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.

Posted in Financial Ratios.