Financial Ratios
Cash Build Rate
Cash build for a fixed period of time, typically a month.
Cash Burn Rate
Cash burn for a fixed period of time, typically a month.
Cross-Sectional Analysis
Comparison of a venture's performance against another firm at the same point in time.
Net Working Capital
Current Assets minus Current Liabilities
Gross Profit Margin
Dividing the gross profit (net sales minus cost of goods sold) by the venture's net sales or revenues. Gross Profit Margin = (Net Sales-Cost of Goods Sold)/Net Sales
Operating Profit Margin
Dividing the venture's operating income, measured as the earnings before interest and taxes (EBIT), by the venture's net sales. If a company has 8% operating profit margin on its sales after covering production and other operating costs, and then can also cover financing costs (primarily interest expenses) and pay the tax bill, it will experience a net profit. Operating Profit Margin = EBIT/Net Sales
Interest
Dollar amount paid on the loan to a lender as compensation for making the loan.
Interest Coverage
Interest repayments represent the most frequent type of debt flow facing a borrower. As long as payments are made, the principal amount frequently can be rolled over with an existing or new lender. To calculate interest coverage, we divide a venture's earnings before interest, taxes, depreciation, and amortization (EBITDA) by the annual interest payment. Interest is paid before taxes, because depreciation and amortization do not involve the outflow of cash, we use earnings prior to both taxes and depreciation (and, of course, before interest). Interest Coverage = EBITDA/Interest. If a company has an Interest Coverage of 3.2, then this means that the company's interest before depreciation, interest, and taxes could have fallen to one-third of its current level without affecting its ability to pay interest.
Purchase-to-Payment Conversion Period
Measures the average time from a purchase of materials and labor to actual cash payment. The ability to delay payment is analogous to borrowing money from suppliers and employees and, therefore, decreases the need for external financing. Purchase-to-Payment Conversion Period = (Average Payables + Average Accrued Liabilities)/(Cost of Goods Sold/365). If a company has a Purchase-to-Payment Conversion Period that equals 77 days, then it has 77 days of the costs of production financed by trade credit and accrued wages and liabilities.
NOPAT
Net Operating Profit after Taxes or EBIT times one minus the firm's tax rate. NOPAT = EBIT(1 - Tax Rate) / Net Sales. This is the profit that each firm would have had in the absence of financial leverage - that is, after restating taxes to what they would be if interest were not tax deductible.
Net Cash Burn Rate
Net cash burn for a fixed period of time, typically a month.
Sinking-Fund Payments
Periodic repayments of a portion of debt principal.
Conversion Period Ratios
Ratios that indicate the average time it takes in days to convert certain current assets and current liability accounts into cash. Operating Cycle, Cash Conversion Cycle, Inventory-to-Sale Conversion Period, Sale-to-Cash Conversion Period, Purchase-to-Payment Conversion Period, Cash Conversion Cycle.
Leverage Ratios
Ratios that indicate the extent to which the venture has used debt and its ability to repay its debt obligations. Total-Debt-to-Total-Assets Ratio, Equity Multiplier, Debt-to-Equity Ratio, Current-Liabilities-to-Total-Debt, Interest Coverage, and Fixed-Charges Coverage.
Return on Assets (ROA)
Return on Assets = Net Income/Average Total Assets. If a company has a ROA of 5 percent, then that means that it earned 5 percent on its assets base.
Liquid Assets
Sum of a venture's cash and marketable securities plus its receivables.
Cash Conversion Cycle
Sum of the inventory-to-sale conversion (amount of time taken to buy materials and product a finished good) and the sale-to-cash conversion (time needed to collect sales made on credit) period less the time taken to pay suppliers for purchases on credit (purchase-to-payment conversion period). Indicates the average time it takes a venture to complete its operating cycle less a deduction for the days supported by trade credit. Cash Conversion Cycle = Inventory-to-Sale Conversion Period + Sale-to-Cash Conversion Period - Purchase-to-Payment Conversion Period.
