Question

PART 1)  Statement of the Assignment:

Please prepare a comprehensive list of financial ratios . Write a brief explanation below each financial ratio, e.g. what does the financial ratio measures or what the significance of it is.

For example:

Current Ratio = Current Assist / Current Liabilities

Current ratio measures whether our current assets, if liquidated, are sufficient to pay all of our current liabilities. A CR of 1.5, for example, shows that if we were to liquidate all of our current assets, we will be able to cover 1.5x our current liabilities, whereas a CR of 0.5 shows that liquidating our current assets only covers half of our current liabilities.

THE FOLLOWING RATIONS ARE THE RATIONS I NEED. CAN I GET AN ANSWER EACH ONE OF THEM. (EACH BULLET POINT) please explain each ration, its process and how each one of them it is used

  Asset management, Or turnover, measures

Receivables Turnover = sales / accounts receivable

• NWC turnover= sales / NWC

• Fixed asset turnover = sales/ net fixed assets

• Total asset turnover = sales/ total assets

• Return on equity = net income / total equity

• EPS = net income/ Shares outstanding

• PE= price per share / earning per share

• Market to book ratio= market value per share / book value per share

• Enterprise value= total market value of the stock + book value of liabilities – cash

• EBITA Ration= enterprise value/ EBITDA

Answer 1

Answer:

Liquidity Ratios- to ascertain the ability of the firm to meet current obligations:

1. Current Ratio (CR). This measures level of  Current Assets (CA) as number of times of current liabilities. It indicates ability of the firm to meet current liabilities (CL) by liquidating its current assets. Formula for CR= CA/CL. Or (CA divided by CL)

2. Quick Ratio or Acid Test Ratio: This shows the level of cash and equivalents (quick assets) including bank balances, short term investments etc. as number of times of current liabilities and indicates ability for speedy liquidation of all current liabilities. Because, Current Ratio includes all Current Assets including those which may take time for realization (like inventory, receivables etc).

Solvency Ratio or Leverage Ratio or Debt-to-Equity Ratio (DER)

This is the level of total outside liabilities (TOL) as number of times of equity funds or Tangible Net Wort (TNW). Formula is as follows:

DER= TOL/TNW. Or (TOL divided by TNW)

This indicates the level of borrowings vis-a-vis the promoters contribution and the degree of leveraging. A maximum DER of 3 to 4 is considered good. More than 4 indicates excessive borrowings with attendant repayment pressure and interest cost. Less than 3 indicates underutilization of debt-capacity and inefficient utilization of capital.

Some analysts consider only the term liabilities (long term loans, debentures etc) on the nominator (instead of TOL) since the denominator, being the equity funds, is essentially long term in nature. In such cases, the benchj mark shall be ideally 2.

Efficiency Ratio- Debtors Turn over Ratio or Receivable Turnover Ratio or Debtors Velocity:

This is the number of times receivables are turned over during a period, normally in a year. This indicates the efficiency with which trade debtors are collected and the liquidity is maintained. Typically, this ratio is calculated using the following formula:

Debtors Turnover= Net Credit Sales divided by Average Receivables.

Average Receivables is the average of opening and closing balances of receivable during the given period (say, one year).

Net Working Capital (NWC) Turnover:

This indicates the efficiency of utilization of net working capital as the number of times NWC is turned over. It is computed by dividing Sales by NWC.

NWC is the amount of Current Assets over and above Current Liabilities.

NWC= CA-CL

Fixed Assets Turnover Ratio.

This is the amount of sales as number of times of net fixed assets. This indicates the efficiency of utilization of fixed assets. It is computed by dividing the amount of sales during the given period (say, one year) by the amount of net fixed assets outstanding. Net Fixed Assets is the gross amount (cost) of fixed assets as reduced by depreciation.

Total Assets Turnover Ratio

As in the case of Fixed Assets Turnover Ratio, this indicates the efficiency of utilization of total assets. It is computed by dividing amount of sales during the given period (say, one year) by the amount of total assets outstanding.

Return on Equity

This is the income generating capacity of the firm, vis-à-vis equity capital employed. Computed in percentage terms, by dividing net income during the given period (normally one year) by the amount of equity funds outstanding. Since equity funds represents total assets less borrowings, this ratio is also called Return on Net Assets.

Earnings per share (EPS)

This is the absolute amount of earning per each of the equity shares of the company. This is another measure of efficiency of earning capacity in relation to the amount of equity capital employed. More significant for the shareholders or equity investors, this is computed by dividing the amount of net profit during the year by number of equity shares of the company.

Price Earnings Ratio (PE Ratio)

This is the number of times the market price of the shares of the company vis-avis the earnings per share (EPS). Computed by dividing the current market price of the share by the EPS. This ratio is used to compare with that of the peer companies to evaluate whether the share is overpriced or underpriced so that appropriate market action can be initiated.

Market Value to Book Value Ratio.

Book value of sharers is the book value of the company reflected in the books of accounts divided by number of common shares. Book value of the company, in turn, is the net surplus of the book value of assets after deducting liabilities (essentially the amount of equity capital). It is drawn from the latest balance sheet.

Market value or price of shares reflects the perception of the stock market operators and comprise both fundamental and technical elements. Since it encompasses the market sentiments of the future prospects of the company, market value vary significantly from the book value. In most of the cases, market value is much higher than the book value.

The ratio of Market Value to book value is the number of times the market price per share over or below the book value. It is computed by dividing the current market price of the share by the book value per share. This ratio is also used to compare with that of the peer companies to evaluate whether the share is overpriced or underpriced so that appropriate market action can be initiated.

Enterprise Value:

It is the amount of market capitalization plus debt and preference shares (if any) as reduced by the amount cash and cash equivalents. Market capitalization is the total market value of shares (number of shares multiplied by current market price per share).

Enterprise value represents the economic value of a company and is considered as the theoretical takeover price.

Enterprise Value (EV) to EBITDA Ratio

Computed by dividing EV by Earnings before interest, taxes, depreciation and amortization (EBIDTA).

This is ideally used by investors and analysts for comparing valuation of peer group companies in the same industry.