Financial Statement Analysis

Basics
Horizontal Analysis
for the balance sheet and income
statement, prepare a comparative
financial statement
Common Base Year

i.e., calculate trend year over year

Compares similar data between periods on an absolute or relative scale. for every item on the financial
statement compared to a base
e.g., cash increased $2,000,000 or 34% from last year to this year. year; also called horizontal
analysis
Typically, the earlier year is the base figure.

Vertical Analysis for the balance sheet and income

statement, prepare and analyze
common-size financial statements
Common Size

i.e., calculate percentage of

Compares data from the same reporting period to a base figure. assets and sales, respectively;
e.g., current assets are 20% of total assets as of the reporting date. also called vertical analysis

Typically, the 100% base figure is revenue or total assets (or equivalent).
Common Size Financial Statements

Allows for comparing of companies of varying sizes.

Common Size Balance Sheet

Each asset % of total assets

Each liability % of total liabilities

Each equity item % of total equity

Common Size Income Statement

Each expense and revenue % of total sales/revenue

Common Size

Vertical Analysis
Balance sheet can also be
Income Statement Common-Sized I.S.
prepared in a similar
schedule.
Revenue 100000 100.000000% A time-series analysis can
identify ratio trends
COGS 58000 58.000000% revealing important
variations.
Gross Profit 42000 42.000000% A comparison of the
common-size percentages
SG&A Expenses 24000 24.000000%
can also be made with other
companies in the same
Operating Income 18000 18.000000%
industry.
Interest and Taxes 8000 8.000000%

Net Income 10000 10.000000%

Common Base Year

Horizontal Analysis
Common Base
Standard B.S.
Year B.S.
20X9 20X0 Constructed by dividing the
Assets current year account value by
the base year account value
Cash 5000 7000 140.000000%

Inventory 3500 4000 114.000000%

A/R 1500 1000 67.000000%

Total Assets 10000 12000 120.000000%

Growth Analysis
Companies set growth rates and determine if they can actually attain the growth
estimate. There are different methods of setting growth; one common computation is
growth of earnings per share (EPS).

Other growth measures include changes in total revenues, dividends per share, and total assets. These
measures may be compared to company expectations and to other companies in the industry.

calculate the growth

rate of individual line

items on the balance
sheet and income
statement
Ratio Analysis

Compares data to related items.

e.g., COGS to inventory.

When comparing data that covers a period of time to data as of a point in time, more
meaningful results are possible if an average of the data is used.

Beginning inventory plus ending inventory divided by 2.

Ratio Analysis
User’s Objective

Liquidity

Assist short-term creditors who are interested in how well a firm meets its currently maturing obligations
Activity

Measure how effectively assets are being employed

Profitability

Of particular interest to investors (both long-term creditors and equity investors) because they indicate the magnitude of the return on investment
Leverage/Coverage

Long-term creditors and investors look to measure the degree of protection afforded their investment
Ratio Analysis
Usefulness

Ratios become informative Pitfalls in relying solely on

when compared to: ratio analyses include:

Industry standards (if Since the statements are

accounting standards are historical in nature, the
uniform) comparisons reflect past,
not future relationships
Prior years’ performance
Ratios have not been
Budgets standardized
Used in conjunction with Accounting methods (e.g.,
other ratios LIFO versus FIFO)
Financial Statement Analysis
Financial Ratios - Liquidity
Liquidity
Objectives
Compares similar data between periods on an absolute or relative scale.
Creditors and Management
e.g., cash increased $2,000,000 or 34% from last year to this year
Composition of current assets and liabilities, primarily assets.
Typically, the earlier year is the base figure
A high proportion of cash or marketable securities is more liquid than a low proportion.
Ability to meet its current obligations.

Short-term Liquidity — Operating activity and cash flow ratios

Operating activity ratios measure how effectively and efficiently the firm is carrying out its business — making
sales, collecting, and managing inventory.

