Ratios Comm217 Updated Lm.pdf

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RATIO

COMPUTATION

EXPLANATION

Tests of profitability Return on equity

𝑁𝑒𝑑 Β πΌπ‘›π‘π‘œπ‘šπ‘’ π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’ Β π‘†β„Žπ‘Žπ‘Ÿπ‘’β„Žπ‘œπ‘™π‘‘π‘’π‘Ÿ ! 𝑠 Β π‘’π‘žπ‘’π‘–π‘‘π‘¦

Return on assets

π‘ƒπ‘Ÿπ‘œπ‘“π‘–π‘‘ + πΌπ‘›π‘‘π‘’π‘Ÿπ‘’π‘ π‘‘  𝑒π‘₯𝑝𝑒𝑛𝑠𝑒 Β (𝑛𝑒𝑑 Β π‘œπ‘“ Β π‘‘π‘Žπ‘₯) π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’ Β π‘‘π‘œπ‘‘π‘Žπ‘™ Β π‘Žπ‘ π‘ π‘’π‘‘π‘ 

Financial leverage ratio

π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’ Β π‘‘π‘œπ‘‘π‘Žπ‘™ Β π‘Žπ‘ π‘ π‘’π‘‘π‘  π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’ Β π‘ β„Žπ‘Žπ‘Ÿπ‘’β„Žπ‘œπ‘™π‘‘π‘’π‘Ÿπ‘  ! π‘’π‘žπ‘’π‘–π‘‘π‘¦

Earnings per share

π‘ƒπ‘Ÿπ‘œπ‘“π‘–π‘‘ Β π‘Žπ‘£π‘Žπ‘–π‘™π‘Žπ‘π‘™π‘’ Β π‘‘π‘œ Β π‘π‘œπ‘šπ‘šπ‘œπ‘› Β π‘ β„Žπ‘Žπ‘Ÿπ‘’β„Žπ‘œπ‘™π‘‘π‘’π‘Ÿπ‘  π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’ Β π‘›π‘’π‘šπ‘π‘’π‘Ÿ Β π‘œπ‘“ Β π‘π‘œπ‘šπ‘šπ‘œπ‘› Β π‘ β„Žπ‘Žπ‘Ÿπ‘’π‘ 

Quality of earnings

πΆπ‘Žπ‘ β„Ž Β π‘“π‘™π‘œπ‘€π‘  Β π‘“π‘Ÿπ‘œπ‘š Β π‘œπ‘π‘’π‘Ÿπ‘Žπ‘‘π‘–π‘›π‘” Β π‘Žπ‘π‘‘π‘–π‘£π‘–π‘‘π‘–π‘’π‘  π‘ƒπ‘Ÿπ‘œπ‘“π‘–π‘‘

Net Profit margin

𝑁𝑒𝑑 Β πΌπ‘›π‘π‘œπ‘šπ‘’ 𝑁𝑒𝑑 Β π‘ π‘Žπ‘™π‘’π‘ 

Gross Profit Margin

πΊπ‘Ÿπ‘œπ‘ π‘  Β π‘ƒπ‘Ÿπ‘œπ‘“π‘–π‘‘ 𝑁𝑒𝑑 Β π‘ π‘Žπ‘™π‘’π‘ 

Fixed asset turnover

𝑁𝑒𝑑 Β π‘ π‘Žπ‘™π‘’π‘  π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’  𝑛𝑒𝑑  𝑓𝑖π‘₯𝑒𝑑 Β π‘Žπ‘ π‘ π‘’π‘‘π‘ 

How how well did the firm use shareholder investment? High ratio = Effective management of its shareholders investments, rising share price. HIGH = GOOD Measures how much the firm has earned from the use of its total assets. Measures the relationship between the assets and the investments made by shareholders to finance them. Low ratio = A high proportion of assets is financed with shareholder’s equity LOW = GOOD HIGH = more risk, more reliance on debt Measures the return on investment based on the number of shares outstanding. Determines if the company if profitable or not. Measures how much cash each dollar of profit generates. High ratio = A greater ability to finance operating and other cash needs from operating cash inflows. Measures how much profit is earned (after expenses) as a percentage of revenues generated during the period. High ratio = Effective management of sales and expenses How much profit is made after covering COGS High = company able to charge high price and keep costs low = higher net income Measures the sales generated by the use of fixed assets (property, plant and equipment, net of accumulated depreciation)

Tests of liquidity Cash ratio

πΆπ‘Žπ‘ β„Ž + πΆπ‘Žπ‘ β„Ž Β π‘’π‘žπ‘’π‘–π‘£π‘Žπ‘™π‘’π‘›π‘‘π‘  πΆπ‘’π‘Ÿπ‘Ÿπ‘’π‘›π‘‘ Β π‘™π‘–π‘Žπ‘π‘–π‘™π‘–π‘‘π‘–π‘’π‘ 

Current ratio

πΆπ‘’π‘Ÿπ‘Ÿπ‘’π‘›π‘‘ Β π‘Žπ‘ π‘ π‘’π‘‘π‘  πΆπ‘’π‘Ÿπ‘Ÿπ‘’π‘›π‘‘ Β π‘™π‘–π‘Žπ‘π‘–π‘™π‘–π‘‘π‘–π‘’π‘ 

