Meaning of ratios 3.0 Flashcards
Equity ratio
Proportion of company’s assets that is funded by equity.
Amount of assets on which shareholders have residual claim
High equity ratio
Effective funding of assets from equity, less credit risk
Low equity ratio
More debt on assets relative to equity
Debt to equity ratio
How leveraged a company is.
The degree to which a company is financing its operations with debt rather than its own resources
Con: not useful for assesssing the short-term leverage
High debt to equity ratio
Company relies mostly on debt financing, may lead to a loan default or bankruptcy.
Indicator of risk
Low debt to equity ratio
Company is relying more on equity financing, indicates a strong financial position
Lower risk of default
Greater ability to absorb financial shocks.
Cons low debt to equity ratio
Company may not be taking advantage of debt financing, since debt is less expensive than equity
Debt to assets ratio
How levearge a company is.
indicates the ability to pay off debts with its available assts.
Pro: creditors use the ratio to see whether a company can pay it’s existing debt and whether it should give the company an additional loan
Con: no indication on the quality of the assets, tangible or intangible
High debt to asset ratio
Company is more funded by debt, may be an indicator of having difficulty meeting its obligations
Interest coverage ratio
Company’s ability to meet its interest payments on outstanding debts.
Shows the room to take on more debt
Level of risk associated with investing in the company
Pro:
Variation with EBITDA & EBIAT are possible.
EBIAT: tax are an important financial element to consider, so it gives a clearer picture of a company’s ability to cover its interest expenses
Con:
Highly variable when comparing
Some companies exclude some items of debt in their calculations
High interest cover ratio
The higher the ratio, the better. Able to meet its interest paymetns.
However, can imply that company is not takin enough debt to maximize its returns
Low interest cover ratio
Company may struggle to meet its debt obligations, may have to borrow further or use its cash reserve (which is better used for capital investments)
Accounts receivable to sales ratio
Efficiency of a companys’s accounts receivable mangement
How well a company is able ot collect payments from its customers
Accounts receivable < benchmark
More efficient collecting of payments than peers.
Good sign for investors, AR is managed effectively and cash flow is generated from its operations
AR > benchmark
Company is taking longer to collect payments. Can result in reduced cash flow and increased working capital requirements