Companies with slow turning inventory and slow paying customers are less liquid.
Cash flow gives an indication of the liquidity of a company as does the speed with which non cash current assets
convert to cash.
Liquidity
Definitions

Current Assets
Cash and other assets that will be converted into cash, sold, or consumed within one year or the operating cycle, whichever is longer.

Increasing current assets are a use of short-term funds for a business.

Cash and cash equivalents

Inventories

Marketable securities — trading and available-for-sale-classifications at FV

Notes and accounts receivable (at NRV)

Prepaid expenses (at unexpired cost)

Liquidity
Definitions
Working Capital
Current Liabilities
The difference between
current assets and
current liabilities.
Liabilities to be paid within one year or the operating cycle, whichever is
longer.

Increasing current liabilities are a source of short-term funds for a business. Creditor’s source of
payment

Accounts payable — arising from acquiring goods or services

Other accrued liabilities — such as wages and interest payable and currently maturing portions of long-term debt

Notes payable — such as, but not limited to, commercial paper, short term bank credit loans, factoring

Collections of amounts in advance — unearned or deferred revenues

Liquidity
Ratios, Computational Issues, and Analysis

Current Ratio

Measure of short-term solvency — the ability to meet current obligations.

Generally, higher is better (exceeding 2.0), but the composition of current assets is also important. Too high of a ratio, say 3.0,
may indicate inefficient use of capital.

Creditors often look at the trend and compare it to other companies as gauges of liquidity.

Current Assets
Current Liabilities
Liquidity
Ratios, Computational Issues, and Analysis

Current Ratio Example:

A company has current assets of $400,000 and current liabilities of $500,000. The companies current ratio would be increased by:

Present Current Ratio = 

A.

A. Purchase of $100,000 of inventory on account 

B. Payment of $100,000 of accounts payable 

C. Collection of $100,000 of accounts receivable (no change, current assets increase and decrease by same amount)

D. Refinancing a $100,000 long-term loan with short-term debt 

Liquidity
Ratios, Computational Issues, and Analysis

Current Ratio Example:

The Solvent Corporation’s current ratio is 2.0 to 1 and its bond indenture specifies the current ratio must remain above 1.5 to 1.

If current liabilities are $25 million, then current assets must be $50 million.

The maximum increase to both current assets and current liabilities is:


Liquidity
Ratios, Computational Issues, and Analysis

Acid-Test (or Quick) Ratio

Measures short-term liquidity, excluding inventory, prepaid expense, and other non-liquid current assets.

A more conservative measure of ability to pay short-term obligations.

1.0 is considered average — a level trend indicates good management.

Provides a greater assurance to short-term lenders about the company’s ability to repay.


Liquidity
Ratios, Computational Issues, and Analysis

Acid-Test (or Quick) Ratio Example

A company has a current ratio of 2 to 1 and a quick ratio of 1 to 1. A transaction that would change the company’s quick ratio, but
not its current ratio is:

A. The sale of short-term marketable securities for cash that results in a profit

B. The sale of inventory on account at cost (inventory is the only item mentioned that is in the current ratio, but not the quick ratio)

C. The collection of accounts receivable

D. The payment of accounts payable

Liquidity
Ratios, Computational Issues, and Analysis

Receivables Turnover Ratio

Indicates the efficiency of receivables collection and the quality of receivables. The higher the quality, the shorter the time
between the sale and collection of cash.

Net Credit Sales excludes cash sales and reflects all other sales during a period.

If no information is available about cash sales, the total sales are used as an estimate of credit sales.



Liquidity
Ratios, Computational Issues, and Analysis

Receivables Turnover Ratio - Comparison Problems

Turnover can be difficult to pin down precisely as companies do not usually report cash versus credit sales.

Inclusion of cash sales will artificially inflate the turnover figure.

Bad Debt Reserves should be deducted from total A/R.

