Chapter Three Slides - Ratios

What is the purpose of financial statements

To communicate financial information to internal and external stakeholders

What is the purpose of financial statement analysis

To analyze a company’s financial statements for decision-making purposes

What are the obstacles when comparing two companies’ financial statements

Size, accounting regulations, and different industries

Equation for common-size balance sheet 

Common size line item = Line item / Total assets 

Equation for common-size Income Statement

Common size line item = Line Item / Total sales

What is the purpose of ratio analysis

To summarize specific aspects of a firm’s financial position and make better comparisons

What does cross-sectional analysis help with

comparing multiple firms at one time

What does time series analysis help with

Compare one firm at a specific time

What does combined analysis help with

Compare two firms over several years

What is the purpose of Liquidity Ratios

To provide information about the firm’s ability to meet short-term obligations

What are the three liquidity ratios

Current ratio, quick(acid test) ratio, and cash ratio

What is the equation for current ratio and what is its purpose

Current Assets / Current Liabilities

Shows you have x in current assets for every $1 in current liabilities 

What is the equation for quick ratio and what is its purpose

(Current Assets - Inventory) / Current Liabilities 

Shows you have x in current assets excluding inventory for every $1 in current liabilities 

What is the equation for cash ratio and what is its purpose

Cash / Current Liabilities 

Shows you have x in cash for every $1 in current liabilities 

What is the purpose of financial leverage ratios

To provide information about the firm’s ability to meet long term obligations

What are the five financial leverage ratios

Total Debt Ratio, Debt Equity Ratio, Equity Multiplier, Times Interest Earned, and Cash Coverage Ratio

What is the equation for total debt ratio and what is its purpose

(Total Assets - Total Equity) / Total Assets

Shows you have x in total debt for every $1 in total assets

What is the equation for debt to equity ratio and what is its purpose

Total Debt / Total Equity

Shows you have x in equity for every $1 in debt or vice versa 

What is the equation for equity multiplier and what is its purpose

Total Assets / Total Equity

Value greater than one means you rely on equity more than debt 

What is the equation for times interest earned ratio and what is its purpose

EBIT / Interest

Interest obligations can be covered by its current income x times

What is the equation for cash coverage ratio and what is its purpose

(EBIT + Depreciation & Amortization) / Interest

Shows that interest obligations can be covered by its current generated cash flows x times

What is the purpose of Asset Management (Turnover) Ratios

To provide information about how efficiently a firm uses its assets

What are the three asset management ratios

Days inventory outstanding ( inventory turnover), Days sales outstanding (receivable turnover), and days payable outstanding

What is the equation for current ratio and what is its purpose

Inventory / CoGs X 365 (Inventory Turnover = CoGs / Inventory)

It takes about x days to sell inventory ( Can turnover inventory x times in a year

What is the equation for days sales outstanding ( receivables turnover) and what is its purpose

Accounts Receivable / Sales X 365 (Receivables Turnover = Sales / Accounts Receivable)

It takes x days to collect from sales   ( Can collect accounts receivable x times a year) 

What is the equation for days payable outstanding ( payables outstanding) and what is its purpose

Accounts Payable / CoGs X 365   ( Payables Turnover = CoGs / Accounts Payable) 

It takes x days to pay suppliers     ( Pays its suppliers x times a year)

What is the equation for cash conversion cycle and what is its purpose

DSO+DIO - DPO

Takes x days to convert its investments in inventory and other resources into cash flows from sales 

What is the equation for total assets turnover and what is its purpose

Sales / Total Assets

What is the purpose of profitability ratios

To provide information about how efficiently the firm uses and manages its operations by evaluating the firms profits 

What are the four profitability ratios

Profit Margin, EBITDA Margin, Return on Assets, and Return on Equity

What is the equation for profit margin and what is its purpose

Net Income / Sales

Each $1 of sales generates x in net income to shareholders

What is the equation for EBITDA Margin and what is its purpose

EBITDA / Sales

$1 of sales generates x in operating profit

What is the equation for return on assets and what is its purpose

Net Income / Total Assets

$1 of assets generates approximately x of net income (profit)

What is the equation for return on equity and what is its purpose

Net Income/ Total Equity 

$1 of total equity generates approximately x in net income 

What is the purpose of market value ratios

To relate a firm’s market value, as measured by its current share price, to certain accounting values

What is the equation for price earnings ratio and what is its purpose

Price Per Share / Earnings Per Share

Measures the amount that investors are willing to pay for each dollar of a firm’s earnings 

What is the equation for market- to-book ratio and what is its purpose

Market Value Per Share / Book Value Per Share

Provides an assessment of how investors view the firm’s performance 

What is the equation for market capitalization and what is its purpose

Price Per Share X Shares Outstanding

Measures the total dollar market value of a company’s outstanding shares of stock or determine a company’s size

What is the equation for enterprise value and what is its purpose

Market Capitalization - Market Value of Interest-Bearing Debt - Cash

Measure a company’s total value

What is the equation for enterprise value multiples and what is its purpose

Enterprise Value / EBITDA

Used to determine the value of a company’s total business rather than focus on the value of its equity