R20 Ratios Flashcards
Activity ratios (just mention what it measures)
Activity ratios measure: Efficiency of a company in performing its day to day operations
Liquidity ratios (just mention what it measures)
Liquidity ratios measure: A company’s ability to meet its short-term obligations.
Solvency ratios (just mention what it measures)
Solvency ratios measure: A company’s ability to meet its long-term obligations.
Profitability ratios (just mention what it measures)
Profitability ratios measure: A company’s ability generate profit from its resources.
Activity Ratios - Inventory turnover
Inventory turnover = COGS / Average Inventory
Interpretation:
- Indicates how many times per period the entire inventory was sold.
- Measures the ability of a company to sell its inventory.
- Higher number means greater efficiency because inventory is kept for a shorter period. It could also mean insufficient inventory, which in turn, might affect growth / revenue.
Activity Ratios - Days of inventory on hand
Days of inventory on hand = number of days in period / inventory turnover
Interpretation: On an average, how many days of inventory is kept on hand.
Activity Ratios - Receivables turnover
Receivables turnover = revenue / average receivables
Interpretation:
- Indicates how quickly a company collects cash.
- More appropriate to use credit sales instead of revenue but it is not readily available.
- A higher number means greater efficiency in credit and collection. It could also mean stringent cash collection policies are hurting potential sales.
Activity Ratios - Days of sales outstanding
Days of sales outstanding = number of days in period / receivables turnover
Interpretation:
- Elapsed time between credit sale and cash collection.
- Higher number means it takes a long time to collect receivables.
Activity Ratios - Payables turnover
Payables turnover = Purchases / Average trade payables
Interpretation:
- Indicates how quickly a company pays suppliers.
- A high number means the company is paying suppliers quickly and is possibly not making use of credit facilities.
- Low number may mean the company is facing trouble making payments on time and signal liquidity issues.
Activity Ratios - Number of days of payables
Number of days of payables = number of days in period / payables turnover
Interpretation: On an average, how many days it takes to pay suppliers.
Activity Ratios - Working capital turnover
Working capital turnover = Revenue / Average working capital
Interpretation:
- Indicates how efficiently a company generates revenue from working capital.
- Working capital = current assets (CA) – current liabilities (CL)
- Higher number means greater efficiency. If CA = CL, then working capital would be zero making the ratio meaningless.
Activity Ratios - Fixed asset turnover
Fixed asset turnover = revenue / average net fixed assets
Interpretation:
- Indicates how efficiently a company generates revenue from fixed assets.
- A higher number means efficient use of fixed assets.
- A lower number may mean inefficiency, or newer business (higher carrying value on B/S), or a capital-intensive business.
Activity ratios - Total asset turnover
Total asset turnover = Revenue / Average total assets
Interpretation:
- Indicates how efficiently a company generates revenue from total assets (fixed + current assets).
- As with other turnover ratios, higher number means efficiency.
Liquidity Ratios - Current Ratio
Current Ratio = current assets / current liabilities
Interpretation: A higher number implies greater liquidity.
Liquidity Ratios - Quick Ratio
Quick Ratio = (cash + marketable securities + receivables) / current liabilities
interpretation: A higher number implies greater liquidity.
More conservative than current ratio as only more liquid current assets are included.
Liquidity ratios - cash ratio
Cash ratio = (cash + marketable securities) / current liabilities
interpretation: This is the most conservative liquidity ratio and a good measure of a company’s ability to handle a crisis situation.
liquidity ratio - Defensive interval ratio
Defensive interval ratio = (cash + marketable securities + receivables) / daily cash expenditures
Interpretation: Measures the number of days a company can operate before it runs out of cash. A higher number implies greater liquidity.
Liquidity ratios - cash conversion cycle (net operating cycle)
Cash conversion cycle (net operating cycle) = Days of inventory on hand (DOH) + Days of sales outstanding (DSO) - Number of days of payables
Hitesh’s formula:
Net operating cycle / cash conversion cycle = [inventory days + receivable days] - payable days
[inventory days + receivable days] - operating cycle
Interpretation: The time between cash paid (to suppliers) and cash collected (from customers). A low number is better for the company as it means high liquidity. A long cash conversion cycle implies low liquidity.
