Cheat Sheet, Ratio Analysis

Activity Analysis Short-Term (Operating) Activity Ratios Inventory Turnover = (Cost of Goods Sold) / (Average Inventory) Provides an indicator of management's inventory management. A ig er ratio is an indicator t at inventory does not languis in !are ouses or on t e s elves "ut moves from inventory to sale. Average no. days inventory in stoc# = $%& / (Inventory Turnover) Average num"er of days inventory is eld until it is sold. 'eceiva"les Turnover = Sales / (Average 'eceiva"les) 'atio is analogous to Inventory turnover. (easures effectiveness of firm's credit )olicies. * en com)uting t is ratio+ s ould only include trade receiva"les+ e,cluding receiva"les related to investment and financial activities. -o t is to focus on o)erating cycle of com)any. Average no. days receiva"les outstanding = $%& / ('eceiva"les Turnover) Analogous to Average no. days inventory in stoc#. *or#ing ca)ital turnover = Sales / (Average !or#ing ca)ital) 'eflects amount of !or#ing ca)ital needed to maintain a given level of sales. .nly o)erating ca)ital s ould "e used in com)uting t is. /,clude s ort0term de"t+ mar#eta"le securities+ and e,cess cas . .verall1 Turnover ratios also )rovide info a"out o! valid is t e assum)tion1 !e can use !or#ing ca)ital as a )ro,y for cas flo!s. If o)erations etc. are smoot for t e firm+ t en t is assum)tion !ill old1 'atios !ill indicate inventory is "eing moved+ receiva"les are "eing received in a timely fas ion. If ratios start to sli)+ decrease+ t en )er a)s inventory is not "eing moved+ receiva"les not "eing )aid+ so may"e !or#ing ca)ital does not translate into cas flo!. Long-Term (Investment) Activity Ratio 2i,ed Assets Turnover = Sales / (Average 2i,ed Assets) (easures efficiency of long0term ca)ital investment. 'eflects level of sales maintained "y investments in )roductive ca)acity. C ange in time of t is ratio may a))ear irregular or 3agged "ecause sales s ould increase continuously+ "ut Assets may c ange discontinuously+ say for instance !it t e addition of ne! factories+ !are ouses+ etc. Combined long- and short-term Activity Ratio Total Asset Turnover = Sales / (Average total Assets) Provides a measure of overall investment efficiency "y aggregating t e 3oint im)act of "ot s ort0 and long0term assets. 4i5uidity Analysis Ratio concerned with Length o Cash Cycle

Average no. days )aya"les outstanding = ($%& , Average Accounts )aya"le) / Purc ases 'eflects num"er of days it ta#es until )aya"les are settled. !or"ing Capital Ratios and #e ensive Intervals Conce)t of !or#ing ca)ital relies on classification of assets and lia"ilities into 6current7 and 6non0current7 categories. Traditional definition of current "ased on maturity of 8 year or (if longer) one o)erating cycle of com)any. 2ive categories of current assets 8) Cas and cas e5uivalents 9) (ar#eta"le securities $) Accounts receiva"le :) Inventories &) Pre0)aid e,)enses Categories of current lia"ilities 8) S ort0term de"t 9) Accounts )aya"le $) Accrued lia"ilities 'atios used for s ort0term li5uidity analysis evaluate ade5uacy of firm;s cas resources relative to its cas o"ligations. Cas 'esources may "e measured "y (8) current cas "alance or (9) net cas flo!s from o"ligations. Similarly for cas o"ligations. -ifferences are "et!een levels and lows. * en forming ratios+ if c oose level for numerator+ t en s ould also c oose level for denominator+ and similarly for flo!s. Current 'atio = (Current assets) / (Current lia"ilities) Com)ares )resent level of cas resources !it )resent level of o"ligations. <ses all current assets to define cas resources. =uic# 'atio = (Cas > (ar#eta"le securities > Accounts receiva"le) / (Current lia"ilities) (ore conservative measure of li5uidity. /,cludes inventory from cas resources+ since conversion of inventory into cas is less certain in "ot timing and amount. Cas 'atio = (Cas > (ar#eta"le securities) / Current lia"ilities (ost conservative measure of li5uidity. Includes only actual cas and cas e5uivalent "alances to measure cas resources. Cas flo! from o)erations ratio = (Cas flo! from o)erations) / (Current lia"ilities) Addresses )ossi"le s ortcoming of )revious li5uidity ratios "y addressing issues of converti"ility to cas + turnover+ and need for minimum levels of !or#ing ca)ital to maintain o)erations. (easures li5uidity t roug com)arison of actual cas flo!s !it current lia"ilities. -efensive interval = $%& , (Cas > (ar#eta"le securities > Accounts receiva"le) / (Pro3ected e,)enditures)

