Financial perf ratios
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Financial perf ratios Financial perf ratios Document Transcript

  • General Financial Performance Ratios Liquidity RatiosCurrent Ratio The current ratio measures the ability of the firm to pay is current bills while still allowing for a safetymargin above their required amount needed to pay current obligations. Liquidity ratios (or solvencyratios) most often includes the current ratio, quick ratio and net working capital. Current ratio = current assets / current liabilities  Current assets include cash, marketable securities, inventory, and prepaid expenses  Current liabilities include accounts payable (12 months or less), current portions of long-term debt, and salaries payableQuick Ratio The quick ratio is similar to the current ratio but eliminates the inventory figure in the current assetssection of the balance sheet. Generally, the quick ratio should be lower than the current ratio because iteliminates the inventory figure from the calculation. The inventory figure is thought to be the leastliquid figure and should thus, be eliminated. The quick ratio can be calculated as follows: Quick ratio = (Current Assets - Inventory) / Current LiabilitiesNet Working Capital (Current Ratio)The Net Working Capital figure simply deducts the current assets from the current liabilities on thebalance sheet. Net Working capital can be calculated as follows: NWC = Current Assets - Current LiabilitiesCash FlowCash flow is a measure of how well current liabilities are covered by the cash flow generated from acompanys operations. Formula: Cash Flow Ratio = Cash from Operations/Current LiabilitiesThe operating cash flow ratio can gauge a companys liquidity in the short term. Using cash flow asopposed to income is sometimes a better indication of liquidity simply because, as we know, cash is howbills are normally paid off.  42459 Bradner Rd., Northville, MI 48168  d: 248-773-7580  f: 888-548-9213 dgaddis@curtisfunding.com  www.curtisfunding.com 1|Page
  • General Financial Performance Ratios Asset RatiosDays Sales OutstandingActivity ratios measure the operating characteristics of the firm. Activity ratios include the inventoryturnover rate, average collection period, average payment period, fixed asset turnover ratio, and totalasset turnover ratio. The average collection period formula: DSO = Accounts Receivable / (Sales / 360 days)Total accounts receivable includes all outstanding credit obligations from customers. The sales figureincludes sales for the prior four quarters of financial performance. The figure may also include amountson a quarterly basis only. The accounts receivable period is a measure of a company’s ability to collectaccounts receivable within a timely and reasonable period. The accounts collection period varies fromindustry to industry. The smaller the accounts receivable period, the more effectively a company is inmanaging and collecting money from customers.Average Payment PeriodThe average payment period is calculated by the following formula: APP = Accounts Payable / (Purchases / 360)The accounts payable turnover ratio includes all outstanding obligations that a company owes itscreditors. The average payment period is derived by adding all current accounts payable financialobligations from the latest four quarters of financial performance. The total purchases include apercentage of sales based on historical figures.Fixed Assets TurnoverThe fixed assets turnover is a measure of how efficiently a company uses its fixed assets to generatesales. Higher fixed asset ratios are preferable. The fixed assets turnover is calculated by adding all salesof the company and dividing the amount by net fixed assets for the latest four quarters of financialperformance. The basic formula is as follows: FAT = ( Sales / Net Fixed Assets )  42459 Bradner Rd., Northville, MI 48168  d: 248-773-7580  f: 888-548-9213 dgaddis@curtisfunding.com  www.curtisfunding.com 2|Page
