Financial Rations- relationships determined from firms financial information and used for comparison purposes.
Short Term Solvency or Liquidity Rations:
✓ These ratios provide information about the firm’s liquidity. The primary concern us the firm’s ability to pay its bills over a short run without undue stress. The focus on current assets and liabilities. Generally, but not always, the book value and the market value of a firm’s current assets/liabilities are similar as their life is not long enough to cause huge differences.
1. Current Ration= Current Assets/Current Liabilities
o Because current assets and liabilities are, in principle, converted to ...view middle of the document...
This is generally used for new companies to see how long they can go until they need financing again.
Long Term Solvency Measures
1. Intended to address the firm’s long-term ability to meet its obligations, or more general, its financial leverage.
2. Total Debt Ration=(Total Assets-Total Equity)/Total Assets
• Takes into account debts of all maturities to all creditors; it can be expressed in the following ways as well. Takes into account ALL debt, short term and long term
• Debt-Equity Ration=Total Debt/Total Equity
• Equity Multiplier=Total Assets/Total Equity
3. Long Term Debt Ration=Long Term Debt/(Long Term Debt+Total Equity)
• Frequently. Financial analysts are more concerned with long-term debt because short-term debt changes so rapidly. Also their accounts payable may reflect trade practice more than debt management policy.
4. Times Interest Earned Ration=EBIT/Interest
• Measures how well a firm has its interest obligations covered.
5. Cash Coverage Ration=(EBIT+Depreciation)/ Interest
• Like the TIE ratio, this also measures how well a firm can pay its interest obligations, however unlike TIE, it is a better measure of cash flows because it does not take into account depreciation costs.
Asset Management or Turnover Measures
✓ Also known as asset utilization ratios, these measures are all measures of turnover, they are intended to tell you how efficiently or intensively a firm uses its assets to generate sales.
1. Inventory Turnover and Days Sales Inventory
o Inventory Turnover=COGS/Inventory
o Days Sales in Inventory=365/Inventory Turnover
2. Receivable Turnover and Days Sales in Receivables
✓ Receivables Turnover=Sales/Accounts Receivable
✓ Days Sales in Receivables=365/Recievables Turnover
✓ The best known and most widely used financial ratios. They are intended to measure how efficiently a firm uses its assets and manage its operations; the focus is on the bottom line, net income.
1. Profit Margin=Net Income/Sales
o A relatively high profit margin is desirable
2. Return on Assets (ROA)=Net Income/Total Assets
o Measures profit per dollar of assets
3. Return on Equity (ROE)=Net Income/Total Equity
o Measure of how the stockholders did for the year, bottom line of performance measurement
Market Value Measures
✓ Based on market price on share of stock, can only be used for publicly traded companies.
1. EPS=Net Income/Shares Outstanding
2. Price-Earnings (PE) Ratio=Price per share/EPS
o If this is high, it means that this company is expected to grow. Measures how much investors are willing to pay
3. Price-Sales Ratio=Price Per Share/Sales Per Share
o Used to measure growth in...