Financial Statement Analysis Text

8/12/2019 Financial Statement Analysis Text

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Financial Statements

Financial statements are a collection ofdocuments describing the financial state of a

business. They may be internal (prepared and usedwithin the business) or external(prepared andused outside the business).

External statementsare usually prepared byexternal accountants or auditors. They consist ofanAuditors Report, Income Statement,Balance

Sheet, Cash Flow Statementor other reconcilingstatement andNotes to the Financial Statements.

TheAuditors Report(orAccountants Report) is

often titledNotice to Reader. It states whether thestatements are based on an audit(highest level),reviewor compilation(lowest level) engagement.It also states the extent to which the reader shouldrely on the information. If audited, the reportshould state that the auditor believes the statementsfairly represent the company.Auditors Reportsnot signed by the auditor are likely only draftcopies.

TheIncome Statementis sometimes referred to asthero!it and "oss Statement. It lists therevenuesin terms of sales and other revenues. It

lists the cost o! goods sold, providing thegrossmargin(sales less costs of goods sold). It also listsand adds the selling and administration expenses.

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The difference between thegross marginandselling and administration expensesis called

pro!its !rom operations.

Deduced from thepro!its !rom operationsareprior period ad#ustmentsand unusual items(usually profits or loss from sale of fixed assets) toarrive at the !IT (net $e!ore interest ant taxes).

Interest is then deducted to yield the net beforetaxes. "inally, taxesare deducted to determine thenet income.

TheBalance Sheetlists the assets, lia$ilitiesande%uit&(ownership) of the business. The assetsarelisted on the left, in order of li#uidity. The assets

are broken into short term assets(also referred toas current assets) and long term assets. The shortterm assetsare generally used within a year andconsist of cash, mar'eta$le securities, accountsreceiva$le, inventoryandprepaid expenses. Thelong term assetsconsist of vehicles,plant ande%uipment, landand intangi$le assets(goodwill,

patents,capitali(ed research and developmentandcapitali(ed startup costs).

The right side of theBalance Sheetlists lia$ilities(also referred to as de$t) and owners e%uit&(alsoreferred to as net worthor shareholders e%uit&).Current lia$ilitiesconsist of accounts pa&a$leandthe current portion o! long term de$t. Theshareholders e%uit&is broken into proceeds from

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the sale of shares (orpaid in capital) and retainedearnings(sum of previous net incomes less cash

dividends)

The total of all assetson the left hand side e#ualsthe total of all lia$ilitiesand owners e%uit&on theright hand side.

The Cash Flow Statement, Sources and )ses o!Funds orChanges in *or'ing Capital Statementis a reconciling statement. It reconciles thechanges in cashor wor'ing capital(currentassetsless current lia$ilities) to the changes in

Balance SheetandIncome Statementitems. TheCash Flow Statementis broken into cash !low

!rom operations, cash !low !rom !inancingandcash !low !rom investments.

Notes to the Financial Statement, or are noteswhich provide information to the reader. Itincludes changes in accounting policy, a

breakdown of plant and e#uipment and

depreciation, details on non$arms lengthtransactions, pending law suits, and significantevents or transactions which occurred during theaudit.

Comparative !inancial statementsinclude a sideby side comparison of the income statement andbalance sheet to those of prior years.

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Internal !inancial statementsusually consist of anIncome Statement,Balance Sheetand+anagersComments. TheIncome Statementusuallycompares the results to budget and reports thevariances to the budgeted amount. The+anagers

Reportcomments on the operating changes to the$udgetand its effects on the variances.

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Financial Statement Analysis

Side-by-Side Analysis

This is usually the first step in financial statementanalysis. It is also the only step taken by manyrecipients of financial statements.

In this method, the reader simply eyeballs thefinancial statements.

%sing this method, the reader does not have to doany calculations.

During this approach, the reader can see whetherthere are any material changes to financialstatements figures, whether the business hasearned a profit and whether the profits haveimproved over the previous period.

The side$&side anal&sisis also referred to as

hori(ontal anal&sis or comparative anal&sis.

Notes to Financial Statements

The second step to financial statement analysis isreading the notes. They do not re#uire anycalculations and enable the reader to see whether

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ad&ustments should be made if and whencalculations are made.

The notes to the financial statement provide abreakdown of some figures, explain the method ofaccounting used in determining the reportedfigures and provide other important items ofinformation to the readers. They are important in

the analysis of a business. They should beexamined before doing any other analysis todetermine whether there is any information thatsuggests a change of business or ad&ustments thatmay be needed to current figures to forecast futureresults or ratios.

The notes may contain a breakdown of the control,ownership and accounting forinvestments inother companies. 'artial ownerships, which arenot consolidated, may indicate profits from these

partially owned companies that are not reported inthe income statement. If profits continue, theyshould show in future periods as dividend income

or gain on disposal of investments. hen doingcalculations, any unreported current years profitsfrom the investments should be included in profitsand the accumulated non$reported profits should

be included in the investment and owners e#uity.

Inventories using"IF- (last$in$first$out)accounting indicate that the inventories are valued

based on old values, whereas those using FIF-

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(first$in$first$out) indicate the inventories arevalued at the most recent prices. If the company

holds inventories which decrease in value overtime, such as computers and other electronics, theuse of"IF-indicates that the inventories andincome may be overstated. * note on prices beingad&usted to the lower of actual and replacementcosts will decrease concerns about obsolete and

overpriced inventories.

otes may indicate that thepropert&, plant ande%uipmentvalues may not reflect the costs ofreplacing them. There may also be a note onimpairment to !ixed assetswhich would indicatethat the assets are overstated. +verstated

depreciation rates will indicate that thedepreciated value of the fixed assets and theincome are understated.

The breakdown of intangi$le assetswill disclosehow the value was determined and how they are

being amortied. It will also disclose whether

current expenditures on research and developmentare capitalied or expensed. The amount ofintangible assets compared to their amortiationrates and the profits derived from them should becompared to similar companies to determinewhether they are overvalued.

ension $ene!itsmay indicate obligations whichhave not been accounted for. %nderstated

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obligations indicate that the net worth and incomeis overvalued. It may also indicate unreasonably

high pensions being paid to executives.

+ther contingenciesmay indicate outstandingclaims and whether a contingency has been

provided for such. *d&ustments may be needed toprovide contingencies for the extent and risk of

these claims. This area may show claims whichhave depressed the current price of the shares.Depending on the extent of the effect on the share

price, the perceived risk of the contingency and therisk attitude of the investor, this may present eithera high$risk high$reward investment opportunity oran investment to avoid.

If shown in the notes on income taxes, lossescarried !orwardindicate the extent to which future

profits are not taxable. This creates a higher after$tax return until the losses carried forward have

been used up. The extent of anticipated futureprofits will determine the value of the losses

carried !orward.

Stoc' optionsmay cause a concern about dilutionif there are significant options outstanding and-orthe striking price is significantly below the currentvalue of the business. * large amount of stockoptions may present an incentive to overstateincome in an attempt to raise stock prices throughaggressive accounting. If stock options were re$

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issued at a lower striking price after a drop inprices, the insiders may be unreasonably benefiting

from stock, or stock market volatility.

oncentration of business, or accounts receivable,with a few customers, or a large portion with onecustomer, may be a concern about the effect thatthe risk or loss of that key customer may create to

future income.

In theRelated art& .ransactions, a determinationshould be made as to whether they are being madefor the benefit of the owners or the company. Ifthey indicate unusual benefits to the owners suchas low interest loans, there should be concern

about whether the owners are more intent on theirpersonal gains than those of the business.

Su$se%uent Eventswill state significant eventswhich happened since the date of the financialstatements. These events may indicate that futureresults may be significantly different than prior

results.

Changes in Accounting olic&may indicate thatad&ustments are needed when comparing previousresults. ontinuous changes to accounting policiesmay indicate the company is changing accounting

policies to create a more positive incomestatement.

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rior eriod Ad#ustmentsshould be read as towhat caused a change in previously reported

figures. onsecutive years of reportingpriorperiod ad#ustmentsraises concerns about theaccounting and the auditors ability to find andmake the corrections in the correct period.

Quantity of Changes in Financial StatementFigures

This method determines the dollar value of anychanges in figures.

The extent of the changes is determined by

subtracting the previous period figures from theperiod figures. (ie/ if the figures for the years 0112,0110 and 0113 are 45,611, 46,211 and 46,311, thechanges would be 4711 846,211 $ 45,6119 for 0110and 4011 846,311 $ 46,2119 for 0113).

