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Financial Ratios

1.0     Investment Decisions

         Efficiency Ratios

ASSETS TURNOVER RATIO Sales

 

Total Assets at Start of the Year

 

OR

 

Sales

 

Average Total Assets

 

Shows how much sales are generated by each dollar of total assets, and therefore it measure how hard is the firm’s assets are working.

 

 

 

 

 

RECEIVABLES TURNOVER Sales

 

Acct Receivables Start of the Year

 

Measures the firm’s sales as  a multiple of its receivables. Means, how quickly receivables are collected.
INVENTORY TURNOVER RATIO Costs of Goods Sold

 

Inventory at Start of the Year

 

Measure how quickly inventory sells
AVERAGE DAYS IN INVENTORY Inventory Start of the Year

x 365

Daily COGS

 

Measure to look at how many days of output are represented by the daily COGS

 

AVERAGE COLLECTION PERIOD Acct Receivable Start of the Year

x 365

Sales

It measures the number of days it takes to collect its bills.

 

Profitability Ratios

RETURN ON CAPITAL (ROC) After-Tax Operating Income

 

Average Total Capitalization

 

*After-Tax Operating Income = Net Income + Interest Expense (interest expense = interest (1-tax rate)

* Average Total Capitalization = LT Debt + Shareholder’s Equity

 

Measures how well the firm uses its capital to generate income
RETURN ON ASSETS (ROA) After-Tax Operating Income

 

Average Total Assets

 

*After-Tax Operating Income = Net Income + Interest Expense (interest expense = interest (1-tax rate)

 

OR

After-Tax Operating Income

 

Total Assets Start of the Year

 

Measures how well the firm uses its assets to generate income
RETURN ON EQUITY (ROE) Net Income

Average Total Equity

 

OR

 

Net Income

 

Total Equity Start of the Year

 

 

Measured the return of income to shareholders per dollar they have invested
PROFIT MARGIN Net Income

 

Sales

 

Measures how much out of every dollar of sales a company actually keeps in earnings

 

OPERATING PROFIT MARGIN Net Income + After Tax Interest

Sales

 

Measurement of what proportion of a company’s revenue is left over after paying for variable costs of production such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs, such as interest on debt.

 

DU PONT SYSTEM (ROA) Sales              After-Tax Operating Income

X

Assets                          Sales

 

 

 

After – Tax Operating Income

=

Assets

 

DU PONT SYSTEM (ROE) Net Profit              Sales                    Assets

X                         X

Sales                    Assets                   Equity

 

Net Profit

=

Equity

The higher the ROE, the better. But a higher ROE does not necessarily mean better financial performance of the company. As shown above, in the DuPont formula, the higher ROE can be the result of high financial leverage, but too high financial leverage is dangerous for a company’s solvency.

2.0     Financing Decisions

Leverage Ratios

LONG TERM DEBT RATIO quick ratio Long Term Debt

 

Long Term Debt + Equity

 

Represents the financial position of the company and the company’s ability to meet all its financial requirements. It shows the percentage of a company’s assets that are financed with loans and other financial obligations that last over a year.
LONG TERM DEBT EQUITY RATIO Long Term Debt

 

Equity

 

A long term debt to capitalization ratio which is greater than 1.0 indicates that the business has more debts than capital which is not a good thing for a business as it can lead to lots of financial problems, especially the company getting bankrupt. A high long term debt to capitalization ratio would indicate the financial weakness of the firm and the debt would most likely increase the risk of the company.
TOTAL DEBT RATIO Total Liabilities

 

Total Assets

 

Measures Percentage of assets financed by creditors; indicates relative size of the equity portion.
TIMES INTEREST EARNED EBIT

Interest Payments

 

Also known as the Interest Coverage Ratio is a measure of profit relative to interest expense. Essentially, it counts the number of times a business’ interest expense is met by its EBIT (earnings before interest and tax). It is an indicator of the serviceability of a business’ debt.

The higher the result, the easier it is for the business to meet its interest payments.

 

CASH COVERAGE RATIO EBIT + Depreciation

 

Interest Payments

is useful for determining the amount of cash available to pay for interest, and is expressed as a ratio of the cash available to the amount of interest to be paid. The ratio should be substantially greater than 1:1.

 

Liquidity Ratios

NET WORKING CAPITAL TO TOTAL ASSETS RATIO Net Working Capital

 

Total Assets

 

* NWC = Current Assets – Current Liabilities

Is a liquidity ratio that expresses the net current assets or working capital of a company as a percentage of its total assets.
CURRENT RATIO Current Assets

 

Current Liabilities

 

The current ratio measures whether or not a firm has enough resources to pay its debts over the next 12 months.
QUICK RATIO / ACID – TEST RATIO Cash + Marketable Securities + Receivables

 

Current Liabilities

 

If the value of the acid-term ratio is less than 1, then it is said that such a company is not stable and may face difficulty is paying off their debts (short term). In order to clear the short term debts they probably would need to sell some of their assets. But such an option affects the overall position of the company because if the company owns very little assets.
CASH RATIO Cash + Marketable Securities

 

Current Liabilities

 

It only looks at the company’s most liquid short-term assets – cash and cash equivalents– which can be most easily used to pay off current obligations.

 

 

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