X (times/year) or # days J411 Financial Ratio Review
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Summary of Financial Ratios Profitability
Return to Investors Return to Investors
Leverage /Debt Management Amount of Debt
Liquidity
Asset Management
Coverage of Debt
Short Run Solvency
Current Assets
Operating Efficiency
Margins
Returns
*Net Profit Margin (ROS)
*Return on Equity
*Return on Equity
*Total Liabilities/ Equity
Times Interest Earned
*Current Ratio
*A/R Average Collection Period
*A/R Turnover
Operating Profit Margin
Return on Total Assets (ROA)
Return on Total Assets (ROA)
Debt/ Equity
Fixed Charge Coverage
*Quick or Acid Test Ratio
*Days Inventory Held
*Inventory Turnover
Gross Profit Margin
Cash Return on Assets
*Earnings Per Share
LEVERAGE Cash Assets/ Flow Equity Adequacy
Cash Flow Liquidity Ratio
Days Payables Outstanding
Fixed Asset Turnover
Days of Working Capital
Total Asset Turnover
Product Contribution Margin
Price to Earnings Ratio
Debt/ Assets
Cash Flow Margin
Dividend Yield
LT Debt/ Total Capitalization
Cash Interest Coverage
*‘Top 8’ & CAPSTONE Financial Ratios
J411 Financial Ratio Review
Other Common Ratios
Return on Total Assets (ROA)
Derived from: Fraser/Ormiston, Understanding the Corporate Annual Report; Understanding Financial Statements 6e
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Key Financial Statements ● PPE ● Fixed Assets
TOTAL ASSETS Current
(12mo)
Long-Term
● A/P ● ST Debt ● LT Debt
TOTAL LIABILITIES
Contributed Capital Retained Earnings
● Stock @ par ● Paid-in Capital ● Accumulated Net Income ● less Dividends
TOTAL OWNERS’/ SHAREHOLDERS’ EQUITY
Net Sales
for Period
● Units Sold ● @ Price ● less Returns & Allowances
TOTAL REVENUES Cost of Goods Sold
● ● ● ●
Units Sold @ Material @ Labor @ Overhead
Expenses for Period
● ● ● ● ●
R&D Marketing Distribution Sales Admin
TOTAL OP EXPENSES Operating Profit Other Expenses
● Interest ● Taxes ● One-time
TOTAL NET INCOME or (LOSS)
J411 Financial Ratio Review
Cash Flow Statement Change in cash - Sources & (Uses) between Periods Income Statement Net Income ● ● Accrual Based
Adjustments for Non-cash Items
● ● ● ●
Depreciation A/R & A/P Inventory Other Accruals
CASH provided (used) by OPERATING Activities ● (Additions) Sale PPE ● (Additions) Sale Other Investments
CASH provided (used) by INVESTING Activities Stock Dividends
● Sale (Purchase) ● (Paid)
● Increase Debt/ (Decrease) Borrowing
CASH provided (used) by FINANCING Activities
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Cash
Long-Term
● Cash ● A/R ● Inventories
Income Statement
Revenues – Expenses = Net Income
(12mo)
Assets = Liabilities + Owners’ Equity
Current
Period Ending
∆ = Operating + Investing + Financing
Balance Sheet
Profitability and Return to Investors ROE *Return on Owners’ Equity %
ROA Return on Total Assets %
ROS *Return on Sales %
EPS *Earnings per Share $ DD.00
Net Income (after taxes) Owners’ Equity
Net Income (after taxes) Total Assets
Net Income (after taxes) Net Sales Revenue Net Income or Loss (after taxes) Average # of Common Stock Shares Outstanding
J411 Financial Ratio Review
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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.
Net Income (after taxes) Owners’ Equity Typically between 15% and 25% for profitable companies J411 Financial Ratio Review
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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.
Net Income (after taxes) 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. J411 Financial Ratio Review
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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.
Net Income or Loss (after taxes) Average # Shares of Common Stock Outstanding These earnings may be paid to the stockholders as dividends . . . or reinvested (as retained earnings) back into the business to fund its growth. J411 Financial Ratio Review
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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
*Inventory Turnover
Net Sales . Average Accounts Receivable # days = 365 days/AR turnover Cost of Goods Sold Average Inventory
X (times/year) or # days
# days = 365 days/Inventory turns
J411 Financial Ratio Review
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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.
Current Assets Current Liabilities Capstone requires a current ratio >2.0, to indicate that the firm can pay its current liabilities using its current assets. J411 Financial Ratio Review
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Acid-Test or Quick Ratio Measures liquidity - the ability of a firm to pay current liabilities ‘quickly’ – without selling inventory.
Current Assets - Inventory Current Liabilities For all businesses the desired acid-test ratio is ~1.0 indicating firm can pay its current liabilities from its non-inventory current assets. J411 Financial Ratio Review
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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.
Net Sales Average Accounts Receivable 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. J411 Financial Ratio Review
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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.
Cost of Goods Sold Average Inventory 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). J411 Financial Ratio Review
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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
Capstone Ideal Range
Working Capital
J411 Financial Ratio Review
=
90 days
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Better Returns via Asset Management How good are we at producing wealth with our assets?
Asset Turnover
Sales Assets
X
ROS Return on Sales
=
ROA Return on Assets
X
Profits Sales
=
Profits Assets
1.2
Aircraft - Boeing 3.6%
4.3%
3.1
Grocery - Kroger 1.7%
5.3%
J411 Financial Ratio Review
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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
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Leverage and Debt Management *Total Liabilities to Equity %
Total Liabilities Owners’ Equity
J411 Financial Ratio Review
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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.
Total Liabilities Owners’ Equity The liabilities-to-owners’ equity ratio typically ranges between 33 and 50%. The higher this ratio, the riskier the situation for lenders and shareholders. J411 Financial Ratio Review
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Leverage and Debt Management *Total Liabilities to Equity %