Financial Management – Chapter 3
– Lead us to look in right places
– Evaluating if firm achieving stated goal to maximize shareholder wealth
– Asset use efficiency
– Current Ratio
– Quick Ratio (Acid Test Ratio)
– Average Collection Period
– AR Turnover
– Inventory Turnover
Most common liquidity ratio. Compares current assets to current liabilities. Shows whether or not a company can meet its sort-term obligations using cash or near cash assets today. Higher current ratios mean better likelihood firm will be able to meet its short-term obligations. Increasing current ratio interpreted as increasing liquidity.
Similar to current ratio in that it compares current assets to current liabilities. Only difference is that it uses a more strict definition of liquidity, or what is considered a liquid asset. For this, just take out inventory and leave cash, marketable securities, and AR.
Number of days it takes on average for a company to collect its receivables. Daily credit sales = annual credit sales divided by 365. If financial statements don’t differentiate between cash and credit sales, assume all on credit. If 32 it means on average it takes firm 32 days to collect cash.
Describes the number of times a firm’s AR account turns per year. Inverse of avg. collection period. If 12, it means company collects its entire AR 12 times per year. In that case Average collection period would be 30 days. Since these are closely related, you don’t see them used together.
The number of times it turns (or sells) its inventory annually. Inventory on balance sheet is stated as its cost, not as its selling price. That’s why you can’t use sales, that would be cost + markup.
– Total Asset Turnover
– Fixed Asset Turnover
– Operating Income Return on Investment (OIROI)
Calculates how many dollars in sales the form generates per dollar of assets it owns. If its 3 it means for every dollar of assets within the firm, it produces three dollars of sales.
Similar to total asset turnover. This calculates sales generated per dollar of fixed assets. Fixed assets include all non-current assets.
Describes the relationship between operating profit (EBIT) and company’s total asset base. Tells us how much pretax, pre-financing profit the company generates per dollar of assets. Calculating the return, or profit, made per dollar of assets invested in the company’s operations. So if you have $1,000 worth of assets and operating profit is $100 then you made 10%.
– Debt Ratio
– Times Interest Earned (TIE)
Compares total debt to total assets. Shows what proportion of debt financed with debt. 1 – debt ratio would then show proportion financed with equity. If .4 then for every dollar of assets firm owns, 40 cents is financed with debt (60 cents equity).
Tells us how many times a company covers (or could pay) its interest expanse given its earnings. Like if company EBIT = $1,000 and annual interest expanse = $100, its times interest earned ratio of 10 would mean it could pay its interest expanse 10 times over with its EBIT.
– Return on Assets (ROA)
– Return on Equity (ROE)
– Gross Margin, Operating Margin, Net Margin
Show how profitable the firm is given its asset investment.
Comparing ROA with ROE will tell us how effective the firm is at financing new assets
The grand-daddy ratio of them all. Allows us to see the various levers we can pull to get a certain ROE. If we drop leverage multiplier from DuPont we get ROA. If we want ROE of 20% , how can this be done? DuPont allows us to see various levers to pull.
This is a measure of a firms efficiency in controlling costs. Measure for amount of bang for buck a firm sells.
Measures how efficiently the firm is using its assets to generate sales.
Allows us to remove the impact of debt from the leverage factor.
NOPAT is equal to net operating profit after taxes and is defined as EBIT (l-t) and costly capital equals all interest bearing debt plus total equity.
This is to completely remove the effects of leverage in profitability ratios.
This measures the return regardless if the company’s financing comes from debt or equity.
This is interested in measuring the cash flows before either creditors and owners are compensated.
FCFF = Free cash flow to the firm
Cash Tax Payments = Total tax payments from the income statement
Depreciation = depreciation from the income statement (or two balance sheets)
EBIT = from income statement
CAPEX = Capital expenditure (gross property, plant, and equipment) changes from two balance sheets.
NWC = Networking capital (current assets – current liabilities) changes from two balance sheets.
NI = Net Income
Net Long-Term Debt = new long-term debt minus principal (debt due) payments.
Term coined to define a specific approach to economic profit. The two names are used interchangeably (two on front of this flash card).
NOPAT = Net operating profit after taxes. Also equals EBIT minus taxes
WACC = Weighted average cost of capital. Includes cost of debt and cost of equity
Costly Capital = all of our interest bearing debt and all of our equity.
Equity = assets – liabilities.
Measure progress and achieve goals
2)High growth firms
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