External liquidity
· Total market value of o/s securities (no of common stocks o/s x market price per share)
· no of shareholders-more shareholders translates to greater liquidity
· Trading turnover (no of shares traded in a year / total no of shares o/s)
Traditional car dealership against internet-based dealership:
· lower asset turnover (due to larger capital tied up in physical facilities);
· higher gross profit margin ( due to keen competitive over internet)
Showing posts with label Classifications of financial ratios. Show all posts
Showing posts with label Classifications of financial ratios. Show all posts
Monday, November 24
DuPont and sustainable growth
Used to determine what the company is worth, and allows creditors to estimate the company’s ability to pay its existing debt and evaluate their additional debt application.
ROE = net income /equity
(reminders: 1) not subtract preferred dividend 2) use end of year equity but no average)
ROE = (net income/sales) x (sales/equity) = profit margin x equity turnover
Basic DuPont:
ROE = Net margin x Asset turnover x Equity multiplier = (Net income/Sales) x (Sales/Assets) x (Assets/Equity).
(equity multiplier- measure if a company is leveraged)
Extended DuPont:
ROE = [(EBIT/Sales) x (Sales/Assets) - (Interest expense/Assets)] x (Assets/ Equity) x (1 - Tax rate). = {(operating profit margin x total asset turnover – interest expense rate) x financial leverage multiplier x tax retention rate}
As leverage rises, so does the interest expense rate, +ve effects of leverage can be mitigated by the higher interest payments. Higher taxes leads to lower ROE; High profit margin & asset turnover leads to high ROE
Retention rate = 1 - Dividend payout.
(dividend payout = dividends declared / operating income after taxes = Dividend per share / earnings per share)
Sustainable growth rate = ROE x RR = Return on equity x Retention rate.
ROE = net income /equity
(reminders: 1) not subtract preferred dividend 2) use end of year equity but no average)
ROE = (net income/sales) x (sales/equity) = profit margin x equity turnover
Basic DuPont:
ROE = Net margin x Asset turnover x Equity multiplier = (Net income/Sales) x (Sales/Assets) x (Assets/Equity).
(equity multiplier- measure if a company is leveraged)
Extended DuPont:
ROE = [(EBIT/Sales) x (Sales/Assets) - (Interest expense/Assets)] x (Assets/ Equity) x (1 - Tax rate). = {(operating profit margin x total asset turnover – interest expense rate) x financial leverage multiplier x tax retention rate}
As leverage rises, so does the interest expense rate, +ve effects of leverage can be mitigated by the higher interest payments. Higher taxes leads to lower ROE; High profit margin & asset turnover leads to high ROE
Retention rate = 1 - Dividend payout.
(dividend payout = dividends declared / operating income after taxes = Dividend per share / earnings per share)
Sustainable growth rate = ROE x RR = Return on equity x Retention rate.
Earnings and cash flow ratios
Interest coverage = EBIT / Interest expense.
(ability to repay its debt obligations)
Fixed financial cost coverage = EBIT /(interest expense +1/3 lease payment)
(1/3 derived from a bond rating agency guideline that suggests 1/3 of lease payments represent the effective int component of borrowing)
Fixed charge coverage = EBIT / [Interest expense + Lease payments + Preferred dividends / (1-t)].
Total charge coverage ratio
(ability to make good on all of obligations), as preferred dividends are paid from after-tax dollars and need to be adjusted to a pretax basis)
Cash flow to interest expense = (net income + depreciation expense + increase in deferred taxes)/ interest expense
(use traditional cash flow instead of income in numerator, a different type of coverage ratio. Some use CFO or free cash flow)
Cash flow coverage of fixed financial cost coverage = {(traditional CF+ Interest Expense +1/3 lease payments)/(interest expense + 1/3 lease payments)}
Cash flow to LT debt= (net income + depreciation expense + increase in deferred taxes ) / Book value of LT debt
(denominator either with or without deferred taxes, If low->difficult to meet LT debt payments)
Cash flow to total debt = (net income + depreciation expense + increase in deferred taxes) / total debt)
(ability to repay its debt obligations)
Fixed financial cost coverage = EBIT /(interest expense +1/3 lease payment)
(1/3 derived from a bond rating agency guideline that suggests 1/3 of lease payments represent the effective int component of borrowing)
Fixed charge coverage = EBIT / [Interest expense + Lease payments + Preferred dividends / (1-t)].
