Financial Ratio Analysis


To be of any value, the ratio of a particular operation or business should be compared to other operations or businesses. To illustrate how ratios can be used as measurement tools, let us examine the following table and compare Eastman's 12 ratios to those of the industry in general.

By looking at the table below, it is possible to see whether Eastman's management should be satisfied or concerned about the financial structure and profitability position of its business.

On liquidity, Eastman appears to be in a difficult position compared to the industry. Maybe there is no reason for concern if the company is able to meet its current commitments on time. If the current ratio were too high, say 3.5 or 4.0, it could mean that the company had money tied up in assets that had low earning power, since cash or marketable securities are low profit generators. A high liquidity ratio could also mean that management should reduce inventories and accounts receivable, and put the proceeds to more productive uses.

On leverage, the company appears to be in a more precarious position than industry. This means that the creditors are more exposed; that is, they bear a greater amount of risk. Although Eastman has a higher debt ratio, its fixed debt commitments are better than industry (7.0 compared to 6.0), Nevertheless, the high debt-to-total-assets ratio suggests that Eastman has reached, if not exceeded, its borrowing capacity.

On activity ratios, Eastman is doing a good job with the management of its current assets, but shows signs of weakness in the administration of the fixed and total assets. Both the average collection period and the inventory turnover indicate that management is keeping the accounts receivable and inventory at minimum levels. These ratios are also in line with the liquidity ratios which deal with the current portion of the assets shown on the balance sheet. The fixed assets turnover and total assets turnover indicate that, overall, the business has too many assets (mainly capital assets) for the level of sales. It also means that the capital assets are not working hard enough. The only way to correct this situation is by increasing sales or by liquidating (if possible) some of its capital assets.

On profitability, Eastman is doing well on all counts. Profit margin and income after taxes in relation to sales, assets, or equity is healthy The profit level is particularly encouraging, despite the fact that capital assets and debt burden are higher than industry.



Ratios Eastman
Technologies Inc.
A. Liquidity Ratios    
1. Current ratio (times) 1.35 2.00
2. Quick ratio (times) 0.86 1.25
B. Leverage Ratios    
3. Debt to total assets (%) 0.69 0.55
4. Times interest earned (times) 7.0 6.0
5. Fixed charges coverage (times) 4.82 4.12
C. Activity Ratios    
6. Average collection period (days) 44 53
7. Inventory turnover (times) 8.7 6.3
8. Fixed assets turnover (times) 2.1 4.3
9. Total assets turnover (times) 1.4 2.1
D. Profitability Ratios    
10. Profit margin on sales (%) 8.4 6.2
11. Return on total assets (%) 5.4 4.4
12. Return on equity (%) 17.6 14.3

Financial ratio analysis