Financial Ratios Case

Ratios to be calculated:

• Effective Tax Rate = income tax expense/income earned before taxes

• Effective tax rate is a ratio termed as a profitability indicator. It is the average tax rate paid by the firm on its earned income.

• ROE (Return on Equity) = Net Income/Average common equity

• Return on equity measures a firm’s profitability. It indicates the extent of profit that a firm generates with the money invested by shareholders. It measures how much of net income is returned as a percentage from shareholders’ equity.

• ROA (unadjusted) = Net Income/Average total assets

• Return on Assets indicates how profitable a firm is relative to its total assets. It highlights the efficiency of management at generating earnings from its assets.

• ROA (financing-adjusted) = Net Income + After-tax interest expense + Minority Interest /Average total assets

• Financial Leverage = Total assets / Shareholders’ Equity

• The financial leverage ratio shows how much of the company assets belong to the shareholders rather than the creditors. It measures the degree of debt financing of a company.

• Liabilities/Assets

• Leverage ratio that defines the total amount of debt relative to assets. The higher the ratio, the higher is the degree of leverage, leading to financial risk.

• Interest-bearing debt/Assets

• Total Asset Turnover (TAT) = Sales/average total assets

• The Total Asset Turnover ratio measures the capability of a firm to produce sales efficiently from its assets. It is used to evaluate operations of a business.

• Net Profit Margin (Profit Margin Percentage) = Net Income/Sales

• The Net Profit Margin measures the amount of profit that a firm can obtain from its total sales. It is intended to measure the overall success of a business.

• Gross Profit Margin = (Sales – CGS)/Sales

• The Gross Profit Margin assesses a firm’s financial health through showing the proportion of money that is left over from revenues after accounting for the cost of goods sold.

• SG&A Percentage = SG&A expenses/Sales

• SG&A Percentage is the percentage of selling, general and administrative costs to sales. Look for a steady or decreasing percentage indicating that the company is controlling its overhead expenses.

• Advertising-to-sales percentage = total advertising expense/sales revenue

• Advertising-to-sales percentage measures the effectiveness of an advertising campaign calculated by dividing total advertising expenses by sales revenue. It shows whether the resources that a firm spends on an advertising campaign aided in generating new sales.

• Receivables turnover = Sales Revenue/Average Accounts Receivable

• The receivables turnover is an activity ratio that measures how efficiently a firm manages its credit issued to customers and collects on that credit. It indicates the number of accounts receivable the firm collects during the year.

• Days Receivable = 365/Accounts receivable turnover

• Days Receivable measures the average number of days it takes for a firm to collect revenue after a sale was made.

• Inventory Turnover= Cost of goods sold/Average Inventories

• Inventory Turnover shows the number of times that a company’s inventory is sold and replaced over a period. A low turnover implies poor sales and excess inventory. A high turnover in turn indicates strong sales or ineffective buying.

• Days Inventory = 365/Inventory Turnover

• Days Inventory indicates how many days it takes to sell the inventory on hand. Basically, it reveals how quickly management turns inventories into cash.

• Calculating approximate purchases:

• Inventoryt-1 + Purchasest = Inventoryt + COGSt

• Payables Turnover = Total Supplier Purchases/Average Accounts Payable

• Payables turnover is a short-term liquidity measure. It calculates the rate of pay off from a firm to its suppliers. It is basically a measure of how many times the firm pays off its average amount payable per period.

• Days Payable = 365/Accounts Payable Turnover

• Days Payable measures the average number of days it takes for a firm to pay its suppliers.

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