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Return on Equity
. Net Income after
Taxes .
Return on Equity = Total
Stockholders Equity
1) How
effective a company used funds invested by stockholders during the year is measured by the return
on equity ratio.
2) The higher this ratio is,
the more successful the company has been in generating a return to the
stockholders of the business.
Equity to Assets Ratio
. Total Stockholders
Equity .
Equity to assets
=
Total Assets
1) What
portion of a company’s funds financed by stockholders is measured by
equity to assets ratio.
2) If this
ratio is too high, it may be a sign the company is not taking advantage
of opportunities to use borrowed funds to leverage its returns to its
stockholders.
Gross Profit Margin
. Gross Profit .
Gross profit Margin
= Net
Sales
1) The percentage of each
sales dollar left after the company has paid for its goods and results of
operations are measured by the gross profit margin. It also, shows the
extent of control the company has over its cost of goods sold and its
pricing strategies.
2) A material change in the
gross profit margin may mean unrecorded purchases or inventory valuation
schemes are present.
Operating Profit Margin
. Operating Profit .
Operating profit Margin = Net Sales
1) The percentage of each
sales dollar left after the company has paid for its goods and operating
expenses are measured by the operating profit margin.
2) It also, shows the extent
of the company’s use of assets to cover operating expenses as they become
due and still leave enough operating income to cover other expenses.
Debt to Equity Ratio
. Long Term Debt (Non-current Liabilities) .
Debt to Equity
= Total
Stockholders Equity
1) What portion of a
company’s long-term funds are financed by creditors and its relationship
to funds provided by its stockholders is measured by this ratio.
2) It measures of the
company’s financial leverage.
Interest expenses to Notes payable Ratio
. Interest expenses .
Interest
expenses to notes payable Ratio = Notes payable
1) This
ratio helps to spot understatement of interest expenses, for example,
existence of notes payable with no interest expense.
Inventory / Total Assets (Comparison
ratio)
Please note: The average or norm
was calculated based on a representative sample of leading companies in
the industry.
This ratio is
used to compare companies and to see trends.
. Inventory .
Inventory /
Total Assets = Total
Assets
Return on Investment
. Net Income after
Taxes .
Return on Investment = Total
Assets
1) How
effective a company used its available assets to produce net income for
the company during the year is measured by the return on investment ratio.
2) The higher the ratio is,
the more successful the firm has been in generating a return on the
assets invested in the firm.
Sales/Net worth (Comparison ratio)
Please note: The
average or norm was calculated based on a representative sample of
leading companies in the industry.
This ratio is used to compare companies
and to see trends.
. Sales .
Sales/Net worth =
Equity
Selling, General & Administrative
. Selling,
General and Administrative Expenses
.
Selling, general
& administrative = Net Sales (Revenue)
1) How
effective a company used its selling, general & administrative
expense to generate sales for the company during the year is measured by the selling, general & administrative
expense ratio.
2) The lower the ratio is, the more successful the firm has
been in generating a sale for each dollar of selling, general &
administrative expense. (An HarriFin
Ratio)
It is an efficiency ratio. An increasing
efficiency ratio means the company has to spend more money in order to
make $1.00 of net income.
This ratio is also
called operating expenses and for banks non-interest expenses.
Operating Cash Flow to Total Debt
. Operating Cash Flow .
Operating Cash Flow to total Debt = Total
Debt
1) A company’s
ability to cover its total debt with current operating cash flow is
measured by the operating cash flow to total debt ratio.
2) The
higher the ratio is, the more successful the firm has been in carrying
its total debt.
Operating Cash Flow to Net Income
130,000=. Operating Cash Flow .
Operating Cash Flow to Net Income = 100,000 Net Income
= 1.30 or 130%
1) A company’s
ability to maintain its net income with current operating cash flow is
measured by the operating cash flow to net income ratio
2) The
higher the ratio is, the more successful the firm has been in maintaining
its net income even after making its non-cash adjustment such as
depreciation, extraordinary gains and losses. The cash flow in the
example is 30% higher than the net income amount. In the example below
net income is maintain at $100,000, with an additional $30,000. The firm
in this example could have generated a negative cash flow or loss (Use) if
there were items that reduce the net income to below zero i.e., a
poorly maintained net income or poor cash flow generation from operating
activities.
Depreciation $10,000, Net income $100,000, Provision
for losses $20,000
For example: Net income + depreciation + losses = Net operating cash flow
100,000 + 10,000 +
20,000 = 130,000
Note:
Cash flow from operation or Net Cash Flow provided FROM (by) Operating
Activities (opposite of cash use from
operation) is always positive.
