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# Formulae and Ratio Analysis

## on Feb 09, 2011

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## Formulae and Ratio AnalysisPresentation Transcript

• Formulae and Ratio Analysis
Jr Vi, Lilia Karimi, MeghVakaria, Kyle Petty, Linh Le and Jordan Alfaro
• Profitability Ratios
• Profitability RatiosGross Profit Margin
• Result of:
• Price structure
• How well expenses are controlled
• Return after variable cost are taken from the sales revenue
• Can be compared to industry standards
• Profitability RatiosGross Profit Margin
• Example
• Profitability RatiosNet Profit Margin
• The profit left after all the cost have been taken from the sales revenue
• Liquidity Ratios
• Liquidity Ratios
Ability to meet its near-term obligations, and it is a major measure of financial health
Liquidity= cash that is within a business/ability to generate cash quickly
The higher value the ratio is, the larger the margin of safety the business has to pay off debts
• Liquidity Ratios
Creditors are the people interested in the ratio because it shows if you can pay off your business
If you're looking to secure money via the sale of some stock through an initial public offering, many State Securities Bureaus will require that you have a current ratio of 2:1 or better.
• Liquidity RatiosCurrent Ratio
It signifies a company's ability to meet its short-term liabilities with its short-term assets
Current Ratio= Current Assets/ Current Liabilities
\$48 Million/ \$34 Million= 1.4 Times
Current assets includes cash, marketable securities, accounts receivable, prepaid expenses and inventories.
Current liabilities include accounts payable, current maturity of long term debt and accrued income taxes.
• Liquidity RatiosAcid Test (Quick) Ratio
Refined version of current ratio
It eliminates certain current assets such as inventory and prepaid expenses that may be more difficult to convert to cash.
Example:
\$48 Million- \$10 Million/ \$34 Million = 1.1 Times
In general, a quick or acid-test ratio of at least 1:1 is good. That signals that your quick current assets can cover your current liabilities.
• Efficiency Ratios
• Efficiency RatiosReturn on Capital Employed (ROCE)
The “primary ratio”
Tells how effective the business is at returning a profit from the capital it has
Shareholders – compare ROCE with other investments
Should be higher for more risk as a good investment
• Efficiency RatiosStock Turnover
Low ratio = poor sales and therefore excessive inventory
High ratio = strong sales or effective buying.
• Efficiency RatiosStock Turnover (Number of Days)
Calculates the days it takes to sell the stock and how many days’ worth of stock is held by the business
• Gearing Ratio
• Gearing Ratio
• Looks at the promotion of capital employed that comes from long-term loans.
• Companies borrow money
• Expand
• New machinery and equipment
• More capital = more interest pay
• Borrowing is a risk
• Assess how big that risk is
• Measures proportion of company's total capital borrowed
• Gearing Ratio
Example 1
Company A: gearing 75%
Profit \$100 million
Interest \$50 million
Cover interest payments twice over.
Example 2
Company B: gearing 35%
Profit \$20 million
Interest \$18 million