Total charge coverage ratio
(ability to make good on all of obligations), as preferred dividends are paid from after-tax dollars and need to be adjusted to a pretax basis)
Cash flow to interest expense = (net income + depreciation expense + increase in deferred taxes)/ interest expense
(use traditional cash flow instead of income in numerator, a different type of coverage ratio. Some use CFO or free cash flow)
Cash flow coverage of fixed financial cost coverage = {(traditional CF+ Interest Expense +1/3 lease payments)/(interest expense + 1/3 lease payments)}
Cash flow to LT debt= (net income + depreciation expense + increase in deferred taxes ) / Book value of LT debt
(denominator either with or without deferred taxes, If low->difficult to meet LT debt payments)
Cash flow to total debt = (net income + depreciation expense + increase in deferred taxes) / total debt)
Risk Measures
Business risk: – related to the company’s income variance
Business risk = coefficent of variation = standard deviation of operating income / mean operating income (use 5-10 yrs data as too short-> not reliable; If too long->not relevant)
sales volatility= SD of sales / mean sales
(use 5-10 yrs data as too short-> not reliable; If too long->not relevant)
Operating leverage =mean [absolute value (% change in operating earning/%change in sales)
(how much the production costs are fixed as opposed to variable. If greater use of fixed costs, greater impact of a change in sales on operating income of a company-> greater the risk will be
Financial risk: - related to the company’s financial structure (use of debt).
Debt to equity = LT debt / Total equity.
(measure of fixed cost financing, the analyst has a choice of whether to include deferred taxes as part of debt; If deferred taxes resulted from accelerated & SL depreciation difference, should not be included; If result from income recognition on LT contracts, taxes will have to paid at some point,->include)
LT debt to total capital = LT debt / LT capital.
(may or may not include deferred taxes)
Total debt ratio = Total interest bearing debt / (Total capital - Non interest bearing liabilities).
Business risk = coefficent of variation = standard deviation of operating income / mean operating income (use 5-10 yrs data as too short-> not reliable; If too long->not relevant)
sales volatility= SD of sales / mean sales
(use 5-10 yrs data as too short-> not reliable; If too long->not relevant)
Operating leverage =mean [absolute value (% change in operating earning/%change in sales)
(how much the production costs are fixed as opposed to variable. If greater use of fixed costs, greater impact of a change in sales on operating income of a company-> greater the risk will be
Financial risk: - related to the company’s financial structure (use of debt).
Debt to equity = LT debt / Total equity.
(measure of fixed cost financing, the analyst has a choice of whether to include deferred taxes as part of debt; If deferred taxes resulted from accelerated & SL depreciation difference, should not be included; If result from income recognition on LT contracts, taxes will have to paid at some point,->include)
LT debt to total capital = LT debt / LT capital.
(may or may not include deferred taxes)
Total debt ratio = Total interest bearing debt / (Total capital - Non interest bearing liabilities).
Operating Performance
The measurement of operating performance is used to analyze and determine how well management operates a company.
Operating efficiency - revealed if the company’s assets were utilized efficiently.
Total asset turnover = Sales / Average total net assets.
(Differene across industries; manufacturing business that are capital intensive, near 1; Retail business- near 10; If too low->capital tied up; If too high-> too few assets for potential sales or asset base is outdated)
Fixed asset turnover = Sales / Average net fixed assets.
(utilization of fixed asset, If low,->means too much capital tied up in its asset base; If too high-> has obsolete equipment)
Equity turnover = Sales / Average equity.
(measure of employment of owner’s capital, include preferred/common stock, paid-in-capital & retained earning; about capital structure as co can increase this ratio by using more debt financing)
Working capital turnover = Revenue / average working capital
Operating profitability - related to the company’s overall profitability
Gross margin = Gross profit / Sales = (Sales - COGS) / Sales.
(concerned if too low)
Operating margin = Operating profit / Sales = EBIT / Sales.
concerned if too low)
Net margin = Net income / Sales
(concerned if too low)
Return on total capital (ROTC) = EBIT / Average total capital.
(should add back gross interest expense as total capital includes debt. Do Not use net interest expense,i.e. gross interest expense – interest income; total capital is the same as total asset, concerned if too low)
Return on total equity (ROE) = NI / Average total equity
= (net income /sales) (Sales / total assets) (total assets / equity)
(concerned if too low, include preferred stock)
Return on owners’ equity = (NI - Preferred dividends) / (Average total equity – Preferred stock) (concerned if too low)
Operating efficiency - revealed if the company’s assets were utilized efficiently.
Total asset turnover = Sales / Average total net assets.
(Differene across industries; manufacturing business that are capital intensive, near 1; Retail business- near 10; If too low->capital tied up; If too high-> too few assets for potential sales or asset base is outdated)
Fixed asset turnover = Sales / Average net fixed assets.
(utilization of fixed asset, If low,->means too much capital tied up in its asset base; If too high-> has obsolete equipment)
Equity turnover = Sales / Average equity.
