Chapter 4: Ratios!

How should ratio compirasons be reviewed? (3)

Trend analysis over time
Industry analysis
Benchmarking (peer) analysis

What are the 5 major categories of ratios and its key question?

Liquidity: Can we make required payments
Asset management: Right amount of assets vs. sales?
Debt management: Right mix of debt and equity?
Profitability: Do sales prices exceed unit costs, and are sales high enough as reflected in Profit Margins, ROE, and ROA?
Market value: Do investors like what they see as reflected in P/E and M/B ratios?

Current Ratio=

CA / CL

Quick Ratio =

(CA - Inv) / CL

What are the liquidity ratios? (3)

Current ratio
Quick ratio
Inventory Turn

Inventory Turn =

COGS / Inventories

What are the Asset Management ratios?

DSO
DPO
DIO
CCC
FA Turn
TA Turn
Operating Asset Turn

DSO = Use 360 (OR 90 if quarterly specified)

AR / Avg Sales per day

DIO =

Inventory / Avg COGS per day

DPO=

AP / Avg COGS per day

CCC =

DIO + DSO - DPO

FA Turn =

Sales / Net FA

TA Turn =

Sales / Total Assets

Operating asset turnover =

Sales / (Mgmt WC + LT Assets)

Mngmt WC =

AR + Inv - AP

What are the debt management ratios?

Debt to capital
Interest Coverage ratios (TIE and TIE using EBITDA)

Debt to capital =

Total Debt / Total Invested capital

Interest coverage ratios are a common:

debt covenant on loans (so use the FULL interest expense, not the net)

TIE =

Adj EBITDA / Interest

What are the profitability ratios? (6)

Operating Margin
Profit Margin
BEP
ROA
ROE
ROIC

Operating margin =

EBIT / sales

Profit Margin =

NI / Sales

BEP =

EBIT / TA

ROA =

NI / Total Assets

ROE =

NI / Total Common Equity (BV not market)

ROIC =

(EBIT)(1-T) / Total Invested capital

Holding assets constant, if debt increases,

Equity decreases, interest exp increases, NI decreases
ROA declines
ROE may increase or decrease

What are the problems with ROE?

Does not consider risk and is a historic book value
Does not consider the amount of capital invested nor dividends paid

What are the Market Value Ratios (4)

PE
Market / Book
Enterprise Value (EV)
EV / EBITDA

PE =

Price / Earnings per share

Market / Book =

Mkt stock price / BV per share

What is the meaning of PE?

How much investors are willing to pay for $1 of earnings next year

What is the meaning Market / Book?

How much investors are willing to pay for $1 of Book value equity

EV / EBITDa is cnsidered the:

Comparable ratio mesure of market value

EV =

MVe + (MVd + MVclaims - (cash and equivalents))

DuPont equation (not chart) =

ROE = PM x TA Turn x EM