
Owners
Basic Analysis
Greater than 4
All like to see this ratio as
high as possible
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Profitability Ratio
Ratios
Formula
Profit Margin
Net Income / Gross Profit
Sales Revenues
Return on Assets
(ROA)
Net Income
Average Total Assets
Return on
Owner’s Equity
(ROE)
Net Income
Average Owner’s Equity
Earning per Share
(EPS)
Net Income
Average Common Shares
Outstanding
Price/Earning
Ratio
(P/E Ratio)
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Market Price per Share
Earning per Share
Users
Basic Analysis
Creditors
Management
Owners
Indicate management’s ability to
generate Sales and control
expenses
Mostly Creditors
Management
Owners
Measures the effectiveness of
management’s use of the
company’s assets
Higher is better (>15%)
Creditors
Management
Mostly Owners
Measures the effectiveness of
management’s use of equity funds
Higher is better, usually higher
than interest rate
Creditors
Management
Owners
Creditors
Management
Owners
Higher is better
The higher the ratio, the better the
investors’ expectation about the
company
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Activity Ratio
Ratios
Formula
Users
Comparing Standards
Basic Analysis
Inventory
Turnover
Ratio
Food: Turnover from 2 – 4
times a month
Cost of Sales
Management
Average Inventory
Beverages: Turnover from
1 – 4 times a month
Shows how quickly the
inventory is being used.
Although high turnover is
good, it can be an
indication of stockout
problems
Inventory
Holding
Period
Operating days for
the period
Management
Inventory turnover
for the period
Food: should be 15 days
at most and at least 1
week
Beverages: 1 month at
most and 1 week at least
Fixed Assets
Turnover
Ratio
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Sales Revenue
Average Fixed
Assets
For hotel, this ratio vary
from one half to two or
more per year.
Management For food service, usually
has a turnover of 4 – 5
times a year if the building
is being rented
Higher ratio means an
effective use of assets
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Operating Ratio
Ratios
Formula
Users
Food
(Beverage)
cost %
Food (Beverage) Cost
Food (Beverage) Revenue
Management
Comparing
Standards
Basic Analysis
-A standard
or a The difference should be
predetermined % investigated
Average Food
(Beverage)
Check
Food (Beverage) Revenue
Number of food covers
Management
This ratio sometimes are
calculated by each menu
items. Help to find out the
most attractive dishes to
guests & decide the menu
items
Seat Turnover
Guest Served
Seats Available
Management
Analyze the trend for
further improvement
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Operating Ratio
Ratios
Formula
Users
Basic Analysis
Average Room Rate
(Average Daily Rate)
ADR
Rooms Revenue
Rooms Occupied
Management
Calculate the ratio by each
market segment or by each
room type. Higher result is better
when the occupancy % stay the
same
Occupancy %
Rooms Occupied
Total Rooms
Management
High result is better when the
ADR stay the same
Revenue per Available
Room
(REVPAR)
Rooms Revenue
Total Rooms
Management
Look at the combined effect of
ADR and Occupancy % on the
total revenue, an improvement
on ADR and Occupancy %
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A company owns two restaurants with 100 seats in the same town. Operating results for the first
three months of the current year for restaurant A and B are as follows:
Restaurant A Restaurant B
A%
B%
Sales Revenue
$ 154,300
$ 206,100
Cost of sales
60,200
78,900
Gross margin
94,100
127,200
Wages expense
45,600
70,400
Supplies expense
12,700
16,800
Other direct costs
4,500
6,100
31,300
33,900
Rent Expense
6,500
9,000
Insurance expense
2,000
3,000
Other indirect expense
3,200
3,600
$ 19,600
$ 18,300
Direct Expenses
Contributory Income
Indirect Expenses
Operating Income
The owners of the two restaurants are concerned that Restaurant B reports higher sales revenue yet
produces a lower operating income than Restaurant Analyze this information by using appropriat
tool and comment on the results (what appears to require the attention of the owners?)
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ANSWER:
Restaurant A
Sales Revenue
Restaurant B
A%
B%
$ 154,300
$ 206,100
100
100
Cost of sales
60,200
78,900
39
38.3
Gross margin
94,100
127,200
61
61.7
Wages expense
45,600
70,400
29.6
29.6
Supplies expense
12,700
16,800
8.2
12.71
Other direct costs
4,500
6,100
2.9
3
31,300
33,900
20.3
16.4
Rent Expense
6,500
9,000
4.2
4.4
Insurance expense
2,000
3,000
1.3
1.5
Other indirect expense
3,200
3,600
2.1
1.7
$ 19,600
$ 18,300
12.7
8.9
Direct Expenses
Contributory Income
Indirect Expenses
Operating Income
The difference in Operating Income seems to be the supplies expense. B has
4.51% higher than A. Since both restaurants A&B are in the same town and have
the same size , the difference in supplies expense should be evaluated further.
The variance might be due to the difference in menu, service style, or supplies.
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