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TRANSCRIPT
©2012 KEAW v5
Financial Ratio Review
Kenneth EA Wendeln
‘Top 8’ Plus
Capstone
Financial Ratios
J411 Financial Ratio Review 2
Asset Turnover
Liquidity
Financial Leverage
Profitability
‘Top 8’ Key Financial Ratios
Return on Owners’ Equity %
EPS – Earnings per Share $ DD.00
Return on Sales % Accounts Receivable
Turnover X (times/year) or # days
Inventory Turnover X (times/year) or # days
Current Ratio # n.nn
Acid Test or Quick Ratio # n.nn
Total Liabilities to Equity %
J411 Financial Ratio Review 3
Summary of Financial Ratios
*Return on
Equity
Return on Total Assets (ROA)
Return to
Investors
*Earnings Per
Share
Price to
Earnings Ratio
Dividend Yield
Return to Investors
Derived from: Fraser/Ormiston, Understanding the Corporate Annual Report; Understanding Financial Statements 6e
*A/R Turnover
*Inventory Turnover
Fixed Asset
Turnover
Total Asset
Turnover
Return on Total Assets (ROA)
Asset Management
Operating Efficiency
*‘Top 8’ & CAPSTONE Financial
Ratios
Other Common
Ratios
*Return on
Equity
Returns
Return on Total Assets (ROA)
Cash Return
on Assets
Profitability
*Net Profit
Margin (ROS)
Margins
Operating Profit Margin
Gross Profit
Margin
Product Contri- bution Margin
Cash Flow
Margin
Amount of
Debt
LEVERAGE Assets/ Equity
Debt/ Equity
Debt/ Assets
*Total Liabilities/
Equity
Coverage of
Debt
Times Interest Earned
Fixed Charge
Coverage
Cash Flow
Adequacy
Cash Interest Coverage
Leverage /Debt Management
LT Debt/ Total
Capital- ization
Short Run
Solvency
*Current Ratio
*Quick or
Acid Test Ratio
Cash Flow
Liquidity Ratio
Current Assets
*A/R Average
Collection Period
*Days Inventory
Held
Days Payables
Out- standing
Liquidity
Days of
Working Capital
J411 Financial Ratio Review 4
Key Financial Statements
Current (12mo)
Long-Term
TOTAL ASSETS
● Cash ● A/R ● Inventories
● PPE ● Fixed Assets
Current (12mo)
Long-Term
TOTAL LIABILITIES
● A/P ● ST Debt
● LT Debt
● Stock @ par ● Paid-in Capital
● Accumulated Net Income ● less Dividends
Contributed Capital
Retained Earnings
TOTAL OWNERS’/ SHAREHOLDERS’ EQUITY
Assets =
Liabilities +
Ow
ners’ E
quity
Balance Sheet Period Ending
Net Sales
TOTAL REVENUES
● Units Sold ● @ Price ● less Returns & Allowances
Change in cash - Sources & (Uses) - between Periods
Other Expenses
● Interest ● Taxes ● One-time
Operating Profit
TOTAL NET INCOME or (LOSS) CASH provided (used) by
FINANCING Activities
Stock ● Sale (Purchase)
Dividends Debt/ Borrowing
● (Paid)
● Increase (Decrease)
CASH provided (used) by INVESTING Activities
PPE ● (Additions) Sale
Other Investments
● (Additions) Sale
TOTAL OP EXPENSES
Expenses for Period
● R & D ● Marketing ● Distribution ● Sales ● Admin
Cost of Goods Sold
● Units Sold ● @ Material ● @ Labor ● @ Overhead
CASH provided (used) by OPERATING Activities
Net Income ● Income Statement ● Accrual Based
● Depreciation ● A/R & A/P ● Inventory ● Other Accruals
Adjustments for Non-cash Items
Income Statement for Period
Reven
ues –
Exp
enses =
Net In
com
e
Cash Flow Statement ∆C
ash =
Operatin
g +
Investin
g +
Finan
cing
J411 Financial Ratio Review 5
Profitability and Return to Investors
ROE *Return on Owners’ Equity
%
ROS *Return on Sales
%
ROA Return on Total Assets
%
Net Income (after taxes) Owners’ Equity
Net Income or Loss (after taxes) Average # of Common Stock
Shares Outstanding
Net Income (after taxes) Net Sales Revenue
Net Income (after taxes) Total Assets
EPS *Earnings per Share
$ DD.00
J411 Financial Ratio Review 6
Return on Owners’ Equity Profitability ratio that provides an overall measure of a business’s performance. Net income earned (after tax) per dollar of owners’ investment accumulated in the business.
Typically between 15% and 25% for profitable companies
Net Income (after taxes) Owners’ Equity
J411 Financial Ratio Review 7
Return on Sales or Net Profit Margin
This profitability ratio measures how well the company generated net profit (after tax) per dollar of net sales revenue.
This ratio is best evaluated by analyzing a firm’s year to year trends and by comparing to businesses within appropriate industries.
Net Income (after taxes) Net Sales Revenue
J411 Financial Ratio Review 8
EPS Earnings per Share
This profitability ratio tells the owner of a share of stock how much of the net earnings for the year belongs to him or her.
