Reading 27 Financial Analysis Techniques
Defensive Interval Ratio
(Cash + Short-term marketable investments + Receivables) / Daily cash expenditures a Ratio of 50 shows the company can pay its operating expenses for 50 days before running out of quick assets, assuming no additional cash inflow
Quick Ratio
(Current Assets - Inventory) / Current Liabilities or (Cash + short term marketable investments + receivables) / current liabilities reflects that inventory may not be easily sold
Return on total capital (ROTC):
(EBIT or Operating Income)/average short and long term debt and equity
operating segment definition
(a) that engages in activities that may generate revenue and create expenses, including a start-up segment that has yet to earn revenues, b) whose results are regularly reviewed by the company's senior management, and c) for which discrete financial information is available
Retention Rate (b)
(earnings per share - div per share) / earnings per share self explanatory
Fixed Cover Charge
(ebit + lease payments) / (interest payments and lease payments) shows greater solvency - apparently used to evaluate preferred dividend
DuPont Analysis: Decomposition of ROE
Also known as ROE = ROA * Leverage so ROE is a function of the firms ROA and use of leveraging so if no leverage then ROE = ROA if leverage increases and returns increase (ROE) (making more money than interest payments) then ROA (net income) is going up as assets/equity is going up If leverage increases and ROE goes down then ROA is also going down
DuPont Analysis: Decomposition of ROE with a tax perspective
Also known as ROE = Tax burden [% left after taxes] × Interest burden [% left after interest] × EBIT margin [% left after Operating expenses] × Total asset turnover [Revenue per Asset or efficiency] × Leverage
Working Capital
Assets - minus current liabilities
Free Operating Cash flow to debt
CFO (adjusted) minus capital expenditures / total debt
Discretionary Cash Flow to debt
CFO minus capital expenditures minus dividends paid / Total Debt
CFO
Cash flow from operations
Cashflow per share
Cashflow from operations / average number of outstanding shares
Inventory Turnover and DOH (Days of Inventory on Hand)
Cost of sales or cost of goods sold / average inventory entities. It indicates the resources tied up in inventory (i.e., the carrying costs) and can, therefore, be used to indicate inventory management effectiveness. A higher inventory turnover ratio implies a shorter period that inventory is held, and thus a lower DOH. In general, inventory turnover and DOH should be benchmarked against industry norms. High inventory could mean very efficient, or doesn't have enough on hand to meet demand so never has inventory
Current Ratio
Current assets divided by current liabilities; measures the availability of current assets to pay current liabilities
Cash Conversion Cycle (net operating cycle)
DOH + DSO - Number of days of payables This metric indicates the amount of time that elapses from the point when a companyinvests in working capital until the point at which the company collects cash.
Dividend payout ratio
Dividends per share / Earnings per share
Return on Capital
EBIT / Average Capital (where capital = equity + non-current deferred taxes + debt)
EBIT Interest Coverage
EBIT / Gross interest (prior to deductions for capitalized interest or interest income)
Interest Coverage
EBIT / interest payments Higher the ratio more solvent a firm is as they can meet their immediate needs
EBITDA Interest Coverage
EBITDA / Gross interest (prior to deductions for capitalized interest or interest income)
Pretax Margin
EBT (Earnings Before Tax [so operating profit - interest]) /Revenue need to know if this is changing due to main sources of income or other sources outside of the main source
FFO Interest Coverage
FFO / Gross interest (prior to deductions for capitalized interest or interest income)
FFO to Debt
FFO / Total Debt
Net Cash Flow to Capital
FFO minus dividends / Capital Expenditures
FFO
Funds from Operations
Gross Profit Margin
Gross Profit/Revenue
Return on Common Equity (ROE)
Net Income - preferred div / Average common equity
Return on Equity (ROE)
Net Income / Average Total Equity
Net Profit Margin
Net Income / Revenue used as guidance for future potential revenue
Activity Ratio Averages Denominator how are they determined
Often ratios are calculated using the average (start of period end of period) Can also do quarterly (average of all 4 in a year, 4 points) or '5 points' (start of year and all the 4 quarters) can also get ratios from periods up to current by multiplying (so quarters by 4) and from there
Operating Profit Margin
Operating profit / revenue
Payables Turnover and the Number of Days of Payables
Purchases / Average trade payables A payables turnover ratio that is high (low days payable) relative to the industry could indicate that the company is not making full use of available credit facilities; alternatively, it could result from a company taking advantage of early payment discounts. An excessively low turnover ratio (high days payable) could indicate trouble making payments on time, or alternatively, exploitation of lenient supplier terms. This is another example where it is useful to look simultaneously at other ratios. If liquidity ratios indicate that the company has sufficient cash and other short-term assets to pay obligations and yet the days payable ratio is relatively high, the analyst would favor the lenient supplier credit and collection policies as an explanation.
