Fin 4201/8001 1

Ratios

Measure strength of various firm aspects Informational needs of creditors and investors Facilitate time-series or cross-sectional analysis Five types

• Activity

• Liquidity

• Debt and solvency

• Profitability

• Valuation

Fin 4201/8001 2

Activity Ratios

1) Inventory turnover – COGS /Avg.Inventory

2) Receivables turn – Sales / avg.Receivables

3) Working Capital turn – Sales / Avg.Working Capital

4) Fixed Assets turn – Sales / Avg.Fixed Assets

5) Total Assets turn – Sales / Avg. Total Assets

Fin 4201/8001 3

Examples from handout

1 Inventory Turnover     4.55

Cost of goods sold 2142

Average Inventory 471

Avg. no. of days inventory in stock 80

2 Receivables turnover     10.76

Sales 4063

Average Receivables 378

Avg. no. of days receivables are outstanding 34

Fin 4201/8001 4

Examples from handout

3 Working capital turnover     18.26

Sales406

3

Average working capital 223

4 Fixed assets turnover     2.60

Sales406

3

Average fixed assets156

3

Fin 4201/8001 5

Examples from handout

5 Total assets turnover     1.21

Sales406

3

Avg. total assets334

8

Fin 4201/8001 6

Liquidity Ratios

1) Current – Current Asset / Current Liability

2) Quick – $+securities+AR / Current Liability

3) Cash – $+securities / Current Liability

Fin 4201/8001 7

Examples from handout

1 Current ratio     1.25

Current Assets102

0

Current Liabilities 815

2 Quick ratio     0.72

Cash + Mkt. sec + Accounts Receivable 584

Current Liabilities 815

Fin 4201/8001 8

Examples from handout

3 Cash Ratio     0.23

Cash + Mkt. sec 190

Current Liabilities815

Fin 4201/8001 9

Debt and Solvency Ratios

1) Long-term Debt to CapitalLong-term debt + other long-term liab. / Total capital (debt + equity)

2) Long-term Debt to EquityLong-term debt + other long-term liab. / Total capital (debt + equity)

3) Times Interest EarnedEBIT / Interest Expense

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Examples from handout

1Long-term Debt to total capital (no deferred tax or CL)     0.54

Long-term debt 1226

Total capital (Long-term debt plus SH's eqty) 2268

  Long-term Debt to total capital (no CL)     0.60

Long-term debt plus deferred tax 1547

Total capital 2589

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Examples from handout

2 Long-term Debt to equity     1.18

Long-term debt 1226

Total equity 1042

  Long-term Debt to equity     1.48

Long-term debt plus deferred tax 1547

Total equity 1042

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Examples from handout

3 Times Interest earned     6.92

EBIT 595

Interest expenses 86

Fin 4201/8001 13

Profitability Ratios

1) Gross Margin – Gross Profit / Sales

2) Operating Margin – Operating Income / Sales

3) Margin before Interest and Tax – EBIT / Sales

4) Pre-tax Margin – EBT / Sales

5) Profit Margin – Net Income / Sales

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Examples from handout

1 Gross margin     0.47

Gross profit192

1

Sales406

3

2 Operating margin     0.19

Operating income 753

Sales406

3

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Examples from handout

3 Margin before interest and tax     0.15

EBIT 595

Sales406

3

4 Pre-tax margin     0.14

EBT 557

Sales406

3

Fin 4201/8001 16

Examples from handout

5 Profit margin     0.08

Net Income 341

Sales406

3

Fin 4201/8001 17

Valuation Ratios

1) Price to Earnings (P/E) – Price / EPS2) Price to Book (P/B) – Price / Book value per share3) Price to Tangible Book – Price / Total Assets –

Intangibles - Goodwill

Valuation Analysis

Price (December, 1998) $62

Number of shares 180 mn

EPS (Net Income / No. of shares) $1.89

Book value (SH’s value / No. of shares) $5.79

Tangible assets per share $16

Fin 4201/8001 18

Examples from handout

1 P/E Ratio     32.73

Price per share 62

EPS per share 1.89

2 Price to book value     10.71

Price per share 62

Book Value per share 5.79

Book Value = Sh's equity / no. of shares

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Examples from handout

3 Price to Tangible Assets     3.88

Price per share 62

Tangible assets per share 16

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Other stuff not covered here, but may want to address in report/presentation

Return on Invested Capital (ROIC) – NOPLAT/ Invested Capital covered with spreadsheet later

Return on Assets (ROA) – Net income + After-tax interest / Avg. Total Assets

Return on Equity (ROE) – Net Income / Avg. Total equity

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Other stuff not covered here, but may want to address in report/presentation

DuPont system

• 2 is greatest when no leverage

• 1*2*3 = profit margin

• 4 = asset turnover

• 3 * 4 = ROA (does not depend on leverage)

• 5 = leverage ratio – boosts ROE only if ROA>cost capital

(5) (4) (3) (2) (1)

Equity

Assets*

Assets

Sales*

Sales

EBIT*

EBIT

ProfitPretax *

ProfitPretax

NetProfitROE

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Just because

Return on equity (ROE)     0.36

Net Income 341

Average total equity 948

OR

Profit margin 0.08

Total asset turnover 1.21

Financial leverage 3.53

Note some rounding error 0.35

Fin 4201/8001 23

Still more ratios

PEG – PE ratio / Earnings growthevaluates if price of growth is being realized

Enterprise value / EBITDA(market cap + total debt – Total cash) / EBITDAgood for comparisons if high level of debt or high level of cash

Fixed asset spending / Depreciationhigher may reveal long term planning, but needs to cover at least 3 years