Turnover rates will vary widely across industries and are affected by credit policies, aggressiveness of collection efforts, and
economic trends.

If ending A/R balance is used instead of the average, the ratio provides a more current snapshot of the current situation
(assuming average daily sales remains constant throughout the year)
Liquidity
Ratios, Computational Issues, and Analysis

Average Collection Period (or Days Sales Outstanding)

The average time in days that receivables are outstanding (date of sale to date of collection).

Calculated by dividing 365 days by the receivables turnover, its interpretation is inversely related to that of the receivables
turnover ratio — the greater number of days outstanding, the greater the possibility of delinquencies becoming uncollectible.

Ideal ratio is less than the terms extended to customers.

If you offer net 30 day terms and everyone pays exactly on time, the ratio should be 30 days.


Liquidity
Ratios, Computational Issues, and Analysis

Inventory Turnover
Measures how effectively the inventory portion of working capital is being used in terms of the number of times inventory is
replaced every year.

Measure of turnover (higher is better) and length of turnover (shorter is better).

High inventory turnover can indicate high liquidity and/or good merchandising, or frequent stockout and lost potential sales.

Low turnover could mean obsolete merchandise or excessive inventory accumulation.


Beg. Inventory + End. Inventory
2
Liquidity
Ratios, Computational Issues, and Analysis

Inventory Turnover - Comparisons and Values to Use

Ratio should be compared to the industry standard to be meaningful. Inventory turnover is a function of the industry’s technology as
well as the operating efficiency.

Inventory includes raw materials, work-in-process, and finished goods. Analysis is usually done on the total, but may be
conducted on a portion.

Valued at the lower of cost or market, not at the price for which it will be sold.

Sometimes may be calculated using sales instead of cost of sales (e.g., COGS) in the numerator. However, cost of sales is a
better base because it eliminates any changes due solely to sales price changes.
Liquidity
Ratios, Computational Issues, and Analysis

Inventory Turnover Example

Calculate the inventory turnover for 20X2. Select only the information needed.

20X1 20X2 920,000 920,000

= = 4.6
(190,000 + 210,000) ÷ 2 200,000

Sales 1400000.000000USD 1800000.000000USD

Inventory 190000 210000

Liquidity
Ratios, Computational Issues, and Analysis

Inventory Turnover Example

Earth Corporation has budgeted sales of $144,000 and cost of sales of $90,000. It is earning 11% on its investment in certificates of deposit. If
Earth Corp. can increase inventory turnover from its present level of 9 times per year to 12 times per year, how much can it save?

If inventory turnover is currently at 9 times per year, then we can use the ratio formula and the information about cost of sales to calculate
average inventory:

 Cost of Sales
Inventory Turnover of 12 → = 12
Average Inventory





The average reduction in inventory would be: $10,000 - $7,500 = $2,500

At a rate of return of 11%, the savings would be: $2,500 × .11 = $275
Liquidity
Ratios, Computational Issues, and Analysis

Number of Days in Inventory (or Days Sales in Inventory)

The average length of time in days that merchandise is in inventory (the length of time necessary to sell an item of inventory).

Because this ratio is calculated by dividing 365 days by the inventory turnover, its interpretation is inversely related to that of
inventory turnover ratio.


Liquidity
Ratios, Computational Issues, and Analysis

Accounts Payables Turnover

Measures how many times per period accounts payable are paid.

The turnover ratio is not used as frequently as the Days Purchases in Accounts Payable (next topic).


Liquidity
Ratios, Computational Issues, and Analysis

Days Purchases in Accounts Payables

Measures how many days’ worth of inventory purchases are still unpaid. Gives some information about how well a company is paying its
bills to suppliers.

Caution of data quality in receivables and inventory.

In theory, it would be preferable to separate inventory purchases from all other payables, but this information is seldom given to
outsiders. Therefore, COGS and A/P must be used as surrogates.

