Accounting Ratios

Balance Sheet

A financial statement that summarizes a company's assets, liabilities, and shareholders' equity at a specific point in time, providing a snapshot of its financial position.

Income Statement

A financial statement that reports a company's revenues, expenses, and profits or losses over a specified period, reflecting its operational performance.

Statement of Cash Flows

A financial summary of all cash inflows and outflows entering and exiting a company over a specific period.It highlights how well the company manages its cash position, showing how cash is generated and used in operating, investing, and financing activities.

3 Primary Types of Company Funding

Debt (borrowed funds)

Private savings / Equity (owner investments)

Retained earnings (reinvested profits)

The Accounting Equation

Assets=Liabilities+Equity

Paid-in Capital

Money invested by owner

3 Elements Reported in the Statement of Cash Flows

Operating Activities: Recurring cash flows needed to run day-to-day core business operations.

Investing Activities: Occasional cash expenditures or proceeds from purchasing/selling long-term assets to grow the business.

Financing Activities: Cash flows associated with raising capital, such as borrowing money, repaying debt principal, issuing equity, or distributing dividends.

Equity

The funds provided to a business by its owners, representing the residual interest in the company's assets after deducting all liabilities.

Return on Equity (ROE)

A profitability metric that measures the amount of net profit earned by a company relative to each dollar of shareholder investment.

Formula for Return on Equity (ROE)

Net Income/Stockholder’s Equity

The DuPont framework

ROE = Leverage (financial leverage) x Efficiency (Asset Turnover) x Profitability (Profit Margin)

Leverage formula

Assets/Equity —— assets we get per dollar of equity

Efficiency formula

Sales/Assets - Sales we get per dollar of assets

Profit margin formula

Net income/Sales

Gross sales

Total sales before any deductions

Net income (Profit After Tax)

Income after deducting all costs (including tax, COS, other expenses)

Common size financial statements

Financial statements adjusted to the size of the organisation by dividing everything by either sales or assets (you see changes in % too and not just figures)

Inventory turnover

COGS/Average Inventory

Accounts receivable turnover

Revenue/Average accounts receivable

Gross profit

Sales minus the cost of goods sold (COGS)

Operating profit is…

gross profit less overheads/SGA (Selling General and Administrative expenses)… note it’s before tax

EBITDA

Earnings Before Interest Tax Depreciation and Amortization

P/E (Price to Earnings) ratio

Measures the relationship between a company’s net income (E) a company generates that year against the price/market value that people are willing to pay for the company - reflects expected future growth

Operating cycle

Time from paying for inventory to collecting cash from sale —— Operating cycle = inventory turnover + AR turnover

Fixed Asset Turnover

Measures dollars generated by each dollar worth of fixed assets

Fixed Asset

Long-term tangible asset (PPE - buildings, machinery, equipment)

Current ratio

Reflects liquidity - the ability of a company to pay its debt in the short term

Assets-to-equity ratio

Total assets/Total shareholder Equity

Debt-to-asset Ratio

The fraction of finance that was acquired through borrowing —— Total Liabilities/Total assets

Debt-To-Equity ratio

Total Liabilities/Total Shareholder investment (Equity basically)

Times interest earned

Tells us how many times more we are generating profit than paying back our interest - Operating income/Amount of interest expensed