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Financial Ratios

Autor:   •  January 21, 2019  •  Term Paper  •  2,007 Words (9 Pages)  •  101 Views

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Activity ratio

  • Days’ sales receivable : En cb de jours les clients écoulent le stock de ventes
  • Plus c’est court mieux c’est
  • Account receivable turnover : Cb de fois par an les clients nous payent
  • Plus c’est grand mieux c’est
  • Account receivable turnover in days:
  • En cb de jours les clients nous payent

  • (NB: Working capital cycle = Inventory turnover in days + Receivable turnover in days – payable turnover in days  Pendant cb de jours sommes nous en manque de cash. )

        

  • Days’sales in inventory: le temps qu’il faut pour vendre tout l’inventaire
  • Shorter is better
  • Inventory turnover : Inventory turnover indicates the liquidity of the inventory : cb de réapprovisionnement de stock on doit réaliser chaque année
  • Longer better
  • Inventory turnover in days : le nombre de jours qu’il faut pour écouler un stock
  • Shorter better
  • Operating cycle : le temps qu’il se passe entre l’approvisionnement du premier stock et l’acquisition du cash qui résulte des ventes.

Liquidity ratios

  • Working capital : besoin en fonds de roulement : capacité de l’entreprise à être solvable sur le court terme : si WC <  0  Trop de dettes / WC > 0 : les assets peuvent être financés par les dettes mais aussi par le capital de l’entreprise :
  • Doit être comparé aux années précédentes pour pouvoir être estimé.

  • Current ratio
  • Une baisse du ratio indique que la firme possède moins de liquidité
  • 2.00 est une moyenne de bonne liquidité par rapport aux dettes.
  • Si le CR reste stable d’année en année et proche de 2 cela montre un bon contrôle des receivables et/ ou des stocks
  • In general, the shorter the operating cycle, the lower the current ratio. The longer the operating cycle, the higher the current ratio
  • Acid-test ratio : capacité de l’entreprise a liquider ses assets rapidement. Ressemble beaucoup au current ratio mais ne prend pas en compte l’inventaire
  • La ratio de base est : 1.00  Adequate liquidity
  • Cash ratio : ratio encore plus poussé sur la liquidité de l’entreprise parce qu’il prend en compte le cash :
  • The cash ratio indicates the immediate liquidity of the firm. A high cash ratio indicates that the firm is not using its cash to its best advantage; cash should be put to work in the operations of the company. Detailed knowledge of the firm is required, however, before drawing a definite conclusion. Management may have plans for the cash, such as a building expansion program. A cash ratio that is too low could indicate an immediate problem with paying bills.
  • Sales to working capital :
  • A low working capital turnover ratio tentatively indicates an unprofitable use of working capital: sales are not adequate in relation to the available working capital.
  • A high ratio tentatively indicates that the firm is undercapitalized (overtrading). An undercapitalized firm is particularly susceptible to liquidity problems when a major adverse change in business conditions occurs.

Financial ratios and the statement of cash flow

  • Operating cash flow/current maturities of long-term debt and current notes payable: indicates a firm’s ability to meet its current maturities of debt.
  •  The higher this ratio, the better the firm’s ability to meet its current maturities of debt. The higher this ratio, the better the firm’s liquidity

  • Operating cash flow/total debt: indicates a firm’s ability to cover total debt with the yearly operating cash flow.
  • The higher the ratio, the better the firm’s ability to carry its total debt. It is a type of income view of debt, except that operating cash flow is the perspective instead of an income figure. The operating cash flow is the same cash flow amount that is used for the operating cash flow/current maturities of long-term debt and current notes payable.
  • Operating cash flow/cash dividends : indicates a firm’s ability to cover cash dividends with the yearly operating cash flow. The higher the ratio, the better the firm’s ability to cover cash dividends

Income Statement Consideration when Determining Long-Term Debt-Paying Ability

  • Times interest earned: indicates a firm’s long-term debt-paying ability from the income statement view. If the times interest earned is adequate, little danger exists that the firm will not be able to meet its interest obligation. If the firm has good coverage of the interest obligation, it should also be able to refinance the principal when it comes due. In effect, the funds will probably never be required to pay off the principal if the company has a good record of covering the interest expense.
  • A relatively high, stable coverage of interest over the years indicates a good record.
  • A low, fluctuating coverage from year to year indicates a poor record. Companies that maintain a good record can finance a relatively high proportion of debt in relation to stockholders’ equity and, at the same time, obtain funds at favorable rates.

  • Fixed charge coverage : also indicates a firm’s long-term debt-paying ability from the income statement view. The fixed charge coverage ratio indicates a firm’s ability to cover fixed charges.

