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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