Provides an intuitive feel for t e firm;s li5uidity. Com)ares currently availa"le 65uic#7 sources of cas !it t e estimated outflo!s needed to o)erate t e firm. *orst0case scenario t at tells o! many days t e firm could maintain its )resent level of o)erations !it )resent cas resources+ "ut !it out additional revenues. 4ong0Term -e"t and Solvency Analysis Capitali$ation Table and #ebt Ratios -e"t to total ca)ital = (Total de"t (current and long term)) / (Total ca)ital (de"t > e5uity)) -e"t to e5uity = (Total de"t) / (Total e5uity) -e"t may or may not include o)erating de"t+ ! ic is incurred as )art of o)erations cycle. T is ratio may "e very different for different industries. Ca)ital0intensive industries may ave ig levels of de"t in order to finance )ro)erty+ )lant+ and e5ui)ment. (Total de"t at "oo# value) / (/5uity at mar#et) Same ratio as a"ove+ "ut ta#es into account ! at t e mar#et t in#s of t e firm;s )ros)ects. Also gives info on firm;s future a"ility to raise funds t roug de"t or e5uity offerings. (i,es "oo# value/mar#et value in a single ratio+ and s ould "e used in con3unction !it ratios t at measure solely "oo#0 or mar#et0value. A note a"out de"t1 (easuring total de"t is not al!ays straig tfor!ard. ?e a!are of 6innovative7 accounting tec ni5ues+ used for !indo! dressing or ot er )ur)oses. *atc out for off0"alance0s eet items+ suc as leases+ contractual o"ligations+ deferred ta,es. Also !atc for financial instruments !it "ot de"t and e5uity c aracteristics. And c ec# t e @otesA Interest Coverage Ratios Times interest earned = (/arnings "efore interest and ta,es (/?IT)) / (Interest e,)ense) (easure of a"ility to meet interest )ayments. Also #no!n as Interest coverage ratio. 2i,ed c arge coverage = (/arnings "efore fi,ed c arges and ta,es) / (2i,ed c arges) (ore com)re ensive measure of )rotection availa"le to firm;s creditors. Includes all fi,ed c arges arising from de"t commitments. 2i,ed c arges defined as contractually committed )eriodic interest and )rinci)al )ayments on leases as !ell as funded de"t. T ese ratios may use Ad3usted o)erating cas flo! for numerator instead. -efined as cas from o)erations > interest )ayments > ta, )ayments. I don;t 5uite understand t is definition of ad3usted cas flo!. Capital %&pendit're and Cash (low rom Operations-to-#ebt Ratios

Ca)ital e,)enditure ratio = (Cas from o)erations) / (Ca)ital e,)enditures) (easures relations i) "et!een firm;s cas generating a"ility and its investment e,)enditures. To t e e,tent t at it e,ceeds 8+ it indicates amount of money t e firm as left for de"t after )ayment for ca)ital e,)enditures. Tho'ght rom )en* T is seems li#e a "ac#!ards inter)retation. It !ould seem de"t re)ayment is a more immediate re5uirement t an ne! ca)ital e,)enditures. C2. to de"t = C2. / (Total de"t) Provides info as to amount of )rinci)al current C2. can cover. 4o! ratio could re)resent long0term solvency )ro"lem as firm is not a"le to generate enoug cas internally to re)ay its de"t. Profita"ility Analysis Ret'rn on Sales Gross margin = (Gross )rofit) / Sales Ca)tures relations i) "et!een sales and manufacturing costs. .)erating (argin = (.)erating income) / Sales Provides info a"out )rofita"ility from o)erations of core "usiness !/o regard to investment )olicy+ financing )olicy+ ta, )osition. (argin "efore interest and ta, = (/arnings "efore interest and ta,) / Sales Profit margin measure t at is inde)endent of firm;s financing and ta, )osition. Preta, margin = (/arnings "efore ta, (/?T)) / Sales Calculated after financing costs "ut )rior to income ta,es. Profit margin = (@et income) / Sales .verall )rofit margin is net of all e,)enses. Contri"ution margin = Contri"ution / Sales Contri"ution = sales B varia"le costs. Ret'rn on Investment 'eturn on assets = (@et income > After0ta, interest cost) / (Average total assets) (easures o)erating efficiency !/o regard to financial structure. 'eturn defined as net income )rior to cost of financing. Com)uted "y adding "ac# t e after0ta, interest cost. Cariation of '.A = (/arnings "efore interest and ta,es) / (Average total assets) <ses )reta, earnings to "y)ass firm;s financing )olicy and ta, )osition. Pre0interest measures facilitate com)arison of firms !it varying degrees of leverage. C anging t en to )ost0interest negates t is advantage and s o!s effect of leverage. 'eturn on common e5uity ('.C/) = (@et income B Preferred dividends) / (Average common

e5uity) 2ocuses on returns accruing to residual o!ners of firm B common s are olders. 'eturn on (total) e5uity ('./) = (@et income) / (Average total e5uity) (ore general definition+ com)utes return on total stoc# olders; e5uity.