Finance CH 3 part 1
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The so called bottom-line. Defined as total revenue minus total expenses Shareholders look closely at Net income because dividend payout and retained earnings are closely linked to net income.
- Net income divided by the number of shares outstanding. It expresses net income on a per share basis.
- EPS= (Net income)/ (Shares outstanding)
Earnings before interest expense, depreciation, and amortization.
such ratios are ways of comparing and investigating the relationship between different pieces of financial information.
Short term solvency or liquidity measures
- intended to provide information about a companies liquidity. Primary concern to see if a business can pay its bills in the short run w/o stress. The focus on current assets and current liabilities
- 1. Current Ratio
- 2. Quick (or acid test) ratio
- 3. Cash ratio
One of the best known and widely used
Current ratio= current assets/ current liabilities
to a firm, a high current ratio indicates liquidity, but it also may indicate inefficient use of cash and short term assests.
We expect a current ratio of a least 1
Quick Ratio= Current Assets-Inventory/ Current liabilities
Relatively large inventory are a sign of trouble.
A short term creditor may be interested
Cash ratio= Cash/ Current liabilities
Long Term Solvency Measures
- Intended to address its long run ability to to meet its obligations or more generally its financial leverage. Some times called financial leverage ratios.
- 1. Total Debt Ratio
- 2. Time interest Earned
- 3. Cash Coverage
Total Debt Ratio
it takes into account all debts of all maturities to all creditors.
Total debt ratio= total assets-total equity/ total assets
whether it's high or low depends on capital structure matters.
Debt Equity Ratio
Total Debt/ Total equity
Total Assets/ Total equity
Times interest Earned (TIE) Ratio
TIE= EBIT/ Interest
This ration measures how well a company has its interest obligations covered.
Cash Coverage Ratio
The problem with TIE is that its covered to EBIT and its not a measure of cash to pay interest.
Cash Coverage Ratio= EBIT+ (Depreciation and amoratization) / Interest
Assets management or Turnover Measures
- Specific ratios used to interpret turnover. The describe how effiecient, or intensive a firm uses its assets to generate sales.
- 1. Inventory Turnover and Day's Sales in Inventory
- 2. Receivables Turnover and Day's sales receivables
- 3. Total Assets Turnover
Inventory Turnover = Cost of goods sold/ Inventory
when you get the number ex: 3.2, that mean 3.2 times during the year. Then apply this number to the day's sales inventory equation
Day's Sales in inventory
Day's Sales in inventory = 365 days / Inventory turnover
Ex: 365/ 3.2 = 114 days
Receivables Turnover and Day's sale Receivables
Receivables = Sales / Acccounts Receivables
- This is to see how fast a company can collect on a sale
- then use the Day's Sales in receivables
- 365 days/ Receivables turnover
Total Assest Turnover
Total Assets turnover = Sales / Total Assets
- Intended to measure how efficiently the firm uses it assets and how effeciently the firm mamages it operations.
- 1. Profit Margin
- 2. EBITDA Margin
- 3. Return on Assets
- 4. Return on Equity
Profit Margin = Net Income / Sales
EBITDA Margin = EBITDA/ Sales
looks more directly at operating cash flows than does net income and does not include the effect of capital structure or taxes.
Return on Assets
- Return on Assets = Net income/ total assets
- AKA ROA is a measure of profit per dollar of assets
Return on Equity
- ROE is a measure of how the srock holder fared druing the year. True bottom line measure of performance.
- Return on Equity = Net Income / Total Equity
Market Value Measures
- The market price per share of the stock
- 1. Price-Earning Ratio
- 2. Market to book Ratio
- 3. Market Capitalization
- 4. Enterprise Value Multiples
EPS = Net Income / Shares outstanding
Price Earning Ratio
PE Ratio= Price per share / Earnings per share
High PE ratios are often taken to mean that the firm has significant prospect for future growth.
Market to Book Ratio
- market to book ratio = market value per share/ book value per share
- book value reflects historical costs. Compares the market value of the firms investments to their cost.
- capitalization of the public firm compared to the stock market price per share x shares outstanding.
- PPSx Shares outstanding.
- Measure of the firms value that focuses on only the market value of outstanding shares of stock.
- EV = market capitalization + market value of interest bearing debt - cash
Enterprise Value Multiples
- is to estimate the value of the firms total business rather than just focusing on the value of its equity
- EV/ EBITDA
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