It shows the cash flow from operating the business. It does not include
non-operating activities such as gain and losses such as extraordinary
items like loan losses or gains or estimates for losses and it does not
use non-cash items such as depreciation, which involves no cash.
Depreciation was deducted in arriving at the net income figure so it must
be added back to show the true cash flow from operating the business. The
same for the other adjustments,
Note also:
Negative divided by negative is
negative or Nothing from nothing leaves nothing
The computer math negative divided by negative equal
positive is different though. Consider the following example using those
negatives:
Using the example above make the net income negative or (Loss) will show you that the computer’s
mathematics does not apply to financial ratios.
Depreciation $10,000, Net income(-Loss)
$-100,000, Provision for losses $20,000
For example: Net income + depreciation + losses = Net operating cash flow
-100,000 +
10,000 + 20,000 = -70,000
-70,000=. Operating Cash Flow .
Operating Cash Flow to Net Income
= -100,000 Net Income
= 70%
The computer shows this result as positive cash flow ratio
of 70% when you have no cash flow or a negative cash flow. To
resolve this problem for financial ratios to show the true cash flow
figure is to make the denominator positive or an absolute value if it is
negative as follows:
-70,000=.
Operating Cash
Flow .
Operating Cash
Flow to Net Income = Absolute -100,000 Net Income
= -70% Period
Note: A negative Net Cash Flow Used by Operating Activities is similar to
an over drawn bank account. The deficit replenished by new equity shares
or from new loans.
(An HarriRatio)
Cash Flow Margin
Operating Cash Flow .
Cash Flow Margin = Net Sales
1) A company’s ability to change sales into
cash flow that can be used to pay dividends, debts or acquire assets is measured by the cash
flow margin.
2) The higher the ratio is, the more
successful the company has been in producing cash flow from every dollar
of sales.
Cash Flow Margin (Without the questionable adjustment)
Operating Cash Flow (Plus or minus
questionable adjustments).
Cash Flow Margin = Net Sales
1) A company’s ability to change sales into
cash flow that can be used to pay dividends, debts or acquire assets is measured by the cash
flow margin.
2) The higher the ratio is, the more
successful the company has been in producing cash flow from every dollar
of sales.
What is Without the questionable
adjustment?
Using the example above for Operating
Cash Flow to Net Income with some adjustment
Depreciation $10,000, Net income $5,000, Extraordinary
gain $20,000, Provision losses $15,000
For example: Net income + depreciation – gains + losses = Net operating cash flow
5,000 + 10,000 -
20,000 + 15,000 = $10,000
The provision for losses $15,000 will be considered questionable because it gives the
company positive cash flow of $10,000 and it covers up a negative
transaction i.e., the extraordinary gain that reduces cash flow. This
adjustment will be appropriate if there was no similar adjustment in the
prior period, thus making the transaction a questionable adjustment.
Cash Flow Margin (Without the questionable adjustment) is:
For example: Net income + depreciation – gains = Net operating cash flow
5,000 + 10,000 -
20,000 = -5,000
There is a negative cash
flow -5,000 instead of a positive cash flow of $10,000 as a result of the
adjustments.
Note:
Cash flow from operation or Net Cash Flow provided FROM (by) Operating
Activities (opposite of cash use from
operation) is always positive.
It shows the cash flow from operating the business. It does not include
non-operating activities such as gain and losses such as extraordinary
items like loan losses or gains or estimates for losses and it does not
use non-cash items such as depreciation, which involves no cash.
Depreciation was deducted in arriving at the net income figure so it must
be added back to show the true cash flow from operating the business. The
same for the other adjustments,
Cash Flow Return
Operating Cash Flow .
Cash Flow Return = Total Assets
1) A company’s
ability to use all its assets to produce cash flow is measured by the cash
flow return.
2) The higher
the ratio is, the more successful the company has been in producing cash
flow on its total investment in assets.
Time interest Earned
Please note: How is a company ability
to pay its interest expense on long term debt as it become due is
measured by the time interest earned ratio it is calculated by dividing
Earnings before Interest and taxes by Interest Expense. If this ratio is
sufficient it is unlikely there will be a default on the loan. The
average or norm was calculated based on a representative sample of
leading companies in the industry.
Time
interest Earned = Earning before Interest and Taxes
Interest Expense
Total Current assets/ Total Assets (Comparison ratio)
Please note: The average or norm
was calculated based on a representative sample of leading companies in the
industry.
This ratio
is used to compare companies and to see trends.
. Total Current assets .
