Lecture 3:
RATIO ANALYSIS
USING FINANCIAL STATEMENTS
Dr. Jay H. Jung
Senior Lecturer in Accounting
1
,Review on Lecture #2
Q1) What are the internal sources of short-term
finance for businesses?
Reducing inventory levels
Delaying payment to trade payables (i.e., money owed to
lenders)
Tightening credit control
Redundancies (layoffs)
Q2) What are the advantages of being listed on the
stock market?
Easy to raise funds at a lower cost
Attract more investors, employees, and customers (due to
visibility)
2
,Overview of Lecture #3
Today, we will cover:
Understanding ratios
• Use of ratios
• Misuse of ratios
• Limitations of ratio analyses
The need for comparison (Benchmarks)
• Past periods
• Similar businesses
• Forecasted performance
Ratio analyses and applications
• Profitability, efficiency, liquidity, financial gearing, and
investment
• DuPont analysis
• Case Study – Amazon, Walmart, Stitch Fix
3
, Q) Which company is more profitable?
Firm A Firm B
Operating profit
£1 million £8 million
(A)
Total assets (B) £10 million £100 million
10%
=A/B (more 8%
profitable)
A) Firm A
For each £1 of total assets, Firm A generates £0.10
(10%) in profits whereas Firm B generates £0.08
(8%) in profits.
It is important to control for different scales
using a ratio. 4
RATIO ANALYSIS
USING FINANCIAL STATEMENTS
Dr. Jay H. Jung
Senior Lecturer in Accounting
1
,Review on Lecture #2
Q1) What are the internal sources of short-term
finance for businesses?
Reducing inventory levels
Delaying payment to trade payables (i.e., money owed to
lenders)
Tightening credit control
Redundancies (layoffs)
Q2) What are the advantages of being listed on the
stock market?
Easy to raise funds at a lower cost
Attract more investors, employees, and customers (due to
visibility)
2
,Overview of Lecture #3
Today, we will cover:
Understanding ratios
• Use of ratios
• Misuse of ratios
• Limitations of ratio analyses
The need for comparison (Benchmarks)
• Past periods
• Similar businesses
• Forecasted performance
Ratio analyses and applications
• Profitability, efficiency, liquidity, financial gearing, and
investment
• DuPont analysis
• Case Study – Amazon, Walmart, Stitch Fix
3
, Q) Which company is more profitable?
Firm A Firm B
Operating profit
£1 million £8 million
(A)
Total assets (B) £10 million £100 million
10%
=A/B (more 8%
profitable)
A) Firm A
For each £1 of total assets, Firm A generates £0.10
(10%) in profits whereas Firm B generates £0.08
(8%) in profits.
It is important to control for different scales
using a ratio. 4
