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