(measure of employment of owner’s capital, include preferred/common stock, paid-in-capital & retained earning; about capital structure as co can increase this ratio by using more debt financing)
Working capital turnover = Revenue / average working capital
Operating profitability - related to the company’s overall profitability
Gross margin = Gross profit / Sales = (Sales - COGS) / Sales.
(concerned if too low)
Operating margin = Operating profit / Sales = EBIT / Sales.
concerned if too low)
Net margin = Net income / Sales
(concerned if too low)
Return on total capital (ROTC) = EBIT / Average total capital.
(should add back gross interest expense as total capital includes debt. Do Not use net interest expense,i.e. gross interest expense – interest income; total capital is the same as total asset, concerned if too low)
Return on total equity (ROE) = NI / Average total equity
= (net income /sales) (Sales / total assets) (total assets / equity)
(concerned if too low, include preferred stock)
Return on owners’ equity = (NI - Preferred dividends) / (Average total equity – Preferred stock) (concerned if too low)
Profitability ratios
Profitability ratios - The higher, the better
Gross profit margin
Can increase by raising sales prices or lowering per unit cost
Gross profit margin = gross profit/ revenue
Net profit margin
Can increase by raising sales prices or cutting costs
Others profit ratios:
Net profit margin = net income / revenue
Operating profit margin = operating income / revenue
Pre-tax margin = pre-tax earning / revenue
Gross profit margin
Can increase by raising sales prices or lowering per unit cost
Gross profit margin = gross profit/ revenue
Net profit margin
Can increase by raising sales prices or cutting costs
Others profit ratios:
Net profit margin = net income / revenue
Operating profit margin = operating income / revenue
Pre-tax margin = pre-tax earning / revenue
Liquidity ratios
Liquidity ratios are used to analyze and determine a company’s financial ability to meet short-term liabilities.
Current ratio = Current assets / Current liabilities.
(If <1,> liquidity crisis. If higher-> better the ability to pay ST liability.)
Quick ratio = (Cash + Marketable securities + Receivables) / Current liabilities.
(more stringent measure of liquidity- not incl inventories & other not very liquid asset)
Cash ratio = (Cash + Marketable securities) / Current liabilities.
(most conservative measures)
Receivables turnover = Sales / Average receivables. {ave = (beg + End)/2}
(desirable to have figures close to the industry norm)
Inventory turnover = COGS / Average inventories.
(desirable to have figures close to the industry norm. If the stock level is too low, it is probably to lose sales, if too high, too much cash is tied up.
Payables turnover = COGS / Average payables.
Receivables period = 365 / Receivables turnover.
(no of days receivables ,desirable to have figures close to the industry norm; If too high-> too much capital tied up in assets; If too low-> too rigorous credit policy)
Inventory processing period = 365 / Inventory turnover
(no. of days inventory ,desirable to have figures close to the industry norm, If too high->capital tied up & obsolete inventory; If too low->inadequate stock->adversely impact sales)
Payables period = 365 / Payables turnover.
(no. of days of payables, paying too early is costly unless the firm can take advantage of discounts; Postponing the payment is costly due to the discount foregone, late payment penalties/interest, deterioration of credit rating and business relationship)
Operating Cycle = days of inventory + days of receivable
Cash conversion cycle = days of inventory + days of receivable – days of payable
(if too high-> not desirable, excessive amt of capital investment in the sales process)
Current ratio = Current assets / Current liabilities.
(If <1,> liquidity crisis. If higher-> better the ability to pay ST liability.)
Quick ratio = (Cash + Marketable securities + Receivables) / Current liabilities.
(more stringent measure of liquidity- not incl inventories & other not very liquid asset)
Cash ratio = (Cash + Marketable securities) / Current liabilities.
(most conservative measures)
Receivables turnover = Sales / Average receivables. {ave = (beg + End)/2}
(desirable to have figures close to the industry norm)
Inventory turnover = COGS / Average inventories.
(desirable to have figures close to the industry norm. If the stock level is too low, it is probably to lose sales, if too high, too much cash is tied up.
Payables turnover = COGS / Average payables.
Receivables period = 365 / Receivables turnover.
(no of days receivables ,desirable to have figures close to the industry norm; If too high-> too much capital tied up in assets; If too low-> too rigorous credit policy)
Inventory processing period = 365 / Inventory turnover
(no. of days inventory ,desirable to have figures close to the industry norm, If too high->capital tied up & obsolete inventory; If too low->inadequate stock->adversely impact sales)
Payables period = 365 / Payables turnover.
(no. of days of payables, paying too early is costly unless the firm can take advantage of discounts; Postponing the payment is costly due to the discount foregone, late payment penalties/interest, deterioration of credit rating and business relationship)
Operating Cycle = days of inventory + days of receivable
Cash conversion cycle = days of inventory + days of receivable – days of payable
(if too high-> not desirable, excessive amt of capital investment in the sales process)
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