Unit 4 Ratios Flashcards
why are ratios useful
help standardize info from financial statements for comparison
describe flexibility of ratios
any numbers of ratios can be used, modified or created for a unique situation
describe how ratios allow focus
help spot trends and point in a direction to investigate
describe how ratios allow evaluation
evaluate if a firm is reaching its stated goals
benchmarking
process of doing a financial analysis on a firm and comparing it to other similar firms
Types of comparison methods
Trend analysis
Cross-Sectional analysis
Progress Measurement
Describe Trend Analysis
look at a firms ratios over time
Describe Cross-Sectional Analysis
compare ratios between firm and peer group
Describe Progress Measurement
compare ratios to goals
2 pitfalls to ratios
Timing issues
Accounting issues
2 types of timing issues with pitfalls
Seasonal firms - different growth rates in different seasons
High-growth firms - balance sheets are from one point in time, income statements are an average over 1 year. Growth was much slower at start of year, creating timing issue. Can mitigate by using average of 2 balance sheets.
Describe accounting issues with ratios
firms can have different accounting policies and may appear different, even though they are economically identical ie each may use different inventory systems
5 types of ratios
Liquidity Activity (efficiency) Leverage (financing, solvency) Profitability Market
Describe liquidity ratios
measure ability to meet short term obligations
Describe Activity ratios
aka efficiency ratios
measure how well a firm uses assets to generate cash
Describe Leverage ratios
aka financing/solvency ratios
measure how a firm in financed
proportions of equity and debt to finance assets
Describe Profitability ratios
directly judge how profitable a company is compared to past or to competitors
Describe Market ratios
evaluate if stock is overvalued or undervalued
Current Ratio
Liquidity Ratio
CA/CL
use current assets to pay current liabilities
higher CR means better ability to pa short term obligations
Quick Ratio
Liquidity Ratio (acid test ratio)
CA-I/CL
remove inventory from Current Ratio
use immediate assets to pay liabilities
Accounts Receivable Turnover
Activity Ratio
CSAR
ability to collect credit payments, times per year
evaluate with trend analysis
Average Collection Period
Activity Ratio
365/ART
days to collect all credit payments
indicates tightness of credit standards
Inventory Turnover
Activity Ratio
COGS/I
measure if sufficient inventory is on hand
evaluate with cross sectional analysis
Total Asset Turnover
Activity Ratio SA asset use efficiency higher TAT means firm is generating more sales per asset $ trend and xsec
Fixed Asset Turnover
Activity Ratio
SFA
remove current assets from TAT, which are influenced by risk preferences
exclude risk preference from asset use efficiency
Operating Income Return on Investment
Activity Ratio (Profitability)
OIA
measure profit as pct of assets
Looks only at operations to evaluate asset use efficiency
How much pre tax, pre financing $ generated per asset $
Debt Ratio
Leverage Ratio
TL/TA
proportion of assets financed with debt
aggressiveness in leveraging debt
Debt to Equity Ratio
Leverage Ratio
LE
ability to use equity to pay debt
Times Interest Earned
Leverage Ratio
EBIT/I
ability to pay interest with earnings
Return on Assets
Profitability Ratio NIA proportion of earnings related to assets higher ROA is better use in xsec analysis
Return on Equity
Profitability Ratio
NIE
ROE>ROA means better use of debt
Gross Margin
Profitability Ratio PS percentage of gross profit from sales shows how much waste is minimized in production process use in cross sectional analysis
Operating Margin
Profitability Ratio
EBIT/S
pretax -compare firms with different capital structures
Net Profit Margin
Profitability Ratio NIS measures profit as a pct of sales positive means value created used in trend and xsec
Market to Book Ratio
Market Ratio
MVEBVE
>1 growth, <1 value
Price to Earnings Ratio
Market Ratio
PPSEPS
predict value of stock, firm
COGS
Cost of Goods Sold
EBIT
Earnings before Interest and Tax
Dupont framework formula
ROE = Net Profit Margin x Total Asset Turnover x Leverage Multiplier
summary of Dupont framework formula
ROE = NPM x TAT x Leverage Multiplier
Dupont alternate formula
ROE = ROA x Leverage Multiplier
Meaning of dupont framework
ROE is a function of Operating efficiency, Asset efficiency and financing policy
Meaning of alternate dupont framework formula
Return on all investors is measured by profitability and asset use efficiency
The effect of capital structure appears only in ROE
