Econ 118 Final - Fulkerson

Current Ratio

• Current Assets/Current Liabilities

• good if >1

• is there enough assets to cover obligations coming due

Quick Ratio

• (cash and cash equivalents + short term investments + AR) / current liabilities

• acid test ratio

• indicate how much of the assets that can be quickly turned to cash can cover upcoming obligations

• asset threshold = 90 days

Operating Cash Flow to Current Liabilities Ratio

Cash Flow from Operations/avg current liabilities

AR turnover

Sales/Avg AR

Inventory Turnover

COGS/avg inventory

AP turnover

purchases/Avg AP

Liabilties to Assets Ratio

total liabilites/total assets

Liabilities to Shareholder’s Equity Ratio

Total Liabilities/Total shareholder’s Equity

Long term debt to long term capital ratio

Long term debt / (long term Debt + total SE)

Long Term Debt to SE ratio

Total Long Term Debt/Total SE

Interest Coverage Ratio

(EBIT + NCI)/Interest Expense

Operating Cash Flow to total Liabilities Ratio

cash flow from operations / avg total liabilities

Rule for Ratios that use both I/S and B/S accounts

• avg balance sheet account

• apples to oranges

• because I/S is overtime and B/S is point in time, you must avg B/S acct

working capital ratios

• AR turnover

• inventory turnover

• AP turnover

Financial Position

• liquidity and solvency ratios

Collateral

• when banks have priority to your assets if you don’t pay loans

• assets including: inventory and real estate

• types of assets are specified in the agreement

Is debt bad?

• not always

• depends, but can be if you are using it to cover costs

• good: used to expand business

Liquidity/liquidity ratios

• short term/near term

• in this moment

Solvency

• long-term

• incorporates future elements

• examines firm’s ability to make interst and principal payments on LT debt and similar obligations

Financial flexibility

• financial position

• profitability/cash flows

• how well they manage money

• how well they utilize money to generate profits and rev

Fulkerson’s perspective on ratios

• theres a long list

• tailor to your purpose

what are the most common liquidity ratios

• current ratio

• quick ratio

• turnover ratios

• operating cash flow ratios

operating cash flow ratios

• compare if operating cash flow is enough to cover liabilities

Common Solvency Ratios

• liabilities to assets

• liabilities to SE

• Debt to Equity

• Interest Coverage Ratio

What method can you use to understand Debt Ratios

3 = 2 + 1

What you need to consider when interpreting financial stmt ratios

• definition of industry and what is “normal”

• industry average

• distribution of ratios around mean

• definition of financial statement ratios

• consider what the company has done in the past

share price of company

• future or forcasted cash value of the company

• if share price of company = liquidation value —> BAD

Going Concern

Things that are huge red flags

Basic EPS

• earnings per share

• (net income - preferred stock dividends) / Weighted average common shares outstanding

what is a con of EPS?

• ignores how a company might be utilizing their assets better than another

eps

• just because one company has a higher eps doesn’t mean they are utilizing their assets

the value of the company is…?

• the stock price today

• what investors value the company in the future

• in its future earnings, not financial position

when does financial position matter?

when it is so weak that we are worried about future cash flows

• it doesn’t matter about a low EPS, as long as the company has potential to grow then investors will still invest.

Diluted EPS

(Net Income - Preferred Stock dividends + adjustments for dilutive securities)/(weighted average of CS outstanding + weighted avg of shares issuable from dilutive securites)

• if all of the dilutive securities like stock options were converted to C/S, what would the EPS be

EBITDA

• earnings before interest, tax, dep, and amort

• Net income + interest + tax + dep + amort

Adjusted EBITDA

EBITDA ± management one time non-cash expenses

add backs:

• restructuring charges

• stock based comp

• goodwill impairments

why? because they do not reflect the companies actual earnings because they are one-time non-cash

• must show reconciliation from GAAP to noGAAP

• MD&A + earnings release

PE ratio

price to earnings ratio

• current share price/ reported EPS for most recent prior fiscal year

Pros of PE Ratio

• quick and efficient way to value firm

• readily observed

Cons of PE ratio

• historical earnings divided into share price (present value)

• comparing apples to oranges

• historical earnings can include unusual items

• different accounting methods (Lifo vs Fifo) can change net income making it hard to compare PE ratios of companies

Return on Assets

• ROA

• measures firms success in using assets to generate earnings INDEPENDENT of financing/debt

• measuring ongoing profitability

• unusual/non recurring may be removed

• net income - (1-tax rate)(interest exp) - NCI / average total assets

• profit margin for ROA x asset turnover

  • profit margin = adjusted NI / sales

  • asset turnover = sales/avg total assets

total assets turnover

• how efficiently assets are being utilized to generate rev

• sales/avg total assets

Operating ROA

NI + (1-tax rate)(interest exp) + NCI / avg net operating assets

• net operating assets = assets-goodwill - intangibles

• co operating income generated per dollar invested in total op assets

gross profit ratio

net sales - cost of sales / sales

*gross profit/sales

ROCE

Return on common stockholders equity after subtracting operating expenses and costs of debt financing and preferred stock

NI - noncontrolling interest in earnings - preferred stock dividend / avg CS equity

capital structure leverage

how well SE is leveraged to raise money

NOT leverage ratio

average total assets/avg common SE

higher number = highly leveraged —> how well the company has financed its assets through use of equity raise

net borrowing rate

net financing exp - (1-tax rate)(interest exp)/ avg financial obligations (short term and long term and NP)

common size analysis

• converts every line item on fin stmts into percentage

• increases comparability

• most used in IS and BS (more in IS)