financial analysis - ratios Flashcards
gross margin
Gross margin = gross profit/revenue
operating margin
EBIT/revenue
net profit margin
net income/revenue
EBITDA margin
EBITDA/revenue
what happend to EBITDA multiples in EBITDA margin increase
- they are inversely proportional one goes up one goes down
- simple rules of mathematics, EBITDA is btoh denominator and numerator
examples or non-recurring expenses
- goodwill write down
- impairment
- asset write down
how does depreciation and capex shift as companies grow
- more capex ->more D&A
why is cash and debt excluded from net working capital
net working capital = operating current assets- operating current liabilities
- cash and debt are seen as investing as there is potential for interest income
Is negative working capital a bad signal about a company’s health?
- depends
- could be seen as efficient to collect revenue, quick inventory turnover, cash quickly invested into high yield inv estments and delaying payments to supplies
- or liquidity issues or misman agement, leading to high accounts payable, and low levels of accounts receivable
What does change in net working capital tell you about a company’s cash flows?
- a sense of how much a company’s cash flows will deviate from its accrual-based net income.
- If a company’s NWC has increased year-over-year, its operating assets have grown and/or its operating liabilities have shrunk from the prior year. Since an increase in an operating asset is a cash outflow, it should be intuitive why an increase in NWC means less cash flow for a company (and vice versa).
how does inventory, accounts receivale and accounts payable change forecasted
- AR: as revenue percentage
- inventory as COGs
- prepaid expense: SG&A
- AP: COGS
- Accrued expenses: Sg&A
- Deferred revenue: revenue
- Capex: revenue
- D&A: revenue - need to calculate useful lifetime of asset
- PPE: End PPE =beg PPE + CAPEX - DEPRECIATION
what is the use of cash conversion cycle
CCC = DIO+ DSO - DPO
- how many days it takes a company to convert its inventory into cash from sales, how efficiently company generates and collects cash from customers
- lower CCC - operational efficiency, more bargaining power w suppliers
What is the difference between the current ratio and the quick ratio?
- both used to asses company’s short term liquidity position
- current ratio: uses current assets, ratio >1 means healthy.
- Current assets/current liabilities
- quick ratio: only uses high liquidity assets (< 90days conversion) to measure short term liquidity
- (cash + AR + short term investments)/ current liabilities
Give some examples of when the current ratio might be misleading?
- cash includes monimum cash required for operations, so isnt technically liquid, restricted cash
- short term but low liquidity stocks
- bad AR, where mnagement cant efficiently collect them
Is it bad if a company has negative retained earnings?
- depends
- no, if high capex, high R&D for startup companies. It just means more loss than profit
- no if made dividends
- yes if continued profit loss due to bad investment or management inefficiency
How can a profitable firm go bankrupt?
- due to accrual based accounting, not yet receiving cash but recorded it as revenue and then profit
- lots of accounts receivable and not able to efficiently collect it, and also cannot bargain with suppliers, leading to cash inflow outflow mismatch. didnt collect cash in time to pay suppliers
- or took on too much debt and cant pay debt obligations and interest expense
ROA and ROE meaning?
- ROA = use of assets = NI/Avg beg and end of total assets
- ROE = use of equity = NI/Avg beg and end of Book Value of Equity
What is the relationship between return on assets (ROA) and return on equity (ROE)?
- tied by use of leverage
- without debt the 2 are the same
- with debt, more cash, so asset increases and ROA decreases, so it is higher than ROE.
When using metrics such as ROA and ROE, why do we use averages for the denominator?
- bcuz asset or equity value is shown on balance sheet which is a snapshot
- NI is on income statement which is over a period of time, hence needs to be averages to adjust for mismatch
What is the return on invested capital (ROIC) metric used to measure?
- non-operating profit after tax / invested capital
- if ROIC is higher than WACC it means effective use of capital in this investment, as WACC is the minimum requirement of return expected by investors otherwsise they could invest in more profitable investments
- “How much in returns is the company earning for each dollar invested?”
- P/E also related to this
asset turnover ratio:
- how efficiently a company uses its assets to generate sales.
- “How many dollars in revenue does the company generate per dollar of assets?”
- revenue/avg of assets
inventory turnover ratio
- how often a company has sold and replaced its inventory balance throughout a specified period
- COGS/ avg inventory
AR turnover
- the number of times per year that a company can collect its average accounts receivable from customers. The higher the turnover ratio, the better as it indicates the company is efficient at collecting its due payments from customers that paid on credit
- revenue/Avg AR
AP turnover
- how quickly a company pays its vendors
- higher means more bargaining power, more flexibility with cash on hand
- COGS/Avg AP
Coverage ratios and meanings
- debt service charge ratios: measure of creditworthiness that tests a company’s ability to pay its current debt obligations using its current cash flows, >1 is good. (EBITDA - CAPEX)/ mandatory principal payment + interest expense
- fixed charege coverage ratio: assess if a company’s earnings can cover its fixed charges, which can include rent, utilities, and interest expense, higher better: (EBIT + lease charge) / (lease charge + interest)
liquidity ratios
- current ratio: current assets/current liabilities
- quick ratio: high liquid assets/current liabilities
- cash ratio: cash/current liabilities
leverage ratio
- debt/EBITDA
- debt/asset
- debt/equity
profitability ratios
- Gross, operating, Net profit, EBITDA margins (X/revenue)
- ROA, ROE, (NI/X), ROIC (NOPAT/Invested capital)
what are ratios to look at to perform credit analysis
- profitability ratios
- leverage ratios
- coverage ratios
- profitability ratios
what ratios to look at for risk analysis
- leverage ratios
- coverage ratios
what ratios to look at for efficiency in operations to generate cash flow
- turnover ratios: Asset, inventory, AR, AP turnover ratio
