Finance 101 Part 2 Chapter 4
Economic Value Added (EVA)
the amount by which company profits (revenues, minus expenses, minus taxes) exceed the cost of capital in a given year
Comparison to Industry Average
to compare the company's key ratios to the industry averages
Inventory Turnover Ratio
cost of goods sold/average inventory This ratio is calculated by dividing sales by inventories. these ratios show how many times the particular asset is "turned over" during the year. Here is the inventory turnover ratio:
factors, as summarized by the American Association of Individual Investors (AAII), include the following
pG 154
Information on financial data online:
pG: 131
Which is the second Liquidity Ratio? Example: PG 132
quick, or acid test, ratio: This ratio is calculated by deducting inventories from current assets and then dividing the remainder by current liabilities.
6. Tying the Ratios Together: The DuPont Equation PG: 144
r to determine the ROE. For this, we use the DuPont equation, a formula developed by the chemical giant's financial staff in the 1920s. 1. DuPont Equation
What 3 factors does EVA depend on?
rate of return, as reflected in ROE; risk, which affects the cost of equity; and size, which is measured by the equity employed.
What Ratio is the industry average?
ratio 4.2
liquid assets
An asset that can be converted to cash quickly without having to reduce the asset's price very much.
ratio analysis
An evaluation of the relationship among selected financial statement data, expressed in terms of either a percentage, a rate, or a simple proportion.
What are the total debt managements?
1. The ratio of total debt to total capital. 2. Times-InterestEarned (TIE) Ratio
4. Profitability Ratios pg: 139
1. operating margin 2. return on sales (ROS) 3. return on assets 4. return on equity (ROE) 5. return on invested capital (ROIC) 6. e basic earning power (BEP) ratio i profitability ratios, which reflect the net result of all of the firm's financing policies and operating decisions.
Name the 4 ways to use excell?
1. As a financial calculator. 2. To modify the work when things change. 3. Sensitivity analysis. 4. Risk assessments
Name the asset management ratios:
1. Inventory turnover ratio 2. Days Sales Outstanding (DSO) Ratio 3. Fixed Assets Turnover Ratio 4. Total Assets Turnover Ratio
Name the 5 categories into what ratios are divided:
1. Liquidity ratios, which give an idea of the firm's ability to pay off debts that are maturing within a year. 2. Asset management ratios, which give an idea of how efficiently the firm is using its assets. 3. Debt management ratios, which give an idea of how the firm has financed its assets as well as the firm's ability to repay its long-term debt. 4. Profitability ratios, which give an idea of how profitably the firm is operating and utilizing its assets. 5. Market value ratios, which give an idea of what investors think about the firm and its future prospects.
Ratios can provide information but they also have limitations we will mention some of the problems.
1. ratio analysis is more useful for narrowly focused firms than for multidivisional ones 2. As a target for high-level performance, it is best to focus on the industry leaders' ratios. Benchmarking helps in this regard. 3. Because of inflation that affects, value depreciation etc ratio analysis for one firm over time or a comparative analysis of firms of different ages must be interpreted with care and judgment. 4. Seasonal factors can also distort a ratio analysis. This problem can be mitigated by using monthly averages for inventory (and receivables) when calculating turnover ratios. 5. "Window Dressing" Techniques Techniques employed by firms to make their financial statements look better than they really are. 6. inventory valuation and depreciation methods can affect financial statements and thus distort comparisons among firms. 7. leasing can artificially improve both turnover and the debt ratios because leasing does not appear on the balance sheet as DEBT and this could improve the income. 8. Ratios is difficult to tell if they are bad or good. For example excess cash in the bank may look good, but it may also tell you theres non earning asset.
8. Uses and Limitations of Ratios pg. 151
: (1) managers, who use ratios to help analyze, control, and thus improve their firms' operations; (2) credit analysts, including bank loan officers and bond rating analysts, who analyze ratios to help judge a company's ability to repay its debts; and (3) stock analysts, who are interested in a company's efficiency, risk, and growth prospects
trend analysis
An analysis of a firm's financial ratios over time; used to estimate the likelihood of improvement or deterioration in its financial condition
2. Asset management ratios Pg 132
A set of ratios that measure how effectively a firm is managing its assets. These ratios answer this question: Does the amount of each type of asset seem reasonable, too high, or too low in view of current and projected sales?
3. Debt Mananagement Ratios PG: 135
A set of ratios that measure how effectively a firm manages its debt.
What does turnover mean?
Annual sales divided by inventory equaled turnover, or trips per year. example: If he made 10 trips per year, stocked 100 pots and pans, and made a gross profit of $5 per item, his annual gross profit was (100) ($5) (10) = $5,000.
