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Lecture

Ratios.pdf

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Department
Commerce 
Course
COMM 101
Professor
Laura Allan
Semester
Winter

Description
Ratios Tuesday, March 5, 2013 8:42 AM Liquidity - Compares assets that can be quickly converted to cash with liabilities that represent neat-term needs for cash - Addresses long-term trends ○ Looking at current, but see trend from assessment - Evaluates working capital managementissues ○ Assessing how we are managing working capital Current ratio = average current assets/averagecurrent liabilities - Rule of thumb >2, <4 ○ 2 times of assets to liabilities to have enough coverage ○ Over 4 times is too much, don't need it to cover risk => less return + less investment Acid Test/QuickRatio = (average current assets - average inventories)/averagecurrent liabilities - Rule of thumb >1 ○ Less than 1 then there is too much inventory NWC (net working capital) to Total Assets Ratio = (average current assets - average current liabilities)/averagetotal assets - Higher percentage greater liquidity - Burning more cash and building more cash - 45% greater burn but that is faster than building percentage - Less than month of cash Conversionperiod ratios - Measure average time in days required for non-cash current assets and selected current liabilities to create or demand cash ○ Faster assets can be converted to cash, greater the liquidity (all other things being equal) - Operating cycle Measures time it takes to purchase raw material, assemble product book sale, and collect ○ Measures time it takes to purchase raw material, assemble product book sale, and collect on it Measuring conversiontimes Inventory-to-saleConversion Period = average inventory/(costof goods sold/365) Sale to Cash conversionperiod (days of sales outstanding or average collection period) = average receivables/(netsales/365) Inventory to sale + sale to cash conversion period = average operating cycle Purchase to payment conversion period = (average payables + average accrued liabilities)/costof goods sold/365 Inventory to sale + sale to cash - purchase to payment conversionperiod = cash conversion cycle (C3) - Gap between (num of days of operation that must be externally financed) - Should be as close to 0 as possible - Time for inventory to sold is up - Time takes us to pay - Sale to cash go up - how much getting as cash - Inventory should only go up when sales go up ○ Don't stock inventoryto increase sales Leverage - Consider how firm acquired external financing (to support longer C3) - Measures extent to which firm has used debt and its ability tomeetits debt obligations - What is benefit debt vs equity - What is benefit debt vs equity ○ Interest vs dividends - interest is cheaper than dividends - interest is on expense (deducted before tax => tax benefit), but dividends after tax and purely profit ○ Risk/return tradeoff - less risk to dividends ○ Control vs legal - no legal control for dividends • Total Debt-to-TotalAssets = average total debt / average total assets • Equity Multiplier = average total assets / average owners’ equity OR 1 / (1- total debt-to-totalassets) > ½ of assets supported by debt vs equity • Debt-to-Equity = average total debt / average owners’ equity OR TD-to-TA / (1 – TD-to-TA) • Current Liabilities-to-TotalDebt = average current liabilities / average total debt • Interest Coverage - how many times you can pay for interest = EBITDA / interest • Fixed Charges Coverage = (EBITDA + lease payments)/(interest+ lease pymnts + (debt repymnts/(1-taxrate)) - Find if you can handle all of them - Loan repaymentis not on income statement,cause it's purely cash problem - (1-tax rate) takes out tax impact LeverageRatio Trends - Ability to pay payment go down - Earnings have not gone up but debt increased - Percentage of need to pay now debts increased so need lot of liquid Profitability - Measure how efficiently a venture controls it expenses and uses it assets - Accounting based measures of profitability are standard starting point for examine venture value Gross profit margin = (net sales - cost of goods sold)/net sales = 33.91% Operating profit margin = EBIT/net sales = 8.17% Net profit margin = net income/netsales NOPAT margin (net operating profit after tax) = EBIT (1 - tax rate) / net sales - Net operating profit after tax - Removesimpact of lever and interest tax shield Sales to total assets = net sales / average total assets Operating return on assets = EBIT / average total assets - Venture's basic earning power - Needs to be > interest to benefit from leverage Return on assets (ROA) = net income/average total assets - Represents ROA as joint outcomeof two distinct aspects of venture's operations - Represents ROA as joint outcomeof two distinct aspects of venture's operations = net profit margin x sales to total assets
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