Quick ratio

Receivables turnover

π‘„π‘’π‘–π‘π‘˜ Β π‘Žπ‘ π‘ π‘’π‘‘π‘  πΆπ‘’π‘Ÿπ‘Ÿπ‘’π‘›π‘‘ Β π‘™π‘–π‘Žπ‘π‘–π‘™π‘–π‘‘π‘–π‘’π‘  𝑡𝒆𝒕 Β π’„π’“π’†π’…π’Šπ’•  𝒔𝒂𝒍𝒆𝒔 π‘¨π’—π’†π’“π’‚π’ˆπ’†  𝒏𝒆𝒕  𝒕𝒓𝒂𝒅𝒆 Β π’“π’†π’„π’†π’Šπ’—π’‚π’ƒπ’π’†π’” Average collection period:

!"# !"#"$%&'(") Β !"#$%&'#

Payables turnover

𝑁𝑒𝑑 Β π‘π‘Ÿπ‘’π‘‘π‘–π‘‘ Β π‘π‘’π‘Ÿπ‘β„Žπ‘Žπ‘ π‘’π‘  π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’  𝑛𝑒𝑑 Β π‘‘π‘Ÿπ‘Žπ‘‘π‘’ Β π‘π‘Žπ‘¦π‘Žπ‘π‘™π‘’π‘  !"# Average age of payables:

Inventory turnover

πΆπ‘œπ‘ π‘‘ Β π‘œπ‘“ Β π‘ π‘Žπ‘™π‘’π‘  π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’  𝑛𝑒𝑑 Β π‘–π‘›π‘£π‘’π‘›π‘‘π‘œπ‘Ÿπ‘¦ !"# Average days in inventory:

!"#"$%&' Β !"#$%&'#

!"#$"%&'( Β !"#$%&'#

Total Asset Turnover

Sales ______ Average Total Assets

Measures the adequacy of available cash by comparing the cash reserve to the current liabilities. The ratio should not be too high because holding too much cash is uneconomical (it should be invested instead) Shows a firm’s ability to repay current liabilities with current assets. High ratio = High ability to repay current liabilities. Compares quick assets (cash, near-cash assets: cash, short-term investments, trade receivables) to current liabilities: a more stringent test of short-term liquidity. Reflects how many times average trade receivables were recorded and collected during the period. High ratio = Fast receivable collection = good liquidity Measures how quickly management is paying its trade creditors. High ratio = The company is paying its suppliers in a timely manner. Reflects how many times the average inventory was produced and sold during the period. High ratio = Inventory moves quickly through the production process to the customer HIGH = GOOD High = Efficient management of assets to generate sales

Tests of solvency Times interest earned

π‘ƒπ‘Ÿπ‘œπ‘“π‘–π‘‘ Β (π‘π‘’π‘“π‘œπ‘Ÿπ‘’ Β π‘–π‘›π‘‘π‘’π‘Ÿπ‘’π‘ π‘‘ Β π‘Žπ‘›π‘‘ Β π‘‘π‘Žπ‘₯𝑒𝑠) πΌπ‘›π‘‘π‘’π‘Ÿπ‘’π‘ π‘‘  𝑒π‘₯𝑝𝑒𝑛𝑠𝑒

Cash coverage

πΆπ‘Žπ‘ β„Ž Β π‘“π‘™π‘œπ‘€π‘  Β π‘“π‘Ÿπ‘œπ‘š Β π‘œπ‘π‘’π‘Ÿπ‘Žπ‘‘π‘–π‘›π‘” Β π‘Žπ‘π‘‘π‘–π‘£π‘–π‘‘π‘–π‘’π‘  πΌπ‘›π‘‘π‘’π‘Ÿπ‘’π‘ π‘‘ Β π‘π‘Žπ‘–π‘‘

Debt-to-equity

π‘‡π‘œπ‘‘π‘Žπ‘™ Β π‘™π‘–π‘Žπ‘π‘–π‘™π‘–π‘‘π‘–π‘’π‘  π‘†β„Žπ‘Žπ‘Ÿπ‘’β„Žπ‘œπ‘™π‘‘π‘’π‘Ÿ ! 𝑠 Β π‘’π‘žπ‘’π‘–π‘‘π‘¦

Shows the amount of profit before interest and tax that is generated relative to interest expense. Its measures the ability for a firm to meet its required interest payments. Compares the cash generated with the cash obligations of the period. High ratio = The company generates more cash than it pays interest Expresses the company’s debt as a percentage of its shareholders’ equity. High ratio = The company relies heavily on funds provided by creditors

Market tests Price/earnings (P/E)

πΆπ‘’π‘Ÿπ‘Ÿπ‘’π‘›π‘‘ Β π‘šπ‘Žπ‘Ÿπ‘˜π‘’π‘‘ Β π‘π‘Ÿπ‘–π‘π‘’ Β π‘π‘’π‘Ÿ Β π‘ β„Žπ‘Žπ‘Ÿπ‘’ 𝑁𝑒𝑑 Β πΌπ‘›π‘π‘œπ‘šπ‘’ Β π‘π‘’π‘Ÿ Β π‘ β„Žπ‘Žπ‘Ÿπ‘’

Dividend yield

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 Β π‘π‘’π‘Ÿ Β π‘ β„Žπ‘Žπ‘Ÿπ‘’ π‘€π‘Žπ‘Ÿπ‘˜π‘’π‘‘ Β π‘π‘Ÿπ‘–π‘π‘’ Β π‘π‘’π‘Ÿ Β π‘ β„Žπ‘Žπ‘Ÿπ‘’

Measures the relationship between the current market price per share and its earnings per share. High = The market expects earnings to grow rapidly (lots of confidence profits will increase) HIGH = GOOD Measures how much investors earn based on the dividends they receive.

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