  • General Financial Performance RatiosTotal Asset TurnoverThe total asset turnover is a measure of how efficiently and effectively a company uses its assets togenerate sales. The figure is similar to the fixed assets turnover but includes all assets. The higher thetotal asset turnover ratio, the more efficiently a firm’s assets have been used. Total asset turnover ratiois calculated as follows: Total Asset Turnover = Sales / Total AssetsInventory TurnoverThe inventory turnover ratio measures the number of times during a year that a company replaces itsinventory. The turnover is only meaningful when comparing other firms in the industry or a company’sprior inventory turnover. Differences in turnover rates result from differing operating characteristicswithin an industry. The inventory turnover rate formula: Inventory Turnover = Cost of Goods / Total InventoryThe higher the inventory turnover rate means the more efficiently a company is able to grow salesvolume. Inventory turnover can be compiled by using the cost of goods figure in the numerator sinceinventories are usually carried at cost. Many other compilers of financial data use sales in thenumerator. However, the sales alternative provides an inaccurate barometer of financial performanceto determine the inventory turnover rate as sales reflects gross profit dollars.  42459 Bradner Rd., Northville, MI 48168  d: 248-773-7580  f: 888-548-9213 dgaddis@curtisfunding.com  www.curtisfunding.com 3|Page
  • General Financial Performance Ratios Debt RatiosDebt RatioDebt ratios measure the total amount and proportion of debt within the liabilities section of a firm’sbalance sheet. These figures are normally appropriate for comparing a company’s performance fromone period to another. Utilize the proportion of total assets provided by a companys creditors. Thedebt ratio is calculated by dividing the total liabilities by total assets. The greater the degree of outsidefinancing by creditors, the higher this ratio. This ratio determines in part if the firm is more highlyleveraged (debt) and therefore more of a risk to creditors. The basic formula is as follows: Debt Ratio = Total Liabilities / Total AssetsDebt-Service Coverage RatioIn corporate finance, it is the amount of cash flow available to meet annual interest and principalpayments on debt, including sinking fund payments. In government finance, it is the amount of exportearnings needed to meet annual interest and principal payments on a countrys external debts. Inpersonal finance, it is a ratio used by bank loan officers in determining income property loans. This ratioshould ideally be over 1. That would mean the property is generating enough income to pay its debtobligations. In general, it is calculated by: DSCR = Net Operating Income/Total Debt ServiceA DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1, say .95, would mean thatthere is only enough net operating income to cover 95% of annual debt payments. For example, in thecontext of personal finance, this would mean that the borrower would have to delve into his or herpersonal funds every month to keep the project afloat. Generally, lenders frown on a negative cash flow,but some allow it if the borrower has strong outside income. Higher ratios indicate high financialleverage. Ignore short term obligations or current liabilities when calculating debt ratios based on theprior four quarters of financial performance.Long Term Debt to Total CapitalizationWhile the debt ratio considers the proportion of all assets that are financed with debt, the ratio of long-term debt to total capitalization reveals the extent to which long-term debt is used for the firm’spermanent financing (both long-term debt and equity). Long-Term Debt to Total Capitalization = Long Term Debt / Long Term Debt + Total EquityThe higher the proportion of debt, the greater the degree of risk because creditors must be satisfiedbefore owners in the event of bankruptcy.  42459 Bradner Rd., Northville, MI 48168  d: 248-773-7580  f: 888-548-9213 dgaddis@curtisfunding.com  www.curtisfunding.com 4|Page
  • General Financial Performance RatiosDebt to EquityThis ratio indicates the ratio of debt on a firm’s balance sheet to the amount of funds provided by itsowners. Use only long term debt divided by total equity. The basic formula is calculated as follows: Debt to Equity = Long Term Debt / Total EquityA higher debt to equity ratio indicates a more capital intensive firm, i.e., it measures the percentage ofdebt tied up in owner equity.Times Interest EarnedTimes interest earned measures the ability of the firm to service debt. This figure will indicate howmany times a company can cover its fixed contractual obligations to its creditors. The higher the timesinterest earned, the more likely the firm can meet its obligations. This basic formula is as follows: Times Interest Earned = EBIT / InterestThis figure is determined from the income statement after deriving the operating profit margin. Theoperating profit margin is the profits of the firm before interest and taxes are subtracted. The interestfigure is the interest obligations for the prior four quarters of financial performance from the use of longterm debt funds.Fixed Payment Coverage RatioThe fixed payment coverage ratio indicates the ability of the firm to pay its fixed obligations for aspecified period of time. This figure includes the principal plus interest amount owed to creditors. Thefigure is determined by the following formula: Fixed Payment = EBIT / Interest + (Principal + Preferred div). x [ 1/(1- Taxes ) ]The higher the ratio the safer creditors are of receiving amounts owed them.  42459 Bradner Rd., Northville, MI 48168  d: 248-773-7580  f: 888-548-9213 dgaddis@curtisfunding.com  www.curtisfunding.com 5|Page
