formulae and ratio analysis

Formulae and Ratio AnalysisJr Vi, Lilia Karimi, Megh Vakaria, Kyle Petty,

Linh Le and Jordan Alfaro

Profitability Ratios

Profitability RatiosGross Profit Margin

• Result of:−Price structure−Amount of business done−How well expenses are controlled

• Return after variable cost are taken from the sales revenue

• Can be compared to industry standards

Profitability RatiosGross Profit Margin

•Example

Profitability RatiosNet Profit Margin

•The profit left after all the cost have been taken from the sales revenue

Liquidity Ratios

Liquidity Ratios

• Ability to meet its near-term obligations, and it is a major measure of financial health

• Liquidity= cash that is within a business/ability to generate cash quickly

• The higher value the ratio is, the larger the margin of safety the business has to pay off debts

Liquidity Ratios

• Creditors are the people interested in the ratio because it shows if you can pay off your business

• If you're looking to secure money via the sale of some stock through an initial public offering, many State Securities Bureaus will require that you have a current ratio of 2:1 or better.

Liquidity RatiosCurrent Ratio

• It signifies a company's ability to meet its short-term liabilities with its short-term assets

• Current Ratio= Current Assets/ Current Liabilities $48 Million/ $34 Million= 1.4 Times

• Current assets includes cash, marketable securities, accounts receivable, prepaid expenses and inventories.

• Current liabilities include accounts payable, current maturity of long term debt and accrued income taxes.

Liquidity RatiosAcid Test (Quick) Ratio

• Refined version of current ratio• It eliminates certain current assets such as

inventory and prepaid expenses that may be more difficult to convert to cash.

Example:

$48 Million- $10 Million/ $34 Million = 1.1 Times

• In general, a quick or acid-test ratio of at least 1:1 is good. That signals that your quick current assets can cover your current liabilities.

Efficiency Ratios

Efficiency RatiosReturn on Capital Employed (ROCE)

• The “primary ratio” • Tells how effective the business is at returning

a profit from the capital it has• Can compare small businesses to big

businesses • Shareholders – compare ROCE with other

investments – Should be higher for more risk as a good

investment

Efficiency RatiosStock Turnover

• Low ratio = poor sales and therefore excessive inventory

• High ratio = strong sales or effective buying.

Efficiency RatiosStock Turnover (Number of Days)

• Calculates the days it takes to sell the stock and how many days’ worth of stock is held by the business

Gearing Ratio

Gearing Ratio Looks at the promotion of capital employed

that comes from long-term loans. Companies borrow money

Expand New machinery and equipment

More capital = more interest pay Borrowing is a risk Assess how big that risk is

Measures proportion of company's total capital borrowed

Gearing Ratio• Example 1

– Company A: gearing 75%• Profit $100 million• Interest $50 million

– Cover interest payments twice over.• Example 2

– Company B: gearing 35%• Profit $20 million• Interest $18 million

– Just about cover interest payments.

Investment Appraisal

Investment Appraisal Average Rate of Return (ARR)

• Used in investment appraisal • Measures profitability/accounting of a project

of its life • Considers all data, not just cash flows up the

point of payback

Investment Appraisal Average Rate of Return (ARR)

•Example:–“Stilgitz Instruments AG is considering buying a new calibrating machine for €200,000. The extra costs and revenues over its useful life are shown in Table 1.0.”

Investment Appraisal Average Rate of Return (ARR)

•