Financial Ratio Analysis and Fundamental Valuation

Practice flashcards covering financial ratio analysis, performance metrics, and fundamental valuation concepts from the FATA lecture notes.

Financial Ratio

An expression of the relationship between two accounting figures expressed mathematically, used to convey inter-relationships and enable decision making.

Gross Profit Margin

A performance ratio calculated as $\frac{\text{Gross profit}}{\text{Revenue from Operations}} \times 100$, reflecting profitability from products or services without considering overheads.

Net Profit Margin

A performance ratio calculated as $\frac{\text{Net profit}}{\text{Revenue from Operations}} \times 100$, which includes normal expenses.

Return on Equity (ROE)

A profitability ratio measuring profit as a percentage of owner's investment, calculated as $\frac{\text{Profit (before tax)}}{\text{Equity}} \times 100$.

Return on Capital Employed (ROCE)

A ratio showing profit generated as a percentage of both equity and debt funds deployed, calculated as $\frac{\text{Profit (before tax)}}{\text{Equity + LT Debt}} \times 100$.

Return on Assets (ROA)

Also known as ROI, it measures earnings derived from total assets controlled, calculated as $\frac{\text{Profit (before tax)}}{\text{Total Assets}} \times 100$.

Financial Leverage

The proportion of debt and equity used to buy assets, expressed as $\frac{\text{Total Assets}}{\text{Equity}} \times 100$.

Current Ratio

Also known as the banker's ratio, it measures current resources available to meet short-term debts, calculated as $\frac{\text{Current assets}}{\text{Current liabilities}}$; an ideal ratio is $2:1$.

Quick Ratio (Acid Test)

Measures a company's ability to meet liabilities quickly without liquidating inventory, calculated as $\frac{\text{Current assets - inventories}}{\text{Current liabilities}}$; an ideal ratio is $1:1$.

Debt Equity Ratio

A solvency ratio showing the comparison of borrowed funds with owner's funds, calculated as $\frac{\text{Debt}}{\text{Equity}} \times 100$.

Interest Coverage Ratio

Measures the margin of safety by showing how many times a company can make interest payments from operating profit, calculated as $\frac{\text{Earnings before interest and tax}}{\text{Interest}}$.

Asset Turnover Ratio

An efficiency ratio measuring the ability to generate sales from assets, calculated as $\frac{\text{Net Sales}}{\text{Total Assets}}$.

EBITDA

Acronym for earnings before interest, tax, depreciation and amortisation; serves as an indicator of financial performance for ongoing operations.

Enterprise Value (EV)

The valuation of a firm calculated as $\text{Market Capitalization + Total Debt - Cash and cash equivalents}$.

Price-to-Earnings (P/E) Ratio

A valuation metric used to assess if a stock is fairly valued, calculated as $\frac{\text{Market price per share}}{\text{Earnings per share}}$.

PEG Ratio

A ratio used to address P/E growth limitations, calculated as $\frac{\text{P/E Ratio}}{\text{Earnings Growth Rate}}$; a value less than $1$ suggests the stock may be undervalued.

Book Value

The net worth of a company from an accounting perspective, calculated as $\text{Total Assets - Total Liabilities}$.

Discounted Cash Flow (DCF)

A valuation method where the value of an asset is defined as the present value of its expected future cash flows.

Free Cash Flow (FCF)

Surplus cash left with a company after meeting all operational investment needs, calculated from the cash flow statement as $\text{CFO - CFI}$.

Free Cash Flow to the Firm (FCFF)

Free cash flows belonging to both debt and equity holders, calculated as $\text{CFO - CFI + Interest Expenses}$.

Free Cash Flow to Equity (FCFE)

Free cash flows belonging solely to equity holders, calculated as $\text{CFO - CFI + Net Borrowings}$.

Weighted Average Cost of Capital (WACC)

The average rate a company is expected to pay to all its security holders to finance its assets, calculated using the weight of equity, debt, and preferred stock.

Terminal Value

The value of cash flows for the time frame from a specific future year (e.g., 8th year) until perpetuity, where g represents the Long term Growth rate.