Balance Sheet Consideration when Determining Long-Term Debt-Paying Ability

  • Debt ratio: indicates the percentage of assets financed by creditors, and it helps to determine how well creditors are protected in case of insolvency. If creditors are not well protected, the company is not in a position to issue additional long-term debt. From the perspective of long-term debt-paying ability, the lower this ratio, the better the company’s position.

Profitability ratio

  • Net profit margin: This ratio gives a measure of net income dollars generated by each dollar of sales. While it is desirable for this ratio to be high, competitive forces within an industry, economic conditions, use of debt financing, and operating characteristics such as high fixed costs will cause the net profit margin to vary between and within industries.

  • Total asset turnover Total asset turnover measures the activity of the assets and the ability of the firm to generate sales through the use of the assets

  • Return on assets Return on assets measures the firm’s ability to utilize its assets to create profits by comparing profits with the assets that generate the profits.
  • Dupont return on assets The net profit margin, the total asset turnover, and the return on assets are usually reviewed together because of the direct influence that the net profit margin and the total asset turnover have on return on assets. When these ratios are reviewed together, it is called the DuPont return on assets. The rate of return on assets can be broken down into two component ratios: the net profit margin and the total asset turnover. These ratios allow for improved analysis of changes in the return on assets percentage.
  • Return on investment (ROI) The return on investment (ROI) applies to ratios measuring the income earned on the invested capital. These types of measures are widely used to evaluate enterprise performance. Since return on investment is a type of return on capital, this ratio measures the ability of the firm to reward those who provide long-term funds and to attract providers of future funds.
  • This ratio evaluates the earnings performance of the firm without regard to the way the investment is financed. It measures the earnings on investment and indicates how well the firm utilizes its asset base.
  • Return on total equity: The return on total equity measures the return to both common and preferred stockholders.
  • Return on common equity This ratio measures the return to the common stockholder, the residual owner.
  • Gross profit margin Gross profit equals the difference between net sales revenue and the cost of goods sold. The cost of goods sold is the beginning inventory plus purchases minus the ending inventory. It is the cost of the product sold during the period. Changes in the cost of goods sold, which represents such a large expense for merchandising and manufacturing firms, can have a substantial impact on the profit for the period. Gross profit margins are also used in cost control. Estimations utilizing gross profit margins can determine inventory levels for interim statements in the merchandising industries. Gross profit margins can also be used to estimate inventory involved in insured losses. In addition, gross profit measures are used by auditors and the Internal Revenue Service to judge the accuracy of accounting systems

for the investor

  • Financial leverage: The use of financing with a fixed charge (such as interest) is termed financial leverage. Financial leverage is successful if the firm earns more on the borrowed funds than it pays to use them. It is not successful if the firm earns less on the borrowed funds than it pays to use them. Using financial leverage results in a fixed financing charge that can materially affect the earnings available to the common shareholders.

  • Two things are important in looking at financial leverage as part of financial analysis. First, how high is the degree of financial leverage? This is a type of risk (or opportunity) measurement from the viewpoint of the stockholder. The higher the degree of financial leverage, the greater the multiplication factor. Second, does the financial leverage work for or against the owners?
  • Earnings per share—the amount of income earned on a share of common stock during an accounting period—applies only to common stock and to corporate income statements.
  • Price/Earnings Ratio : expresses the relationship between the market price of a share of common stock and that stock’s current earnings per share. Using diluted earnings per share results in a higher price/earnings ratio, a conservative computation of the ratio. Ideally, the P/E ratio should be computed using diluted earnings per share for continuing earnings per share. This gives an indication of what is being paid for a dollar of recurring earnings.
  • Investors view the P/E ratio as a gauge of future earning power of the firm. Companies with high growth opportunities generally have high P/E ratios; firms with low growth tend to have lower P/E ratios
  • P/E ratios do not have any meaning when a firm has abnormally low profits in relation to the asset base or when a firm has losses. The P/E ratio in these cases would be abnormally high or negative
  • Percentage of Earnings Retained
  • The percentage of earnings retained is better for trend analysis if nonrecurring items are removed. This indicates what is being retained of recurring earnings. Determine dividends from the statement of cash flows
  • Dividend Payout The dividend payout ratio measures the portion of current earnings per common share being paid out in dividends
  • In general, new firms, growing firms, and firms perceived as growth firms have a relatively low dividend payout.
  • Book value per share: indicates the amount of stockholders’ equity that relates to each share of outstanding common stock.
  • Market value < Book value: When market value is below book value, investors view the company as lacking potential.
  • Market value > Book value: A market value above book value indicates that investors view the company as having enough potential to be worth more than the book numbers.

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