Ch 3 Flashcards
Financial ratios
Relationships determined from firm’s financial info
And used for comparison purposes
Common-size statement
Standardized financial statement presenting all items
In percentage terms
Balance sheet items are shown as percentage of assets
Income statement items are shown as percentage of sales
5 categories of financial ratios?
1 short term solvency, liquidity ratios 2 Longterm solvency, financial leverage ratios 3 asset management, turnover ratios 4 profitability ratios 5 market value ratios
Current ratio
Current ratio= current assets/current liabilities
The higher the better
Suppose a firm were to pay off some of its suppliers and short term creditors, what would happen to its current ratio?
It will move away from one
If its greater than 1 it will get bigger
If its less than 1 it will get smaller
Quick ratio AKA Acid test
Quick ratio = (current assets - inventory)/current liabilities
Cash ratio
A very short term creditor would be interested in the cash ratio
Cash ratio = cash/current liabilities
3 types of short term solvency ratios, purpose?
Current ratio, quick ratio, cash ratio
Measure firms ability to pay its bills over short run without
Undue stress
5 Longterm solvency measures, purpose?
1Total debt ratio, 2debt-equity ratio, 3equity multiplier 4 times interest earned ratio 5 cash coverage ratio Address firms long run ability to meet its obligations
Total debt ratio
Total debt ratio = (total assets - total equity)/total assets
Ex: a total debt ratio = 0.28 means company has 28%
Debt for every $1 of assets
Debt-equity ratio
Debt-equity ratio = total debt/total equity
Equity multiplier
Equity multiplier = total assets/ total equity
Times interest earned ratio
Times interest earned ratio = EBIT/interest
Cash coverage ratio
Cash coverage ratio = (EBIT + depreciation)/interest
EBITD, EBITDA
EBITD = EBIT + depreciation
EBITDA = earnings before interest, taxes, depreciation
and amortization
Amortization
Non cash deduction similar to depreciation except
Applies to an intangible asset (ex patents)
5 Asset management AKA Turnover ratios, purpose?
1 inventory turnover 2 days' sales in inventory 3 receivables turnover 4 days' sales in receivables 5 total asset turnover
Describe how efficiently/ intensively a firm uses its assets to generate sales
Inventory turnover
Inventory turnover = cost of goods sold/inventory
The higher this ratio is, the more efficiently inventory is being managed
Receivables turnover
Receivables turnover = sales/accounts receivable
Days’ sales in receivables AKA Average collection period
Days sales in receivables = 365/receivables turnovers
Total asset turnover
Total asset turnover = sales/total assets
Ex. Total asset turnover = $0.64, so for ever $1 in assets
we generate $.64 in sales
Capital intensity, define, equation?
1/total asset turnover = capital intensity
Ex if capital intensity =$1.56, it takes the company
$1.56 in assets to create $1 in sales
Suppose you find a particular company generating $.40 in sales for every $1 of total assets.
How often does the company turnover it’s total assets?
Total asset turnover = .4 times per year. It takes
1/.40 = 2.5 years to turn assets over completely
3 profitability measures, their purpose?
Profit margin, return on assets, return on equity
Measure how efficiently firm uses its assets and
How efficiently firm manages its operations
Profit margin
Profit margin= net income/sales
Return on Assets (ROA)
Return on assets = net income/total assets
Measures profit per dollar of assets
Return on equity (ROE), 2 equations?
Return on equity = net income/total equity
= (net income/sales) x (sales/assets) x (assets/equity)
Profit for every dollar of equity
Return on book assets and return on Book equity
Measured rates of return of ROA and ROE
What does it mean when a company’s ROE exceeds its ROA?
The company uses financial leverage
6 Market value measures, purpose?
1 EPS 2 PE ratio 3 price-sales ratio 4 Market-to-book ratio 5 enterprise value 6 EBITDA ratio
Measures used to determine the market price per share
EPS
EPS = net income/shares outstanding
PE ratio
PE ratio = price per share/earnings per share
Price to sales ratio, equation, when is it used?
Price-sales ratio = price per share/sales per share
Used when company has negative earnings, so measures
Revenues
Market-to-book ratio
Market-to-book ratio = market value per share/book value per shr.
Book value per share
Book value per share = total equity/# shares outstanding
Enterprise value, what does it measure?
Enterprise value =
Total market value of stock + book value of all liabilities - cash
Measures value of operating assets
EBITDA ratio, what does it measure
EBITDA ratio = enterprise value/EBITDA
Relates value of operating assets (enterprise value)
To a measure of operating cash flow generated by
Assets (EBITDA)
DuPont identity, define, equation?
Popular expression breaking ROE into 3 parts:
Operating efficiency, asset use efficiency and
Financial leverage
ROE = profit margin x total asset turnover x equity multiplier
What does it mean when google has a higher profit margin and total asset turnover compared to yahoo?
Google is able to generate revenues at far
lower costs than yahoo
Dividend payout ratio
Dividend payout ratio = cash dividends/net income
Retention ratio AKA plow back ratio
Retention ratio = addition to retained earnings/net income
Internal financing
What the firm earns and plows back into the business
External financing
Funds raised from borrowing money or selling stock
Internal growth rate, equation, define?
Maximum possible growth rate when Firm grows only throw internal financing, so wont borrow or sell stock
Internal growth rate = (ROA X b)/(1 - ROA X b)
Where b is the retention
If a firm only relies on internal financing then overtime it’s …
Total debt ratio will decline
As assets grow and debt remains the same
Sustainable growth rate, equation, define?
Sustainable growth rate = (ROE x b)/(1 - ROE x b)
Maximum possible growth rate for a firm that maintains
Constant debt ratio and doesn’t sell stock
4 factors of a firm’s ability to sustain growth?
- Increase profit margin from internal growth
- Increase total asset turnover, by increasing
sales relative to each asset
3 Financial policy, increase debt-equity ratio
4 Dividend policy, a decrease in percentage of net income
Paid as dividends will increase retention rate and internal growth
Standard industrial classification code (SIC)
US government code to classify firm by its type
Of business operations