Total Current
assets/ Total Assets = Total Assets
Defensive-Interval Ratio
Please note: A complete
explanation of the company ability to pay its current debt as it become
due is measured by the Defensive-Interval Ratio it is calculated by
dividing Defensive assets (cash, marketable securities, and net
receivables) by projected daily expenditures from operations (Cost of
goods sold add selling and administrative expenses and other ordinary and
necessary cash expenses and divide by 365 days). (It measures liquidity)
Adjustment to total expenses for non-cash expenses must be made for
depreciation and amortizations and previous period charges. This ratio
shows the period that a company can operate using the current liquid
assets before having to use income from the following period’s revenue
sources. This ratio sets a safety margin for investors in showing the
ability of a company cover its operational costs. A high ratio gives a
company protection given a low current or acid test ratio. The following
question must be answered:
1) Is the current ratio or acid test
ratio low?
Defensive-Interval
Ratio = _____Defensive Assets__________
Projected daily operational expenditures (less non cash
expenses)
.Rate of return on Common
stock Equity
Please note: If a
company is trading on the equity (Use of borrowed funds at fixed interest
rates or giving preferred stock for a set dividend rate with expectation
of getting a higher rate of return on funds used than the interest or
preferred dividend paid) it can be measured by the rate of return on
common stock equity it is calculated by dividing net income after
interest, taxes and preferred dividend by average common stockholders’
equity. (It measures profitability) If the rate of return on common stock
equity ratio is higher than the rate of return on total assets it is said
the company is trading on equity that opens the company up for financial
risks, but makes residual revenue look good whenever the rate of return
on assets is greater than cost of debt capital. The average or norm was
calculated based on a representative sample of leading companies in the
industry. The following question must be
answered:
1) Is
one company more profitable than the other? Both ratios must be considered in the
analysis.
. Net Income less
Preferred dividends .
Return on Common Equity = Average Common Stockholders’
Equity
Payout ratio
Please note: A
company’s dividend paying ability during the year is measured by the
payout ratio. If preferred dividend is outstanding then it is calculated
by dividing cash dividend by net income. (It measures profitability) Investors want to know if a company is
paying dividend. If the company is a growth company, then the payout
ratio is low because of the reinvesting of its earnings. The average or
norm was calculated based on a representative sample of leading companies
in the industry.
The Pay out ratio is only one way of measuring
activity. More analysis of other related data is needed.
. Cash dividend .
Pay out ratio= Net Income
Payment Days Accounts payable (Comparison ratio)
Please note: The average or norm
was calculated based on a representative sample of leading companies in
the industry.
This ratio is used to compare companies
and to see trends.
. 365 .
Payment Days Accounts payable = Accounts payable turnover
Dividend
yield
Please note: A
company’s rate of return in the short term to its investors is measured
by the dividend yield. It is calculated by dividing cash dividend per
share by market price. (It measures profitability) The average or norm was calculated
based on a representative sample of leading companies in the industry.
The Dividend yield is
only one way of measuring activity. More analysis of other related data
is needed.
. Cash dividend per share .
Dividend yield = Market price
Book value per share
Please note: A
company’s net worth during the year is measured by the book value per share. It shows how much each share
would receive if the company was liquidated on the balance sheet date. It
is calculated by allocating the stockholders’ equity accounts among
various classes of stock and then dividing the total to each class by the
number of shares outstanding. (It measures coverage) The average or norm
was calculated based on a representative sample of leading companies in
the industry. The following questions must be answered:
1)
How to handle authorized and un-issued shares?
2)
What was the number of treasury shares on hand?
3)
Any commitment exists with respect to un-issued or reissued
treasury shares?
4)
What are the rights and privileges of various types of stocks that
are authorized?
The Book value per share
is only one way of measuring activity. More analysis of other related
data is needed.
. Common
Stockholders’ Equity .
Book value per share = Outstanding
shares
Federal Funds Asset
Please note: A bank’s management of Federal Funds Asset sold and securities borrowed or
purchased under agreements to resell during the year is measured by the Federal Funds Asset.
It is compared to the
liability account Federal funds purchased and securities loaned or sold
under agreements to repurchase. The higher the ratio the better is the
asset trading activity by the bank.
. Federal Funds Asset .
Federal Funds Asset =
Federal
Funds Liabilities
Cash + Marketable Security ratio
Please note: A bank’s management of Cash + Marketable Security
during the year is measured by the Cash + Marketable Security ratio.
It shows what percentage
of total assets is in liquid assets. The higher the ratio the more liquid
assets are available for current needs.
. Cash
+ Marketable Security ratio.
Cash + Marketable
Security ratio = Total
Assets
Cost of goods sold to total revenue (Comparison ratio)
Please note: The average or norm
was calculated based on a representative sample of leading companies in
the industry.
This ratio
is used to compare companies and to see trends.
. Cost of goods sold .
