F2-M8 Ratio and Variance Analysis (FAR Formulas)

Profitability Ratios (Definition)

Measures of the success or failure of an enterprise for a given time period.

Gross (Profit) Margin

[Sales (net) - COGS] / [Sales (net)]

Profit Margin

[Net Income] / [Sales (net)]

Indicates the percentage return on each sale

Return on Sales

[Income before Interest Income, Interest Expense, & Taxes] / [Sales (net)]

Return on Assets

[Net Income] / [Average Total Assets]

DuPont Return on Assets

[Profit Margin] * [Asset Turnover]

OR

It can be calculated the same as Return on Assets

[Net Income] / [Average Total Assets]

Uses both Profit Margin and Asset Turnover. Allows for increased analysis of the changes in percentages.

If Turnover is in the name of the formula - the “X” Turnover is in the… (Numerator or Denominator)

Denominator

Example: “Asset” Turnover = Sales / Average Total “Assets”

If Return is in the name of the formula - the Return on “X” is in the… (Numerator or Denominator)

Denominator

Example: Return on “Equity” = Net Income / Average Total “Equity”

If “Days in” is in the name of the formula - the Days in “X” is in the… (Numerator or Denominator)

Numerator

Example: Days in Inventory = [Ending Inventory] / [COGS / 365]

Asset Turnover

[Sales (net)] / [Average Total Assets]

Indicates the effective use of assets in generating sales

Return on Equity

[Net Income] / [Average Total Equity]

Operating Cash Flow Ratio

[Cash Flow from Operations] / [Current Liabilities]

Liquidity Ratios (Definition)

Measures of a firm’s short-term ability to pay maturing obligations

Current Ratio

[Current Assets] / [Current Liabilities]

Quick Ratio

[Cash & Equivalents + ST Marketable Securities + Receivables (net)] / [Current Liabilities]

Account Receivable Turnover

[Sales (net)] / [Average Accounts Receivable (net)]

Indicates the receivables’ quality and indicates the success of the firm in collecting outstanding receivables. Faster turnover gives credibility to the current and acid-test ratios.

Days Sales in Account Receivable

[Ending Accounts Receivable (net)] / [Sales (net) / 365]

Indicates the average number of days required to collect accounts receivable.

Inventory Turnover

[COGS] / [Average Inventory]

Measure of how quickly inventory is sold is an indicator of enterprise performance. The higher the turnover, in general, the better the performance.

Days in Inventory

[Ending Inventory] / [COGS / 365]

Indicates the average number of days required to sell inventory

Accounts Payable Turnover

[COGS] / [Average Accounts Payable]

Indicates the number of times trade payables turn over during the year. A low turnover may indicate a delay in payments, such as form a shortage of cash.

Days of Payables Outstanding

[Ending Accounts Payable] / [COGS / 365]

Cash Conversion Cycle

[Days Sales in AR] + [Days in Inventory] - [Days of Payables Outstanding]

Solvency Ratios

Measures of security or protection for long-term creditors/investors

Debt-to-Equity

[Total Liabilities] / [Total Equity]

Total Debt Ratio

[Total Liabilities] / [Total Assets]

Equity Multiplier

[Total Assets] / [Total Equity]

Times Interest Earned

[Income before Interest Expense & Taxes] / [Interest Expense]

or

[Earnings before Interest & Taxes] / [Interest Expense]

Reflects the ability of a company to cover interest charges. It uses income before interest and taxes to reflect the amount of income available to cover interest expense.

Performance Metrics

Measures used to evaluate operating performance and elements of a company’s stock performance from the perspective of current and potential investors

EBTIA (Definition)

Earnings Before Interest, Taxes, Depreciation, and Amortization

Can be calculated from the income statement using either a “top-down” or “bottom-up” approach

Top-Down - EBITDA Calculation

Sales - COGS - Operating Expenses (Excluding Depr. & Amort.)

Bottom-Up - EBITDA Calculation

Net Income + Income Tax Expense + Interest Expenses + Depr. & Amort.

Earnings Per Share

[Income Available to Common Shareholders] / [Weighted Average Common Shares Outstanding]

Price-to-Earnings Ratio

[Price per Share] / [Basic Earnings per Share]

Indicates the investment potential of an enterprise; a rise in this ratio indicates that investors are pleased with the firm’s opportunity for growth.

Dividend Payout

[Cash Dividends] / [Net Income]

Indicates the portion of current earnings being paid out in dividends

Asset Turnover

[Sales (net)] / [Average Total Assets]

Indicates how a firm makes effective use of its assets. A high ratio indicates effective asset use to generate sales.

What are the limitations of Ratios?

They depend on the reliability of the data. Additional information is also valuable when analyzing a company.

Horizontal analysis measures the dollar and percentages change over time. This is useful in evaluating trends and material changes.

Vertical analysis reduces statements to a common size. It not only allows for period-to-period comparison, but also allows for comparability to other entities as the statement is in a common size

Variance Analysis (Actual Versus Budget)

A tool for comparing some measure of performance to a plan, budget, or standard for that measure.

Examples:

• Budget vs Plan Performance Report: Compares a Budget to a Actual Performance

• Flexible Budget Performance Report: Adjusts Budgets of Variable Expenses based on actual vs budget Units Sold (Measures revenue per unit)