Financial Ratios

In this chapter we consider additional financial ratios estimated company benchmarked against global averages. Estimates are then presented for the firm and average. Global benchmarks for ratios where there are large deviations between the firm and the benchmarks, graphics are provided then the distribution of ratios is presented in the form of ranks and percentiles. Certain key ratios are highlighted across companies in the comparison group.

 

Definition of Terms

 

Current Ratio

 A liquidity ratio that measures a company's ability to pay short-term obligations The current ratio can give a sense of the efficiency of a company's operating cycle or its ability to turn its product into cash. Companies that have trouble getting paid on their receivables or have long inventory turnover can run into liquidity problems because they are unable to alleviate their obligations. Because business operations differ in each industry, it is always more useful to compare companies within the same industry.

This ratio is similar to the acid-test ratio except that the acid-test ratio does not include inventory and prepaid as assets that can be liquidated. The components of current ratio (current assets and current liabilities) can be used to derive working capital (difference between current assets and current liabilities). Working capital is frequently used to derive the

Quick Ratio

An indicator of a company’s short-term liquidity the quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.

The quick ratio is more conservative than the current ratio because it excludes inventories from current assets. The ratio derives its name presumably from the fact that assets such as cash and marketable securities are quick sources of cash. Inventories generally take time to be converted into cash, and if they have to be sold quickly, the company may have to accept a lower price than book value of these inventories. As a result, they are justifiably excluded from assets that are ready sources of immediate cash.

Debt ratio

A financial ratio that measures the extent of a company’s or consumer’s leverage The debt ratio is defined as the ratio of total debt to total assets, expressed in percentage, and can be interpreted as the proportion of a company’s assets that are financed by debt.

He higher this ratio, the more leveraged the company and the greater its financial risk. Debt ratios vary widely across industries, with capital-intensive businesses such as utilities and pipelines having much higher debt ratios than other industries like technology. In the consumer lending and mortgage businesses, debt ratio is defined as the ratio of total debt service obligations to gross annual income

Fixed-Asset Turnover Ratio

A financial ratio of net sales to fixed assets. The fixed-asset turnover ratio measures a company's ability to generate net sales from fixed-asset investments – specifically property, plant and equipment (PP&E) – net of depreciation. A higher fixed-asset turnover ratio shows that the company has been more effective in using the investment in fixed assets to generate revenues.

Asset Turnover Ratio

The amount of sales or revenues generated per dollar of assets. The Asset Turnover ratio is an indicator of the efficiency with which a company is deploying its assets. Asset Turnover is typically calculated over an annual basis – either fiscal or calendar year – with the “Total Assets” figure used in the denominator calculated as the average of assets at the beginning and end of the year.

Return on Equity = Net Income/Shareholder's Equity

Net income is for the full fiscal year (before dividends paid to common stock holders but after dividends to preferred stock.) Shareholder's equity does not include preferred shares. The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.

Net Margin

The ratio of net profits to revenues for a company or business segment – typically expressed as a percentage – that shows how much of each dollar earned by the company is translated into profits.

Profitability

A regulation for evaluating whether to proceed with a project or investment. The profitability index rule states: If the profitability index or ratio is greater than 1, the project is profitable and may receive the green signal to proceed. Conversely, if the profitability ratio or index is below, the optimum course of action may be to reject or abandon the project.

Added Value Structure

In this chapter we consider the added Value t structure of company benchmarked against global averages. The chapter begins by defining relevant terms. A common-size statement or vertical analysis of assets is then presented for the firm and the average global benchmarks. For ratios where there are large deviations between the firm and the benchmarks, graphics are provided (sometimes referred to as a financial “gap” analysis). Then the distribution of ratios is presented in the form of ranks and percentiles. Certain key vertical analysis asset ratios are highlighted across companies in the comparison group.

 

DEFINITIONS OF TERMS

The enhancement a company gives its product or service before offering the product to customers. Value added is used to describe instances where a firm takes a product that may be considered a homogeneous product, with few differences (if any) from that of a competitor, and provides potential customers with a feature or add-on that gives it a greater sense of value.

Added Value can either increase the product's price or value. For example, offering one year of free support on a new computer would be a value-added feature. Additionally, individuals can bring value add to services that they perform, such as bringing advanced financial modeling skills to a position in which the hiring manager may not have foreseen the need for such skills.