The two payables ratios are not used as frequently as the receivables and inventory ratios, but they come into play when determining
the operating cycle.
Liquidity
Ratios, Computational Issues, and Analysis

Operating Cycle
Represents the average number of days it takes to sell inventory and then collect on sales. It is a key measure of the enterprise’s
operating efficiency and financial health.

A shorter operating cycle indicates a company is more efficient than either it was last year or than a competitor with equivalent
products and markets. A longer cycle time indicates the reverse.

Not only are the absolute numbers important, but the trend over time is often more important. For instance, short-term lenders
will want to know how quickly they can expect to be paid back.


Liquidity
Ratios, Computational Issues, and Analysis

Operating Cycle Example

Estimate the operating cycle.

Accounts Receivable Turnover Ratio = 3.65

Inventory Turnover Ratio = 3.30



Liquidity
Ratios, Computational Issues, and Analysis

Cash Flow Cycle

Takes the Operating Cycle and deducts the days purchases in accounts payable.

This gives recognition to the fact cash is not used to purchase inventory at the time it is acquired.
However, the longer Operating Cycle is more frequently used for analysis.

Example of Cash Flow Cycle

If the average age of inventory is 60 days, the average age of accounts receivable is 40 days, and the average purchases in accounts payable is 35 days, the length of the
cash flow cycle is:


Liquidity
Ratios, Computational Issues, and Analysis

Cash Ratio (or Cash to Current Liabilities)

Severe liquidity problems with receivables and inventories, or pledging those assets, may require an even more
conservative analysis of liquidity.

The cash ratio includes only cash and current assets that are readily converted to cash (i.e., cash equivalents and
marketable securities) in the numerator.
Thus, it is more conservative than the current ratio or the acid-test (quick) ratio for measuring the company’s
short-term liquidity.


Liquidity
Ratios, Computational Issues, and Analysis

Liquidity Index
A more comprehensive ratio for trend analysis and comparative analysis across companies.
It is measured in days and can be considered a weighted average conversion time for current assets.

This number is not necessarily meaningful in itself, but it gains significance when compared to other periods or
other entities.
A higher or increasing liquidity index is a sign of less liquidity, while a lower or declining index indicates greater
liquidity.


Liquidity
Ratios, Computational Issues, and Analysis

Liquidity Index Example

ᵃ The days to convert A/R to cash is equal to the number of Days to

days it takes to collect A/R CA Component $ Amount Convert to Dollar-Days
Cash
(i.e., the average collection period)
ᵇ The days in the operating cycle
Cash 25000 0 0

(i.e., the number of days to convert inventory to cash

plus the number of days it takes to collect A/R) Marketable 5000 2 10000
 Securities

Accounts 20000 45ᵃ 900000

Receivable

Inventory 50000 60ᵇ 3e+06

Total Current 100000 3.91e+06

Assets
Financial Statement Analysis
Leverage
Leverage
Operating Leverage

Operating Leverage —
Relates the percentage changes in EBIT to the percentage change in revenue.
Business risk is partially built on the degree of fixed cost use in operations.

The higher the fixed costs, the greater risk that the breakeven point will not be reached given a
drop in sales.
When fixed costs are high, a small drop in sales can result in a loss.
Leverage
Operating Leverage

Operating Leverage —
The greater the operating leverage, the greater the change in operating income will be
given a particular change in sales.

High degree of operating leverage

Large change in operating income for a relatively small change in sales

Leverage
Operating Leverage

Degree of Operating Leverage (DOL)

Percentage change in EBIT related to a given percentage change in revenue.

A DOL of 2 means that the percentage change of EBIT will be twice the size of the
percentage change in sales.

If sales increase by 20%, then EBIT will increase by 40%.

If sales decrease by 20%, then EBIT will decrease by 40%.


Leverage
Operating Leverage

Degree of Operating Leverage (DOL)

DOL can be changed by altering the proportion of fixed costs to variable costs.

Higher proportion of fixed costs — higher DOL and breakeven point.

