Ratios Flashcards
(18 cards)
Compute Average Collection Period
365 / AR Turnover
365 / (Net Credit Sales / Average AR)
Average AR / Average Daily SAles
Average AR / (Net Credit Sales/365)
Only for credit sales. Total sales will shift ratio.
Use Average AR Net of allowance for doubtful accounts
Beta Coefficient
Measures market risk of a security relative to other securities
Return on Equity
Net Income - Preferred Dividends / Average Common Equity
Or, using the DuPont equation:
ROE = Net income − Preferred dividends × Sales × Average assets
Sales Average assets Average stockholders’ equity
The denominator consists of the average of the total equity less preferred shares and minority interest. One of the major problems with this ratio is that the historical issue price is used as opposed to the current market value.
The common stockholders’ leverage ratio (Average assets/Average stockholders’ equity used above) measures the portion of assets that are financed through common equity (also called the equity multiplier). The larger this ratio, the greater the financial leverage will be. Various organizations within an industry will have potentially dramatic differences in ROE resulting from financing decisions—debt vs. equity. If ROA is greater than the cost of borrowing, then ROE will be higher than ROA due to the impact of financial leverage.
Calculation using data from the Sample Company for 20X2 (section 2160.01):
Net income − Preferred dividends = Return on equity
Average common equity
$75,000 − $15,000 = 22% ($300,000 + $250,000) ÷ 2
Required Rate of Retun
Risk-free rate + Beta coefficient (Market rate - Risk-free rate)
Return on Assets
Net Income / Average Total Assets
ALSO Profit Margin Ratio x Asset Turnover Ratio
ALSO Return on Equity x (1 - Debt Ratio)
Book Value per Share
Total Stockholders’ Equity - Preferred Equity (and dividends in arears) / Number of Share of Common Stock Outstanding
Earnings per Share
Net Income - Preferred Dividends / Average Total Equity
Profit Margin Ratio
Profit Measure / Net Income
Asset Turnover
Total sales / Total average assets
Dividend Payout Ratio
Cash Dividends Paid on Common Stock / (Net income - Preferred Dividends)
Defensive Interval Ratio
A ratio that measures liquidity - indicator of ability to pay debts with quick assets
Current assets / Daily operating expenses
Watson Corporation computed the following items from its financial records for 20X1:
Price-earnings (P/E) ratio 12
Payout ratio 0.6
Asset turnover 0.9
The dividend yield on Watson’s common stock for 20X1 is:
The dividend yield on Watson’s common stock for 20X1 is 5.0%, calculated as follows:
Dividend yield = Dividends per common share / Market price per share
P/E ratio = Market price per share / Earnings per share
= 12
Payout ratio = Dividends / Earnings
= 0.60
Dividend yield = (Earnings/Market price)(1) x (Dividends/Earnings)(2)
Dividend yield = 1/12 x 0.60
= 0.05 or 5%
1 Reciprocal of the price-earnings (P/E) ratio
2 Payout ratio
DuPont Equation / Method
Using the DuPont equation:
Net income Net sales Average assets Return on equity = ---------- x -------------- x --------------------- (ROE) Net sales Average assets Average stockholders' equity = Profit margin × Total asset turnover × Equity multiplier
Return on equity can be found using the following equation:
Net income − Preferred dividends Return on equity = -------------------------------- Average common equity
As total assets increase, ROE will decrease if all other financial statement items are held constant because the increase in assets will be associated with a matching increase in stockholders’ equity, given that assets equal liabilities plus stockholder’s equity.
ROE will decrease, not increase, as the debt ratio decreases. Given that assets equal liabilities plus stockholder’s equity, as debt decreases, the funding provided by stockholder’s equity increases, lowering ROE.
ROE will increase as COGS (cost of goods sold) as a percentage of sales decreases because the main driver of the numerator, net income, will increase, causing an increase in ROE.
ROE will decrease as equity increases because the denominator, average common equity, would increase, creating a smaller ratio holding sales and net income constant.
Return on Investment
ROI = Net income / Invested Capital (or operating assets)
Can be at point in time or over period of time, in which case you would use an average
Dividend Yield
Dividends per common share / Market price per share
Payout Ratio