Net Profit Margin
The bottom line for a company's owners is whether the company made a profit after all expenses have been taken into account. As a venture matures, a net income or net profit is an increasingly critical source of financing. Remember that net income is the first source of cash found in the statement of cash flows. Net Profit Margin = Net Income/Net Sales
Return on Equity (ROE)
This calculates the single-period returns using accounting information. For a venture organized as a corporation, owners' equity often is referred to as shareholders' equity, which may comprise a common stock account and accumulated retention of profits account referred to as retained earnings. ROE = Net Income/Average Owners' Equity. If a company earns 12.5 percent ROE, this means that generates a 12.5 return on its equity investments.
Price to Earnings Ratio (P/E)
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P/E to Growth Ratio (PEG)
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Price to Book
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Price to Cash Flow or Free Cash Flow
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Cash Burn
Cash a venture expends on its operating and financing expenses and its investments in assets.
Net Cash Burn
When cash burn exceeds cash build in a specified time period; also cash burn less cash build. Net Cash Burn = Cash Burn - Cash Build.
Current-Liabilities-to-Total-Debt Ratio
While a debt snapshot is useful, survival is about current debt obligations. Accounting rules have simplified this determination by requiring that the current portion of long-term debt obligations (that which is due soon) be classified as a current liability. The percent of total debt held in current liabilities therefore is a reasonable glimpse of the venture's reliance on debt that will soon require cash outflow. Other things being equal, the greater the ratio of current liabilities to total debt, the more quickly the venture faces payment or restructure of its outstanding debt. Current-Liabilities-to-Total-Debt Ratio = Average Current Liabilities/Average Total Debt. A high total-debt-to-total-assets ratio coupled with a high current-liabilities-to-total-debt ratio makes it more likely that the venture will encounter debt repayment problems.
Dividend Yield/Payout
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Capital Gains
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Inventory-to-Sale Conversion Period
= Average Inventories/(Cost of Goods Sold/365). When materials are purchased and labor is contributed, the associated costs are booked into the cost of inventories. When the products are completed and sold, the associated labor and material costs are subtracted from the inventory balance and added to the cost of goods sold. If the Inventory-to-Sale Conversion Period is 113 days, it means that it took 113 days to convert the purchase of materials into a sale of finished goods.
Debt-to-Equity Ratio
A direct comparison of debt and equity gives yet another view of the same scenery. For a total-debt-to-total-assets ratio of 0.5, we get an equity multiplier of 2 and a debt-to-equity ratio of 1. The debt-to-equity ratio equals total debt to total assets / (1 - total debts to total assets).
Current Ratio
A simple indication of the margin of current assets over Current Liabilities. Current Ratio = Average Current Assets/Average Current Liabilities. A Current Ratio of 1.0 or more indicates if all current assets could be converted into cash, they would be adequate to pay all current liabilities. A ratio of 1.37 indicates the current assets provide a 37% cushion over and above current liabilities.
Industry Comparables Analysis
Comparison of a venture's performance against the average performance of other firms in the same industry.
Operating Return on Assets
Every venture must be able to generate profits from operations if it is to survive. We can calculate the operating return on average assets, which is sometimes called the venture's basic earning power. Operating Return on Assets = EBIT/Average Total Assets. If a company has a Operating Return on Assets of 12 percent, this means that the company earned 12 percent on the average assets outstanding. The higher the venture's basic earning power, the more easily it can cover interest expenses, pay its taxes, and produce profits for its owners.
Trend Analysis
Examination of a venture's performance over time.
Sales-to-Total Assets Ratio
Ideally, it would be great for a company to be able to generate revenues without having to invest in any assets. The Sales-to-Total Assets Ratio tells you how many times your sales are covered by your Total Assets base. Sales-to-Total Assets = Net Sales/Average Total Assets. If a company has a Sales-to-Total Assets Ratio of 1.5, then the company can create sales of about 1.5 times the Total Assets base.
Fixed-Charges Coverage
Interest repayments often are not the only payments that need to be made to creditors. For instance, if a venture decides to rent or lease equipment or buildings, periodic (often monthly) payments must be made. Also, many debt arrangements stipulate that a portion of a loan's principal amount or balance must be regularly repaid. Rental or lease payments should be listed on the income statement before the tax line. It is easy for venture insiders to get data on the scheduled payments for debt. For venture outsiders who are looking at a company, this data may not be readily available and can pose a significant challenge to calculating a proper accurate fixed-charges coverage ratio. To calculate a companies Fixed-Charges Coverage, we divide the venture's EBITDA plus lease payments by the sum of interest payments, rental or lease payments, and the before-tax amount of earnings needed to make after-tax debt repayments. Fixed-Charges Coverage = (EBITDA + Lease Payments)/(Interest + Lease Payments + [Debt Repayments/(1 - Tax Rate)]). If the company has a value of 1.87, it can pay its fixed charges 1.87 times.