This shows the dollar amount of changes from one

period to the next.

Percent Changes in Financial Statement

Figures

This method calculates the change as a percent,instead of a dollar figure.

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To determine the percent change, the dollar changeis divided by the previous figure (ie/ as in the

example above, the 4711 change would be dividedby 45,611, yielding a 23.3: change).

This method enables the reader to see whichfigures are changing #uicker than others.

Real Dollar Comparisons

This method removes the extent of inflation fromthe figures so the reader can see the figures in real(current) dollar terms.

"igures from previous periods are increased by therate of inflation over that period.

Real Dollar Changes

+nce real dollar figures are determined for the

previous periods, the reader can calculate realdollar changes. These are changes above, or below,the rate of inflation.

These figures are calculated by subtracting theprevious inflated figures from the next period (ie/inflated 0112 figures from inflated 0110 figures orinflated prior period figures from non$inflatedcurrent period figures).

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Real Dollar Percent Changes

This techni#ue shows the real changes in terms ofpercent instead of dollars.

To calculate these figures, divide the real dollarchange by the inflated figure for the previous

period.

ote that consecutive years of real dollar losses insales or income (profits) is a concern as it showsthat the business is growing at a slower rate thaninflation. If such is the case, the company may beheading for financial troubles. It also indicates thatthe slow growth in the business should, at best, be

treated as an annuity. The amount of net tangibleassets per share should be compared to its currentshare price to determine the extent of the riskshould the business collapse.

Common Sied Ratios

Common si(ed ratiosare ratios based on a percentof sales for income statement items and a percentof total assets for balance sheet items.

These enable a side by side comparison ofdifferent sied companies. They are usually usedfor side by side comparisons of period to periodresults. They are an easy way to compare results.

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Common si(ed income statement ratiosshow theefficiencies and cost overruns.

;ometimes this method is referred to as verticalanal&sis orcrosssectional anal&sis.

Changes in Common Sied Ratios

The changes in common si(ed ratios showwhether the efficiency of the business, as measuredas a percent of sales, is improving. It also showshow the asset mix, as a percent of total assets, ischanging.

To calculate these changes, subtract the previousperiod common si(ed ratioform the currentperiod.

Percent Changes in Common Sied Ratios

This calculation shows the degree, as a percentchange, in the common si(ed ratios.

These percent changes are determined by dividingthe change in a common si(ed ratioby thecommon sied ratio for the previous period (ie/ ifthe common sied ratios were 3.6: and 5.0:, thechange in common si(ed ratiowould be 1.


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the percent change in the common si(ed ratiowould be 01: 81.


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Percent Change in Dollar per Share

This approach calculates the extent of the changesin dollar per sharefigures in terms of percent.

This calculation is mage by dividing the change indollar per shareby the previous period dollar persharefigure.

Common Dollar !nvestment

This is a techni#ue that enables the reader tocompare various investments in a common term,money invested.

In this approach, the financial statement figures aredivided by the mar'etcapitali(ation(number ofshares outstanding x the market price per share) orsuggested selling price for the business. Ifcomparing different periods for the same company,using their market prices at the end of each period

will compare similar investments in the companyat different points in time.

;ince the figures are small, it is usually better tocalculate the figures per 42,111 investment insteadof per dollar.

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Change in Common Dollar !nvestment

This approach enables the reader to determine thechanges of investing at this period than at a

previous point in time.

This involves subtracting the common dollar(or42,111) investmentfigures from the previous

period to those of the current period.

Percent Change in Common Dollar !nvestment

Figures

This expresses the change in common dollar

investmentas a percent.

It is accomplished by dividing the change incommon dollar investmentby the previous periodcommon dollar investmentfigure.

Comparisons to N"!#

omparing costs toNBI.(Net $e!ore Income and.axes) determines the effect that improvements incost categories will have on !IT.

;ome costs may have a numeric value that exceedsthat on the !IT. These costs create a greater

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percent gain in !IT than their percentagedecrease.

*n example is a cost which has a numeric value01: greater than !IT. * 2: decrease in that costwould produce a 2.0: improvement in !IT.

This method enables management to determine

where to concentrate to achieve improvements andthe effects that their percentage improvement willhave on the !IT.

Ratio Analysis

This is the method of analysis used by most peoplewho do any more than a cursory analysis of thefinancial statements.

=atio analysis enables the user to comparenumbers from different categories. It also enablesthe reader to compare differing sied businesses.

>ost of our ratios are derived by comparingBalance SheetandIncome Statementfigures.

?ater in this book we provide over 011 ratios.These are divided into"i%uidit& Ratios,"everage

Ratios,E!!icienc& Ratios,ro!ita$ilit& Ratios,.urnover Ratios, Cash Flow Ratios,Sales Ratios,

Investment Ratios,"a$or Ratios, Costs per

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Emplo&ee Ratios,/iscretionar& Cost Ratios,roductivit& and 0nowledge Ratiosand -therAccounting Ratios.

$ptimal Performance

The optimal per!ormanceis a calculation of what

the business could perform based on the bestresults of previous years.

The optimal resultis the highest sales figure, thelowest common sied ratios times this sales figurefor variable costs, and the lowest cost for fixedcosts.

Side-by-Side Comparisons to $ptimal

+nce the optimal per!ormanceis calculated, it canbe placed beside actual results for a side$&sidecomparison.

Actual salesare compared to optimal sales(highest sales of previous years). 1aria$le costsare compared to actual salesmultiplied by optimalcommon si(ed ratios. *ctualgross margin(salesless varia$le costs) is separated into sales volume(8actual salesx optimal common si(ed ratios9 @8optimal salesx optimal common si(ed ratios9).

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Fixed costsare compared to optimal costs(optimal salesx optimal common si(ed ratiofor

that item).

Dollar Comparisons to $ptimal

This calculates the extent to which line items and

total profits could have been improved had thebusiness performed at their optimal. It shows theextent of business losses due to su$optimal

per!ormance. This method is a variance anal&sisby comparing actual results to the optimal.

E!!icienc& variances are calculated bysubtracting

!lexed optimal varia$le costs(optimal commonsi(ed ratiofor variable cost item x actual sales)from actual varia$le costs.

Sales volume varianceis calculated by subtractingthe optimal gross margin(optimal salesx optimalcommon si(ed ratios) from the optimal !lexed

gross margin(actual salesx optimal commonsi(ed ratios).

-ptimal !ixed costsare subtracted from actual!ixed costs.

ote that all varianceswill be negative numbers,also referred to as un!avora$le variances.

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resulting variancesare either!avora$le(betterthan budgeted) or un!avora$le(worse than

budgeted).

The budget results used may be actual $udget, or a!lexed $udget, where the budget is ad&usted toreflect what the budget would have been for theactual amount produced. The difference between

the actual and flexed budget is referred to as theproduction varianceor!lexed $udget variance.The difference between the actual budget andoriginal budget is called the activit& variance.

;ome variancesare broken into factors whichcontribute to the changes. In a!lexed $udget, cost

o! salesmay be broken intoprice variance((actualprice @ standard or budgeted price) x actual usage)and %ualit& variance((actual usage @ budgetedusage) x budgeted price). 2ualit& variancesmay

be broken into mix variance((budgeted mix @actual mix) x actual #uantity) and&ield variances(budgeted #uantity of individual input item @

actual #uantity of input item) x budgeted cost).

"a$or variancesmay be broken into la$or ratevariance((actual rate @ budgeted rate) x actualusage) and la$or e!!icienc& varianceor la$or usevariance((actual hours @ budgeted hours) x

budgeted rate).

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"usiness %aluation

The value o! a pu$lic compan&can be determinedby multiplying the number of outstanding commonshares by the price per share.

The value o! a private compan&is based upon thegreater of the value as a going concernor the

disposal value.

The disposal valuecan be determined based on thebalance sheet items.

*ll lia$ilitiesare based on actual prices.

Assetsare based on their recovery after disposalcosts. Typical asset recoveriesare 211: for cash,A


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The resulting ad&usted income statement isad&usted by a multiplier, which is usually between

3 to 5 times. The price is reduced by the amount ofexcess cash and increased by the amount ofadditional investment re#uired.

The multiplieris a factor of performance measuressuch as growth in sale, growth in profits, years of

sales growth and years of profit growth. +therad&ustments are made for market considerationssuch as number of interested purchasers andindustry expectations.

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&i'uidity Ratios

The li%uidit& ratiosare the basic bank financialratios.

