Final Chapter 12 Flashcards
Profitability Ratios
Focus on net earnnings and how it compares to other amounts reported on the financial statements
Profitability Ratios include
- ROE
- ROA
- Gross profit margin
- Net profit margin
- Earnings per share
- Quality of earnings
ROE
- net earnings/average se
- how much earnings were generated for every dollar invested by owners
- relate net earnings vs investmend made by owners
ROA
- NET EARNINGS/AVERAGE TOTAL ASSETS
- compare net earnings to the total assets used to generate net earnings
- many consider as the best overall measure of a company’s profitability
Gross profit margin ratio (gross profit percentage)
=GROSS PROFIT/NET SALES
- reflect gross profit as a percent of sales
- gross profit = net sales - costs of sales
have “ratio%” cent of each dollar of sales remaining to cover other expenses
Net profit margin ratio
=NET EARNINGS/NET SALES
- reflects net earnings as a percentage of sales.
- A measure of operating effieciency
- each dollar of sales generated (ratio%) cents in net earnings
there is a trade off between profit margin and sales volume
Earnings per share (EPS)
= NET EARNING/AVERAGE NUMBER OF SHARES OUTSTANDING FOR THE PERIOD
- if there are preferred dividends, the amount is substracted from net earnings
- a mesure of return on investment that is based on the number of common shares outstanding
- the single most widely reported financial ratio (required by IFRS)
Managers can significantly alter EPS by selling common shares or repurchasing common shares
QUALITY OF EARNINGS
= CASH FLOW FROM OPERATING/NET EARNINGS
- a ratio higher than 1 indicates high-quality earnings because each dollar of earnings is supported by one or more dollars of cash flows
Asset turnover ratios
captureing how efficiently a company uses its assets
asst turnover ratio includes
- total asset turnover ratio
- fixed asset turnover
- receivables turnover
- inventory turnover
total asset turnover
=NET SALES/AVERAGE TOTAL ASSETS
- how well a company uses its assets to generate revenue
- on average, every dollars of assets generate (ratio) of revenu
fixed asset turnover
net sales/average net fixed assets
- ability to generate sales given its investment in fixed assets (PPE)
- For each dollar invested in PPE, right of use assets, the company was able to generate (ratio) dollar in sales revenue
receivables turnover ratio
= net credit sales/average net accounts receivable
- how quickly a company collects its accounts receivables
- high ratio -> company collects its account receivables many times during a year
- If credit sales are not reported separetely, use net sales as an approximation
average days to collect receivables
days in a year/receivables turnover ratio
inventory turnover ratio
= cost of sales/average inventory
- how quickly a company sells its inventory
- an increase in this ratio is usually favorable. However, if the ratio is too high, it may be an indication that sales were lost because desired items were not in stock.
average days to sell inventory
= days in a year/inventory turnover ratio
- number of days, on average, it takes a company to sells it inventory
Roa profit driver analysis
ROA = NET PROFIT MARGIN X TOTAL ASSET TURNOVER RATIO
operating cycle
the time it takes for a company to pay cash to its suppliers, sell goods to its customers, and collect cash from its customers
help them evaluate company’s cash needs and is a good indicator of operating efficiency.
- acquisition of inventory
- the sale of inventory
- collection of cash from customer
account payable turnover ratio
= cost of sales/ average account payable
how quick company pay back suppliers
Liquidity ratios
measure a company ability to meet its short-term obligations
Liquidity ratio includes
- current ratio
- quick ratio
- cash ratio
Current ratio
= CURRENT ASSETS/CURRENT LIABILITIES
- measures the ability of the company to pay current debts as they become due
- ratio > 1 -> current assets are sufficient to cover its current liability
- less than 1 -> want to understand how the company intends to meet its short term obli
- too high -> operating ineffiencityly when it ties up too much money in inventory or account receivables
quick ratio
= quick asset/current liabilities
- is a more stringent test of liquidity than the current ratio.
- company’s immediate ability to pay current debts as they become due
- quick assets: cash, short-term investments and net accounts receivables
has (ratio) cents in cash and near cash for every 1 dollar in current liabilities
cash ratio
= cash and cash equivalents/current liabilities
- measure the adequacy of available cash
- holding too much cash = not investing the cash in productive assets that will grow the business
- has (ratio) cents of cash for each dollar of current liabilitites
solvency ratios
measure a company’s ability to meet its long-term obligations
solvancy ratios include
- times interest earned ratio
- cash coverage ratio
- debt-to-equity
times interest earned ratio
= (net earnings + interest expense + income tax expense)/ interest expense
- compares the earnings available to cover interest in a period to a company’s interst obligation for the same period
- indicates a margin of protection for creditors.
- Interest expense and income tax expense are included because earnings before interest and tax are available to cover interest expense
- high ratio -> secure position for creditors
cash coverage
= cash flow from op before interest and income taxes/interest paid
- some believe that times interest earned ratio is flawed because interest is paid in cash, not with earnings. These analysis prefer to use the cash coverage ratio
- measure the ability to meet its periodic interest payments through the cash generated from operations
debt-to-equity
= total liabilities/shareholder’s equity
- express company debt as a proportion of its shareholder equity
- for each 1 dollar of SE, had (ratio) of liability
- debt is risky because interest payments must be made even if the company has not generated sufficient cash from operations to pay them. In contrast, dividends are always at the company’s discretion and are not legally enforeceable until they are declared.
market ratio
relate the current price per share to the return that accrues to shareholders
based on the current value of an owner’s investment in a company
Price/earnings
= current market price per share/earnings per shares
- relationship between the current market price per share and its earning per share
- reflect the stock’s market assessment of a company’s future performance.
- high -> earnings are expected to grow rapidly.
- shares were selling at a price close to (ratio) times its earnings per share.
dividend yield ratio
= dividend per share/ market price per share
- reflect the return on investment solely due to the dividends a company pays.
- used to compare the dividend paying performance of different investment alternatives
- investors are willing to accept low dividend yileds if they expect that the price of a stock will increase while they own it
- stocks with high dividend yields often appeal to retired investors who need current income rather than future growth potential