Ratios
Solvency ratios - financial leverage = avg total assets / avg total liab
Avg means the avg of the values at the beg and at the end of the period. Greater use of debt financing increases financial leverage and, typically, risk to equity holders and bondholders alike: financial leverage = avg total assets / avg total liab
CV NI
CV NI = st dev on NI / mean NI
CV operating income
CV operating income = st dev of operating income / mean operating income
CV sales
CV sales = st dev of sales / mean sales
Profitability ratios - pretax margin (EBT)
EBT can be calculated by subtracting interest from EBIT: pretax margin = EBT / revenue
Activity ratios - fixed asset turnover
Low fixed asset turnover might mean that the company has too much capital tied up in its asset base or is using the assets it has inefficiently. A ratio that is too high might imply that the firm has obsolete equipment: fixed asset turnover = revenue / avg net fixed assets
Profitability ratios - Net profit margin (the higher the better)
Net profit margin should be based on NI from continuing operations, bc analyst should be concerned abt future expectiations and discontinued operations doesn't affect that: net profit margin = net income / revenue
Profitability ratios - Return on common equity
Only differenc from ROE is that preferred div are not taken into account: Return on common equity = NI - preferred div / avg common equity
Payout ratio (NI to common can be EPS since dividends are declared on a per share basis)
Payout ratio = dividends declared / NI to common
Profitability ratios - ROA
ROA = NI / Avg total assets ; however, since NI excludes interest and assets include debt and equity. An alternative calculation for ROA could be: ROA = NI + interest expense (1-tax rate) / avg total assets
DuPont Analysis - extended 5-way approach (by formulas) ** Net profit margin has been decomposed into three segments**
ROE = (NI/EBT)*(EBT/EBIT)*(EBIT/revenue)*(sales/total assets)*(assets/equity)
DuPont Analysis - Original approach (by formulas)
ROE = (NI/sales)*(sales/assets)*(assets/equity)
DuPont Analysis - Original approach (by ratios) ; **leverage ratio is sometimes called Equity Mutliplier
ROE = (net profit margin)*(asset turnover)*(leverage ratio)
DuPont Analysis - extended 5-way approach (by ratios) ** Net profit margin has been decomposed into three segments**
ROE = (tax burden)*(interest burden)*(EBIT margin)*(asset turnover)*(financial leverage)
Profitability ratios - (ROE) Sometimes called return on total equity
ROE = NI / avg total equity
RR (retention ratio)
RR = NI to common - dividends declared / NI to common ; = 1 - div payout ratio
How ratios can be used to forecast earnings
Ratio analysis can be used in preparing pro forma statements for one or more periods. Using common-size income statements, COGS is calculated as % of sales. If analyst has no reason to believe that COGS in relation to sales will change, then this could be used to calculate estimates of sales
Solvency ratios
Solvency ratios include various debt ratios that are based on the balance sheet and coverage ratios that are based on the income statement
Profitability ratios - operating margin (EBIT) or gross profit less SG&A
Some preferred to add back deb and amort to make it EBITDA: operating profit margin = operating income / revenue
Activity ratios
This category includes several ratios also referred to asset utilization or turnover ratios (inventory turnover, receivables turnover). They often give indications of how well a firm utilizes various assets such as inventory and fixed assets
Activity ratios - Inventory turnover
a measure of firm's efficiency w respect to its processing and inventory mgt: inventory turnover = COGS / avg inventory
DuPont Analysis
approach that can be used to analyze ROE. Breaks down ROE so an analyst can see the impact of leverage, profit margins, and turnover on shareholder returns. There are two variants of DuPont: Orignal three-part and extended five-part approach.