"i%uidit& ratiosare the financial statement ratioswhich measure the ability of a business to meet itsshort term financial obligations on time and, as

such, are usually used by potential creditors.

"i%uidit& ratiosare also referred to as solvenc&ratios.

Cash Ratio

Cash Ratio ( cash ) current liabilities*

The cash ratio(cash to current liabilities ratio)measures the immediate amount of cashavailable to satisfy short term debt.

* ratio of 1.6/2 or greater is preferred.

Acid #est Ratio

Acid #est Ratio ( +cash , maretable

securities. ) current liabilities

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The acid test ratiomeasures the immediateamount of cash immediately available to satisfy

short term debt.*n acid test ratioof 1.


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Current Ratio

Current Ratio ( current assets ) current

liabilities*

The current ratiois used to evaluate theli#uidity, or ability to meet short term debts.

Cigh current ratiosare needed for companiesthat have difficulty borrowing on short termnotice.

The generally acceptable current ratiois 0/2

The minimum acceptable current ratiois 2/2

The current ratiois one of 25 key business ratiosused by Dun and !radstreet.

The current ratiois also known as the real ratioor wor'ing capital ratio.

Accounts Receivable to Accounts Payable Ratio

Accounts Receivable to Accounts Payable (

accounts receivable ) accounts payable

The accounts receiva$le to accounts pa&a$leratiois also called the receiva$les to pa&a$lesratio.

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This ratio shows the extent to which payablescan be paid through collection of receivables.

* ratio of 2/2 or greater shows that the businesshas more money owing to it than it owes toothers.

* ratio above 2.06/2 indicates that all payables

can be paid by factoring receivables.

%nless the business is a cash business, or thereceivables have not been paid through recentcash increases from collections, a ratio below 2/2is a concern as the business owes more to othersthan what is owed to them.

Cash Debt Coverage Ratio

Cash Debt Coverage ( +cash flo/ from

operations - dividends. ) total debt*

The cashde$t coverage ratioshows the percent ofdebt that current cash flow can retire.

* cash de$t coverage ratioof 2/2 (211:) orgreater shows that the company can repay alldebt within one year.

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Current &iabilities to !nventory

Current &iabilities to !nventory ( current

liabilities ) inventory

The current lia$ilities to inventor& ratiois usedby Dun and !radstreet.

This ratio indicates the extent to which businessrelies on the sale of its inventory to pay its debt.

* ratio above 2/2 is a concern.

Current &iabilities to Net 0orth

Current &iabilities to Net 0orth ( current

liabilities ) shareholder e'uity

The current lia$ilities to net worth ratiois oneof the 25 ratios used by Dun and !radstreet todetermine credit risk.

The larger the ratio, the greater the risk forcreditors.

* ratio of more than 1.7


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Current &iabilities to #otal &iabilities

Current &iabilities to #otal &iabilities (

current liabilities ) +current liabilities , long

term debt.

The current lia$ilities to total lia$ilities ratioisalso called the shortterm de$t ratioor %ualit& o!

de$t ratio.

This ratio shows the extent to which debt ispayable in the current year.

* low ratio indicates less concern for ability topay debts during the current year.

Fi1ed Assets to Net 0orth

Fi1ed Assets to Net 0orth ( fi1ed assets )

shareholders e'uity

The!ixed assets to net worth ratiois used by Dunand !radstreet.

Eenerally, a low ratio is favored.

* high ratio may be a concern as it indicates a lowwor'ing capital to net worth ratio.

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* ratio above 1.


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* ratio of greater than 2/2 indicates that thebusiness is heavily levered and may not be able

to attain further financing through debt.

* ratio of less than 2/2 indicates that the businessmay be able to attain further funding throughdebt, which is usually #uicker to attain thane#uity financing.

Net 0orth to #otal Debt

Net 0orth to #otal Debt ( net /orth )

+current liabilities , long term debt.

The net worth to total de$t ratiois also referredto as net worth to total lia$ilitiesor solvenc&ratio.

This ratio compares what is owned by theinvestors to what is owed to creditors.

* ratio of 2/2 or greater is preferred by lenders asit indicates that more of the business is owned bythe investors than the amount owed to creditors.

#otal Assets to #otal Debt

#otal Assets to #otal Debt ( total assets )

+current liabilities , long term debt.

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This ratio compares the amount of the assets ofthe business to what it owes.

* ratio of 0/2 or greater is preferred as itindicates that less than half of assets areencumbered with debt.

* ratio of greater than 0/2 indicates that more of

the business is owned by investors than creditors.

#otal &iabilities to Net 0orth

#otal &iabilities to Net 0orth ( total liabilities )

shareholders e'uity

The total lia$ilities to net worth ratiois used byDun and !radstreet.

* low or decreasing ratio is preferred by creditors.

* ratio above 2/2 is a concern to lenders as

creditors would have a larger stake in thebusiness than the shareholders.

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0oring Capital from $perations to #otal

&iabilities

0oring Capital from $perations to #otal

&iabilities ( +operating profit plus

depreciation. ) total liabilities

This ratio measures the degree by which

internally generated working capital is generatedto satisfy obligations.

This ratio indicates the interest rate charge thatthe business can weather before while stillgenerating a positive cash flow.

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&everage Ratios

"everage ratiosare the financial statement ratioswhich show the degree to which the business isleveraging itself through its use of borrowedmoney.

"everage ratiosare of direct interest to current

and potential lenders and investors, as they wishto know the expected return that the business willachieve from borrowing money.

Capital Ac'uisition Ratio

Capital Ac'uisition Ratio ( +cash flo/ fromoperations - dividends. ) cash paid for

ac'uisitions and investments in other

companies*

The capital ac%uisition ratioreflects thecompanyFs ability finance capital expendituresfrom internal sources.

* ratio of less than 2/2 (211 :) indicates thatcapital ac#uisitions are draining more cash fromthe business than it is generating.

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Capital 2mployment Ratio

Capital 2mployment Ratio ( sales ) +o/ners

e'uity - non-operating assets.*

The capital emplo&ment ratiois also referred to as

the capital employed ratio.

The capital emplo&ment ratioshows the amountof sales which ownerFs investment in operationsgenerates.

* high or increasing ratio is preferred.

+ar'eta$le securitiesare considered non

operating assets.

Capital Structure Ratio

Capital Structure Ratio ( long term debt )

+shareholders e'uity , long term debt.*

The capital structure ratioshows the percent of

long term financing represented by longterm debt.

* capital structure ratioover 61: indicates thata company may be near their borrowing limit(often 76:).

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Capital to Non-Current Assets Ratio

Capital to Non-Current Assets Ratio ( o/ners

e'uity ) non-current assets

* higher capital to noncurrent assetsratioindicates that it is easier to meet the businessF

debt and creditor commitments.

* high ratio may indicate insufficient workingcapital being used to generate sales.

Cash Ratio

Cash Ratio ( cash ) current liabilities

The cash ratio(cash to current liabilities ratio)measures the immediate amount of cashavailable to satisfy short term debt.

* ratio above 1.


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The cash $alance ratiois also referred to as da&scash $alance*

The cash $alance ratioindicates the number ofdays that a company can pay its debts, as they

become due, out of current cash.

* low ratio may indicate a high reliance oncollecting receivables to pay debts as they

become due. ;uch reliance can turn a collectionproblem #uickly into a credit problem.

Debt to 2'uity Ratio

Debt to 2'uity Ratio ( +Short #erm Debt ,

&ong #erm Debt. ) #otal Shareholders 2'uity

Thede$t to e%uit& ratiois also referred to asde$t ratio,!inancial leverage ratio, gearingratioor leverage ratio.

The de$t to e%uit&3de$tor!inancial leverage)

ratioindicates the extent to which the businessrelies on debt financing.

%pper acceptable limit of the de$t to e%uit&(de$tor!inancial leverage)ratiois usually 0/2, withno more than one$third of debt in long term.

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Eenerally, lenders prefer a ratio of 2/2 or loweras it indicates that more of the business is owned

by the investors than by the debtors.

* high!inancial leverageor de$t to e%uit& ratioindicates possible difficulty in paying interest and

principal while obtaining more funding.

Debt Ratio

Debt Ratio ( total liabilities ) total assets

The de$t ratiois also known as the de$t to assetsratio.

The de$t ratioshows the reliance on debtfinancing.

This ratio indicates the extent to which assets areencumbered by debt.

* high de$t ratiois unfavorable because itindicates that the company is alreadyoverburdened with debt.

