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These
ratios are calculated to comment upon the short term paying capacity of a concern or the firm's
ability to meet its current obligation
II/ Efficiency Ratio is operating espenses divided by free income plus tax equivalent net
interest income.
1/ Inventory Turnover Ratio: Inventory turnover ratio indicates the number of time the
stock has been turned over during the period and evaluates the efficiency with which a firm is
able to manage its inventory. This ratio indicates whether investment in stock is within proper
limit or not.
III/ Profitiability Ratio : measures that indicate how well a firm is performing in terms of its
ability to generate profit.
1/ Gross Profit Ratio : is the ratio of gross profit to net sales expressed as a percentage. It
expresses the relationship between gross profit and sales.
- Gross profit:(alternative term for gross income) amount by which sales revenue exceeds
production costs (cost of sales). Though operating income (gross income less depreciation and
taxes) gives a more accurate picture of a firm's profitability, gross income provides a top-line
view of a firm's production or (in case of a trading firm) sales related cost structure. It is a
measure of how well (or badly) a firm is utilizing its capital, capacity, and other resources, and
shows its competitive strengths and weaknesses in comparison with other firms in the same
industry. A high gross income means stability in times of economic downturn because the firm
can afford to cut prices; a low gross income may mean low creditworthiness or inability to fight
off competition. A falling gross income shows cost of production is rising faster than the selling
price, or that inventory is shrinking due to stealing or spoilage. It is allocated to employees as
wages, to lenders as interest, to investors as dividends, to government as taxes, and to the firm
as reinvestment. When expressed as a percentage of cost of sales, it is called gross margin.
Called also gross profit or value added.
2/ Operating Margin : Operating ratio measures the cost of operations per dollar of sales.
This is closely related to the ratio of operating profit to net sales
3/ Return on Assets (ROA) : return on assets (ROA) percentage shows how profitable a
company's assets are in generating revenue.
- Net income: total revenue in an accounting period less all expenses during the same period.
If income taxes and interest are not deducted, it is called operating profit (or Loss, as the case
may be). Also called earnings, net earnings, or net profit.
- Average total assets: average of the aggregate assets during a two year period.
* = Total assets (current year) + Total assets (previous year) ÷ 2.
- Shareholders’ equity: capital employed in a firm, computed by deducting the book value of
the liabilitiesfrom the book value of the assets.
5/ Dividend Payout Ratio: measures the portion of current earning per common share being
paid out in dividend .
IV/ Capital Structure Ratio: framework of different types of financing employed by a firm
to acquire resources necessary for its operations and growth. Commonly, it comprises of
stockholders' investments (equity capital) and long-term loans (loan capital), but, unlike
financial structure, does not include short-term loans (such as overdraft) and liabilities (such as
trade credit).
1/ Fixed Assets Ratio:
Fixed assets ratio = Fixed Assets / Total Assets
Valuation
ROIC is always calculated as a percentage. Invested capital can be in buildings, projects, machinery, other
companies etc. One downside of return on capital is that it tells nothing about where the return is being
generated. For example, it does not specify whether it is from continuing operations or from a one-time event,
such as a gain from foreign currency transactions.
The WACC equation is the cost of each capital component multiplied by its proportional weight and then
summing:
Where:
Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V=E+D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate
Businesses often discount cash flows at WACC to determine the Net Present Value (NPV) of a project, using
the formula:
A firm's WACC is the overall required return on the firm as a whole and, as such, it is often used internally by
company directors to determine the economic feasibility of expansionary opportunities and mergers. It is the
appropriate discount rate to use for cash flows with risk that is similar to that of the overall firm.