Benchmarking
Comparing an organization's practices, processes, and products against the world's best.
Which are the 2 most common liquidity ratios?
Current ratios: This ratio is calculated by dividing current assets by current liabilities. It indicates the extent to which current liabilities are covered by those assets expected to be converted to cash in the near future. Liquidity ratios : Ratios that show the relationship of a firm's cash and other current assets to its current liabilities.
Basic Earning Power (BEP) Ratio
EBIT/Total Assets This ratio indicates the ability of the firm's assets to generate operating income; it is calculated by dividing EBIT by total assets.
How is EVA different from ROE?
EVA is different from traditional accounting profit because EVA reflects the cost of equity as well as the cost of debt.
What is the Industry average ratio?
Industry average ratio: 2.2
Which is the least liquid of the firm's current assets?
Inventories
Economic value formula
Investment center's after-tax operating income - investment charge
8. Using Financial Ratios to Assess Performance pg; 148
Its hard to see companies performance by just looking at the ratios this is why there's different approaches like benchmarks to do this: 1. COMPARISON TO INDUSTRY AVERAGE 2. BENCHMARKING 3. TREND ANALYSIS
1. Liquidity Ratios
Measures of the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash.
DuPont Equation (ROE) pg 144
Net Income / Sales X Sales / Total Assets X Assets / Equity or Net Margin X TAT X FLR A formula that shows that the rate of return on equity can be found as the product of profit margin, total assets turnover, and the equity multiplier. It shows the relationships among asset management, debt management, and profitability ratios. Example: pg 144
Return on Total Assets (ROA)
Net Income/Total Assets The ratio of net income to total assets.
Return on Invested Capital (ROIC) [Formula]
ROIC = (EBIT - Taxes) / Invested Capital The ratio of after-tax operating income to total invested capital; it measures the total return that the company has provided for its investors. Example: 141
5. Market value ratios pg 141
Ratios that relate the firm's stock price to its earnings and book value per share. The market value ratios are used in three primary ways: (1) by investors when they are deciding to buy or sell a stock, (2) by investment bankers when they are setting the share price for a new stock issue (an IPO), and (3) by firms when they are deciding how much to offer for another firm in a potential merger. 1. Price/Earnings (P/E) Ratio 2. MARKET/BOOK RATIO
ROE
Return on equity (ROE) is a measure of financial performance calculated by dividing net income by shareholders' equity. ... ROE is considered a measure of how effectively management is using a company's assets to create profits.
ROE
The ROE is always important; but a high ROE depends on maintaining liquidity, on efficient asset management, and on the proper use of debt. Managers are, of course, vitally concerned with the stock price; but managers have little direct control over the stock market's performance, while they do have control over their firm's ROE. So ROE tends to be the main focal point.
Market-to-book ratio (price-to-book [P/B] ratio)
The ratio of a stock's market price to its book value. divide the market price per share by the book value per share to get the market/book (M/B) Ratio,
Times-InterestEarned (TIE) Ratio
The ratio of earnings before interest and taxes (EBIT) to interest charges; a measure of the firm's ability to meet its annual interest payments. o is determined by dividing earnings before interest and taxes (EBIT in Table 3.2) by the interest charges: interest is paid with pretax dollars, the firm's ability to pay current interest is not affected by taxes Example: 138
Return on Common Equity (ROE)
The ratio of net income to common equity; measures the rate of return on common stockholders' investment
Fixed assets turnover ratio
The ratio of sales to net fixed assets. which is the ratio of sales to net fixed assets, measures how effectively the firm uses its plant and equipment: Industry Average: 2.8
Price/Earnings (P/E) Ratio
The ratio of the price per share to earnings per share; shows the dollar amount investors will pay for $1 of current earnings.
The ratio of total debt to total capital.
The ratio of total debt to total capital. measures the percentage of the firm's capital provided by debt holders: total debt includes all short-term and long-term interest bearing debt, but it does not include operating items such as accounts payable and accruals. Example: pg 137
Days Sales Outstanding (DSO) Ratio
This ratio is calculated by dividing accounts receivable by average sales per day. It indicates the average length of time the firm must wait after making a sale before it receives cash. Example problem Pg: 134
Total assets turnover ratio
This ratio is calculated by dividing sales by total assets. measures the turnover of all of the firm's assets, and it is calculated by dividing sales by total assets:
profit margin
This ratio measures net income per dollar of sales and is calculated by dividing net income by sales. net income is after interest
Operating Margin
This ratio measures operating income, or EBIT, per dollar of sales; it is calculated by dividing operating income by sales. Calculated by dividing operating income (EBIT) by sales, gives the operating profit per dollar of sales:
