B classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios; Flashcards
Classify, calculate, and interpret financial ratios
Activity, asset utilization, turnover, or operating efficiency
- Efficiency (asset management, utilization> working capital [inventory] and Long term [fixed assets] impacts liquidity)
- Indicates ongoing operational performance (effective asset use)
Most Common: Inventory Turnover, DOH, Recievables Turnover, DSO, Payables Turnover, Number of Days of Payables, Working Capital Turnover, Fixed Asset Turnover, Total Asset Turnover
Receivables Turnover = Credit Sales / Avg Accts Receivable Credit sales is a IS-CF item. Accts R. is a BS item. IS and BS item ratios means BS item is averaged. Rec. T ratio close to industry norm is desired. Avg. collection period, Days of Sales Outstanding (inverse of Receivables turnover) : Average number of days it takes for the companies customers to pay its bills = 365/recievables turnover Desirable: Industry norm. Too high: Customers are slow in paying their bills: too much capital is tied up in assets. Too Low?: Firms credit policy is too rigorous and sales are hampered. Inventory Turnover: COGS (not cost of sales)(IS) / Avg. Inventory (Avg because Inv is in BS): measures a firms efficiency with respect to its processing and inventory management 4. Days of Inventory on Hand = 365 / inventory turnover: average inventory processing period Desirable: Close to industry norm. Too High?: Too much capital is tied up in inventory, inventory may be obsolete. Too low?: The firm has inadequate stock on hand, could hurt sales. 5. A/P turnover = Cost of Sales / Avg Trade Payables: A measure of the use of trade credit. Where ‘Purchases’ = ending inventory - beginning inventory + COGS 6. Number of Days Payable, payables payment period (inverse payable turnover ratio): Average amount of time it takes the company to pay its bills = 365/payables turnover ratio 7. Total Asset Turnover = Net Sales / Avg Total Assets (How many $’s of sales generated for ev. $ assets) : Effectiveness of the firms use of its total assets to create revenue Desirable: Close to industry norm. Low: Too much capital tied up. too high: The firm has too few assets for potential sales or the asset base is outdated. 8. Working Capital Turnover = Net Sales / Average Working Capital : How effectively a company is using its working capital - info about the utilization of working capital in terms of dollars of sales per dollar of working capital. ex: A firm may have low working capital if outstanding payables equal or exceed inventory and receivables 9. Fixed Asset Turnover = Net Sales (revenue) / average net fixed assets : The utilization of fixed assets. Desired: Close to industry norm. Low: Company may have too much capital tied up in its asset base or is using the assets it has inefficiently. Too high?: The firm has obsolete equipment or the firm will probably have to incur capital expenditures in the near future to increase capacity to support growing revenues. “net” here refers to accumulated depreciation - firms w/ newly acquired assets will typically have lower fixed asset turnover ratios. Working Capital RAtio = Rev/ Avg working capital, utilization in terms of dollars of sales per dollars of working capital. (Varys wildy, less efficient about changes in the firms operating efficiency) Measures efficiency - below 1 is negative; CL > CA. WC > 2; company is not investing its excess assets. *Slow collection is not operationally efficient - money may be tied in inventory. Customers may still owe the firm money.
Liquidity (Indicates the ability to pay short term obligations as they come due)(Each ratio assumes a level of liquidity of CA’s used to pay current liabilities)
in order of strictness Current RAtio = CA/CL. Higher than 1 is better. -CA/CL indicates a liquidity crisis; inability to pay short term debt. Quick Ratio: Cash + ‘Market sec’(liquid, good credit quality;ST debt instruments) + Receivables / CL’s. Cash Ratio: Cash + Mrktble Securities / CLs’ Defensive Interval Ratio = Cash + Marketable + Receivables / ‘Avg Daily Expenditures’ (COGS exp, SGA, R&D) Cash Conversion Cycle = T to turn ‘cash investment in inventory’ back into cash in the form of ‘collections from the sales of that inventory’ = DAys of Sales outstanding + Days of Inv on Hand - Number of days payable. High CCcycle = bad; Too much capital investment in the sales process.
