Unit 4 Flashcards
What is the RATE OF RETURN ON TOTAL ASSETS/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Profitability
As %
(net operating profit + interest expense)/average total assets
WHERE average total assets = across 2 years (current and past)/2
WHERE net operating profit = operating net profit before tax
Return on assets provided by whoever(owner/investor) - how efficiently company manage assets to produce profits during a period
HIGH is GOOD
- usually indicates upward profit trend
USEFUL:
comparing companies in same industry as they use similar assets
What is the DEBT TO EQUITY RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Stability Ratio
As ratio:1
NOT IN SUBJECT MATTER BUT IN FORMULA BOOK
FORMULA: - from financial statement
total debt (liabilities)/total equity
Ratio of debt to equity
Percentage of company financing that comes from creditors and investors
GOOD if LESS than 1:1
I.e. 0.5:1
Meaning half as many liabilities than there is equity - assets of company funded 2:1 by investors to creditors
1:1 means investors and creditors have equal stake of assets
LOW = more financially stable
What is the LONG TERM DEBT COVERAGE RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Additional Ratios
As ratio i.e. 2:1
(cash flows from operations - dividends paid)/long term debts)
WHERE long term debts = non-current liabilites
ratio (2:1) is GOOD/STRONG - company generates twice as much cash from operations as it needs to cover its long-term debt obligations
- Ratio BELOW 1 = negative cash flow (BAD)
i.e. 0.92:1 –> net operating income is enough to cover only 92% of its long term debts
Whether a company can meet long term liabilities and take additional debt (using operating cash flow) without jeopardising its survival
- financial stability of business
- capacity to service long-term debt without relying on additional financing or asset sales.
What is the EBITDA MARGIN RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Profitability
As %
NOT IN SUBJECT MATTER BUT IN FORMULA BOOK
FORMULA:
Earnings before interest, tax, depreciation and amortisation/total revenue
Measures companies profitability before deductions often considered irrelevant in certain decisions
- EBITDA strips all numbers out to focus on essentials: OPERATING PROFITABILITY and CASH FLOW
USEFUL:
Compare relative profitability of various companies, different sizes but same industry
What is the EQUITY MARGIN/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Stability Ratio
As %
FORMULA:
total OE/total assets
Percentage of assets provided by owners
GOOD if GREATER than 50%
- higher shows potential shareholders that company is worth investing in since so many investors already willing to finance
USEFUL:
Shows creditors company sustainable/less risky to lend future loans
Shows investors that its trustworthy to invest in
What is the NET PROFIT RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
%
Profitability
Net profit per dollar of net sales
How much revenue remains to be paid to shareholders (dividends)/reinvested
HIGH Is GOOD
USEFUL:
Determine if profitability improving/declining (sustainability of business)
Net Profit (after tax)/Net Sales
Where net sales = total sales - sales returns
What is the EARNINGS PER SHARE RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Specific ratios for companies - somewhat profitability (accounted to shares)
In cents (so x * 100) since originally in dollars
FORMULA:
Operating profit after tax (net profit after tax) - preference dividends/average number of ordinary shares (n. shares)
- Amount of money each shareholder would receive if all profits distributed at the end of year
- High ratio makes share price rise
HIGH is GOOD
= more profitable - more profits to distribute
USEFUL:
Investors don’t pay attention, still look, to EPS since so many things can manipulate the ratio
What is the PRICE-EARNINGS RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Specific ratios for companies
As $
share price/earnings per share
WHERE earnings per share = net profit after tax/number of shares
SO earnings per share = gross profit - expenses/number of shares
SO share price/((sales + other revenue - expenses - cost of goods sold)/number of shares)
What investors willing to pay based on companies current earnings (market value of a share)
As rises - market value per share rises
More expenses vs Profit = higher ratio number
HIGH is GOOD
- positive future performance - investors pay more
What is the CURRENT RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Liquidity
As Ratio:1
FORMULA:
Current Assets/Current Liabilities
Ability meet current debts with current assets
IMPORTANT because short term liabilities are due within 12 months
