CHAPTER THREE :

FINANCIAL RATIOS ANALYSIS &

FINANCIAL PLANNING
[5] FINANCIAL RATIOS
The most common used ratios under the following classifications:

• Liquidity ratios.

• Activity ratios.

• Debt / Leverage ratios.

• Profitability ratios.

• Market Ratios.

2
Ex . National food Company Income Statement
Notes:
1-Common stock dividends for year 2020 was L.E 300,000, and for
year 2019 L.E 200,000.
2-Outstanding number of common stock shares was 1,500,000 shares
for year 2020 and 1,200,000 shares for year 2019.
3- The market price per share at the end of year 2019 was L.E. 5.25,
year 2020 was EGP 6.25.
4-purchases equaled 70 Percent of its cost of goods sold.
Debt / Leverage Ratios
■ The term debt ratio refers to a financial ratio that measures the extent of a company's
leverage..

■ A leverage ratio is any kind of financial ratio that indicates the level of debt

■ Leverage refers to the proportion of a company's capital that has been contributed by
investors as compared to creditors.

■ In other words, leverage is the extent to which a company has depended upon borrowing to
finance its operations (the firm use of debt financing).

■ A high leverage ratio may increase a company's exposure to risk and business downturns,
but along with this higher risk also comes the potential for higher returns.
Calculating and interpreting financial ratios
The kind of The measurements The interpretation
ratios
Debt/ Debt ratio = Total liabilities / Total assets The total-debt-to-total-assets ratio shows
Leverage Total liabilities = long term liabilities + current liabilities the degree to which a company has used
Ratios debt to finance its assets.
Measures a firm's degree of leverage.
Companies with higher levels of
liabilities compared with assets are
considered highly leveraged and more
risky for lenders.
Equity multiplier (EM) = Total assets / common stock equity Financial ratio that measures how much
of a company's assets are financed
through stockholders' equity rather than
by debt.
The percentage of assets that are
financed by the shareholders.
Times interest earned ratio = EBIT / Interest Testing the ability of the firm to pay
interest.
Measure of a company's ability to meet
its debt obligations based on its current
income.
 1. Debt / Leverage Ratios
1- Debt ratio
Debt ratio = Total liabilities / Total assets
Indicates the degree to which a company has used debt to finance its assets.
Measure of the company's assets that are financed by debt rather than equity.
Total liabilities = long term liabilities + current liabilities
In 2019, Total current liabilities + long term debts = 1932000 +3868000= 5800000
In 2020, Total current liabilities + long term debts = 2480000 + 4092000 = 6572000
The company ratio
2019 2020
5800000 / 13080000 6572000 / 14388000
= 44.3 % = 45.68 %

This means that 2019 is better than 2020 because the ratio of debt financing is lower.
■ This value indicates that the company has financed close to half of its assets with debt, and
this value increased in the year 2020 compared to the year 2019, which generate more risk to the
company.
 2- Equity multiplier (EM)

Equity multiplier (EM) = Total assets / common stock equity

Measures the amount of a firm’s assets that are financed by its shareholders.
The percentage of assets that are financed or owed by the shareholders.

The company ratio

2019 2020
13080000 / 7280000 14388000 / 7816000
= 1.796 times = 1.84 times

This means that the ratio of equity to assets in 2019 is better than in 2020
 3- Times interest earned ratio
Times interest earned ratio =(Operating profit) EBIT / Interest
Measure of a company's ability to meet its debt obligations based on its current
income.
The number of times that a company could pay off its interest expense using its
operating income

The company ratio

2019 2020
212000 / 364000 1672000 / 372000
= 3.33 times = 4.49 times

■ This means that 2020 is better than 2019 because the number of times interest is covered is
greater.
 4-Profitability Ratios
■ Profitability refers to management's performance in using the resources of a
business.

■ Profitability ratios are measures of performance that indicate what the firm is
earning on its sales or assets or equity.