Quick Ratio
Measures the ability of liquid assets to pay current liabilities. Quick Ratio = (Average Current Assets - Average Inventories)/Average Current Liabilities. A Quick ratio of less than 1.0 indicates that the venture's liquid assets would not be adequate to pay off its current liabilities. If a companies quick ratio is .62, the company would be forced to liquidate inventory to make up the other .38.
Sale-to-Cash Conversion Period
Measures the average days of sales committed to the extension of trade credit. Sales-to-Cash Conversion Period = Average Receivables/(Net Sales/365). Analysts may refer to this calculation as the "days of sales outstanding" or the "average collection period". If the Sales-to-Cash Conversion Period is 57 days, then it takes a company 57 days to collect its credit sales.
NWC-to-Total-Assets
NWC-to-Total-Assets = (Average Current Assets - Average Current Liabilties)/Average Total Assets. The higher the percentage is, the greater the liquidity is, other things being equal.
Cash Build
Net Sales less the increase in Receivables. Cash Build = Net Sales - (Receivables t+1 - Receivables t)
Interest Tax Shield
Proportion of a venture's interest payment that is paid by the government because interest is deductible before taxes are paid. This is basically a gift from the government for using debt instead of equity.
Profitability and Efficiency Ratios
Ratios that indicate how efficiently a venture controls its expenses and uses its assets. Gross Profit Margin, Operating Profit Margin, Net Profit Margin, NOPAT Margin, Sales-to-Total-Assets, Operating Return on Assets, Return on Assets (ROA), Return on Equity (ROE).
Liquidity Ratios
Ratios that indicate the ability to pay short-term liabilities when they come due. Current Ratio, Quick Ratio, NWC to Total Assets Ratio.
Financial Ratios
Relationships between two or more financial variables or between financial variables and time.
ROA Model
The decomposition of ROA into the Product of the net profit margin and the sales-to-total-asset ratio. Return on Assets can be stated as ROA = (Net Income/Sales) x (Net Sales/Average Total Assets)
ROE Model
The decomposition of ROE into the product of the net profit margin, the sales-to-total assets ratio, and the equity multiplier. ROE = ROA * Equity Multiplier. ROA = Net Profit Margin x Asset Turnover. Asset Turnover = Net Sales/Average Total Assets. Equity Multipler = Average Total Assets/Average Owners' Equity.
Equity Multiplier
This ratio summarizes the venture's debt position from a different vantage point, total assets divided by owners' equity. It shows the magnification of equity injections into amount of assets. Equity Multipler = Average Total Assets/Average Owners' Equity. A value of 2 would mean that one-half of the book value of the venture's assets was financed by (the book value of) debt financial capital. If a company has a value of 2.6 times, this means that more assets are supported by debt than equity. Equity multiplier is just another way of reporting the total-debt-to-total-assets. Note that the equity multiplier equals 1/(1 - total debt to total assets).
Operating Cycle
Time it takes to purchase required materials, assemble, and sell the product plus the time needed to collect receivables if the sales are on credit. If the Sales-to-Cash Conversion Period equals 57 days, and the Inventory-to-Sale Conversion Period equals 113 days, then the Operating Cycle is 170 days.
Total-Debt-to-Total-Assets Ratio
Total-Debt-to-Total-Assets Ratio = Average Total Debt/Average Total Assets. By comparing a venture's total debt (current liabilities plus long-term debt) to its total assets, we can construct a quick picture of how much of the venture has been pledged to debt holders and how much is supported by equity. The more that has been pledged, the higher is the risk that a pledge will be broken. Subsequent to the broken pledge, the debt holders will control the enterprise. If a company has a Total-Debt-to-Total-Assets value of 61 percent, then according to the notion of (book) value, approximately 61 percent of that company was pledged to debt holders and other creditors. This leaves 39 percent to equity holders.
Price to Sales
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Loan Principal Amount
Dollar amount borrowed from a lender.
