FIN 311 1st Edition Lecture 5Outline of Last Lecture I. Estimate Cash Flow From Assets (CFFA)II. Using Financial Statement Information i. Internal Usesii. External Usesiii. Ratio Analysisiv. Common Size Financial Statementsv. 5 Categories of Financial Ratios Outline of Current LectureI. Short Term Solvency RatiosII. Long Term Solvency RatiosIII. Coverage RatiosIV. Assets Management RatiosV. Profitability RatiosVI. Market Value Ratios Current LectureI. Short Term Solvency Ratios- Liquidity - Working Capital- Current Ratio = CA/CL Measures the number of times the firm’s current assets cover its current liabilities  Benchmark is 1 (But is barely making it by) High ratio indicates high liquidity tradeoff between liquidity and returns Liquidity is low risk and low return By looking at Pepsi, they have become more liquid in 2013 compared to 2012 Current Ratio = 1.24x…Means: Pepsi can pay its current liabilities 1.24 times from its current assets- Quick Ratio = (CA – Inventory)/CL - Inventory is less liquid that other current assets- Cash Ratio = Cash/CLThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.- NWC to Total Assets = NWC/TAII. Long Term Solvency Ratiosi. Examining the capital structure of a firm. Capital Structure: Mix of debt and equity in a firm how the firm chooses to finance its assetsii. How easily the firm can pay the costs related to the issuance of debt (interest)- Issue Debt → Pay Interest- Issue Equity → Pay Dividends residual claimants - Total Debt Ratio = (TA –TE)/TA  Shows the proportion of the company’s value represented by borrowed funds Percent of debt in the firm’s capital structure- Debt/Equity = TD/TE- Equity Multiplier = TA/TE = 1 + Debt Equity Ratio TA = TD + TE 100% = 38% + 62%- Long-term debt ratio = LTD/(LTD + TE)III. Coverage Ratios- Looks at how easily a firm can pay its debt- Times Interest Earned = EBIT/Interest- Times interest earned = 10.65x…Means: The firm can pay its outstanding interest payment 10.65 timesIV. Assets Management Ratios- Measure how effectively a firm is managing its assets to generate sales and profits- Receivables Turnover = Sales/Accts Rev  Measures how many times per year we collect our accounts receivable/the asset is completely “sold” in 1 year Units → x times- Days’ Sales in Receivables = 365/Receivables Turnover Measures the number of days in 1 year it take to completely “sell” the asset Average Collection Period Shows approximately how many days on average it takes to collect the firm’s account receivables- Inventory Turnover = Cost of Goods Sold/Inventory Provides a measure of how many times per year the inventory is physically turning over- Days’ Sales in Inventory = 365/Inventory Turnover - Fixed Asset Turnover = 3.52x…Means: For every $1.00 in net fixed asset, Pepsi generates $3.52 in sales- Asset management ratios use both the income statement (over the year) and balance sheet (at the end of the year). To be thorough, it is probably better to use average figures for balance sheet items.- For our purposes most often, you will be asked to use year end figures for balance sheet itemsV. Profitability Ratios- Profit Margin = Net Income/Sales Measures the profit that is available from each dollar of sales after all expenses have been paid, including COGS, selling, general and administrative expenses, depreciation, interest and taxes\ How profitable the firm is  Cost structure- Return on Assets (ROA) = Net Income/Total AssetsVI. Market Value Ratios - Include the stock prices as of the date of the firm’s financial statements - Earnings per share = Net Income/ #shares outstanding Measures how much the firm earned for each share of stock outstanding- (Price Earnings) PE Ratio = Price per share/ Earnings per share Shows how much investors are willing to pay per dollar of reported profits Pepsi: PE = 14.67..Means: For $1 in EPS investors are willing to pay $14.67- Market-to-Book Ratio = Stock price per share/ Book value of liquidity per share Compares what the market believes the firm’s equity is worth to what accounts believe the firm’s equity is worth (based on current GAAP) Book value per share = total common equity/ #shares outstanding- (Earnings Before Interest, Taxes, Depreciation and Amortization) EBITDA Ratio The cash flow to the shareholders and