MGMT 497 Some Notes on Financial Ratio Analysis Profitability Ratios (1) Gross Profit Margin (GPM) = Total Revenues  Cost of Sales  100% Total Revenues The gross margin indicates how much of every dollar of sales is left after paying out the costs of goods sold. The margin reflects the company’s pricing, cost structure and production efficiency. A healthy gross margin is important for keeping cash flow strong. This financial ratio is not available for some companies like banks and insurance companies. (2) Operating Profit Margin (OPM) = Operating Income  100 % Total Revenues Operating income (or operating profit), which equals gross profit minus operating expenses, tells us show how much income a company can generate from its own operations. It does not include income from investments in other businesses. Operating profit margin indicates how effective a company is at controlling the costs and expenses associated with their normal business operations. It shows how much a company makes (before interest and taxes) on each dollar of sales. A high operating margin gives management more flexibility in determining prices. (3) Net Profit Margin (NPM) = Net Income  100% Total Revenues This indicates how much a company actually keeps in earnings per dollar of sales after all expenses (including interest and taxes) are paid. It shows the company’s ability to sell a product or service at a low cost or a high price. NPM can be significantly different from OPM in size due to the impact of interest and tax expenses. (4) Return on Asset (ROA) = Net Income = Net Profit Margin  Asset Turnover Ratio Total Assets This is a measure of profit per dollar of assets, a common measure of managerial performance. It indicates how efficiently the firm uses its assets. Since the return on asset can be expressed as the net profit margin (which shows the level of operational efficiency) times the asset turnover ratio (which indicates the degree of asset use efficiency), the firm may increase ROA by expanding profit margins or increasing asset turnover. (5) Return on Equity (ROE) = Net Income = ROA  (1 + Debt-to-Equity Ratio) = ROA x Equity Shareholde rs' Equity Multiplier It measures how efficiently a company is using shareholders’ money to generate profits. It shows how efficiently the firm manages its overall operations (including operational efficiency, asset use efficiency, and use of financial leverage). Financial Leverage Ratios (for Debt Management) (6) Debt-to-Asset Ratio = Total Debt Total Assets The debt-to-asset ratio indicates the proportion of assets that are financed with debt (total liabilities that include all shortterm and long-term liabilities). It gauges the degree of the firm’s financing obligations and its ability to meet all these obligations. It also shows the firm’s ability to obtain additional financing for potential expansion and growth opportunities. (7) Total Debt Total Shareholde rs' Equity Equity Multiplier =Total Assets/Total Shareholders’ equity Debt-to-Equity Ratio = MGMT 497 Some Notes on Financial Ratio Analysis The debt-to-equity ratio indicates the relative use of debt and equity as sources of capital to finance the firm’s assets. (8) Interest Coverage Ratio = Income before Taxes  Interest Expense on Debt Interest Expense on Debt This ratio measures the company’s ability to generate enough income before interest and taxes (EBIT) – including both operating and non-operating income – to meet debt service payments. Liquidity and Efficiency Ratios (9) Current Ratio = Current Assets Current Liabilitie s The current ratio is one of the liquidity ratios for operation management. It indicates a firm’s ability to meet current obligations (including accounts payable, short-term notes payable, current portion of long-term debt, accrued income taxes, and other accrued expenses) with its current assets (including cash and cash equivalents, marketable securities, account receivables, prepaid expenses, and inventories). (10) Quick Ratio = Current Assets  Inventory Current Liabilitie s The quick ratio – also referred to as the acid test ratio – indicates a firm's ability to meet short-term obligations based on its most liquid assets without liquidating inventories, which are typically the least liquid of a firm’s current assets and may not be sold for their full price. (11) Inventory Turnover = Total Sales Inventory The inventory turnover ratio indicates the average number of times inventories are sold and re-stocked (or turned over) in a year. It gauges the firm’s ability to manage inventory efficiently. (12) Asset Turnover = Total Sales Total Asset The asset turnover ratio is one of the activity (or efficiency) ratios for asset use management. It indicates how effectively the firm is using its assets to generate sales. Illustrative Example Costco: Profitability Ratios Leverage Ratios Liquidity Ratios Efficiency Ratios Gross Profit Margin Operating Profit Margin Net Profit Margin Return on Asset Return on Equity Debt-to-Asset Ratio Debt-to-Equity Ratio Interest Coverage Ratio Current Ratio Quick Ratio Inventory Turnover FY2011 10.69% 2.80% 1.68% 5.46% 11.63% 0.53 1.13 21.54 1.14 0.59 13.11 FY 2010 10.83% 2.72% 1.71% 5.47% 12.03% 0.55 1.20 19.50 1.16 0.60 13.53 FY 2009 10.81% 2.54% 1.55% 4.94% 10.84% 0.54 1.19 16.87 1.11 0.53 12.93 MGMT 497 Some Notes on Financial Ratio Analysis Asset Turnover 3.25 3.20 3.18 Apple cash and short-term investments reveivables inventories property depreciation asset a/p long term debt liabilities stockholders equity sale/turnover cost of good sold selling general and adm expense income taxes income before rxtraordinart items net income Net profit margin Return on Asset Return on Equity Debt to Asset Ratio Debt to Equity Ratio Equity Multiplier Asset Turnover 2013 25620 9924 1051 4768 2466 75183 12015 0 27392 47791 65225 38609 7299 4527 14013 14013 2012 25952 11717 776 7777 3991 116371 14632 0 39756 76615 108249 62609 10028 8283 25922 25922 2011 29129 18692 791 15452 6435 176064 21175 0 57854 118210 156508 84641 13421 14030 41733 41733 2010 40546 20641 1764 16597 11922 207000 22367 16960 83451 123549 170910 99849 15305 13118 37037 37037 2009 25077 27219 2111 20624 18391 231839 30196 28987 102292 111547 182795 104312 18304 13973 39510 39510 21,48% 18,64% 29,32% 36,43% 57,32% 157,32% 86,75% 23,95% 22,28% 33,83% 34,16% 51,89% 151,89% 93,02% 26,67% 23,70% 35,30% 32,86% 48,94% 148,94% 88,89% 21,67% 17,89% 29,98% 40,31% 67,54% 167,54% 82,57% 21,61% 17,04% 35,42% 44,12% 91,70% 207,84% 78,85%
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