July 2012

Top 12 Financial Ratios to look at when analyzing annual report

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Annual report is a very important communication of the Management with the shareholders. It not only gives the information on the past performance, but also gives information on the future direction of the company.

Analyzing the Financial statements from the annual report is an important element towards successful investing.

The following top 12 Financial Ratios give the overall performance of a company.

Of course, there are numerous ratios which have to be looked when doing a deeper analysis on a particular aspect of a company. However the following 12 ratios are good enough when scanning or to get an overview of the companies performance. 

Measures of Performance : Profitability (Gross Margin) %, Net Margin %, Capital Turnover, Stock Turnover & Working Capital Turnover

Financial Ratios, Annual Report, Measures of performance, Gross Margin, Net Margin, Profitability ratios,

Measures of Investments : Return on Equity, Earnings Per Share, Dividend cover, Dividend %, Book Value

Financial Ratios, EPS, ROE,  Annual Report, Measures of Investment, Debt Equity Ratio, Net Margin, Profitability ratios,

Measures of Financial Status: Debt Equity Ratio, Current Ratio, Fixed Asset times Shareholders Funds

Financial Ratios, Annual Report, Measures of Financial Performance, Current Ratio, Debt Equity, Profitability ratios,

Happy Analysis.

June 2012

Working Capital Management Analysis ~ Key Ratios to be considered

Cash Flow Cycle, Working Capital, Finance, Management , Capital Budgeting, Accounts, Receivables, Inventory, Payables,

Here are the Key ratios which needs analysis when looking at the Balance Sheet , P&L of a company when trying to get a perspective on the Working Capital efficiency of a company and it’s competitors. 

Current Asset / Total Asset %
Current Asset/ Sales %
Debt/Asset Times
quick ratio or  acid-test Times
Turnover of Cash and Sec Times
Inventory Turnover (Sales/Invntry) Times
Days Sales in Inventory (DSI) Days
Days sales outstanding (DSO) Days
Days payable outstanding (DPO) Days
Gross operating cycle(DSI+DSO) Days
Net operating cycle (ccc) Days
FA turnover (Sales/FA) Times
Total Assets Turnover (Sales/Asset) Times
Profit Margin Percent
ROI Percent
Leverage (Total Asset/Equity) Times
ROE Percent

More later…. Other information on Financial Analysis

Common Multiples used in Valuation

Common Multiples ,  Valuation, EBIT, EBIDTA, ROE, ROIC, WACC, Debt, Equity Ratio, Returns, Revenues generated.
You can analyse the past, but you have to design the future
~ Edward de Bono 
 
A multiple is simply expression of market value of an asset relative to a key statistic that is assumed to relate to that value
 
 
 
Here are some of the most common multiples used in evaluating a business :
 
1.Earnings of the asset
–Price/Earnings Ratio (PE) and variants (PEG and Relative PE)
–Value/EBIT
–Value/EBITDA
–Value/Cash Flow
 
2.Book value of the asset
–Price/Book Value(of Equity) (PBV)
–Value/ Book Value of Assets
–Value/Replacement Cost (Tobin’s Q)
 
3.Revenues generated by the asset
–Price/Sales per Share (PS)
–Value/Sales
 
5.Asset or Industry Specific Variable , specific to the industry make analysis relevant.
–Price/kwh
–Price per ton of production
–Price per subscriber
–Price per click
–In PR industry – pricing based on coverage
–Pb with sector specific multiples – One needs to be careful if industry is mis priced
 
We really want relationship to cash flows!!!
Comparisons which matter in Valuation
– We cannot compare profit margins ((NP margin / Gross Profit Margin)) across industries because profit margins is useful for comparing companies within an industry and not across.
– However we can compare (ROE or ROIC) across industries since ultimately investors and entrepreneurs chase return on investments, it makes sense to compare them across industries.
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– But investments need not necessarily be made into the industries with highest RoE. Both RoE as well as the quantum of capital that can be deployed have to be studied.
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– Similarly if two companies in the same industry have different depreciation policies and operate in different tax environments, it makes sense to use EBIT(1-t) to factor in (remove) the tax impact / depreciation impact and then compare
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– This will also imply that cost of total capital should be compared to RoIC and cost of equity to RoE and the two should not be mixed and matched
 
More information and an Interesting note on relative valuation here

Financial Measures of performance ~ What gets measured gets managed…

Financial Performance Measures, Cash ,Corporate Finance,  income, Value, Returns, Dupont, ROI, MBA,ROE, EBID, EBIDTA, EVA, NOPAT,

What gets measured, gets managed ~ Peter Drucker

Performance Measures should be linked to Value. Managers are evaluated based on these measures.  Of course, there are extremely important non-performance measures like Customer Satisfaction, Quality, Cycle Time which is important and not captured in the objectivity of the financial measures.

So what are the financial performance of measures which are commonly used….

There are four main categories of financial measures, which are used for performance:
CASH
INCOME
RETURN
VALUE

CASH FLOW MEASURES

Gross cash flow

Earnings before interest, tax and depreciation/amortization (EBITDA)

INCOME MEASURES

Earnings before interest and tax (EBIT)
EBITDA – Depreciation/Amortization

Net operating profit after tax (NOPAT)
EBIT ( 1- tax rate)

Net Income (NI)
EBIT + Interest Income – Interest Expense

Earnings per share (EPS):
Net Income/ # of shares outstanding

RETURN MEASURES

Return on Equity (ROE):
Net income/Total common equity

Dupont ratio:
(NI/Sales) x (Sales/TA) = ROI

Identify value drivers based on different components of ROE

Return on Capital Employed (ROCE) or Return on Net Assets (RONA):
NOPAT/ Net Assets (TA-Current Liabilities)

SINGLE PERIOD VALUE ADDED MEASURES

Residual Income (RI):
EBIT minus a charge for assets

Economic Value Added (EVA):
Stern Stewart measure of economic profit minus a charge for capital employed

Net Operating Profit After Taxes (Stern Stewart) –  (Weighted Average Cost of Capital)  X (Capital  Employed)