After the break-even point is reached with a high DOL, the operating profit increases quickly
Higher risk associated with higher fixed costs and low variable costs also provides the possibility
of higher profits in the event of a positive sales outcome.
Higher proportion of variable costs — lower DOL and breakeven point.
Leverage
Operating Leverage

Degree of Operating Leverage (DOL)

Given the same sales as in the diagram, a lower percentage of fixed cost will cause the
breakeven point to be reached at an earlier sales level.

However, the operating profit will increase slowly in relation to increased sales.
The operating profit (loss) is the difference between the sales and total costs.
Leverage
Operating Leverage

Degree of Operating Leverage (DOL) Example

Tally Company has the following information available regarding sales and costs from
the last period:

Contribution Margin
Sales in Units 10000 DOL =
Contribution Margin - Fixed Costs
Selling Price per Unit 10.000000USD

Variable Costs per Unit 6.000000USD

Fixed Costs for Period 20000.000000USD

Leverage
Financial Leverage

Financial Leverage —
Extent to which debt and preferred stock (fixed income securities) are used in the capital
structure.

The larger the percentage of debt and preferred stock that is used for financing,
the greater the risk that the company will not earn enough to cover the fixed
interest and preferred dividend payments.
The more leverage, the greater the risk, and the higher the cost of capital.
Leverage
Financial Leverage

Degree of Financial Leverage (DFL)

Percentage change in earnings available to common stockholders related to a given percentage
change in EBIT.

When there is no debt financing used, the DFL will equal 1.

When debt does exist, a change in EBIT will result in a greater proportional change in EPS.
If the DFL were 2, then a 10% increase in EBIT would result in a 20% (10% × 2) increase
in EPS.
Leverage
Financial Leverage

Degree of Financial Leverage (DFL)

If a firm has no debt and begins to substitute debt for equity, at first the value of the firm
will rise, reach a peak, and begin to fall due to the increased risk of additional debt.
This peak in maximized value is the target capital structure.

If the organization has preferred stock, the DFL equation is modified to:


Leverage
Financial Leverage

Degree of Financial Leverage (DFL) Example

Tally Company has the following information available regarding sales and costs from
the last period:

EBIT
Sales in Units DFL =
10000
EBIT - Interest Expense
Selling Price per Unit 10.000000USD

Variable Costs per Unit 6.000000USD

Fixed Costs for Period 20000.000000USD

Interest Costs for Period 15000.000000USD

Leverage
Total Leverage (Degree of Combined Leverage)

Degree of Total (Combined) Leverage

If a company used both high degrees of operating and financial leverage, only small changes in sales will
result in large fluctuations in EPS.

Can be used to predict the effect of a change in sales on income and ultimately earnings available to
common stockholders.
Determined by the relationship between operating and financial leverage.

If risk is lowered by reducing the DOL, then the firm would be in a better position to increase the
use of debt, thus increasing the financial leverage.
Leverage
Total Leverage (Degree of Combined Leverage)

Percent Resulting
Previous
Increase Change
Degree of Total DTL of 8 DOL of 2 Sales 100000.000000US
10.000000% 110000.000000USD
(Combined)
D

Leverage Example Variable Costs 60000 66000

The financial Fixed Costs 20000 20000

statement effects of EBIT 20000 20.000000% 24000

DOL and DFL can be

Fixed Financing
shown by using the DFL of 4
Costs
15000 15000

income statement
format: EBT 5000 9000

Taxes (40%) 2000 3600

Net Income 3000.000000USD 80.000000% 5400.000000USD

Leverage
Financial Leverage

Degree of Total (Combined) Leverage Example

Tally Company has the following information available
regarding sales and costs from the last period: 


Sales in Units 10000

Selling Price per Unit 10.000000USD

DTL = DOL × DFL = 8

Variable Costs per Unit 6.000000USD

Fixed Costs for Period 20000.000000USD

Interest Costs for Period 15000.000000USD

Financial Statement Analysis
Profitability
Profitability
Asset Utilization

Measure of success in terms of income defined in a variety of ways over a period of

time.
Earnings are compared to a base such as sales, productive assets, or equity.