Identifies overall debt burden of the company - if weighted down with current debt, cash flow will suffer
GOOD if GREATER than 2:1 (BENCHMARK)
i.e. have 2 times current assets than current liabilities
LOWER than 1:1
Company has to sell non-current assets (bad) - not making enough money from operations to support activities (losing money)
- sometimes as result of poor collections of a/c rec
What is the GROSS PROFIT RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Profitability
As %
Portion of sales revenue turned into profit
Management/investors use to measure how EFFICIENTLY business SELL products
How profitable range of products are
HIGH = GOOD
gross profit/net sales
WHERE net sales = total sales - sales returns
What is the RATE OF TURNOVER OF INVENTORIES/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Liquidity
As times per day/annum 365/ratio)
HIGH is GOOD
- How quickly inventory sold (liquidity of inventory)
Inventory into cash - varies with industry
KNOW: average means across 2 years (current and past)
ratio = cost of goods sold/AVERAGE accounts payable
What is the DIVIDENT YIELD RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Specific ratios for companies - financial leverage ratios
As %
FORMULA:
Dividend per share/market value per share
IMPORTAN WHERE:
Dividend per share = dividend paid (declared to be paid aka liability)/paid up capital (if $1 sahre) (n. shares)
WHERE: n. shares = paid up capital/issue price per share
- amount of cash declared to be paid as dividends relative to market value per share
(market value per share is price of share in market currently vs issue price per share which is original price per share when released in public)
USEFUL:
Show investors how their investment in shares generates cash flows in dividends or increases in asset value by stock appreciation
HIGH VALUE =
pays investors large dividend compared to market value of shares - investors highly compensated thus good when compared to lower dividend yielding shares (GOOD FOR INVESTORS)
What is the RATE OF TURNOVER OF ACCOUNTS RECEIVABLE/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Liquidity
As times per day/annnum (365/ratio)
HIGH is GOOD
- effectiveness of collections/whether acounts receivable too high
i.e ratio 2 = collect every 6 months
or 365/2 = every 182.5 days collect a/c rec
Higher efficiency = better from cash flow standpoint - can use to pay other bill/obligations sooner
KNOW: average means across 2 years (current and past)
ratio = Net credit sales/AVERAGE accounts receivable
What is the TIMES INTEREST EARNED RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Financial Stability Ratio
As n. of times i.e. 5.3 times
EBIT = earnings before interest and tax
Earnings before income tax and interest (EBIT)/Interest expense
- how many times company pay its interest with its income before tax
(might be shown on financial statements)
HIGH is GOOD
- 3-4 times considered an acceptable risk (interest paid 3-4 times over)
LOW - credit risk
USEFUL:
Investors favour company with high n. - shows company can afford to pay its interest payments when they come due
What is the CASH GENERATING POWER RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Additional ratio (efficiency)
As Ratio:1
cash flows from operations/(cash flows from operations + cash INFLOWS from investing + cash INFLOWS from financing)
ENSURE, its INFLOWS for last 2
- proportion of company’s positive cash flow that comes from operating the business vs cash from investments/financing activities
Should analyse annually and compare year to year
REDUCTION in value is BAD
What is the GEARING RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Stability Ratio
As RATIO:1
NOT IN SUBJECT MATTER BUT IN FORMULA BOOK
FORMULA:
(short term + long term obligations + overdrafts) / equity investments
WHERE:
equity investments = total OE
Short term/long term = current/non-current liabiltiies
IF OVERDRAFT ALREADY IN NON-CURRENT LIABILIY, DONT INCLUDE
- measure of financial leverage - degree to which a firms operations funded by equity capital vs debt financing
HIGH means high degree of leverage - not always means in a poor financial condition
HIGH = RISKIER vs lower
What is the SHAREHODLER EQUITY RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Financial Stability Ratio
As %
NOT IN SUBJECT MATTER, BUT FORMULA BOOK
Total equity/total assets
- How much companies assets generated/owned by issuing equity shares than taking debts
HIGH is GOOD
(100% = assets financed with stock rather than debt) - lower financial risk and potentially greater financial stability.
Lower = more debt company used to pay for assets
How much shareholders might receive in the event of liquidation
Degree to which it is funded by its owners rather than creditors.