Cost of goods
sold to total revenue = Total Sales
Current liabilities/Total Assets (Comparison ratio)
Please note: The average or norm
was calculated based on a representative sample of leading companies in
the industry.
This ratio
is used to compare companies and to see trends.
. Current liabilities .
Current
liabilities/Total Assets = Total Assets
Current liabilities/Equity (Comparison
ratio)
Please note: The average or norm
was calculated based on a representative sample of leading companies in
the industry.
This ratio
is used to compare companies and to see trends.
. Current liabilities .
Current
liabilities/Equity = Total
Equity
Trading account assets
Please note: A bank’s management of Trading account assets during
the year is measured by the Trading account assets.
It is compared to the
liability account Trading account liabilities. The higher the ratio the
better is the asset management by the bank.
. Trading
account assets.
Trading account asset = Trading
account liabilities
Total loans to Deposit
Please note: A bank’s management of total loans during the year
measured by the total loans to deposit ratio. It is a commonly
used measure of liquidity.
It is compare to the liability
account total deposits. The higher the ratio the better is the asset
management by the bank. Logic: A bank is not to hold on to money. It is
must invest it wisely to increase shareholder’s return.
. Total
loans assets.
Total loans Deposit = Total
deposits liabilities
Total Revenue to Total deposits
Please note: A bank’s management of total revenue to total
deposits during the year is measured by the Total revenue to Total
deposits ratio.
It is compared to the
liability account Total deposits. The higher the ratio the better is the
revenue management by the bank.
. ____Total
Revenue_______.
Total Revenue to
Total deposits = Total deposits liabilities
Liquid assets to deposit
Please note: A bank’s management of Liquid assets to deposit
during the year is measured by the Liquid assets to deposit.
It shows what percentage of
deposits is invested in liquid assets. The higher the ratio the more
deposited funds are invested in liquid assets.
. Cash
+ Marketable Security.
Liquid assets to
deposit = Total deposits (a liability)
Long Term Liabilities/Total Assets (Comparison ratio)
Please note: The average or norm
was calculated based on a representative sample of leading companies in
the industry.
This ratio
is used to compare companies and to see trends.
. Long Term Liabilities .
Long Term
Liabilities/Total Assets = Total
Assets
Number of Days’ Sales in Inventory
Please note: A bank’s management of Liquid assets to deposit during
the year is measured by the Liquid assets to deposit.
This ratio,
which shows the average time it takes to sell inventory, is calculated by
dividing the number of days in a period by the inventory turnover ratio. The higher the ratio the more time it takes to sell
or dispose of inventory.
.
_____365
days___________.
Number of Days’
Sales in Inventory = Inventory Turnover
Total interest expense to Total revenue
Please note: A
bank’s management of Total interest expense to Total revenue during the
year is measured by the Total interest expense to Total revenue ratio.
Interest expense is compared
to the revenue account. The lower the ratio the better is the interest
expense management by the bank.
. _Total interest Expense_______.
Total interest expense to Total revenue = Total Revenue
Total liability/Equity (Comparison
ratio)
Please note: The average or norm
was calculated based on a representative sample of leading companies in
the industry.
This ratio
is used to compare companies and to see trends.
. Total liability .
Total
liability/Equity = Equity
Property plant and equipment to total asset
Please note: A
company’s management of property during the year measured by the property
plant and equipment to total assets ratio.
If the ratio is too low or
too high is a sign of trouble.
. _Property, plant and
equipment_______.
Total interest expense to Total revenue = Total assets
Property Plant & equipment over Equity (Net worth) (Comparison ratio)
Please note: The
average or norm was calculated based on a representative sample of
leading companies in the industry.
This ratio is used to compare companies
and to see trends.
. Property Plant & equipment .
Property Plant &
equipment over Equity
= Equity
Accounts payable to total current liabilities
Please note: A
company’s management of accounts payable during the year measured by the
accounts payable over total current liabilities ratio.
If the ratio is too low or
too high is a sign of trouble.
. _Accounts payable_______.
Accounts payable
to total current liabilities = Total current
liabilities
Accounts payable/Purchases (Comparison
ratio)
Please note The average or norm
was calculated based on a representative sample of leading companies in
the industry. Some important questions
must be asked such as the following:
This ratio
is used to compare companies and to see trends.
. Accounts Payable .
Accounts payable/Purchases =
Purchases
Working Capital Turnover
Please note The ability of a
company to meet its current obligation is an important key to its
financial success. The Working Capital Turnover is net sales divided
average current asset minus
current liabilities during the year. It measures the company pay
current obligations when due.
. Net
sales
__________.
Working Capital
Turnover = Average working capital (current
asset minus current liabilities)
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