Financial Ratios P2 Flashcards
Calculate and explain the Debt to Equity Ratio
Total Debt / Total Shareholders Equity
The debt-to-equity ratio (D/E ratio) shows how much debt a company has compared to its assets. It is found by dividing a company’s total debt by total shareholder equity. A higher D/E ratio means the company may have a harder time covering its liabilities.
Calculate and explain the Debt to Capital Ratio
Total Debt / Total Debt + Total Shareholders Equity
The debt-to-capital ratio is a measurement of a company’s financial leverage. The debt-to-capital ratio is calculated by taking the company’s interest-bearing debt, both short- and long-term liabilities and dividing it by the total capital (all short-term and long-term debt plus preferred stock and equity)
Increases and decreases in this ratio suggest a greater or lesser reliance on debt as a source of financing.
Calculate and explain the Debt to Assets Ratio
Total Debt / Total Assets
Increases and decreases in this ratio suggest a greater or lesser reliance on debt as a source of financing.
Calculate and explain the Financial Leverage Ratio
Average total assets / Average total equity
Average = values at beginning and end of the period / 2
Greater use of debt financing increases financial leverage and, typically, risk to equity holders and bondholders alike.
Calculate and explain the Interest Coverage Ratio
Earnings before interest and taxes / interest payments
The lower this ratio, the more likely it is that the firm will have difficulty meeting its debt payments.
Depreciation and Amortization, which are non-cash expenses
Calculate and explain the Fixed Charge Coverage Ratio
EBIT + FCBT (lease payments + interest payments) / FCBT (interest payments + lease payments) + Interest
The fixed-charge coverage ratio (FCCR) measures a firm’s ability to cover its fixed charges, such as debt payments, interest expense, and equipment lease expense. It shows how well a company’s earnings can cover its fixed expenses. Banks will often look at this ratio when evaluating whether to lend money to a business.
Calculate and explain the Debt to EBITDA Ratio
Why are D and A included
Total Debt / EBITDA
Measuring the amount of income generation available to pay down debt before deducting interest, taxes, depreciation, and amortization
Because they are non-cash charges
Calculate and explain net profit margin ratio
Net income / revenue
The net profit margin, or simply net margin, measures how much net income or profit is generated as a percentage of revenue.
Calculate and explain gross profit margin ratio
Revenue - COGS / revenue
Gross profit margin is the profit after subtracting the cost of goods sold (COGS). Put simply, a company’s gross profit margin is the money it makes after accounting for the cost of doing business.
Calculate and explain operating profit margin ratio
operating income / revenue
The operating margin measures how much profit a company makes on a dollar of sales after paying for variable costs of production, such as wages and raw materials, but before paying interest or tax. It is calculated by dividing a company’s operating income by its net sales.
Calculate and explain the pretax margin ratio
EBT / Revenue
The pretax profit margin is a financial accounting tool used to measure the operating efficiency of a company. It is a ratio that tells us the percentage of sales that has turned into profits or, in other words, how many cents of profit the business has generated for each dollar of sale before deducting taxes.
Calculate and explain the return on assets ratio (ROA)
Why is this ratio misleading?
How can it be adjusted?
net income / average total assets
The ratio shows how profitable a company’s assets are in generating revenue.
This measure is a bit misleading, however, because interest is excluded from net income but total assets include debt as well as equity.
Adding interest adjusted for tax back to net income puts the returns to both equity and debt holders in the numerator. The interest expense that should be added back is gross interest expense, not net interest expense (which is gross interest expense less interest income).
net income + interest expense (1 - tax rate) / average total assets
Calculate and explain operating return on assets
Operating income (or EBIT) / average total asses
Operating return on assets is used to show a company’s operating income that is generated per dollar invested specifically in its assets that are used in its everyday business operations.
Calculate and explain return on total capital
EBIT / Average total capital
Calculate and explain return on equity
Net Income / Average total equity
