Financial ratios computation

A, B, C, and D are coefficients computed with a statistics program. E is the discriminatory value (cutoff value) with a positive sign. If the financial ratios of a corporation are now entered in this function, a function value will be the result. If this value is above the discriminatory value, the credit quality of this corporation is assessed as good. The rough division of corporations into two classes of good and poor credit quality is refined in the following section. 

Financial statements were explained in detail in Chapter 3, providing a foundation to understand ratio analysis. This chapter will introduce many of the common financial performance ratios that executives and analysts use. In addition, the chapter will explain how to compute ratios, what information the ratios offer for decision making, and how to consider multiple factors that are critical to fully understanding the ratios. In subsequent chapters, how operations and supply chain ratios affect and influence financial ratios will be examined. Operations ratios, after all, are used to ensure that financial performance meets the e q)ectations of creditors, investors, and executives. Ultimately, these ratios provide information about an organization s financial health and ability to continue operations. 

The annual financial reports of public companies contain estimates of total firm profit rates based on accounting records. For example, the net income as a percent of the total book value of assets27 is a commonly used benchmark of firm profitability (301). Companies themselves report this ratio in their annual financial statements and compare their performance in specific years with that in previous years. Other commonly used profit ratios, such as net income as a percent of sales, are also easily computed from company financial statements. 

The chapter starts by introducing the basic concepts of an economic analysis, as prices, breakdown of the capital and manufacturing costs, profit, as well as the formation of cash flow. Because the time-value of money plays a central role the next section presents some basic elements of financial methods. Two other sections deal with the detailed estimation of capital and operation costs. Simplified equations based on typically cost ratios can be used for quick estimations. These ratios are also helpful for the control of more detailed computations. The chapter ends with a more detailed description of the profitability analysis, both by traditional and modem methods. Note that the methods developed in this chapter can be applied using spreadsheets. 

The analysis of the performance and financial condition of a company is carried out by computing several ratios fi om information given in its annual report. Such analysis must be done carefully because seemingly good performance might be due more to such factors as inflation and reduction of inventory than to improvements in company operations. 

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