Finance Ratios
17 important questions on Finance Ratios
What statements does an annual report include?
- Balance Sheet- shows what assets the company owns and who has claims on those assets as of a given date
- Income Statement- shows the firm's sales and costs during some past period
- Statement of Cash Flows- shows how much cash the firm started with and ended with and what it did to increase or decrease its cash
- Statement of Stockholders' Equity- shows the amount of equity the stockholders had at the start of the year the items that increased or decreased equity, and the equity at the end of the year
Days Sales Outstanding (DSO)
- indicates the average length of time the firm must wait after making a sale before it receives cash---high DSO deprives the company of funds that could be used to reduce bank loans or other types of costly capital
- Industry Avg: 36 days (lower better)
Fixed Assets Turnover Ratio
- measures how effectively a firm uses its plant and equipment
- Industry Avg: 2.8 (higher better)
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Total Assets Turnover Ratio
- measures the turnover of all the firm's assets---low ratio indicates the firm is not generating enough sales given its total assets
- Industry Avg: 1.8 (higher better)
Debt Management Ratios
- high ratios typically have higher expected returns when the economy is normal, but lower returns and possible bankruptcy if the economy goes into recession
- a high debt ratio and low TIE ratio means the firm would face difficulties if they borrow additional money
- Debt Ratio
- Times-Interest Earned Ratio
Times-Interest-Earned Ratio (TIE)
- measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs---lower means the firm is covering its interest charges by lower margin of safety than the average firm
- Industry Avg: 6.0 (higher better)
Return on Total Assets (ROA)
- lower ROA indicates the use of a great deal of debt
- Industry Avg: 9% (higher better)
Return on Common Equity (ROE)
- measures the rate of return on common stockholders' investment
- a high ROE depends on maintaining liquidity, efficient asset management, and the proper use of debt
- Industry Avg: 15% (higher better)
Return on Invested Capital (ROIC)
- measures the total return that the firm has provided for its investors
- the amount of funds available to pay both stockholders and debt-holders
- Industry Avg: 10.8% (higher better)
Basic Earning Power (BEP)
- measures the ability of the firm's assets to generate income
- shows the raw earning power of the firm's assets
- lower results from having low turnover ratios and low profit margin
- Industry Avg: 18% (higher better)
Market Value Ratios
- by investors when they are deciding to buy or sell a stock
- by investment bankers when they are setting the share price for a new stock issue
- by firms when they are deciding how much to offer another firm in a potential merger
- Price/Earnings Ratio
- Market/Book Ratio
Market Value Added (MVA)
- market value = stock price*number of shares outstanding
Two firms are identical except one has a higher debt ratio, the firm that uses more debt will have lower profit margin on sales (T/F)
If a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. Under these conditions, the ROE will increase. (T/F)
What will increase a firms cash flow for the following year?
Creditors would prefer to give loans to companies with a high or low TIE ratio?
Interest on debt can be deducted which does what to a firm's taxable income and taxes?
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