[FAA 111.10] Lecture 4

Liquidity Ratios

Which gives an idea of the firm’s ability to pay off debts that are maturing within a year

Asset management ratios

Which give an idea of how efficiently the firm is using its assets

Debt management ratios

Which give an idea of how the firm has financed its assets as well as the firm’s ability to repay its long term debt

Profitability ratios

Which give an idea of how profitably the firm is operating and utilizing its assets

Market value ratios

Which give an idea of what investors think about the firm and its future prospects

Liquidity Ratios

Ratios that show the relationship of a firm’s cash and other current assets to its current liabilities

Liquid Asset

An asset that can be converted to cash quickly without having to reduce the asset’s price very much

Current Ratio

It indicates the extent to which current liabilities are covered by those assets to be converted to cash in the near future

Inventories

Typically the least liquid of a firm’s current assets, and if sales slows down, they might not be converted to cash as quickly as expected

Inventories

are the assets on which losses are most likely to occur in the event of liquidation

Quick ratio

Measures the firm’s ability to pay off short-term obligations without relying on the sale of inventories

Asset management ratios

A set of ratios that measure how effectively a firm is managing its assets

Inventory Turnover Ratio

This ratio is calculated by dividing sales by inventories. It indicates how many times inventory is turned over during the year.

Days Sales Outstanding Ratio

This ratio is calculated by dividing accounts receivable by average sales per day. It indicates the average length of time the firm must wait after making a sale before it receives

Fixed Assets Turnover Ratio

The ratio of sales to net fixed assets. It measures how effectively the firm uses its plant and equipment.

Total Assets Turnover Ratio

This ratio is calculated by dividing sales by total assets. It measures how effectively the firm uses its total assets.

Debt Management Ratios

A set of ratios that measure how effectively a firm manages its debt

Total Debt to Total Capital

The ratio of total debt to total capital; it measures the percentage of the firm’s capital provided by debtholders

Times-Interest-Earned Ratio

The ratio of earnings before interest and taxes to interest charges; a measure of the firm’s ability to meet its annual interest payments

Profitability Ratios

A group of ratios that show the combined effects of liquidity, asset management, and debt on operating results

Profitability Ratios

They reflect the net result of all the firm’s financing policies and operating decisions

Operating Margin

This ratio measures operating income, or EBIT, per dollar of sales; it is calculated by dividing operating income by sales

Profit Margin

This ratio measures net income per dollar of sales and is calculated by dividing net income by sales

Return on Total Assets

The ratio of net income to total assets; it measures the rate of return on the firm’s assets

Return on Common Equity

The ratio of net income to common equity; it measures the rate of return on common stockholders’ investment

Return on Invested Capital

The ratio of after-tax operating income to total invested capital; it measures the total return that the company has provided for its investors

Return on Invested Capital

Its return is based on total invested capital rather than total assets

Return on Invested Capital

In the numerator it uses after tax operating income (NOPAT) rather than net income

Basic Earning Power Ratio

This ratio indicates the ability of the firm’s assets to generate operating income; it is calculated by dividing EBIT by total assets

Market Value Ratios

Ratios that relate the firm’s stock price to its earnings and book value per share

Price/Earnings (P/E) Ratio

The ratio of the price per share to earnings per share; shows the dollar amount investors will pay for $1 of current earnings

Market/Book Ratio

The ratio of a stock’s market price to its book value

Enterprise Value/EBITDA Ratio

The ratio of a firm’s enterprise value relative to its EBITDA

DuPont Equation

A formula that shows that the rate of return on equity can be found as the product of profit margin, total assets turnover, and the equity multiplier

DuPont Equation

It shows the relationships among asset management, debt management, and profitability ratios