These earnings may be paid to the stockholders as dividends . . . or reinvested
(as retained earnings) back into the business to fund its growth.
Net Income or Loss (after taxes) Average # Shares of Common
Stock Outstanding
J411 Financial Ratio Review 9
Liquidity and Asset Management
*Current Ratio #.#
Current Assets Current Liabilities
*Acid Test or Quick Ratio #.#
Current Assets - Inventory Current Liabilities
*Accounts Receivable Turnover
X (times/year) or # days
Net Sales . Average Accounts Receivable
# days = 365 days/AR turnover
*Inventory Turnover
X (times/year) or # days
Cost of Goods Sold Average Inventory
# days = 365 days/Inventory turns
J411 Financial Ratio Review 10
Current Ratio Measures liquidity - the capacity of a firm to meet its current obligations using liquid assets that are in cash or other resources that can be quickly converted to cash.
Capstone requires a current ratio >2.0, to indicate that the firm can pay its current
liabilities using its current assets.
Current Assets Current Liabilities
J411 Financial Ratio Review 11
Acid-Test or Quick Ratio Measures liquidity - the ability of a firm to pay current liabilities ‘quickly’ – without selling inventory.
For all businesses the desired acid-test ratio is ~1.0
indicating firm can pay its current liabilities from its non-inventory current assets.
Current Assets - Inventory Current Liabilities
J411 Financial Ratio Review 12
Accounts Receivable Turnover - Activity Ratio
Determines the number of times during the year a company is ‘turning over’ or collecting its accounts receivable. Measured in X times per year. Can be converted to ‘days outstanding’ by dividing turnover ratio into 365 days.
Customers will give a preference to companies that extend payment terms and, in effect, provide a loan.
6X turnover is equivalent to 60 days of outstanding receivables, 9X is 45 days, 12X is 30 days.
Net Sales Average Accounts Receivable
J411 Financial Ratio Review 13
Inventory Turnover Activity Ratio
Determines the number of times during the year a company is ‘turning over’ its inventory. Measured in X times per year. Can also be converted to ‘days of inventory’ by dividing ratio into 365 days.
The average inventory turnover for all firms is about 9 times per year, or about once every 45 days. It varies
considerable by industry. Capstone penalizes firms with excessive inventory carrying costs
(>120 days of current sales).
Cost of Goods Sold Average Inventory
J411 Financial Ratio Review 14
Working Capital Asset Management
Working Capital = Current Assets – Current Liabilities
Working Capital ~ Accts Receivable + Inventory - Accts Payable
Example
A/R = 35 days
Inventory = 70 days
less A/P = -15 days
Working Capital = 90 days
Capstone Ideal Range
J411 Financial Ratio Review 15
Better Returns via Asset Management
Asset Turnover
ROA Return on
Assets
ROS Return on
Sales X =
Sales Assets X Profits
Sales = Profits
Assets
How good are we at producing wealth with our assets?
1.2 3.6% 4.3% Aircraft - Boeing
3.1 1.7% 5.3% Grocery - Kroger
J411 Financial Ratio Review 16
Capital Structure - Leverage Using Equity + Debt for Financing
Using DEBT provides ‘LEVERAGE’ for the shareholders & increases their “Return on Owners’ Equity”
BUT………using more debt (which must be repaid) increases the RISK to the lenders & shareholders
J411 Financial Ratio Review 17
Leverage and Debt Management
*Total Liabilities to Equity %
Total Liabilities Owners’ Equity
J411 Financial Ratio Review 18
Total Liabilities to Owners’ Equity Ratio
This financial leverage ratio indicates the degree to which a firm’s operations are financed through debt, borrowings & other liabilities - determines a firm’s financial risk and ability to borrow money.
The liabilities-to-owners’ equity ratio typically ranges between 33 and 50%.
The higher this ratio, the riskier the situation for lenders and shareholders.
Total Liabilities Owners’ Equity
J411 Financial Ratio Review 19
Leverage and Debt Management
*Total Liabilities to Equity %
Total Liabilities Owners’ Equity
Financial Leverage #.#
Total Assets Owners’ Equity
Total Owners’ Liabilities + Equity
Owners’ Equity
or
50% Liabilities 50% Equity
60% Liabilities 40% Equity
2.0 =
2.5 =
Examples
Capstone Ideal Range
J411 Financial Ratio Review 20
Leverage & Risk Impact on Firm’s Cost of Capital
10.0%
10.1%
10.2%
10.3%
10.4%
10.5%
10.6%
10.7%
10.8%
10.9%
11.0%
0% 20% 40% 60% 80% 100%
Weighted Cost of Capital (Debt & Equity WCC)
Low Financial Leverage High
Debt financing is lower risk & cost than equity, lowering the WCC.
Equity investors require a return at least as great as the ‘best alternative opportunity forgone’.
As ‘Leverage’ increases with more debt, the risk increases to the lenders & the shareholders, increasing the cost of both debt & equity.
‘Optimum’ Leverage & WCC
Source: adapted from The Real Cost of Capital
J411 Financial Ratio Review 21