HB 311 1st Edition Lecture 4 Ratio Analysis Used to highlight areas of performance Takes sets of numbers from financial analysis and forming ratios from them What is a Ratio Math Expression that divides one number by another Important tool to interpret financial statements see relationships Evaluating a Ratio Prior Period Budget Standard Expression of Ratios Percentage o Occupancy 70 o Food Cost 32 o Labor Cost 35 Per Unit Basis o Average Room Rate 100 00 o Average Check 45 00 Turnover o Seat Turnover 100 covers 40 seats 2 5 Coverage o Current Ratio 2 1 o Debt to Equity 1 35 1 Categories of Ratios Liquidity firm s ability to pay its bills in the short term Asset Management Shows how the company uses its resources to generate revenue profit and to avoid cost Debt Management Shows how effectively firm has used funds and whether or not it has a high amount of leverage Profitability Allow assessment of the company s ability to make money Market Value Give an indication of how investors feels about the company s financial future Liquidity Ratios Current Ratio o Current Assets Current Liabilities o To ensure solvency the current ratio must exceed 1 0 o 1 5 or 2 0 required for comfort Quick Ratio o Current Assets Inventory Current Liabilities Measures liquidity without considering inventory Asset Management Ratios Average Collection Period ACP o o ACP Accounts Receivable Average Daily Credit Sales o Measures Time it takes to collect credit sales Inventory Turnover o IT Cost of Goods Sold Inventory o Indication of the quality of inventory as well as how it is managed o Measures how many times per year firm uses up an average stock of goods o Higher Turnover Implies doing business with less tied up in inventory Fixed Asset Turnover o FAT Sales Total Fixed Assets Net o Appropriate where significant equipment is required to do business o Long term measure of performance o Average balance sheet values are appropriate Total Asset Turnover o TAT Sales Total Total Assets o More widely Used than Fixed Asset Turnover o Long term measure of performance Average balance sheet values are appropriate Debt Management Ratios o Need to Determine if company isn t using so much debt that it is assuming excessive risk Debt could mean long term debt and current liabilities Debt Ratio o DR Long term debt Current Liabilities Total Assets High Debt Ratio is viewed as risky by investors o Stated As Debt to Equity Ratio o Can be stated several ways or x y value o Debt to equity LT Debt Common Equity o OR Debt to equity LT debt Common Equity o Measures mix of debt and equity within firm s total capital Times Interest Earned o TIE EBIT Interest Expense TIE is a coverage ratio that reflects how much EBIT covers Interest Expense o o High Level of Interest coverage implies safety Cash Coverage o Cash Coverage EBIT Depreciation Interest Expense o By adding depreciation we have more representative measure of cash Fixed Charge Coverage o FCC EBIT Lease Payment Interest Expense Lease Payments o Interest payments not only mixed charge o Fixed financial charges similar to interest o Must be paid regardless of business decisions Profitability Ratios Return on Sales o ROS Net Income Sales Measures control of the income statement revenue cost and expense o o Represents overall profitability Return on Assets o Adds effectiveness of asset management to Return on Sales Measures Overall Ability of firm to utilize Assets in Which it has invested o Return on Equity o ROE Net Income Stockholders Equity o Adds effect of borrowing to ROA o Measures Firm s ability to earn a return on the owners invested capital o ROE trends to be higher than ROA in good times and lower in bad times Market Value Ratios Price Earnings Ratio PE Ratio o PE Ratio Current Stock Price Earnings Per Share EPS o Indication of value the stock market places on a company Tells how much investors are willing to pay for a dollar of the firm s earnings o o P E is function of expected growth Market to Market Value Ratio o MBVR Current Stock Price Book Value Per Share of equity o Healthy company expected to have market value greater than its book value o Known as going concern value of the firm Combination of assets and human resources will create company able to generate future earnings worth more than assets alone today o Value Less than 1 0 Poor Outlook o