Activity ratios - Days of sales outstanding
avg # of days it takes for the company's customers to pay their bills: days of sales outstanding = 365 / receivables turnover
Activity ratios - # of days payables (if calculated for quarter the # of days changes)
avg amount of time it takes the company to pay its bills: # of days payables = 365 / payables turnover ratio
Activity ratios - Days of inventory on hand (or avg inventory processing period, or # of days of inventory)
avg inventory processing period: days of inventory on hand = 365 / inventory turnover
Sensitivity analysis
based on "what if" questions such as: what will be the effect on NI if sales increase by 3% rather than estimated 5%
Scenario analysis
based on specific scenarios and will also yield a range of values for financial statement items
Activity ratios - total asset turnover
effectiveness of the firm's use of its total assets to create revenue: total asset turnover = revenue / avg total sales
Calculating sustainable growth rate for a firm
g = RR * ROE
Solvency ratios
give the analyst info on the firm's financial leverage and ability to meet its longer-term obligations
Profitability ratios - gross profit margin
gross profit can be increased by raising prices or reducing costs: gross profit margin = gross profit / revenue
Know these terms - gross profits
gross profits = net sales - COGS
Liquidity ratios - current ratio (higher the better)
higher the current ratio, the more likely it is that the company will be able to pay its short-term bills: current ratio = current assets / current liab
Solvency ratios - debt-t-assets
increases and decreases in this ratio suggest a greater or lesser reliance on debt as source of financing: debt-to-assets = total debt / total assets
Solvency ratios - debt-to-capital (capital equals all short-term and long-term debt + preferred stock and equity)
increases and decreases in this ratio suggest a greater or lesser reliance on debt as source of financing: debt-to-capital = total debt / total debt + total shareholders' equity
Solvency ratios - debt-to-equity (we calculate debt as long-term debt + interest bearing short-term debt)
increases and decreases in this ratio suggest a greater or lesser reliance on debt as source of financing: debt-to-equity = total debt / total shareholders' equity
Liquidity ratios - defensive interval
indicates the number of days of avg cash expenditure the firm could pay w its current liquid assets. Expenditures include cash expenses, COGS, SG&A, and R&D (dep should be added): defensive interval = cash + mkt securities + receivables / avg daily expenditures
Solvency ratios - Interest coverage (higher the better)
interest coverage = EBIT / interest payments
Solvency ratios - fixed charge coverage
is the more meaningful measure for companies that lease a large portion of their assets, such as airlines: fixed charge coverage = EBIT + lease payments / interest payments + lease payments
Coefficient of variation for a variable is
its standard deviation divided by its expected value
Activity ratios - Payables turnover
measure of the use of trade credit by the firm: payables turnover = purchases / avg trade payables
Profitability ratios
measure the overall performance of the firm relative to revenues, assets, equity, and capital
Liquidity ratios - quick ratio (higher the better)
more stringent measure of liquidity bc it doesn't include inventories and other not-liquid assets: quick ratio = cash + mkt sec + receivables / current liab
Know these terms - Net Income
net income = earnings after taxes but before dividends
Know these terms - operating profits
operating profits = earnings before interest and taxes (EBIT)
Profitability ratios - operating return on assets
operating return on assets = EBIT / avg total assets
Profitability ratios
provide info on how well the company generates operating profits and net profits from its sales
Activity ratios - Receivables turnover
receivables turnover = annual sales / avg receivables ; In most cases when ratio compares a BS item w a IS item. The Balance Sheet item will be the avg of the item which is calculated by adding beg of yr and end of yr balance then dividing by two.
Liquidity ratios
refers to the ability to pay short-term obligations as they come due
Valuation ratios
sales per share, EPS, and price to CF per share are examples of ratios used in comparing the relative valuation of companies
Three methods of examining the variability of financial outcomes around point estimates are:
sensitivity analysis, scenario analysis, and simulation
Simulation analysis
technique in which probability distributions for key variables are selected and a computer is used to generate a distribution of values for outcomes based on repeated random selection of values for the key variables
Liquidity ratios - cash ratio (higher the better)
the most conservative liquidity measure: cash ratio = cash + mkt sec / current liab
Liquidity ratios - cash conversion cycle (high conversion cycles are undesirable)
time it takes to turn the cash investment in inventory back to cash: cash conversion cycle = (days sales outstanding) + (days of inventory on hand) - (# of days of payables)
Know these terms - Total capital
total capital = long-term debt + short-term debt + common and preferred equity
Know these terms - total capital
total capital = total asstes
Profitability ratios - (ROTC) return on total capital
total capital includes short and long-term debt, preferred equity, and common equity: ROTC = EBIT / avg total capital
Activity ratios - working capital turnover
working capital is current assets minus current liabilities. Gives us info abt the utilization of working capital in terms of dollars of sales per dollar of working capital: working capital turnover = revenue / avg working capital
Professor's Note Activity Ratios
you can use the inventory equation to calculate purchases. Purchases = ending inventory - beg inventory + COGS