L1: Financial Ratios

Question 1

What’s the difference between Time-Trend and Peer Group Analysis?

Answer 1

Time-Trend Analysis
* Used to see how the firm’s performance is changing through time

Peer Group Analysis
* Compare to similar companies or within industries

Question 2

What are the Liquidity Ratios? What do they do?

Answer 2

• Liquidity Ratios are used to measure a firm’s liquidity.
• They determine how easily can we turn assets into cash.

Current Ratio=CA/CL
Quick Ratio=(CA-Inv)/CL
Cash Ratio=Cash/CL

• Tip: They are all /CL

Question 3

What are the Leverage Ratios? What do they do?

Answer 3

• Leverage Ratios measure how much the firm relies on financial debt.

D/A Ratio=TDebt/TA
D/E Ratio=TDebt/TE

Coverage=EBIT/Interest Exp
Debt-to-EBITDA=TD/EBITDA

Question 4

What are the Turnover Ratios? What do they do?

Answer 4

• How efficiently a firm can manage/collect/pay inventory/sales/costs.

Inventory Turnover=COGS/Inv
Receivable Turnover=Sales/Acc Receivable
Payables Turnover=Purchases/AccPayable
Asset Turnover=Sales/TA

Question 5

What are the Profitability Ratios? What do they do?

Answer 5

• Profitabilty Ratios measure the ability to sell product for more than cost and return on investment

Net Profit Margin=N$/Sales
ROA=N$/TA
ROE=N$/TE

Question 6

What is the Invested Capital and its ratio?

Answer 6

IC=TE+TDebt
IC=NCA+NWC
IC=NCA+(CA-CL)

ROI=N$/IC

Question 7

What is the Du Pont Identity?

Answer 7

ROE=Net Profit MarginAsset Turnover (Asset/Equity)

ROE=(NI/Sales)(Sales/Assets)(Assets/Equity)

Equity Multiplier=TA/TE=(1+TD/TE)

Question 8

What are the Market Values Ratios? What do they do?

Answer 8

• Market value ratios provide an idea of what investors think of the firm’s performance and future prospects

EPS=N$/Shares Outstanding

P/E ratio=Market Price/EPS
P/B ratio=Market Price/Book values per share