■ Many measures of profitability involve calculating the financial return that

the company earns on the money that has been invested.
Profitability Ratios
■ These ratios measure how well a company performs in generating a profit. Few
profitability ratios are as follows:

 Gross profit margin: Shows revenues minus the cost of goods sold, as a proportion of
sales

 Operating profit margin : Shows the Operating profit as a proportion of sales.

Operating income is defined as earnings before interest and taxes (EBIT)

 Net profit margin : Shows net income as a proportion of sales.

 1- Gross Profit Margin

Gross profit margin= gross profits / sales

The company ratio

2019 2020
3424000 / 10268000 3944000 / 12296000
= 33.3 % = 32.1 %

This means that the contribution of units sold to profit in 2019 is better than in 2020
 2- Operating profit margin

Operating profit margin= operating profits / sales

The company ratio

2019 2020
1212000 / 10268000 1672000 / 12296000
= 11.8% = 13.6 %
This means that the operating profit compared to sales in 2020 is better than in 2019.
3- Net profit margin

Net profit margin= Earnings available for common stockholders / sales

Note : Earnings Available For Common Stockholders or Net Profit After Tax

The company ratio

2019 2020
592000 / 10268000 924000 / 12296000
= 5.8 % = 7.5%

This means that the percentage of net profit for sales in 2020 is better than in 2019,
and this is due either to an increase in sales or a decrease in costs.
4- Return on total assets (ROA)

Return on total assets = Earnings available for common stockholders / total assets
Note : Earnings Available For Common Stockholders or Net Profit After Tax

The company ratio

2019 2020
592000 / 13080000 924000 / 14388000
= 4.5 % = 6.42 %
This rate refers to the profitability of the pound that is invested in this company, and it
turns out that the profitability of the pound that was invested in 2020 is better than in
2019.
5- Return on Equity (ROE)

Return on total Equity = Earnings available for common stockholders / Common Stock Equity
Note : Earnings Available For Common Stockholders or Net Profit After Tax

The company ratio

2019 2020
592000 / 7280000 924000 / 7816000
= 8.13 % = 11.82 %

■ This rate indicates the profitability of the pound that is invested in this company from the
owners’ money, and it becomes clear that the profitability of the pound that was invested from
the owners’ money in 2020 is better than in 2019.
 5. MARKET RATIOS:
1- Price/ Earnings (P/E) Ratio
Price Earnings (P.E) Ratio = Market price per share of common stock /Earnings per
share
𝑬𝒂𝒓𝒏𝒊𝒏𝒈𝒔 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆(𝑬𝑷𝑺) = 𝑬𝒂𝒓𝒏𝒊𝒏𝒈𝒔 𝒂𝒗𝒂𝒊𝒍𝒂𝒃𝒍𝒆 𝒇𝒐𝒓 𝒄𝒐𝒎𝒎𝒐𝒏 𝒔𝒕𝒐𝒄𝒌𝒉𝒐𝒍𝒅𝒆𝒓𝒔 /
𝑵𝒐. 𝒐𝒇 𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈 𝒄𝒐𝒎𝒎𝒐𝒏 𝒔𝒕𝒐𝒄𝒌

In 2019, 𝑬𝒂𝒓𝒏𝒊𝒏𝒈𝒔 𝒂𝒗𝒂𝒊𝒍𝒂𝒃𝒍𝒆 𝒇𝒐𝒓 𝒄𝒐𝒎𝒎𝒐𝒏 𝒔𝒕𝒐𝒄𝒌𝒉𝒐𝒍𝒅𝒆𝒓𝒔 592000 , 𝑵𝒐. 𝒐𝒇

𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈 𝒄𝒐𝒎𝒎𝒐𝒏 𝒔𝒕𝒐𝒄𝒌 1200000
■ 𝑬𝒂𝒓𝒏𝒊𝒏𝒈𝒔 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆(𝑬𝑷𝑺) = 592000 / 1200000 = L.E. 0.493

