FIN 201 Formulas

Jim Brau

DuPont Framework

Used to break down Return on equity into 3 distinct parts

• Net Profit Margin (Profitability)

• Total Asset Turnover Ratio (Efficiency)

• Equity Multiplier (Leverage)

What are Liquidity ratios?

Ratios that measure how liquid a company is and how able it is to meet its short term obligations

• Current Ratio

• Quick Ratio (Acid Test)

• Average Collection Period

• AR Turnover

• Inventory Turnover

What are efficiency Ratios?

Ratios that tell us how well a company uses its assets to generate sales. They are of interest to investors and creditors

• Total asset turnover

• Fixed asset turnover

• OIROI (also a profitability ratio)

What are financing ratios?

Ratios that consider how a firm is financed. By debt or equity

• Debt Ratio

• Times interest Earned

What are profitability ratios?

Ratios that are commonly used to judge how well management is doing to maximize owner wealth

• Return on Assets

• Return on Equity

• Gross Margin

• Operating Margin

• Net Margin

What are free cash flows?

Cash left over after operations and taxes available to creditors and investors

• FCFF

Cash left over after operations just for investors

• FCFE

What is Economic profit or value added?

A measure that shows how much value a company or project creates for its investors after accounting for the full cost of capital

Current Ratio

Current Assets / Current Liabilities

• Determines whether a company can meet short term obligations

  • Not as good a measure as the quick ratio

Quick ratio

Used to more stringently measure liquidity or ability to cover short term obligations

• (Currents Assets - Inventory) / Current Liabilities

Average collection period

Helps us understand how many days on average it takes a company to collect AR

• AR / Daily credit sales

AR Turnover

Tells us how many times AR is collected in a year by a company

• Total Credit Sales/AR

Inventory Turnover

Tells us how many times inventory sells inventory a year based on COGS

COGS is used because it includes no markups and reflects the historical cost

• COGS/Inventory

Total Asset Turnover

Ratio used to see how much sales is produced per dollar of total assets owned

• Sales/Total assets

Fixed Assets Turnover

Used to see how much sales is produced per dollar of fixed assets owned. Can be seen better than total assets turnover ratio because fixed assets cant be manipulated by management.

• Sales/Fixed Assets

Operating Income Return on Investment

Sees how efficient operations is at using its assets for generating operating income

• EBIT/Total Assets

Debt Ratio

Used to see how much debt a company uses to finance their assets

• Total Debt (liabilities) / Total assets

Time Interest Earned

Tells us how many times a firm covers its interest expense given its in earnings

• EBIT/Interest Expense

Return on Assets (ROA)

Tells us how efficiently a company uses its assets to generate profit

• NI/Total Assets

Return on Equity (ROE)

Broken down by the DuPont frame work

Tells us the firms effectiveness of their financing policy

• NI/Equity

Gross Margin

what percentage of each dollar made is kept as gross profit

• Gross profit/Sales

Operating Margin

What percentage of each dollar made is kept as operating income

• EBIT/Sales

Net Margin

What percentage of sales made is kept as Net income

• NI/Sales

What ways can we increase our ROE?

Decrease costs while holding Net income the same

Increase sales while holding assets constant

Increase debt while holding equity constant

How can ROA be broken down?

Take the DuPont frame work and remove leverage

• ROA = NI/S * S/A

How do we completely remove the effects of leverage in the profitability ratio?

Use Return on Invested Capital ratio

• NOPAT/Costly Capital

What is NOPAT?

Net operating profit after tax

Tells how much a company makes from its operations after tax

• EBIT - Cash taxes paid

What is Costly Capital?

All interest bearing debt plus total equity

Free Cash Flow to the Firm

Tells how much cash a company’s core operations generate that is available to investors and creditors

• EBIT - Cash Tax + Depreciation - Change in Capex - Change in increase in NWC

Free Cash Flow to Equity

Tells how much of operating income is available to solely investors

NI + Depreciation - Change in CAPEX - Increase in NWC + Increase in LTD

Economic Profit or value added formula

NOPAT - [WACC * (CC)]

What two things can net income dump into?

Plowback (Retained Earnings)

Dividends

How would a higher debt ratio impact other ratios?

ROA and Net margin would decrease because more debt indicates more interest, therefore lowering net income

What is corporate finance?

Maximizing shareholder wealth in a firm by focusing on investments, financing, and cash management

What are investment financers

Involves which asset to invest in, recognizing wrongfully priced assets and purchasing low and selling high with said assets and stocks

What are financial institutions?

Banks, Ins Companies, Pensions funds and alike that manage funds between savers and borrowers

What 2 types of books do companies provide?

Tax books

• To comply with GAAP, FASB, and the IRS

Equity

• For investors, to make themselves look good and keep investors

What does it mean to “long” in finance?

It means to hold onto an investment

What does it mean to “short” in finance?

It means to sell an investment

What is book value?

What it is worth on the Balance Sheet

What is market value?

What someone will pay you right now for it

What is the market to book ratio?

Market Value of equity / Book value of equity

What does it mean if market too book ratio is greater than 1?

Stock price will rise “growth stock”

What does it mean when market to book ratio is less than 1?

Called “value stock” means you should short it (sell)

What are all of the names for D/E?

Debt

Financial Leverage

Fixed Income

What are the short term debt accounts?

Accounts Payable (non interest bearing)

Accruals (non interest bearing)

Notes Payable (Interest bearing)

Commercial banks

Have the responsibility to serve larger companies in savings, checking, borrowing and as as intermediaries between savers and borrowers

Consumer banks

Institutions that act as a middle man between savers and borrowers for individuals and average consumers

What is an IPO?

Initial public offering

When a company becomes public for the first time and issues its first shares

What is an SEO?

seasoned equity offering

When a company has already become public but releases more shares.

Why might someone choose an IPO vs SEO?

IPO - Because they want to become public and receive funds from the public

SEO - When a company needs additional capital for expansion, acquisitions, or to strengthen the BS

What is the cost of capital

All interest bearing debt plus all equity

• It is how much it costs the firm to finance their assets through interest on debt and expectations of shareholders

Why is the cost of capital important?

A major part of investor decisions to invest in your company

Affects capital structure of debt to equity

Essential for Economic Value Added calculation

Connects investment decisions to financing decisions

Mutual funds

Professionally managed assets that others can invest in.

• Heavy regulations

• Public

  • Moderate fees

Hedge Funds

Like mutual funds but lest strict

Investors can use long and short decisions and invest in financial derivatives

Only for wealth investors and have high fees

Index funds

Mutual funds that track a specific index like the S&P 500

• Heavily regulated

• passive

• public

• low expense ratios

What is an asset manager?

Highly valued workers who manage portfolios of assets by investing other peoples money into assets.

• They are licensed Charter Financial Analysts (CFA)

Investment Decision

How a firm plans on which assets to finance for

Financing decisions

How a firm plans to raise capital to finance specific assets

Dollar-Cost averaging

When an investor periodically makes payments to an investment to avoid market risk. Used in mutual and index funds