What is the ACID TEST OR QUICK RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Liquidity
As Ratio:1
FORMULA:
(current assets- (inventories + prepayments)) / (current liabilities)
Where prepayments = prepaid expense
Ability to meet immediate debts using most liquid assets
GOOD if GREATER than 1:1 (BENCHMARK)
- Can pay off obligations without having to sell off long term/capital assets
i.e. 1.5:1
OTHERWISE
selling off non-current assets which usually generate revenues, hurt company + show investors current operations don’t make enough profit to pay off liabilities
What is the ACCOUNTS PAYABLE TURNOVER RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Liquidity
Times per yer or
365/n. = every x days
NOT IN SUBJECT MATTER BUT IN FORMULA BOOK
KNOW: average (formula) means across 2 years (current and past)
total supplier purchases/AVERAGE accounts payable
WHERE:
total supplier purchases = inventory from current year - inventory from last year (beginning inv) + cost of goods sold
N. times company pay off its average a/c pay during the course of the year
or
How quickly a company pays off its suppliers over a specific period (year)
USEFUL:
supplies and creditors use to decide to grant/not credit to business
HIGH is GOOD
- shows suppliers/creditors company pays its bills frequently and implies new vendors paid back quickly
VERY HIGH
- maybe company is not fully utilizing credit terms offered by suppliers.
What is the OPERATING CASH FLOW RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
(NOT IN SUBJECT MATTER BUT FORMULA SHEET)
(NOT IN SUBJECT MATTER BUT FORMULA SHEET)
Additional ratio
%
Proportion of cash generated from operating activities relative to the company’s revenue
Cash flows to sales relationship - EFFICIENCY/liquidity - cover their short-term obligations
HIGH is GOOD
What is the DEBT RATIO/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Stability Ratio
In 50%
FORMULA:
total liabilities/total assets
Percentage of assets financed/provided by external parties (extent of gearing)
GOOD if LESS than >50%
LOWER = more stable business (potential of longevity due to overall lower debt)
50% indicates twice as many assets than liabilities
Creditors own half the companies assets, shareholders own the remainder
What is the RETURN ON OWNERS EQUITY/what category under?
How do u calculate it (formula sheet) and deriving to simplest form
What expressed in?
Profitability
As %
Return on investment by owners - how much profit each dollar of owner’s equity generates
- Efficiency using money from shareholders to generate profits/grow
From investors POV not companies - based on investors investment
HIGH is GOOD
as company uses funds effectively - managed effectively and efficiently
(under capitalised maybe which is bad)
If Low –>
Not enough profit per dollar invested
(over capatilised/managed innefficiently)
KNOW: average means across 2 years (current and past)
ratio = net profit/AVERAGE owners equity
What is working capital/calculate?
WORKING CAPITAL = current assets - current liabilities
Measure of a company’s short-term financial health and its ability to cover its short-term obligations with its short-term assets.
- has the liquidity to continue its operations and invest in its business (if positive)
Whats net realisable value (NRV) and how to calculate?
At least 2 Benefits/2 Limitations?
NET REALISABLE VALUE = Original purchase - selling price
i.e. Purchase for (1399.52) - Selling (9752 - 145 (advertising))
Benefit -
* Because its sale price and associated costs are less than historical cost - inventory item more accurately reported in accounts
* Helps avoid overstating/understating value of assets
* Helps reflect true market value of asset
Limitation -
* Costs associated with the sale of inventory items are estimated only (asw the sale price)
* Not account for potential changes in market
* Leads to frequent adjustments in financial statements - causing volatility in reported earnings
What are all the liquidity ratios?
5 TOTAL
current ratio
acid test or quick ratio
rate of turnover of accounts receivable
rate of turnover of inventories
accounts payable turnover ratio
What are all the profitability ratios?
5 TOTAL
gross profit ratio
net profit ratio
return on owners equity
rate of return on total assets
EBITDA margin ratio
What are all the other (not stability/profitabiilty/liquidity) ratios?
3 TOTAL
Cash generating power ratio
Long term debt coverage ratio
Operating cash flow ratio
What are all the stability ratios?
6 TOTAL
equity margin
debt ratio
debt to equity ratio
times interest earned ratio
gearing ratio
shareholder equity ratio
What are all the other ‘specific ratios for companies’ ratios?
3 TOTAL
earnings per share ratio
price - earnings ratio (P/E ratio)
dividend yield ratio
