Financial Ratios Flashcards
Profitability ratios
Company’s ability to make profit on its sales/investments
Capital Employed
(Total Asset - Current Liability) or (Non-current Liability + Equity)
Return on Capital Employed (ROCE)
Net Profit Margin x Asset Turnover Ratio = %
or PBIT / Capital Employed x 100 = %
Higher: better -> for every $1 invested (via debt/equity), company can generate X amount of cents
Reason:
(1) company generating more/less operating profit (numerator of NPM) -> increase/decrease in net profit margin
(2) increase/decrease in asset turnover ratio
(3) increase/decrease in both NPM and ATR
Return on Equity (ROE)
Net Profit / Total Equity = %
Higher: better -> for every $1 invested by shareholders, company is able to generate X cents
Reason: increase/decrease in net profit (profit after tax)
Gross Profit Margin
(Gross Profit / Sales) x 100% = %
Higher: better -> for every $1 of sales, company generates X amount of gross profit
Reason:
(1) product may be poorer/better than industry (competition) so sell at lower/higher price which generates lower/greater revenue
(2) cost of sales is high/low
Net Profit Margin
(PAT / Sales revenue) x 100% = %
Higher: better -> for every $1 of sales, company generates X amount of net profit
Reason:
1. increase/decrease in operating expense(s)
2. profit/loss in disposal of NCA
Asset Turnover Ratio
Sales Revenue / Capital Employed = times (1 decimal)
Higher: better -> efficiency ratio that assesses how well a company can generate sales from each dollar of capital employed (funding)
Reason:
(1) increase/decrease in sales revenue (product can’t compete with industry or economic cycle leads to lower demand of product)
(2) increase/decrease in capital employed (acquiring more assets (machinery), long-term loans or issuing more shares/increase in equity leads to greater capital employed)
Asset Turnover using Closing Book Value
Cost - (Years Used x Cost / Useful Economic Life) = NBV
Asset Turnover: Sales Generated / NBV = x times
Liquidity Ratios
Company’s ability to pay its short-term obligations (liabilities)
2 decimals
Current Ratio
Current Assets / Current Liabilities = times
Higher liquidity: better -> for every dollar of current liablities, current assets can cover by X amount of times
But if higher than industry average: indicates underutilising of working capital (current asset) by not reinvesting to grow or get higher returns for company
Reason:
(1) increase/decrease in current assets
(2) increase/decrease in current liabilities
(3) both
Quick Ratio (Acid Test)
(Current Assets - Inventory - Prepayments) / Current Liabilities = times
OR
(Cash + Marketable Securities + Receivables) / Current Liabilities = times
Difference with current ratio: take out CA that takes longer to convert to cash & assets non-convertible to cash
Higher liquidity: better -> for every dollar of current liabilities, the liquid assets company has can cover by X amount of times
But if higher than industry average: indicates underutilising of liquid working capital (liquid asset) by not reinvesting to grow or get higher returns for company
Reason:
(1) increase/decrease in liquid assets
(2) increase/decrease in current liabilities
(3) both
Working Capital Ratios (Efficiency Ratios)
Company’s ability to use its working capital (cash tied-up in day-to day operations of the business, such as inventory, trade receivables and trade payables) to generate sales
Can be calculated as net current assets (CA without cash - CL)
Round up to 0 decimals or just 1 decimal
Inventory Holding Period
Inventory / Cost of Sales x 365 = days
Lower: better -> once company receives inventory from supplier, it takes X amount of days to sell the inventory
But if too low: may run out of inventory and miss out on a customer order
Reason: poor/good management of inventory, may lead to inventory obsolescence if taking long, but year-end inventory can alternatively accumulate deliberately to anticipate a large customer order or expected price rise
Inventory Turnover Ratio
Cost of Sales / Inventory = times
Higher: better -> company turns over inventory by X amount of times relative to cost of sales
But if too high: poor management in inventory stocking
If high inventory turnover: use current ratio
Low inventory turnover: quick ratio
Receivables Collection Period
Trade Receivables / Total Credit Sales (or just Sales Revenue) x 365 = days
Lower: better -> company takes X amount of days to retrieve money from credit customers
But if too low: may involve company reducing credit terms (the time customers can take to pay company), losing customer goodwill
Reason: poor/good credit control management for individual credit customers and procedures for collecting debts have been followed poorly/well relative to industry average (competitors)