* ratio of greater than 1.6/2 or greater indicatesthat the business is financed more from debt thanfrom shareholders.

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* ratio near or above 1.6/2 indicates that thebusiness may have problems obtaining further

credit or debt financing.

Defensive !nterval Period

Defensive !nterval Period ( +cash ,

maretable securities , accounts receivable. )average daily purchases*

This ratio indicates how long a business canoperate on its li#uid assets without needingfurther revenues.

The de!ensive interval periodreveals near$termli#uidity as a basis to meet expenses.

2'uity 8ultiplier

2'uity 8ultiplier ( total assets ) shareholders

e'uity*

The e%uit& multiplier discloses the amount ofinvestment leverage.

* ratio above 0/2 indicates that the business isoverleveraged and may have problems obtainingfurther credit or loans.

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Financial &everage Ratio

Financial &everage Ratio ( total debt )

shareholders e'uity*

The!inancial leverage ratio is also referred to asthe de$t to e%uit& ratio orgearing ratio.

The!inancial leverage ratioindicates the extentto which the business relies on debt financing.

%pper acceptable limit of the!inancial leverageratiois usually 0/2, with no more than one$thirdof debt in long term.

* highfinancial leverage ratioindicatespossible difficulty in paying interest andprincipal while obtaining more funding.

Fi1ed Assets to Short #erm Debt

Fi1ed Assets to Short #erm Debt ( fi1ed assets

) +accounts payable , current portion of long

term debt.*

The!ixed assets to short term de$t ratiocanindicate dangerous financial policies due to

business vulnerability in a tight money market.

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* low!ixed assets to short term de$t ratioindicates the return on fixed assets may not be

realied before long term liabilities mature.

Fi1ed Costs to #otal Assets Ratio

Fi1ed Costs to #otal Assets ( fi1ed costs ) total

assets*n increase in the!ixed costs to total assets ratiomay indicate higher fixed charges, possiblyresulting in greater instability in operations andearnings.

Fi1ed Coverage Ratio

Fi1ed Coverage ( earnings before interest and

ta1es ) fi1ed charges*

The!ixed coverage ratioindicates the ability of a

business to pay fixed charges (fixed costs)when business activity falls.

The!ixed coverage ratiois also referred to as the!ixed charge coverage ratio.

!nterest Coverage Ratio

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!nterest Coverage Ratio ( +net income ,

interest. ) interest*

The interest coverage ratiois also referred to asthe times interest earned ratio.The interest coverage ratioindicates the extentof which earnings are available to meet interest

payments.

* lower interest coverage ratiomeans lessearnings are available to meet interest paymentsand that the business is more vulnerable toincreases in interest rates.

&ong #erm Debt to Current &iabilities

&ong #erm Debt to Current &iabilities ( long

term debt ) current liabilities

The long term de$t to current lia$ilities ratioisalso referred to as inde$tedness ratio4

This ratio shows the extent to which the businesshas financed its debt by long term debt.

* higher ratio indicates that the ma&ority of debtis not payable in the current year.

&ong #erm Debt to Shareholder9s 2'uity

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&ong #erm Debt to Shareholder9s 2'uity (

long term debt ) shareholders e'uity*

* high ratio is unfavorable because it indicates

possible difficulty in meeting long term debtobligations.

Non-Current Assets to Non-Current &iabilities

Non-Current Assets to Non-Current &iabilities

( non-current assets ) non-current

liabilities

This ratio indicates protection (collateral) forlong term creditors.

* lower ratio means that there is a lower amountof assets backing long term debt.

$perating &everage

$perating &everage ( percent change in 2"!#

) percent change in sales*

The operating leveragereflects the extent towhich a change in sales affects earnings.

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* high operating leverageratio, with a highlyelastic product demand, will cause sharp earnings

fluctuations.

Retained 2arnings to #otal Assets

Retained 2arnings to #otal Assets ( retainedearnings ) total assets

This ratio indicates the extent to which assetshave been paid for by company profits.

* retained earnings to total assetsratio near 2/2

(211:) indicates that growth has been financedthrough profits, not increased debt.

* low ratio indicates that growth may not besustainable as it is financed from increasing debt,instead of reinvesting profits.

Short #erm Debt to Depreciation

Short #erm Debt to Depreciation ( current

portion of long term debt ) depreciation

* short term de$t to depreciation ratio of closeto 2/2 (211:) indicates that the repayment of

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long term debt is in line with the life of theassets.

This ratio should be in line with inflation in fixedasset prices.

Short #erm Debt to &iabilities

Short #erm Debt to &iabilities ( +accounts

payable , current portion of long term

debt. ) +accounts payable , current

portion of long term debt, long term

debt.

This ratio indicates li#uidity.

* higher ratio means less li#uidity.

Short #erm Debt to &ong #erm Debt

Short #erm Debt to &ong #erm Debt (+accounts receivable , current portion of long

term debt. ) long term debt*

The short to long term de$t ratiocan indicate if a

business is vulnerable to a money markets#ueee.

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:ears Debt

:ears Debt ( total debt ) +operating profits ,

depreciation.

The&ears de$t ratioindicates the number of years

that cash flows at the current rate will beneeded to repay all debt.

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2fficiency Ratios

E!!icienc& ratiosare the financial statementratios that measure how effectively a businessuses and controls its assets.

E!!icienc& ratios are of concern to current andpotential lenders, investors and owners as they

wish to see how efficient the business is run.

E!!icienc& ratiosare often referred to as activit&ratios.

Accounts Payable to Sales

Accounts Payable to Sales ( accounts

payable ) sales

The accounts pa&a$le to sales ratiomeasures theextent to which creditors are being paid.

* high or increasing ratio may indicate thatoperations are being financed through suppliers.

* high ratio may indicate a problem payingcreditors.

This ratio is used by Dun and !radstreet.

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Accounts Receivable #urnover Ratio

Accounts Receivable #urnover Ratio ( annual

credit sales ) average accounts receivable

This is the ratio of the number of times thataccounts receivable amount is collectedthroughout the year.

* high accounts receiva$le turnover ratioindicates a tight credit policy.

* low or declining accounts receiva$le turnoverratioindicates a collection problem, part ofwhich may be due to bad debts.

Age of !nventory

Age of !nventory ( 345 days ) inventory

turnover ratio

The age o! inventor& ratiois also referred to asthe num$er o! da&s inventor&, da&s inventor&,average inventor& period, da&s sales in

inventor& or inventor& holding period4

The age o! inventor&shows the number of daysthat inventory is held prior to being sold.

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*n increasing age o! inventor& ratioindicates arisk in the companyFs inability to sell its

products. Individual inventory items should beexamined for obsolete or overstocked items.

* low or decreasing age o! inventor& ratiomayindicate that sufficient inventory is not beingheld to meet demands.

The age o! inventor&should be compared tocompetitors.

Assets to Sales

Assets to Sales ( total assets ) sales

The assets to sales ratioindicates the amount ofassets re#uired for each dollar of sales.Cigh ratios may indicate poor sales.

* low ratio may indicate insufficient investment.

The assets to sales ratiois used by Dun and!radstreet.

Average Collection Period

Collection Period ( +accounts receivable ; 345

days. ) credit sales

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Collection Period ( 345 days ) accounts

receivable turnover ratio

The average collection periodis sometimesreferred to as da&s to collect.

The average collection periodcalculation usesthe average accounts receivable over the sales

period.The collection periodor average collection

periodmust be compared to competitors to seewhether the credit given, and customer risk, is inline with the industry.

* high collection periodshows a high cost inextending credit to customers.

The collection periodis used by Dun and!radstreet.

* collection periodmore than one$third longer

than credit terms (ie/ 51 days for companies with31 day terms of payment) is a concern.

Average $bligation Period

Average $bligation Period ( accounts payable

) average daily purchases*

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The average o$ligation periodis sometimesreferred to as o$ligation periodor da&s to pa&.

The average o$ligation periodratio measures theextent to which accounts payable representscurrent obligations (rather than overdue ones).

* high or increasing ratio may indicate problems

paying bills as they become due.

"ad Debts Ratio

"ad Debts Ratio ( bad debts ) accounts

receivable*

The $ad de$ts ratiois an overall measure of the

possibility of the business incurring bad debts.

The higher the $ad de$ts ratio


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The $rea'even pointis the minimum amount ofsales re#uired to make a profit.

Increasing $rea'even points(period to period)indicates an increase in the risk of losses.