  • General Financial Performance Ratios Profitability RatiosGross Profit MarginProfitability is a measure of the ability of the business to earn a profit from its operations throughassets, sales, and equity. The gross profit margin indicates the percentage of each sales dollar remainingafter a firm has paid for its goods. The basic formula is calculated as follows: GPM = (Sales - Cost of Goods Sold)/ SalesThe higher the GPM the better pricing flexibility and cost management controls a firm has in itsoperations. USBR calculates GPM using the prior four quarters of financial performance.Operating Profit Margin The operating profit margin indicates the profits of the company before interest and taxes are deductedfrom a firm’s operations. The higher the operating profit margin, the greater pricing flexibility a firm hasin its operations. However, it could also indicate the degree of cost control management a firmpossesses. The figure is calculated as follows: Operating Profits = Operating Profits / SalesNet Profit Margin Similar to the operating profit margin, the net profit margin measures the amount of profits available toshareholders after interest and taxes have been deducted on the income statement. The higher theprofit margin, the more pricing flexibility a firm may have in its operations or the greater cost controlinitiated by management. The figure is determined as follows: NPM = Net Profits /SalesReturn on InvestmentBelow is the DuPont method for deriving ROI. ROI is determined by multiplying the Total Asset turnoverby the Net Profit Margin. The result is meaningful because it shows how well a company utilizes itsassets to generate profits. The basic formula is as follows: ROI = Total Asset Turnover x Net Profit MarginThe DuPont method allows the firm to break down its return on investment into a profit on salescomponent and an asset efficiency component. Typically, a firm with a low net profit margin wouldhave a total asset turnover. The relationship between the net profit margin and Total Asset turnover islargely dependent on the industry the firm operates.  42459 Bradner Rd., Northville, MI 48168  d: 248-773-7580  f: 888-548-9213 dgaddis@curtisfunding.com  www.curtisfunding.com 6|Page
  • General Financial Performance RatiosReturn on Capital Return on Capital is a measure of economic performance within a business firm. This ratio is used tomeasure how much capital (e.g. debt and equity) was needed to produce a firms earnings. This ratio isalso an indication of how well a company uses its capital to generate returns to shareholders. This couldalso provide a clue to how a company will perform in the future with its capital. The basic formula is asfollows: Return on Capital = Return on Equity (ROE) / (1 + Debt to Equity Ratio) ~ OR ~ Return on Capital = ROE x (1 - Debt to Capital)This ratio is similar to return on equity. Return on capital has a tendency to be more meaningful fromheavily leveraged (debt-laden) companies.Return on Equity Return on equity measures the return earned on the owners equity. The higher the rate the better thefirm has increased wealth to shareholders. The basic formula is as follows: ROE = Net Profits / Stockholders EquityMeasure the ROE figure by adjusting for new equity infusion from the prior four quarters of a company.Earnings Per ShareEarnings per share reflects the per share dollar return to the owners. The figure is calculated as follows: EPS = Total Earnings / No. of shares outstandingAdd the sum of the prior year earnings and divide the amount by the weighted average of sharesoutstanding. This assumes the most accurate information if a company distributes new sharesoutstanding during the period which could substantially impact (or dilute) shares to currentshareholders with lower per share earnings.  42459 Bradner Rd., Northville, MI 48168  d: 248-773-7580  f: 888-548-9213 dgaddis@curtisfunding.com  www.curtisfunding.com 7|Page