In 2020, 𝑬𝒂𝒓𝒏𝒊𝒏𝒈𝒔 𝒂𝒗𝒂𝒊𝒍𝒂𝒃𝒍𝒆 𝒇𝒐𝒓 𝒄𝒐𝒎𝒎𝒐𝒏 𝒔𝒕𝒐𝒄𝒌𝒉𝒐𝒍𝒅𝒆𝒓𝒔 924000 , 𝑵𝒐. 𝒐𝒇

𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈 𝒄𝒐𝒎𝒎𝒐𝒏 𝒔𝒕𝒐𝒄𝒌 1500000
■ 𝑬𝒂𝒓𝒏𝒊𝒏𝒈𝒔 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆(𝑬𝑷𝑺) = 924000 / 1500000 = L.E. 0.616
 5. MARKET RATIOS:
1- Price/ Earnings (P/E) Ratio
The market price per share at the end of year 2020 was L.E. 6.25 , year 2019
was L.E. 5.
The company ratio
2019 2020
5.25 / 0.493 6.25 / 0.616
= 10.649 times = 10.146 Times

This means that the P/E ratio is better in 2019 than in 2020
Or in other words, The investor is willing to pay an amount greater than the current price of the stock
to obtain the pound return
 2- Price /Book Value (P/BV) ratio

Price /Book Value (P/BV) ratio= Market price per share /book value per share

Book value per share (BV)= 𝒄𝒐𝒎𝒎𝒐𝒏 𝒔𝒕𝒐𝒄𝒌 equity / 𝑵𝒐. 𝒐𝒇 𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈 𝒄𝒐𝒎𝒎𝒐𝒏
𝒔𝒕𝒐𝒄𝒌

𝒄𝒐𝒎𝒎𝒐𝒏 𝒔𝒕𝒐𝒄𝒌 equity= Total stockholders’ Equity

In 2019, 𝒄𝒐𝒎𝒎𝒐𝒏 𝒔𝒕𝒐𝒄𝒌 equity 7280000 , 𝑵𝒐. 𝒐𝒇 𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈 𝒄𝒐𝒎𝒎𝒐𝒏 𝒔𝒕𝒐𝒄𝒌

1200000
■ Book value per share (BV) = 7280000 / 1200000 = 6.07

In 2020, 𝒄𝒐𝒎𝒎𝒐𝒏 𝒔𝒕𝒐𝒄𝒌 equity 7816000 , 𝑵𝒐. 𝒐𝒇 𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈 𝒄𝒐𝒎𝒎𝒐𝒏 𝒔𝒕𝒐𝒄𝒌

1500000
■ Book value per share (BV)= 7816000 / 1500000 = L.E. 5.21
 2- Price /Book Value (P/BV) ratio

The company ratio

2019 2020
5.25 / 6.07 6.25 / 5.21
= 0.865 Times = 1.199 Times

This means that the P/BV ratio is better in 2020 than in 2019

In other words, the stock price in the market is greater than the book value in 2020
than in 2019
 3- Dividends Yield Ratio

Dividends Yield Ratio. = Annual dividends per share /stock price

Dividends per share (DPS)= Dividends paid during the period/ 𝑵𝒐. 𝒐𝒇 𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈
𝒄𝒐𝒎𝒎𝒐𝒏 𝒔𝒕𝒐𝒄𝒌

In 2019, Dividends paid during the period 200000 , 𝑵𝒐. 𝒐𝒇 𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈 𝒄𝒐𝒎𝒎𝒐𝒏
𝒔𝒕𝒐𝒄𝒌 1200000

■ Dividends per share (DPS)= L.E. 0.166 / share

In 2020, Dividends paid during the period 300000 , 𝑵𝒐. 𝒐𝒇 𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈 𝒄𝒐𝒎𝒎𝒐𝒏
𝒔𝒕𝒐𝒄𝒌 1500000

■ Dividends per share (DPS)= L.E. 0.20 / share

 3- Dividends Yield Ratio

The company ratio

2019 2020
0.166 / 5.25 0.20 / 6.25
= 3.16 = 3.2 %

This means that what the investor gets from the dividends compared to the share
price in 2020 is better than in 2019.