Cash "reaeven Point

Cash "reaeven Point ( +fi1ed costs -

depreciation. ) contribution margin per unit*

The cash $rea'even pointindicates the minimumamount of sales re#uired to contribute to a

positive cash flow.

Cash Dividend Coverage

Cash Dividend Coverage ( +cash flo/ from

operations. ) dividends*

The cash dividend coverage ratioreflects thecompanyFs ability to meet dividends fromoperating cash flow.

* cash dividend coverage ratioof less than 2/2(211 :) indicates that dividends are drainingmore cash from the business than it is generating.

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Cash 8aturity Coverage

Cash 8aturity Coverage ( +cash flo/ from

operations - dividends. ) current portion of

long term maturities*

The cash maturit& coverage ratioindicates the

ability to repay long term maturities as they

mature.

The cash maturit& coverage ratioindicateswhether long term debt maturities are in timewith operating cash flow.

Cash Reinvestment Ratio

Cash Reinvestment Ratio ( increases in fi1ed

assets and /oring capital ) +net income ,

depreciation.*

This ratio indicates the degree to which net income

is absorbed (reinvested) in the business.

* cash reinvestment ratioof greater than 2/2(211:) indicates that more cash is being used inthe business than being obtained.

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Cash Return on Assets

Cash Return on Assets +e1cluding interest. (

+cash flo/s from operations before interest

and ta1es. ) total assets*

Cash Return on Assets +including interest. (

+cash flo/ from operations. ) total assets*

* higher cash return on assets ratioindicates agreater cash return.

The cash return on assets 3excluding interest5contains no provision for replacing assets orfuture commitments.

The cash return on assets 3including interest5indicates internal generation of cash available tocreditors and investors.

Cash #urnover Ratio

Cash #urnover ( +cost of sales =e1cluding

depreciation>. ) cash*

Cash #urnover Ratio ( +345 days.) cash

balance ratio*

The cash turnover ratioindicates the number oftimes that cash turns over in a year.

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Collection Period to Payment Period

Collection Period to Payment Period (

collection period ) payment period*

The collection period to pa&ment periodabove 2/2(211:) indicates that suppliers are being paidmore rapidly than the company is collecting from

their customers.

Days of &i'uidity

Days of &i'uidity ( +'uic assets 1 345 days. )

years cash e1penses*

The da&s o! li%uidit& ratioindicates the number ofdays that highly li#uid assets can supportwithout further cash coming from cash salesor collection of receivables.

Fi1ed Charge Coverage Ratio

Fi1ed Charge Coverage Ratio ( +Net !ncome

"efore !nterest and #a1es - interest , fi1ed

costs. ) fi1ed costs*

The!ixed charge coverage ratioindicates the riskinvolved in ability to pay fixed costs when

business activity falls.

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!nventory #urnover Ratio

!nventory #urnover Ratio ( cost of goods sold

) average inventory*

The inventor& turnover ratiomeasures thenumber of times a company sells its inventoryduring the year.

* high inventor& turnover ratioindicated thatthe product is selling well.

The inventor& turnover ratioshould be done byinventory categories or by individual product.

8argin of Safety Ratio

8argin of Safety Ratio ( +e1pected sales -

breaeven sales. ) breaeven sales*

The margin o! sa!et& ratioshows the percent by

which sales exceed the breakeven point.

$perating Cycle

$perating Cycle ( days of inventory ,

collection period

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-perating C&cleis the time from receivinginventory to collecting money on its sale.

* low or decreasing ratio indicates the inventoryis turning over and being collected in a timelymanner.

* high ratio indicates the inventory is not selling

or there are problems collecting on the sale.

Payment Period

Payment Period ( +345 days 1 supplies

payable. ) inventory*

Thepa&ment periodindicates the average period

for paying debts related to inventorypurchases.

* highpa&ment periodmay indicate that thebusiness is having problems generating cash

to pay for inventory purchases.

During growth periods, thepa&ment periodmayincrease due to increased inventory

purchases to support increased sales.

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Payment Period to Average !nventory Period

Payment Period to Average !nventory Period (

payment period ) average inventory

period

*pa&ment period to average inventor& period

above 2/2 (211:) indicates that the inventory issold before it is paid for (inventory does not needto be financed).

The average inventor& periodis also known asthe inventor& holding period4

Payment Period to $perating Cycle

Payment Period to $perating Cycle (

payment period ) +average inventory period ,

collection period.*

*pa&ment period to operating c&cle ratioabove2/2 (211:) indicates that the inventory is soldand collected before it is paid for (inventory doesnot need to be financed).

* highpa&ment period to operating c&cle ratioindicates that the company may be vulnerable totightened terms of payments from their suppliers.

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(the average inventor& periodis also known asthe inventor& holding period)Revenue per 2mployee

Revenue per employee +net sales per employee.

( net sales ) number of employees

This ratio indicates the average revenue

generated per person employed.

It shows how productive employees are and howefficient the business is.

Sales to !nventory

Sales to !nventory ( sales ) inventory

The sales to inventor& ratioshows the speedwhich inventory is sold.

This ratio varies with different lines, markups

and businesses.

This ratio should be compared to otherbusinesses.

?ow sales to inventor& ratios indicate excessiveinventory.

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Gxtremely high figures may indicate insufficientinventory to met demand resulting in lost sales.

The sale to inventor& ratiois used by Dun and!radstreet.

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Profitability Ratios

Thepro!ita$ilit& ratiosare the basic bank financialratios.

ro!ita$ilit& ratiosare the financial statementratios which focus on how well a business is

performing in terms of profit.

ro!ita$ilit& ratiosare of direct concern for currentand potential investors.

Cash Debt Coverage Ratio

Cash Debt Coverage ( +cash flo/ fromoperations - dividends. ) total debt*

The cash de$t coverage ratioshows the percent ofdebt that current cash flow can retire.

* cash de$t coverage ratioof 2/2 (211:) orgreater shows that the company can repay all itsdebt within one year.

Cash Return on Assets

Cash Return on Assets +21cluding !nterest. (+cash flo/s from operations before interest

and ta1es. ) total assets*

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Cash Return on Assets +!ncluding !nterest. (

+cash flo/ from operations. ) total assets*

* higher cash return on assets ratioindicates agreater cash return.

The cash return on assets 3excluding interest5contains no provision for replacing assets or

future commitments.

The cash return on assets 3including interest5indicates internal generation of cash available tocreditors and investors.

Cash Return to Shareholders

Cash Return to Shareholders ( cash flo/

from operations ) shareholders e'uity

The cash return to shareholders ratioindicatesa return earned by shareholders.

* ratio above 21: is preferred.

Contribution 8argin Ratio

Contribution 8argin ( sales - variable costs*

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Contribution 8argin Ratio ( +sales - variable

costs.)sales*

Contri$ution marginis the amount generated bysales to cover fixed costs.

The contri$ution margin ratioindicates thepercent of sales available to cover fixed costs and

profits.

Current Return on #raining and Development

Current Return on #raining and Development

( increase in productivity and no/ledge

contribution ) training costs

This ratio is a general indicator of the currentreturn on training and development.

Debt Service Coverage Ratio

Debt Service Coverage Ratio ( net operating

income ) +interest , current portion of D.

The de$t service coverage ratio is also called thede$t coverage ratio, de$t service capacit& ratioor/SCR.

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The de$t service coverage ratioshows the abilityto meet annual interest and debt repayment

obligations.

* ratio of less than 2/2 means the business doesnot have sufficient cash flow to meet its debtre#uirements.

Deflated Profit ?ro/th

Deflated Profit ?ro/th ( +current profits @

+prior profits 1 inflation rate.. ) prior profits

The de!lated pro!it growthshows the amount of

growth not due to inflation.

* positive number indicates that the profits aregrowing faster than inflation.

* negative number indicates a real decline inprofits.

2arning Po/er

2arning Po/er ( net profit ) +shareholders

e'uity @ intangible assets.

Earning poweris also referred to asnet pro!it totangi$le net worth.

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This measures the return on invested capital andretained earnings.

2"!# to Current &iabilities

2"!# to Current &iabilities ( 2"!# ) current

liabilities

This ratio shows the ability to cover currentliabilities with earnings.

* ratio above 2/2 is preferred.

2"!# to #otal Sales

2"!# to #otal Sales ( 2"!# ) total sales

This ratio is also referred to asReturn on Sales.

EBI. to .otal Salesevaluates the operational

efficiency of the business.

* low or declining ratio indicates that the businessis near its breakeven point.

