Financial Ratios
Monday, October 12th, 20091. Liquidity: is the company capable of paying for its short-term financial needs?
- Current ratio = current assets / current liabilities -> (>2)
- Acid test = c. assets – inventories / c. liabilities -> (>1)
- Days Receivables = average receivables btw BS1 AND BS2 / sales per day (sales/365) ; are you collecting what you sold?
- Days Inventory = average inventory btw BS1 AND BS2 / cost of sales per day (CofS/365) ; are you selling?
- Days Payables = average payables btw BS1 AND BS2 / purchases per day (from Manuf. Account/365) ; are you delaying payments to suppliers?
- Cash Conversion Cycle = Days Receivables + Days Inventory – Days Payable
Working Capital Management and see trends in Receivables, Inventory and Payables (as a % of sales) and ask yourself a) is the company collecting payments ok in comparison to the industry? and b) is growth killing them? i.e. if the company is growing very quickly? Because growth in sales implies a growth in working capital, for a CFO growth is a problem because he needs to find sources of financing. Inventory and receivables grow proportionately to sales, so you will need current liabilities to grow as well to finance them.
2. Solvency: is the company going to be able to pay its creditors?
- Leverage = long-t debt / long-t debt + equity
- Times Interest = interest / net profit
3. Profitability
- Gross Profit
- Net Profit
- ROA: best profitability measure, if ROA>WACC -> the company is creating value; but watch out for strategic assets, only take into account of ROA = Net Profit / Operating Assets (only operating assets, not strategic such as excess cash, etc).
- ROE: it’s not a profitability ratio, it is an indication of how good a company is financing itself, because % ROE varies within a same company that has different capital structures (more leverage, more ROE, but more risk too).