Purchases
CFA formula:
Purchases = cost of goods sold + ending inventory - beginning inventory
Hitesh’s formula:
Beginning inventory + purchases - COGS = Ending inventory
Solvency Ratios - Debt ratios - debt-to-assets ratio
Debt-to-assets ratio = total debt / total assets
interpretation: Measures the amount of debt in total assets.
Higher debt means low solvency and higher risk. A ratio of 0.5 implies 50% of assets are financed with debt.
Solvency rations - debt ratios - debt-to-capital ratio
Debt-to-capital ratio = total debt / (total debt + total shareholder’s equity)
interpretation: Measures the amount of debt as a percentage of capital (debt + shareholder’s equity).
Solvency ratios - debt ratios - debt-to-equity ratios
Debt-to-equity ratio = total debt / total shareholder’s equity
Interpretation: Measures the amount of debt as a percentage of equity.
solvency ratios - debt ratios - financial leverage ratio
Financial leverage ratio = average total assets / average total equity
Interpretation: measures the amount of assets per unit of equity. A higher value means a company is more leveraged.
Solvency ratios - debt ratios - debt-to-EBITDA Ratio
Debt-to-EBITDA Ratio = Total debt / EBITDA
Interpretation: estimates how many years it would take to repay total debt based on earnings before income taxes, depreciation and amortization (an approximation of operating cash flow).
Liquidity ratios - Operating cycle
Operating cycle = Inventory days + receivable days
Solvency Ratios - Coverage Ratios - Interest coverage ratio OR time interest earned
Interest coverage ratio OR time interest earned = EBIT / Interest Payments
Interpretation: measures the company’s ability to make interest payments (how many times the company can make interest payments with its EBIT). Unlike the other solvency ratios, a higher value for this ratio is better as it means stronger solvency.
Solvency Ratios - Coverage Ratios - Fixed charge coverage ratio
Fixed charge coverage ratio = (EBIT + lease payments) / (Interest payments + lease payments)
Interpretation: measures the ability of a company to pay interest on debt. Here, lease payments are added to EBIT as they are an obligation like interest payments. Like the interest coverage ratio, a higher value for this ratio implies stronger solvency. This ratio is a more meaningful measure for companies that lease a large portion of their assets. For example, airline companies.
Profitability ratios - return on sales - gross profit margin
Gross profit margin = gross profit / revenue
Interpretation: A higher value means higher pricing and lower costs.
Profitability ratios - return on sales - operating profit margin
Operating profit margin = operating income / revenue
Interpretation: Operating profit = gross profit - operating costs. A good sign if operating profit margin grows at a faster rate than gross profit margin.
Profitability ratios - return on sales - pretax margin
Pretax margin = EBT / Revenue
Interpretation: EBT = operating profit - interest related expenses. Needs further analysis if pretax income increases only because of non-operating income.
Profitability ratios - return on sales - net profit margin
net profit margin = net profit / revenue
interpretation: Net profit = revenue – all expenses.
Profitability ratios - return on investment - operating ROA
Operating ROA = Operating income / average total assets
Interpretation: For return, either net income or operating income (EBIT) can be used.
Profitability ratios - return on investment - ROA
ROA = Net income / average total assets
Interpretation: For return, either net income or operating income (EBIT) can be used.
Profitability ratios - return on investment - return on total capital
return on total capital = EBIT / (Average short term and long term debt + equity)
interpretation: Like operating ROA, EBIT is used. Measures return on capital before deducting interest.
Profitability ratios - return on investment - return on equity (ROE)
ROE = net income / average total equity
Interpretation: A very important measure of return earned on equity capital. Unlike return on common equity, it includes minority and preferred equity.
Profitability ratios - return on investment - return on common equity
return on common equity = (net income - preferred dividend) / average common equity
Interpretation: Money available to common shareholders.