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21penses to Current Assets

21penses to Current Assets ( +cost of sales ,

operating e1penses , ta1es. ) average current

assets*

The expenses to current assets ratioshows theade#uacy of current assets to satisfy ongoing

business related expenses.

?ross Profit 8argin Ratio

?ross Profit 8argin Ratio ( gross profit )

sales*

Thegross pro!it margin ratiois also called

gross margin ratio.

To calculategross pro!it,subtract cost of sales(variable costs) from sales. (i.e. gross profit Hsales $ cost of sales)

* lowgross pro!it margin ratio(orgrossmargin ratio)indicates that a low amount ofearnings, re#uired to pay fixed costs and profits,is generated from revenues.

* lowgross pro!it margin ratio(orgrossmargin ratio)indicates that the business isunable to control its production costs.

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Thegross pro!it margin ratio(orgross marginratio) provides clues to the companyFs pricing,

cost structure and production efficiency.

Thegross pro!it margin ratio(orgross marginratio)is a good ratio to benchmark againstcompetitors.

?ro/th in 2arnings per Share +2PS.

?ro/th in 2arnings Per Share +2PS. ( +2PS at

end of period - 2PS at beginning of

period. ) 2PS at beginning of period

Thegrowth inearnings per share indicates theamount of growth for investors.

This ratio helps determine the multiplier used incalculating the companyFs market value. * higherratio yields a higher multiplier.

The trend in this ratio indicates whether growthis steady, sporadic, accelerating or declining.


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Net !ncome !ncreases to Pay !ncreases

Net !ncome !ncreases to Pay !ncreases ( change

in net income ) change in salaries< /ages

and benefits

This ratio shows whether net income isincreasing faster than wages (in dollar terms).

* ratio of less than 2/2 (211:) indicates thatprofitability increases are less than the increasesin wages.

* recurring ratio of less than 2/2 (211:)indicates eroding profits and is a cause for

concern.

This ratio calculates the effect in dollar terms.The analyst should also calculate percentincrease in net income to percent increase insalaries, wages and benefits.

Net !ncome to Assets

Net !ncome to Assets ( net profit before

ta1es ) total assets*

The net income to assets ratiois also referred to as

the return on assets ratio.

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The net income to assets ratioprovides astandard for evaluating how efficiently financial

management employs the average dollar investedin the firmFs assets, whether the dollar came frominvestors or creditors.

* low net income to assets ratioindicates thatthe earnings are low for the amount of assets.

The net income to assets ratiomeasures howefficiently profits are being generated from theassets employed.

* low net income to assets ratiocompared toindustry averages indicates inefficient use of

business assets.

Net !ncome to Fi1ed Charges

Net !ncome to Fi1ed Charges ( net income )

fi1ed charges

et income to fixed charges indicates the abilityto pay fixed costs.

* low or declining ratio indicates possibleproblems paying fixed costs, and posting a profit.

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Net Profit 8argin Ratio

Net Profit 8argin Ratio +After #a1 8argin

Ratio. ( net profit after ta1 ) sales*

Preta1 8argin Ratio ( net profit before

ta1es ) sales*

$perating Profit 8argin +$perating 8argin.( net income from operations ) sales*

These ratios are also called return on salesand$asic earning power.

These threepro!it margin ratiosstate how much

profit the company makes for every dollar ofsales.

The net pro!it margin ratiois the mostcommonly usedpro!it margin ratio.

* low netpro!it margin ratioindicates that low

amount of earnings re#uired to pay fixed costsand profits are generated from revenues.

* low netpro!it margin ratioindicates that thebusiness is unable to control its production costs.

The net pro!it margin ratioprovides clues to thecompanyFs pricing, cost structure and productionefficiency.

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The netpro!it margin ratiois a good ratio tobenchmark against competitors.

Net $ne #ime ?ains to Net !ncome

Net $ne #ime ?ains to Net !ncome (

e1traordinary profit or loss ) net income

* rising percent in extraordinary profit - loss or

prior period ad&ustments indicates deteriorationin earnings #uality, which will be reflected in alower multiplier when determining the value ofthe shares.

Non-$perating !ncome to Net !ncome

Non-operating !ncome to Net !ncome ( non-

operating income ) net income

Increasing ratios may indicate changes in

accounting made to boost profits.

Increasing ratios may mean that the business ismoving away from its core business.

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$perating !ncome to 0ages and Salaries

$perating !ncome to 0ages and Salaries (

operating income ) +salaries , /ages ,

benefits.

This ratio shows the relationship betweenoperating income and amount of wages and

salaries paid.

* declining trend indicates a narrowing ofmargins and is a cause for concern.

$perating 8argin

$perating 8argin ( +earnings before interest

and ta1es. ) sales*

The operating marginis also referred to asoperating pro!it margin, orEBI. to sales ratio.

The operating marginratio determines whetherthe fixed costs are too high for the productionvolume.


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Percent Change in $perating !ncome vs* Sales

%olume

Percent change in operating income vs* sales

volume ( change in operating income )

change in sales volume

*n increase may indicate higher fixed charges.

Profit ?ro/th

Profit ?ro/th ( +current profit @ previous

profit.

The profit gro/thshows the extent to which theprofits improved over the previous year.

* low or decliningpro!it growthindicates that thebusiness may have matured and sales and profitshave reached their plateau.

* low or declining ratio is a cause for concernabout future profits.

Profit ?ro/th Consistency

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Profit ?ro/th Consistency ( number of

consecutive years that profits /ere greater than

those of the previous year

Thepro!it growth consistenc&shows the numberof years that profits have grown.

Profits per 2mployee

Profits per 2mployee +Net !ncome per

2mployee. ( net income ) number of

employees

This ratio indicates the average profit generatedper person employed.

* high or increasing ratio indicates thatemployees are highly productive.

Return on Assets

Return on Assets ( net profit before ta1es )total assets*

The return on assets ratioprovides a standardfor evaluating how efficiently financialmanagement employs the average dollar investedin the firmFs assets, whether the dollar came frominvestors or creditors.

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* low return on assetsratio indicates that theearnings are low for the amount of assets.

The return on assetsratiomeasures howefficiently profits are being generated from theassets employed.

* low return on assetsratiocompared to

industry averages indicates inefficient use ofbusiness assets.

Dun and !radstreet use this ratio using after taxprofits.

Return on Capital 2mployed

Return on Capital 2mployed ( N"!# ) +total

assets @ current liabilities.

The return on capital emplo&edis also referredto asR-CE.

This ratio shows the return on capital regardlessof whether borrowed or invested.

The return on capital emplo&edshould begreater than the interest rate.

* return on capital emplo&edthat is less thanthe interest rate indicates that the investors would

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yield a higher return by lending money than byinvesting.

Return on Common 2'uity

Return on Common 2'uity ( +net income @

preferred share dividends. ) +shareholders

e'uity @ preferred shares.

The return on common e%uit&shows the returnafter factoring out preferred shares.

* return of greater than 21: indicates the abilityto pay dividends and retain sufficient funds forfuture growth.

Return on !nvested Capital

Return on !nvested Capital ( net income )

+shareholders e'uity @ retained earnings.

This ratio shows the return based on the originalinvestment in the company.

Return on !nvestment Ratio

Return on !nvestment Ratio ( net profits

before ta1 ) shareholders e'uity*

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The return on investment ratioprovides astandard return on investorFs e#uity.

The return on investment ratiois also referred toas return on shareholders e%uit&, return one%uit&, return on net worth, return oninvestmentorR-I.

Return on investmentis a key ratio for investors.

* ratio above 1.21/2 (21:) shows ability to paydividends and sustain growth.

This is one of the 25 ratios used by Dun and!radstreet to determine credit.

Return on Sales

Return on Sales ( net after ta1 profit ) sales

The return on salesis also referred to as net

pro!it margin.

The return on salesis a key indicator of businessprofit.

The return on salesindicates the ability to whetherfalling sales or rising costs.

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* high or increasing ratio is preferred as itindicates growing profits as a percent of sales.

* low or declining ratio indicates that the businessis dropping towards its breakeven point.

This ratio is one of Dun and !radstreets 25 ratioindicators.

Return on 0oring Capital

Return on 0oring Capital ( sales ) +current


The return on wor'ing capitalis also known aswor'ing capital productivit&.

The return on wor'ing capitalindicates the abilityof working capital to generate sales.

*n increasing ratio indicates increasing

productivity as sales are growing faster than theresources re#uired to generate them.