Increased profitability provides:

Potential for increased dividend payments as well as from stock appreciation.

Greater security for debt holders.

Profitability
Gross Margin

Gross Margin Ratio —

Compares gross margin (gross profit) generated by the net sales revenue.

“What percentage of sales dollars were used to cover the cost of goods sold?”

The remaining amount is left to cover general and administrative expenses as well as to provide
a profit.


Profitability
Gross Margin

Gross Margin Ratio

Generally more useful to management than to creditors/investors since the data
necessary to analyze why changes occurred in the ratio are only available internally.
Changes are caused by one of the following elements or a combination of the following
items:
1.

1. Increase (decrease) in unit sales price

2. Increase (decrease) in cost per unit

Profitability
Profit Margin

Profit Margin Ratio (Return on Sales) —

Calculates the percentage of each dollar of sales that is recognized as net income.

Measures the efficiency of earnings as compared to sales.

“How well has management controlled expenses in relation to revenues earned?”

Efficient way to compare the profits of companies of various sizes.


Profitability
Asset Turnover

Asset Turnover Ratio —

Indicates how many dollars of sales were created by each dollar of total assets.

Assists in determining whether the available assets were used efficiently to create sales.

Management has the goal of generating the highest possible amount of sales per dollar of
invested capital.

Different industries tend to have different reasonable ranges.


Profitability
Asset Turnover

Asset Turnover Ratio

As with all turnover ratios, a high asset turnover is a desirable outcome since it reflects an effective
use of available assets.
It is not abnormal for a company that has recently expanded to see a drop in asset turnover until the new facilities
are fully utilized.

For internal use, it is desirable to calculate this ratio comparing divisional sales to divisional assets.

Inter-firm comparisons within an industry can be difficult due to the varying age of assets used in production of
the sales

Limitation caused by use of historical costs, rather than FMV for productive assets. Additionally, the formula
doesn’t account for certain assets that make no tangible contribution to sales.

Adjustments to the asset figure are used to compensate for this problem. For example, long-term investments
are not involved in the production and sale of the product and are often excluded from the calculation.
Profitability
Return on Assets (ROA)

Return on Assets (ROA) Ratio —

Measures the productivity of assets in terms of producing income.

Depends on the organization’s ability to get a high profit from each sales dollar while generating
high sales per dollar of invested capital.

A consistently high ROA indicates effective management decision making and that the
organization is a growth company.


Profitability
Return on Assets (ROA)
Return on Assets (ROA) Ratio
The DuPont equation breaks ROA down to the asset turnover and profit margin.

ROA is broken down to the profit margin showing:

Effective control of cost (Net Income ÷ Net Sales)
And the asset turnover showing:
Efficient use of assets (Net Sales÷ Average Total Assets)


Profitability
Return on Equity (ROE)

Return on Equity (ROE) Ratio —

Measures the return to common stockholders. “How many dollars were earned for each dollar of common equity?”

When comparing this ratio with ROA, the investment of the creditors is removed

Affected by:
1.

1. Net income available to stockholders (Net Income - Preferred dividends)

2. Profit margin available to stockholders

3. Asset turnover

4. Extent to which assets are financed by common stockholders

5. The method of financing used (debt versus equity) has a major effect on this ratio.
6.
 Profitability
Return on Equity (ROE)

Return on Equity (ROE) Ratio Denominator consists of the average of

the total equity, less preferred shares
and minority interest.


One major problem is that
the historical issue price is
Or, using the DuPont Equation: used as opposed to the
current market value.


