Financial Ratios Flashcards
Profitability ratios
Company’s ability to make profit on its sales/investments
Capital Employed
(Total Asset - Current Liability) or (Non-current Liability + Equity)
Return on Capital Employed (ROCE)
Net Profit Margin x Asset Turnover Ratio = %
or PBIT / Capital Employed x 100 = %
Higher: better -> for every $1 invested (via debt/equity), company can generate X amount of cents
Reason:
(1) company generating more/less operating profit (numerator of NPM) -> increase/decrease in net profit margin
(2) increase/decrease in asset turnover ratio
(3) increase/decrease in both NPM and ATR
Return on Equity (ROE)
Net Profit / Total Equity = %
Higher: better -> for every $1 invested by shareholders, company is able to generate X cents
Reason: increase/decrease in net profit (profit after tax)
Gross Profit Margin
(Gross Profit / Sales) x 100% = %
Higher: better -> for every $1 of sales, company generates X amount of gross profit
Reason:
(1) product may be poorer/better than industry (competition) so sell at lower/higher price which generates lower/greater revenue
(2) cost of sales is high/low
Net Profit Margin
(PAT / Sales revenue) x 100% = %
Higher: better -> for every $1 of sales, company generates X amount of net profit
Reason:
1. increase/decrease in operating expense(s)
2. profit/loss in disposal of NCA
Asset Turnover Ratio
Sales Revenue / Capital Employed = times (1 decimal)
Higher: better -> efficiency ratio that assesses how well a company can generate sales from each dollar of capital employed (funding)
Reason:
(1) increase/decrease in sales revenue (product can’t compete with industry or economic cycle leads to lower demand of product)
(2) increase/decrease in capital employed (acquiring more assets (machinery), long-term loans or issuing more shares/increase in equity leads to greater capital employed)
Asset Turnover using Closing Book Value
Cost - (Years Used x Cost / Useful Economic Life) = NBV
Asset Turnover: Sales Generated / NBV = x times
Liquidity Ratios
Company’s ability to pay its short-term obligations (liabilities)
2 decimals
Current Ratio
Current Assets / Current Liabilities = times
Higher liquidity: better -> for every dollar of current liablities, current assets can cover by X amount of times
But if higher than industry average: indicates underutilising of working capital (current asset) by not reinvesting to grow or get higher returns for company
Reason:
(1) increase/decrease in current assets
(2) increase/decrease in current liabilities
(3) both
Quick Ratio (Acid Test)
(Current Assets - Inventory - Prepayments) / Current Liabilities = times
OR
(Cash + Marketable Securities + Receivables) / Current Liabilities = times
Difference with current ratio: take out CA that takes longer to convert to cash & assets non-convertible to cash
Higher liquidity: better -> for every dollar of current liabilities, the liquid assets company has can cover by X amount of times
But if higher than industry average: indicates underutilising of liquid working capital (liquid asset) by not reinvesting to grow or get higher returns for company
Reason:
(1) increase/decrease in liquid assets
(2) increase/decrease in current liabilities
(3) both
Working Capital Ratios (Efficiency Ratios)
Company’s ability to use its working capital (cash tied-up in day-to day operations of the business, such as inventory, trade receivables and trade payables) to generate sales
Can be calculated as net current assets (CA without cash - CL)
Round up to 0 decimals or just 1 decimal
Inventory Holding Period
Inventory / Cost of Sales x 365 = days
Lower: better -> once company receives inventory from supplier, it takes X amount of days to sell the inventory
But if too low: may run out of inventory and miss out on a customer order
Reason: poor/good management of inventory, may lead to inventory obsolescence if taking long, but year-end inventory can alternatively accumulate deliberately to anticipate a large customer order or expected price rise
Inventory Turnover Ratio
Cost of Sales / Inventory = times
Higher: better -> company turns over inventory by X amount of times relative to cost of sales
But if too high: poor management in inventory stocking
If high inventory turnover: use current ratio
Low inventory turnover: quick ratio
Receivables Collection Period
Trade Receivables / Total Credit Sales (or just Sales Revenue) x 365 = days
Lower: better -> company takes X amount of days to retrieve money from credit customers
But if too low: may involve company reducing credit terms (the time customers can take to pay company), losing customer goodwill
Reason: poor/good credit control management for individual credit customers and procedures for collecting debts have been followed poorly/well relative to industry average (competitors)
Payables Payment Period
Trade Payables / Total Credit Purchases (or just Purchases/Cost of Sales) x 365 = days
Higher: better -> company owes its supplier for purchasing inventory and takes X amount of days to pay
Ideally: 30 days
But if too high: delaying payment can make company lose credit reputation and supplier goodwill (unless bargaining power is high and supplier depends on you)
Reason: cash availability
Gearing Ratios (Financial Risk)
Level of company’s financing that stems from borrowing (loans, debentures, preference shares) as opposed to equity (including reserves)
Debt to Equity
Non-Current Liabilities / Total Equity x 100 = %
Lower: better -> company has X (cents) of debt for every 1 dollar of equity
But if too low: missing out on new opportunities due to the lack of cash
If higher than industry: shareholders see company as financially risky, if cannot meet debt repayments, greater chance of defaulting
Debt to Capital Employed
NCL / Capital Employed x 100 = %
Lower: better -> company has X (cents) of debt for every 1 dollar of capital employed
Interest Cover
PBIT / Interest Expense = times
Higher: better -> company’s operating profit can cover its interest expense by X amount of times
Below 1: alarming if lacking operating profit to cover interest expense
Investment Ratios (Shareholders Ratios)
Ratios for shareholders in regards to dividends and market price of share(s)
Earnings per Share (EPS)
Net profit Before Ordinary Dividends / NUMBER of Ordinary Shares in Issue = Xpence (p)
or PAT / Shares Outstanding = Xp
Interpretation: how much profit company generates for every 1 share. indicates company performance compared to previous year considering if there are any issues of share during the year
Reason:
1. Increase/decrease in number of shares
2. Increase/decrease in profit
Dividend Cover
Net Profit Before Ordinary Dividends / Ordinary Dividends paid = times
Interpretation: depends (prefer low if dividend payout as income vs prefer high if company growth) -> company’s net profit before issue of ordinary dividends can cover its ordinary dividends paid by X amount of times
Dividend Yield (net)
Dividend Per Share / Market Price per Share x 100 = %
Interpretation: whether shares are value for money in comparison to other investments (renting out property, keeping cash in bank, indices, etc.)
Price Earnings Ratio (PE Ratio)
Market Price per Share / Earnings per Share (EPS) = X
Higher: company’s prospects are expected to be very good or share is overvalued and not worth buying (if already owned, should be sold)