#imes !nterest 2arned Ratio

#imes !nterest 2arned Ratio ( +net income ,

interest. ) interest*

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The times interest earned ratioindicates theextent of which earnings are available to meet

interest payments.* lower times interest earned ratiomeans lessearnings are available to meet interest

payments and that the business is morevulnerable to increases in interest rates.

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Sales Ratios

The sales ratiosindicate the ade#uacy of sales.

Sales ratiosare of direct concern of managementand owners as they indicate whether the cost andreturn of achieving the sales figures.

Deflated Sales ?ro/th

Deflated Sales ?ro/th ( +current sales @

+prior sales 1 inflation rate.. ) prior sales

The de!lated sales growthshows the amount of

growth in sales not due to inflation.

* positive number indicates that the sales aregrowing faster than inflation.

* negative number indicates a real decline insales.

Sales ?ro/th

Sales ?ro/th ( current year sales @ previous

years sales

The sales growthmeasures the amount that salesincreased over the previous year

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Sales ?ro/th Consistency

Sales ?ro/th Consistency ( number of

consecutive years of positive sales gro/th

Sales growth consistenc&measures the ability ofthe company to continue to grow in terms of sales.

Sales to Accounts Payable

Sales to Accounts Payable ( sales ) accounts

payable

* high sales to accounts pa&a$le ratioindicates

the inability to obtain short$term credit on theform of cost$free funds to finance sales growth.

Sales to Advertising and Promotion

Sales to Advertising and Promotion ( sales )

+mareting , advertising , promotion.

This ratio calculates the amount of salesgenerated by marketing efforts.

* ratio below 21/2 is a concern as mostbusinesses budget 21: of sales to those efforts.

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Sales to Advertising< Promotion and Rent

Sales to Advertising< Promotion and Rent (

sales ) +mareting , advertising , promotion ,

rent.

This ratio is most applicable to retail business.

This ratio includes rent as a factor to reflect thathigher rents are paid for places with highertraffic of exposure.

* ratio below


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Sales to Cash

Sales to Cash ( sales ) cash

This is sometimes referred to as cash turnoverratio.

* highsales to cash ratiomay indicate a cash

shortage.

* low ratio many reflect the holding of idle andunnecessary cash balances.

The sales to cash ratioindicates the number oftimes that cash turns over per year.

* high sales to cash ratiomay indicateinade#uate cash on hand. This may lead tofinancial problems if further financing is notavailable at reasonable prices.

Sales to Current Assets

Sales to Current Assets ( sales ) current assets

* high sales to current assets ratioindicatesdeficient working capital.

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* decreasing ratio may indicate that the companyhas slowed down production resulting in lower

inventory of finished goods.

Sales to Fi1ed Assets

Sales to Fi1ed Assets ( sales ) fi1ed assets*

The sales to !ixed assets ratiois often called theasset turnover ratio.

* low sales to !ixed assets ratiomeansinefficient utiliation or obsolescence of fixedassets, which may be caused by excess capacity

or interruptions in the supply of raw materials.

Sales to Net !ncome

Sales to Net !ncome ( sales ) net income

* high ratio indicates a low return on sales.

* high sales to net income ratioindicates a lowprofit margin or a high breakeven pointcompared to current sales.

* declining ratio indicates increasedprofitability.

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Sales to #otal Assets

Sales to #otal Assets ( sales ) total assets

* low ratio indicates that the total assets of the

business are not providing ade#uate revenue.

Sales to 0oring Capital

Sales to 0oring Capital ( sales ) +current


* high ratio may indicate inade#uate workingcapital which reflects negatively on li#uidity.

The sales to wor'ing capital is one of 25 keybusiness ratios used by Dun and !radstreet.

#rend in Sales

#rend in Sales is the rate at /hich sales areincreasing or decreasing

The trend in sales is also referred to as the salestrend.

* high, positive ratio indicates high growth.

* positive ratio is preferred.

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!nvestment Ratios

Investment ratiosare used by investors to analyestocks.

;ome of the ratios listed in other sections may alsobe used by investors.

Accounts Receivable #urnover Ratio

Accounts Receivable #urnover Ratio ( annual

credit sales ) average accounts receivable

This is the ratio of the number of times that

accounts receivable amount is collectedthroughout the year.

* high accounts receiva$le turnover ratioindicates a tight credit policy.

* low or declining accounts receiva$le turnoverratioindicates a collection problem, part ofwhich may be due to bad debts.

Assets per 2mployee

Assets per 2mployee ( fi1ed assets ) number ofemployees

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Assets per emplo&ee is also called the capitalintensit& ratio.

This ratio shows the commitment to infrastructureand mechaniation.

"eta

"eta ( percent change in share price ) percent

change in inde1

Betameasures the volatility of a stock.

* $etaabove 2/2 indicates the stock price will

move by a larger percentage than the index.

* $etabelow 2/2 indicates that the percentagechange in the stock price will move less than theindex.

* $etawith a negative number indicates that the

stock will move in the opposite direction to themarket. These stocks reduce the risk of marketfluctuation.

The ;tandard and 'oor 611, or a similar index, isused in this calculation.

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"oo %alue per Share

"oo %alue per Share ( shareholders e'uity )

number of shares outstanding

The $oo' value per shareis an indicator of theunderlying value of the net assets of the company.

This ratio indicates the likely return to theshareholder if the business is li#uidated.

"usiness %alue Premium

"usiness %alue Premium ( +capitalied value @shareholders e'uity. ) shareholders e'uity

"usiness %alue Premium ( +maret price per

share @ boo value per share. ) boo value per

share

The $usiness value premiumcompares the marketvalue of a business to the book value.

This ratio shows the premium to book value thatthe stock is trading at.

* $usiness valuation premium rationear eroindicates that the shares are selling near their bookvalue.

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* negative ratio indicates the shares are selling

below the breakup value of the business. In thiscase, a profit could be made by buying the

business and selling off the assets.

Cash Dividend Coverage Ratio

Cash Dividend Coverage ( +cash flo/ from

operations. ) dividends*

The cash dividend coverage ratioreflects the

companyFs ability to meet dividends fromoperating cash flow.

* cash dividend coverage ratioof less than 2/2(211 :) indicates that dividends are drainingmore cash from the business than it is generating.

Cash to Current &iabilities

Cash to Current &iabilities ( cash ) current

liabilities

Cash to current lia$ilitiesis also called the cashratio.

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Cash to current lia$ilitiesmeasures the ability ofcash to pay off current debt.

* ratio below 1.6/2 indicates possible cash flowproblems due to buildup of accounts receivableor insufficient cash.

Cash to 0oring Capital

Cash to 0oring Capital ( cash ) +current


This ratio shows the extent to which workingcapital is immediately available.

Collection Period

Collection Period ( +accounts receivable ; 345

days. ) credit sales

Collection Period ( 345 days- accounts

receivable turnover ratio

The average collection periodcalculation usesthe average accounts receivable over the sales

period.

The collection periodor average collectionperiodmust be compared to competitors to see

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whether the credit given, and customer risk, is inline with the industry.

* high collection periodshows a high cost inextending credit to customers.

Cost of Capital

Cost of Capital ( +interest rate ,

+shareholder9s e'uity 1 +net profit ) maret

capitaliation.. ) +shareholder9s e'uity , D

, +B*5 1 current portion of D..

The cost o! capitalis the hurdle rate in internal

investment decisions as they should return atleast as much as the cost of financing them.

'ro&ects should not be invested in unless theinternal rate of return (I==) is at or above thecost o! capital.

Cost o! capitalis the interest rate usually used bythe business to determine the net present value(') of any investment decision.

Current Assets to Current &iabilities

Current Assets to Current &iabilities (

current assets ) current liabilities

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The current assets to current lia$ilities ratioisalso referred to as the current ratio.

The current ratiomeasures the ability of currentassets to cover current liabilities.

* ratio above 0/2 is usually preferred.

Current Assets to Sales

Current Assets to Sales ( current assets ) sales

The current assets to sales ratioindicates theextent current assets are leveraged.

* low ratio indicates aggressive managementseeking a high return on investment.

* low ratio indicates that sales may be lost dueto insufficient inventory or a tight credit policy.

Current Assets to #otal Assets

Current Assets to #otal Assets ( current

assets ) total assets

This ratio shows the percent of assets whichturnover within the year.

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This ratio measures the ability to cover the totaldebt with current assets.

*n increasing, or positive, current assets to totalassets ratioindicates the business is able tosatisfy debt obligations using current assets.