 

Asset Structure

 

In this chapter, we consider the asset structure of the company benchmarked against global averages. The chapter begins by defining relevant terms. A common-size statement or vertical analysis of assets is then presented for the firm and the average global benchmarks. For ratios where there are large deviations between the firm and the benchmarks, graphics are provided (sometimes referred to as a financial “gap” analysis). Then the distribution of ratios is presented in the form of ranks and percentiles.

 

Assets

A resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. Assets are bought to increase the value of a firm or benefit the firm's operations. You can think of an asset as something that can generate cash flow, regardless of whether it's a company's manufacturing equipment or an individual's rental apartment.

Assets are divided into five major groups:

1- Current asset

A balance sheet account that represents the value of all assets that are reasonably expected to be converted into cash within one year in the normal course of business. Current assets include cash, accounts receivable, inventory, marketable securities, prepaid expenses and other liquid assets that can be readily converted to cash.

  • Cash

Legal tender or coins that can be used in exchange goods, debt, or services. Sometimes also including the value of assets that can be converted into cash immediately, as reported by a company.

  • Accounts receivable

Money owed by customers (individuals or corporations) to another entity in exchange for goods or services that have been delivered or used, but not yet paid for. Receivables usually come in the form of operating lines of credit and are usually due within a relatively short time period, ranging from a few days to a year.

  • Receivables (Net) 

Net receivables are defined as the net amount due to the company from private persons, businesses, agencies, funds, or governmental units which is expected to be collected in the form of moneys, goods, and/or services.

  • Inventory

The raw materials, work-in-process goods and completely finished goods that are considered to be the portion of a business's assets that are ready or will be ready for sale. Inventory represents one of the most important assets that most businesses possess, because the turnover of inventory represents one of the primary sources of revenue generation and subsequent earnings for the company's shareholders/owners.

  • Prepayments

The satisfaction of a debt or installment payment before its official due date. A prepayment can be for the entire balance or for any upcoming payment that is paid in advance of the date for which the borrower is contractually obligated to pay it. Examples of a prepayment come in the form of rent or early loan repayments.

2- Long term Investments

An account on the asset side of a company's balance sheet that represents the investments that a company intends to hold for more than a year. They may include stocks, bonds, real estate and cash.

3- Fixed Asset

A long-term tangible piece of property that a firm owns and uses in the production of its income and is not expected to be consumed or converted into cash any sooner than at least one year's time.

4- Intangible asset

An asset that is not physical in nature. Corporate intellectual property (items such as patents, trademarks, copyrights, business methodologies), goodwill and brand recognition are all common intangible assets in today's marketplace. An intangible asset can be classified as either indefinite or definite depending on the specifics of that asset. A company brand name is considered to be an indefinite asset, as it stays with the company as long as the company continues operations. However, if a company enters a legal agreement to operate under another company's patent, with no plans of extending the agreement, it would have a limited life and would be classified as a definite asset.

5- Other Asset

Other assets are a grouping of accounts that are listed as a separate line item in the assets section of the balance sheet and which contain minor assets that do not naturally fit into any of the main asset categories.

Liability Structure

 

A common-size statement or vertical analysis of assets is then presented for the firm and the average global benchmarks. For ratios where there are large deviations between the firm and the benchmarks, graphics are provided (sometimes referred to as a financial “gap” analysis). Then the distribution of ratios is presented in the form of ranks and percentiles.

Liability: A company's legal debts or obligations that arise during the course of business operations Liabilities are settled over time through the transfer of economic benefits including money, goods or services. Liabilities are a vital aspect of a company's operations because they are used to finance operations and pay for large expansions. They can also make transactions between businesses more efficient. For example, the outstanding money that a company owes to its suppliers would be considered a liability.

Sales Structure

 

A common-size statement or vertical analysis of assets is then presented for the firm and the average global benchmarks. For ratios where there are large deviations between the firm and the benchmarks, graphics are provided (sometimes referred to as a financial “gap” analysis). Then the distribution of ratios is presented in the form of ranks and percentiles.

Net sales value: The amount of sales generated by a company after the deduction of returns, allowances for damaged or missing goods and any discounts allowed. The sales number reported on a company's financial statements is a net sales number, reflecting these deductions.

Selling, General & Administrative Expense: Reported on the income statement, it is the sum of all direct and indirect selling expenses and all general and administrative expenses of a company.