HB 311 1st Edition Lecture 4Ratio Analysis Used to highlight areas of performance Takes sets of numbers from financial analysis and forming ratios from themWhat 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, StandardExpression of RatiosPercentageo Occupancy: 70% o Food Cost: 32% o Labor Cost: 35% Per Unit Basiso Average Room Rate: $100.00 o Average Check: $45.00 Turnovero Seat Turnover: 100 covers / 40 seats = 2.5 Coverageo 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 moneyMarket Value – Give an indication of how investors feels about the company’s financial futureLiquidity Ratios Current Ratioo 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 Ratioo (Current Assets – Inventory) / Current Liabilities o Measures liquidity without considering inventory Asset Management RatiosAverage Collection Period (ACP)o ACP = Accounts Receivable / Average Daily (Credit) Sales o Measures Time it takes to collect credit sales Inventory Turnovero 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 ofgoods o Higher Turnover Implies doing business with less tied up in inventory Fixed Asset Turnovero 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 Turnovero TAT = Sales (Total) / Total Assets o More widely Used than Fixed Asset Turnover o Long-term measure of performance o Average balance sheet values are appropriate Debt Management Ratios 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 liabilitiesDebt Ratioo DR = (Long-term debt + Current Liabilities) / Total AssetsHigh Debt Ratio is viewed as risky by investors o Stated As % Debt to Equity Ratioo 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 Earnedo TIE = EBIT / Interest Expense o TIE is a coverage ratio that reflects how much EBIT covers InterestExpense o High Level of Interest coverage implies safety Cash Coverageo Cash Coverage = (EBIT + Depreciation) / Interest Expense o By adding depreciation we have more representative measure ofcash Fixed Charge Coverageo 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 RatiosReturn on Saleso ROS = Net Income / Sales o Measures control of the income statement: revenue, cost, andexpense o Represents overall profitability Return on Assetso Adds effectiveness of asset management to Return on Sales o Measures Overall Ability of firm to utilize Assets in Which it hasinvested Return on Equityo ROE = Net Income / Stockholders Equity o Adds effect of borrowing to ROA o Measures Firm’s ability to earn a return on the owners’ investedcapital o ROE trends to be higher than ROA in good times and lower in badtimes 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 companyo Tells how much investors are willing to pay for a dollar of the firm’searnings o P/E is function of expected growth Market-to-Market Value Ratioo MBVR = Current Stock Price / Book Value Per Share (of equity) o Healthy company expected to have market value greater than its bookvalue o Known as going concern value of the firm o Combination of assets and human resources will create companyable to generate future earnings worth more than assets alone today o Value Less than 1.0 = Poor
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