Ratio Analysis Flashcards
In ratio analysis, the analyst can:
1 Compare ratios for a firm over several years (a time-series comparison).
2 Compare ratios for the firm and other firms in the industry (cross-sectional comparison).
3 Compare ratios to some absolute benchmark.
How is profitability measured? Traditional Approach
ROE (Return on equity)
ROE = Profit or loss / Shareholders’ equity
ROE = ROA X Equity multiplier
= Profit or loss / Total assets * Total assets / Equity
What is ROE an indicator of?
Profitability
What is the limitation of using ROE?
Does not recognize the fact that some of a firm’s liabilities are in essence non-interest-bearing operating liabilities.
What is ROA?
Two formulas
Return on Assets
ROA = Profit or loss / Total assets
ROA = Profit or loss / Revenue X Revenue / Total assets
What is asset turnover formula?
Revenue / Total assets
What is Equity multiplier?
The equity multiplier is a financial leverage ratio that measures the amount of a firm’s assets that are financed by its shareholders by comparing total assets with total shareholder’s equity.
What is Equity multiplier?
An equity multiplier is a financial ratio that measures how much of a company’s assets are financed through stockholders’ equity.
Total assets / Equity
Income statement Items
1) Interest expense after tax
2) Net investment profit after tax (NIPAT)
3) Net operating profit after tax (NOPAT)
Interest expense after tax formula
Interest expense x (1 - Tax rate)
NIPAT
Net investment profit after tax = (lnvestment income + Interest income) x (1 - Tax rate)
NOPAT
Net operating profit after tax = Profit or loss - Net investment profit after tax + Interest expense after tax
Balance sheet Items
1) Operating working capital
2) Net non-current operating assets
3) Non-operating investments
4) Net operating assets
5) Business assets
6) Debt
7) Invested capital
Operating working capital formula
(Current assets - Excess cash and cash equivalents) - (Current liabilities -
Current debt and current portion of non-current debt)
Net non -current operating assets
Non -current tangible and intangible assets + (Net) derivatives - (Net) deferred tax
liability - Non-interest-bearing non -current liabilities
Non-operating investments
Minority equity investments + Other non-operating investments + Excess cash and
cash equivalents
Net operating assets
Operating working capital + Net non-current operating assets
Business assets
Net operating assets + Non-operating investments
Debt
Total interest-bearing non-current liabilities + Current debt and current portion of
non-current debt
Invested capital
Debt + Group equity
What is tax shield?
A tax shield is a reduction in taxable income for an individual or corporation achieved through claiming allowable deductions such as mortgage interest, medical expenses, charitable donations, amortization, and depreciation.
Formula: amount of the taxable expense X the tax rate.
Alternative ROE formula
Return on invested capital + Spread X Financial leverage
Financial leverage formula
Debt / Equity
Spread formula
Return on invested capital- Effective interest rate
ROIC
Return on invested capital
Return on invested capital is a measure of how profitably a company is able to deploy its operating and non-operating assets to generate profits
ROIC = NOPAT /Invested Capital + NIPAT/Invested Capital
RNOA
return on net operating assets (RNOA)
RNOA = NOPAT/Revenue X
Revenue/Net operating assets
NOPAT margin
NOPAT/Revenue
measure of how profitable a company’s sales
are from an operating perspective.
Operating asset turnover
Revenue/Net operating assets
measures the extent to which a company is able to use its net operating assets to generate revenue.
The appropriate benchmark for evaluating return on invested capital is the
weighted average cost of debt
and equity capital, or WACC.
WACC formula
WACC=(E/V ×Re)+(D/V ×Rd×(1−Tc)) where: E=Market value of the firm’s equity D=Market value of the firm’s debt V=E+D Re=Cost of equity Rd=Cost of debt Tc=Corporate tax rate
Gross Profit Margin
(Revenue - Cost of sales) / Revenue
NOPAT margin
NOPAT margin provides a comprehensive indication of the operating performance of a company because
it reflects all operating policies and eliminates the effects of debt policy
Net operating profit after tax / Revenue
EBITD
EBITDA margin provides similar information, except that it excludes depreciation and amortization expense, a significant non-cash operating
expense.
Earnings before interest, tax, depreciation and amortization / Revenue
Asset turnover may be broken into two primary components:
Working capital management
Non-current asset management
Operating working capital
Operating working capital
= (Current assets – Excess cash and cash equivalents)
– (Current liabilities – Current debt and current portion of non-current debt)
Operating working capital-to-sales ratio
Operating working capital / Revenue
Operating working capital turnover
Revenue / Operating working capital turnover
Trade receivables turnover
Revenue / Trade Receievables
Inventories turnover
Cost of sales/Inventories
Cost of materials/ Inventories
Trade payables turnover
Purchases / Trade Payables
Cost of sales / Trade payables
Cost of materials / Trade payables
Lower the better
Days’ receivables
Trade receivables / Average
revenue per day
Trade receivables / (Revenue/360)
Lower the better
Days’ inventories
Inventories / Average
cost of sales per day
lower
Days’ payables
Trade payables / Average purchases per day
reasonably high
Net non-current operating assets
Net non-current operating assets
= Total non-current operating assets
– Non-interest bearing non-current liabilities
Net non−current operating asset turnover
Revenue/Net non−operating assets
PP&E turnover
Revenue/ Net property, plant and equipment
Cash conversion cycle
Days’ inventories + Days’ receivables - Days’ payables
Analysis of leverage can be performed on both current and non-current debts:
Liquidity analysis relates to evaluating current liabilities
Solvency analysis relates to longer term liabilities
Liquidity Analysis Ratios
Current ratio
Quick ratio
Cash ratio
Operating cash flow ratio
Current Ratio
Current assets / Current liabilities
Quick Ratio
Cash and marketable securities + Trade receivables (net) / current liability
Cash Ratio
Cash and marketable securities / current liabilities
Operating Cash flow Ratio
Cash flow from operations / current liabilities
Debt and coverage ratios
Liabilities−to−equity ratio
Debt−to−equity ratio
Debt−to−capital ratio
Liabilities−to−equity ratio
Total liabilities. Shareholders’ equity
Debt−to−equity ratio
(Current debt + Non-current debt) / shareholders’ equity
Debt−to−capital ratio
(“Current debt”+”Non−current debt”) / (Current debt+Non−current debt+Shareholders′ equity)
Interest Coverage
(Profit or loss + Interest expense after tax) / interest expense
(cash flow from operations + interest expense + taxes paid) / interest expense
Debt coeverage
(profit or loss + interest and lease expenses * (1- tax rate)) / interest and lease expenses * (1- tax rate) + debt repayment
Sustainable growth rate
Sustainable growth rate measures the ability of a firm to maintain its profitability and financial policies
ROE x (1 − Dividend payout ratio)
Dividend payout ratio = Cash dividends paid / profit or loss
Cash from operations
Working capital from operations
increase (or + decrease) in trade receivables
increase (or + decrease) in inventories
increase (or + decrease) in other current assets excluding cash and cash equivalents
+ increase (or – decrease) in trade payables
+ increase (or – decrease) in other current liabilities excluding debt