Current &iabilities to !nventory

Current &iabilities to !nventory ( current

liabilities ) inventory

The current lia$ilities to inventor&is one of 25ratios used by Dun and !radstreet.

This ratio indicates the reliance on availableinventory for payment of debt. This assumesother working capital figures remain the same.

Current &iabilities to #otal Debt

Current &iabilities to #otal Debt ( current

liabilities ) +current liabilities , long term

debt.

This ratio measures the percent of liabilities thatare payable within the year.

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* high or increasing current lia$ilities to totalde$t ratioindicates a reliance on short term

financing.

Current Portion of D to Net !ncome

Current Portion of D to Net !ncome (

current portion of D ) net income

This ratio indicates the ability to pay currentportion of ?TD as it becomes due.

* ratio of less than 2/2 indicates inability torepay current portion of ?TD as it becomes due.

Debt to 2'uity Ratio

Debt to 2'uity Ratio ( +short term debt , long

term debt. ) total shareholders e'uity

The/e$t to E%uit& Ratiois also referred to as/e$t Ratio, Financial "everage Ratioor"everage Ratio.

The de$t to e%uit&3de$tor!inancial leverage)ratioindicates the extent to which the businessrelies on debt financing.

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%pper acceptable limit of the de$t to e%uit&(de$tor!inancial leverage)ratiois usually 0/2, with

no more than one$third of debt in long term.

* high!inancial leverageor de$t to e%uit& ratioindicates possible difficulty in paying interest and


Debt !ncome Ratio

Debt !ncome Ratio ( total debt ) net income

The de$t income ratioshows the debt as aportion of net income.

It is the inverse of the&ears de$t ratio, whichindicates the number of years to pay off all debtsand replace assets when they become due.

Deflated 0age ?ro/th

Deflated 0age ?ro/th ( +current /ages @

+prior /ages 1 inflation rate.. ) prior /ages

The de!lated wage growthshows the amount ofgrowth not due to inflation.

* positive number indicates that the wages aregrowing faster than inflation.

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* negative number indicates a real decline inwages.

Dividend Payout Ratio

Dividend Payout Ratio ( dividends ) net

earnings

The dividend pa&out ratioshows the proportionof earnings that are paid out in dividends.* low ratio indicates that a large portion of the

profits are retained and likely invested forgrowth.

* high or increasing payout ratio indicates thebusiness may not be able to maintain currentdividend payouts.

Dividends per Common Share

Dividends per Common Share ( +dividends @preferred share dividend. ) number of

common shares outstanding

This ratio indicates the return to the shareholderin terms of current dividends received.

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Dividend :ield

Dividend :ield ( annual dividends per share )

price per share*

The dividend &ieldis the yield a company paysout to its shareholders in terms of dividends.

2arnings per Share

2arnings per Share ( net earnings ) number of

shares outstanding

Earnings per share is also referred to asESor

return to shareholders.This shows the return to the shareholder.

* declining earnings per shareis a cause forconcern.

2nterprise %alue

2nterprise %alue ( maret capitaliation , debt

, preferred shares @ cash @ maretable

securities

The enterprise valueshows the valuation based ona takeover.

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If the enterprise valueis negative, the business canbe bought for its cash holdings.

2'uity per Common Share

2'uity per Common Share ( +shareholders

e'uity @ preferred shares. ) number of shares

outstandingE%uit& per common shareis also calledboo'value per common share.

The e'uity per common shareshows the amountavailable to common shareholders once all debtsare paid.

Financial &everage Ratio

Financial &everage Ratio ( total debt )

shareholders e'uity*

The!inancial leverage ratio is also referred to asthe de$t to e%uit& ratio.

The!inancial leverage ratioindicates the extentto which the business relies on debt financing.

%pper acceptable limit of the!inancial leverageratiois usually 0/2, with no more than one$thirdof debt in long term.

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* high!inancial leverage ratioindicatespossible difficulty in paying interest and


Fi1ed Assets to Shareholders 2'uity

Fi1ed Assets to Shareholders 2'uity ( fi1ed

assets ) shareholders e'uity

This ratio shows the percent by which theshareholders e#uity figure is determined by statedvalue of fixed assets.

* high ratio is of some concern in a business

li#uidation as some fixed assets such as e#uipmentand tangible assets may sell for less than bookvalue and property and plant may sell at more than

book value.

Fi1ed Asset #urnover Ratio

Fi1ed Asset #urnover Ratio ( net sales )

property< plant and e'uipment

The fixed assets turnover ratio measures the returnon plant and e#uipment.

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This ratio will likely decline in the year of ma&orfixed asset purchases, but their effects should be

shown in future years.

*n increasing ratio after a ma&or increase in plantand e#uipment indicates that the investment waseffective.

Fi1ed Charge Coverage Ratio

Fi1ed Charge Coverage Ratio ( +Net !ncome

"efore !nterest and #a1es , fi1ed costs. ) fi1ed

costs*

The!ixed charge coverage ratioindicates therisk involved in ability to pay fixed costs when

business activity falls.

?earing Ratio

?earing Ratio ( long term debt ) shareholderse'uity*

Thegearing ratiois also referred to as the longterm de$t to shareholders e%uit& ratio.

* ratio above 2/2 is a concern as it indicates thatthe business has excessive debt.

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?ross Profit 8argin Ratio

?ross Profit 8argin Ratio ( gross profit )

sales*

Thegross pro!it margin ratiois also called

gross margin ratio.

To calculategross pro!it,subtract cost of sales(variable costs) from sales. (i.e. gross profit Hsales $ cost of sales)

* lowgross pro!it margin ratio(orgrossmargin ratio)indicates that low amount ofearnings, re#uired to pay fixed costs and profits,

is generated from revenues.

* lowgross pro!it margin ratio(orgrossmargin ratio)indicates that the business isunable to control its production costs.

Thegross pro!it margin ratio(orgross margin

ratio) provides clues to the companyFs pricing,cost structure and production efficiency.

Thegross pro!it margin ratio(orgross marginratio)is a good ratio to benchmark againstcompetitors.

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?ro/th in 2arnings per Share +2PS.

?ro/th in 2arnings Per Share +2PS. ( +2PS at

end of period - 2PS at beginning of

period. ) 2PS at beginning of period

Thegrowth inearnings per share indicates theamount of growth for investors.

This ratio helps determine the multiplier used incalculating the companyFs market value. * higherratio yields a higher multiplier.

The trend in this ratio indicates whether growthis steady, sporadic, accelerating or declining.

!nterest "urden

!nterest "urden ( interest e1pense ) 2"!#

The interest $urdenindicates the extent to which

interest affects earnings.

* ratio above 2/2 indicates interest expense isgreater than the before interest profits, creating aloss.

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!nterest Coverage

!nterest Coverage ( 2"!# ) interest e1pense

The interest coverage shows the ability to payinterest expenses.

* ratio of 2.6 to 0.1 is desirable.

!nventory to Current Assets

!nventory to Current Assets ( inventory)

current assets

The inventor& to current assets ratioshows theextent to which current assets consist of inventory.

This ratio indicates the li#uidity of the currentassets.

* ratio of 2/2 is considered acceptable.

* rate of below 2/2 is preferred.

!nventory to 0oring Capital

!nventory to 0oring Capital ( inventory )

/oring capital

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Inventory to working capital measures that abilityto generate cash using its working capital at the

current inventory level.

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D to Net !ncome

D to Net !ncome ( D ) net income

This ratio indicates the portion on long term debtthat can be repaid from net income.

D to #otal Capitaliation

D to #otal Capitaliation ( D ) +D ,

shareholders e'uity.

The"./ to total capitali(ation ratiois also calledthe capital structure ratio.

This ratio measures the percent of financing with?TD.

* ratio above 1.6/2 shows that over half thecapitaliation is in long term debt.

*"./ to total capitali(ation ratiobelow 1.6/2indicates that the business may be able to fundfurther capital re#uirements with debt.

ompanies with ratios above 1.6/2 are usuallyconsidered to be overleveraged.

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8aret Capitaliation

8aret Capitaliation ( price per share 1

number of outstanding shares

>arket capitaliation is the value of the businessplaced on it by the stock market.

8aret Price to "oo

8aret Price to "oo ( maret capitaliation )

shareholders e'uity

The mar'et price to $oo' ratioshows the premium

placed on the company as an on$going concern.

8aret Price to Sales

8aret Price to Sales ( maret capitaliation )

total sales

The mar'et

Documents

Financial Statement Analysis Text