Profitability
Return on Equity (ROE)

Return on Equity (ROE) Ratio

Common stockholders’ leverage ratio measures the portion of assets that are financed through common equity

Also called the equity multiplier

The larger this ratio, the greater financial leverage will be.
Various organizations within an industry will have potentially dramatic differences in ROE resulting from
financing decisions — debt versus equity.

If ROA is greater than the cost of borrowing, then ROE will be higher than ROA due to the impact of
financial leverage.
Financial Statement Analysis
Market
Market
Price-Earnings

Price-Earnings Ratio —
Indicates the relationship of common stock to net earnings.
The market price is the investors’ perception of the future
Therefore, the ratio combines the performance measure of the past (EPS) to perceptions of the future.

EPS computation is subject to arbitrary assumptions and accrual income. EPS is not the only factor affecting market
prices.

A high P/E ratio is a possible indication of a growth company and/or a low-risk organization.
Market
Dividend Yield

Dividend Yield Ratio —

Shows the return to the stockholder based on the current market price of the stock.
Dividend payments are subject to many variables.
Reciprocal relationship between dividends paid and market prices.

Calculated using the current market price; however, most of the shareholders did not purchase shares at
the current price, thus making their personal yield different from the calculated yield.
Market
Payout Ratio to Common Shareholders

Payout Ratio to Common Shareholders —

Measures the portion of net income to common shareholders that is paid out in dividends.

Income doesn’t necessarily measure cash available for dividend payment as payments are heavily influenced by
management policy, industry nature, and development stage. These items diminish comparability between
companies.

Organizations with high growth rates generally have low payout ratios since most earnings are kept as retained
earnings and reinvested.

A firm that has consistently paid a dividend and suddenly lowers its dividend payout often is signaling a lack of
available cash and the existence of liquidity or solvency problems.
Market
Economic Value Added (EVA)
Economic Value Added (EVA) —
Economic profit as opposed to the GAAP profit. Focus on the earnings above the required cost of
capital for shareholders.
If the required rate of return is 12% and the company earns 16%, then value has been created for
the shareholders; therefore, investors value the firm above the amount of capital originally
invested.



Often used in the decision-making process when determining whether a large investment in PP&E would be in the
best shareholder interest.
Market
Price-to-Sales Ratio (P/S)

Price-to-Sales Ratio —
Valuation ratio that compares a company’s stock price to its revenues, and shows how
much investors are willing to pay per dollar of sales — key analysis and valuation tool.

A low P/S ratio may indicate an undervalued stock, while a ratio that is
exceedingly high may suggest overvaluation.


Market
Price-to-Cash Flow Ratio (P/CF)

Price-to-Cash Flow Ratio —

Stock valuation indicator that measures the value of a stock’s price relative to its operating cash
flow per share.

Operating cash flow adds back non cash expenses to net income (depreciation and
amortization).
Useful for valuing stocks that have positive cash flow but are not profitable because of
large non-cash charges.


Market
Price-to-Book Ratio (P/B)

Price-to-Book Ratio —
Used to compare a firm’s market to book value by dividing price per share by book value per share.
Book value is equal to its carrying value on the balance sheet, and is calculated by netting the asset against
its accumulated depreciation.

Book value is also the net asset value of a company calculated as total assets minus intangible assets
and liabilities.
A lower P/B ratio may indicate an undervalued stock, or that something is fundamentally wrong with
the company. Also known as the price-equity ratio, it varies by industry, as with most ratios.


Market
Other Price Multiples

Other Price Multiples —

A price multiple is any ratio that uses the share price of a company in conjunction with some specific
per-share financial metric for a snapshot on valuation.
The share price is typically divided by a chosen per-share metric to form a ratio.

Price-to-earnings ratio, forward price-earnings ratio, price-to-book ratio, and price-to-sales ratio.
Other ratios include price-to-tangible book value, price-to-cash flow, price-to-EBITDA, and
price-to-free cash flow.
Care must be taken to analyze components of the denominator to ensure there are no
extraordinary items, one-offs or nonrecurring factors.