2-stage Du Pont Analysis
ROE = (Net income / Total assets) * (Total assets / Equity)
ROE: ROA * Financial Leverage
3-stage Du Pont Analysis
ROE = (Net income / Sales OR Revenue) * (Sales OR Revenue / Total assets) * (Total assets / Equity)
ROE= (net profit margin) * (asset turnover) * (leverage ratio)
5-stage Du Pont Analysis
ROE = (Net income / EBT) * (EBT / EBIT) * (EBIT / Sales OR Revenue) * (Sales OR Revenue / Total assets) * (Total assets / Total equity)
ROE = (tax burden) * (interest burden) * (EBIT margin) * (asset turnover) * (financial leverage)
Valuation ratio - P/E
P/E = Price per share / Earnings per share
Interpretation: most often used valuation measure. Prone to earnings manipulation. Non-recurring earnings may distort the ratio.
Valuation Ratio - P/CF
P/CF = Price per share / Cash flow per share
Interpretation: less prone to manipulation than P/E.
Valuation Ratios - P/S
P/S = price per share / sales per share
Interpretation: used when net income is not positive.
Valuation Ratios - P/BV
P/BV = price per share / book value per share
Interpretation: an indicator of what the market perceives. A value greater than 1 means future rate of return is higher than required rate of return.
Per-share quantities - Basic EPS
Basic EPS = (Net income - preferred dividends) / Weighted average number of ordinary shares outstanding
Per-share quantities - Diluted EPS
Diluted EPS = (Adjusted income) / Weighted average number of ordinary shares outstanding
Per-share quantities - Cash flow per share
Cash flow per share = Cash flow from operations / Weighted average number of shares outstanding
Per-share quantities - EBITDA per share
EBITDA per share = EBITDA / Weighted average number of shares outstanding
Per-share quantities - Dividends per share
Dividends per share = Common declared dividends / Weighted average number of shares outstanding
Dividend Ratios - Dividend payout ratio
Dividend payout ratio = Dividend / Earnings
Interpretation: Measures the percentage of earnings a company pays out as dividends to equity shareholders.
Dividend Ratio - retention ratio
Retention Ratio = 1 - payout ratio
Interpretation: Measures the percentage of earnings a company retains.
Dividend Ratio - sustainable growth rate
Sustainable growth rate = retention rate x ROE
Interpretation: measures how much growth a company is able to finance from its internally generated funds. A higher retention rate and ROE result in higher sustainable growth rate.
Credit Analysis Ratio - EBITDA interest coverage
EBITDA interest coverage = EBITDA / Gross Interest*
*Gross interest include non-cash interest on conventional debt instruments
Interpretation: a high value implies good credit quality.
Credit Analysis Ratio - FFO (Funds from operations) to debt
FFO (Funds from operations) to debt = FFO / Total debt
Interpretation: a high value implies good credit quality.
Credit Analysis Ratio - Free operating cash flow to debt
Free operating cash flow to debt = (CFO (adjusted) - capital expenditures) / Total debt
Interpretation: a high value implies good credit quality.
Credit analysis ratio - EBIT margin
EBIT margin = EBIT / Total Revenue
Interpretation: a high value implies good credit quality.
Credit Analysis Ratio - EBITDA margin
EBITDA margin = EBITDA / Total revenue
Interpretation: a high value implies good credit quality.
Credit Analysis Ratio - Debt to EBITDA
Debt to EBITDA = Total debt / EBITDA
Interpretation: low debt/EBITDA implies good credit quality.
Credit Analysis Ratio - return on capital
Return on Capital = EBIT / Average beginning-of-year and end-of-year capital
Interpretation: a high value implies good credit quality.
Valuation Ratios (just mention what it measures)
Valuation ratios measure: Quantity of an asset or flow per share.
Calculate tax burden from tax rate
Tax burden = 1 - tax rate
0.7 = 1 - 0.3
0.7 would be the tax burden