Sustainable Growth
Retention rate (b) * ROE
Total Asset Turnover
Revenue / Average Total Assets the company's overall ability to generate revenues with a given level of assets higher ratio indicates greater efficiency. Because this ratio includes both fixed and current assets, inefficient working capital management can distort overall interpretations. It is therefore helpful to analyze working capital and fixed asset turnover ratios separately
Fixed Asset Turnover
Revenue / average net fixed costs measures how efficiently the company generates revenues from its investments in fixed assets. Generally, a higher fixed asset turnover ratio indicates more efficient use of fixed assets in generating revenue. A low ratio can indicate inefficiency, a capital-intensive business environment, or a new business not yet operating at full capacity—in which case the analyst will not be able to link the ratio directly to efficiency. In addition, asset turnover can be affected by factors other than a company's efficiency. The fixed asset turnover ratio would be lower for a company whose assets are newer (and, therefore, less depreciated and so reflected in the financial statements at a higher carrying value) than the ratio for a company with older assets (that are thus more depreciated and so reflected at a lower carrying value). The fixed asset ratio can be erratic because, although revenue may have a steady growth rate, increases in fixed assets may not follow a smooth pattern; so, every year-to-year change in the ratio does not necessarily indicate important changes in the company's efficiency
Receivables Turnover and DSO (Days of Sales Outstanding)
Revenue / average receivables (DSO) The number of DSO represents the elapsed time between a sale and cash collection, reflecting how fast the company collects cash from customers to whom it offers credit A relatively high receivables turnover ratio (and commensurately low DSO) might indicate highly efficient credit and collection. Alternatively, a high receivables turnover ratio could indicate that the company's credit or collection policies are too stringent, suggesting the possibility of sales being lost to competitors offering more lenient terms
Working Capital Turnover
Revenue / average working capital indicates how efficiently the company generates revenue with its working capital. For example, a working capital turnover ratio of 4.0 indicates that the company generates €4 of revenue for every €1 of working capital. A high working capital turnover ratio indicates greater efficiency (i.e., the company is generating a high level of revenues relative to working capital). For some companies, working capital can be near zero or negative, rendering this ratio incapable of being interpreted.
Credit Risk
Risk a debtor will fail on a promised payment
Debt to EBITDA
Total / EBITDA
Financial Leverage Ratio
Total Assets/Total Equity so basically how much assets are supported by equity, which in turn tells you debt so a 3 means $3 for each $1 of equity or $2 of debt
Debt-to-Capital Ratio
Total Debt/(Total Debt + Total Shareholders Equity) how much debt represents the firm's capital
DuPont Analysis: Decomposition of ROE with a further ROA decomposition
also known as ROE = Net Profit Margin [I read this as effect of expenses] * Total Asset Turnover [efficiency] * Leverage
Scenario Analysis
analysis shows the changes in key financial quantities that result from given (economic) events, such as the loss of customers, the loss of a supply source, or a catastrophic event. If the list of events is mutually exclusive and exhaustive and the events can be assigned probabilities, the analyst can evaluate not only the range of outcomes but also standard statistical measures such as the mean and median value for various quantities of interest.
Cash Ratio
cash + marketable securities / current liabilities more of a crisis ratio....not that marketable securities may also lose value in a crisis...so not reliable
Simulation Analysis
computer-generated sensitivity or scenario analysis based on probability models for the factors that drive outcomes. Each event or possible outcome is assigned a probability. Multiple scenarios are then run using the probability factors assigned to the possible values of a variable.
Price to book value interpretation
consider book value the market's take on a company's assets. So at 1 price is = required return, above 1 expectation is that future return higher is than the internal rate of return
EBITDA
earnings before interest, taxes, depreciation and amortization
Sensitivity Analysis
known as "what if" analysis, sensitivity analysis shows the range of possible outcomes as specific assumptions are changed; this could, in turn, influence financing needs or investment in fixed assets.
Solvency Ratios
measure a company's ability to meet long-term obligations. Subsets of these ratios are also known as "leverage" and "long-term debt" ratios.
Activity Ratios
measure how efficiently a company performs day-to-day tasks, such as the collection of receivables and management of inventory.
Profitability Ratios
measure the company's ability to generate profits from its resources (assets)
Liquidity Ratios
measure the company's ability to meet its short-term obligations.
Valuation Ratios
measure the quantity of an asset or flow (e.g., earnings) associated with ownership of a specified claim (e.g., a share or ownership of the enterprise).
Return on Assets (ROA)
net income/average total assets: The basic Net Income + Interest Payment (1-tax) / average assets: gives you more the return based off equity and creditor holders Operating Income or EBIT / Average Assets: Gives you return on all assets (liabilities, debt, equity)
Disclosure requirement for a single customer (segment) is required when
they represent 10% or more of a company's revenue
debt to equity
total debt/stockholders equity 1 represents total equal debt and equity, so really 50%
debt to total assets ratio
total liabilities/total assets .4 or 40% indicates a companies assets are financed through debt
Credit Analysis
uses financial projections and expectations of assets sales and refinancing to determine likelihood of meeting payments and use other sources like credit rating,
When to disclose an operating segement
when it represents 10% or more of Revenue, Assets, Profit / Loss Profit and loss : so the absolute value of the segment P&L vs the greater of the combined profit segments or losses segments If the segments under the above are only 75% of company revenue, then you add smaller segments that are combined under similarities (type of business, geographic area) everything else goes into a "All other segments" category