Week 1 - Ratio Analysis Flashcards
4 levers to achieve growth and profit targets
Operating management
Investment management
Financing strategy
Dividend policy
Ratio analysis
Time series - ratio over time from prior periods
Cross-sectional - Ratios of other firms in the industry
Some absolute benchmark e.g. current ratio >1
Profitability ratios
Price/Earnings
Break even point
Operating management ratios
Gross margin = gross profit/sales
Operating profit margin = operating profit/sales
Net margin = profit after tax/sales
Gross profit
Measures the profitability of sales, less direct CoS
Indicator of the:
price premium a firms product commands in the market
The efficiency of a firms procurement and/or production process
Markup = Profit/Cost
Mark-up is profit/cost. If we buy for 50p and sell for £1 then the mark up is 100% but the margin is 50%.
Investment Management Ratios
Return on capital employed (ROCE) =
Operating profit (or profit before interest and tax)
Capital employed (debt + equity)
This shows the pre-tax return to debt and equity and is a measure of activity and margins
Net asset turnover is sales/net assets
ROCE = operating margin * asset turnover
Working Capital Management
difference between current assets and current liabilities:
Current assets are inventories, receivables and cash
Current liabilities are payables and accruals
Working Capital Ratios
There are several ratios useful to evaluate a firm’s liquidity, including:
Current ratio
Quick or “Acid test” ratio
Inventories days
Receivables days
Payables days
Working capital cycle days
We need to make sure the firm isn’t about to go bust!
Working Capital Ratios 6
Current Ratio = current assets/current liabilities
Acid test ratio = Current assets less inventories/current liabilities
Inventories days = (inventories/cost of sales) *365
Recievables days = (recievables/sales) *365
Payables days = (Trade payables/CoS + expenses) *365
Working capital cycle = Inventories + recievables days - payables days
Financing ratios 3
Gearing = Debt/Debt+Equity
Financial Levereage (FLEV) = Debt/Equity
Interest cover = profit before interest/interest
Measuring return to shareholders FORMULA
ROE (Return on equity) = RONA + (FLEV * (RONA - NFE))
Net Operating Profit after Tax (NOPAT) and calculating Tax rate if it isn’t given
Tax rate (if you arent given it) = Tax charge/Profit before tax
NOPAT = Operating profit less tax
Return on net Assets (RONA)
RONA = NOPAT/Net assets
Net assets = debt + equity
NFE (Net Finance Expense
NFE is the after tax cost of debt
If the tax rate is 25% and debt is paid 6% gross then NFE is 6% * (1-25%) = 4.5%
Spread is the difference between RONA and NFE
e.g. if RONA is 10% and NFE is 4.5% then spread is 5.5%
Sustainable Growth Rate
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