Solvency (Indicates a firm’s financial leverage and the ability to meet longer term obligations; use of debt financing)(includes debt ratios;BS , and coverage ratios; IS)(greater debt usage increases financial leverage; risk to equity and bond holders)(Consider variability of CF’s in solvency ratio analysis; more stable = better)
Debt to Equity: ‘Total Debt’;LT + interest paying ST / Total Shareholders Equity; use of ‘fixed-cost financing’; debt…sources. Lvrg ratio; reliance on debt relative to SE as a source of financing Debt-to-‘capital’;total debt + total SE… ratio = Total Debt / Total debt + ‘total SE’; preferred + common. Suggests reliance on debt as a source of financing. Debt-to-assets ratio; debt utilization = Total debt / Total assets; reliance on debt Financial Leverage Ratio; Leverage Ratio = Average Total Assets / Average Total Equity Abilities to Repay Debt Obligations Interest Coverage Ratio = EBIT / Interest Payments. Lower indicates risk Fixed Charge Coverage; indicates a company’s ability to meet its obligations = EBIT + Lease Payments / interest payments + lease payments; meaningful for airlines; companies that leave a large portion of their assets
Profitability ( Indicates how well the company generates operating profits and net profits from its sales; overall performance relative to revenues, assets, equity, capital)
Net Profit Margin = ratio of net income to revenue = net income / revenue. Base it on NI from cont. ops in order to expect the future. Below the line items; discont. ops, won’t affect future perf. **Operating Profitability ratios**; Can management turn effort into profit?; compares ‘top of the income statement; sales…to profits. *Different ratios isolate specific costs. Gross profits = net sales - COGS Operating Profits = EBIT Net Inc = EArnings After T’s but before Div’s Total Capital = Long-term debt + ST debt + common and preferred equity Total Capital = Total Assets Total cap v. Total cap, diff = working cap liabilities, could be viewed as a source of financing, or the sum of a firms debt and equity Gross Profit Margin; ratio of gross profit (sales - COGS) to ‘sales’;revenue = GP / Revenue. *GP can be + by +P or -Costs, but +P is limited by competition. Operating Profit Margin; ratio of ‘Op. Profit’; GP - SG&A;EBIT to sales = Op Inc or EBIT / Rev *EBIT may inc. non-op items; Gains on investment - so be consistent in calculation Pretax Margin; ‘EBT’; EBIT - interest, or Op earnings - interest = EBT / Rev Profitability measures relative to funds invested in the company by common stockholders, preffered stockholders, and suppliers of bedt financing ROA = Net Inc / Avg Total Assets ROA is misleading. 1. Int is excluded from NI (although total assets include interest bearing debt), so…to fix, add back gross interest expense Corrected ROA = NI + Interest exp (1-tax rate) / avg. total assets A ROA that includes T’s and int.; Operating Return on Assets = Op. Inc, or EBIT / Avg total Assets Return on Total Capital;ROTC; ratio of NI before interest and taxes to total capital = EBIT / Avg total capital ROE; Ratio of NI to avg. total equity (including preferred stock) = NI / avg total equity ROCE;Return on COMMON equity = NI - preff / Avg common eq. = NI available to common / avg. common eq.; measures accounting profits available to and the capital invested by common stockholders.; DuPont decomposition for through analysis.
Valuation (Use in comparing the relative valuation of companies)
Sales per share EPS Price to CF / share
How Op. Profitability ratios relate in the income statements
Net sales - COGS = GP GP - Op. exp’s = Op. Profit (EBIT) Op. Profit (EBIT) - Interest = EBT EBT - Taxes = Earnings After Taxes EAT EAT +/- Below the line items adjusted for tax = net income Net income - Preferred div. = inc. available to common
