FSA Note: Summary of Financial Ratio Calculations

This note contains a summary of the more common financial statement ratios. A few points should be noted: • Calculations vary in practice; consistency and the intuition underlying the calculated ratio are important. This list is not exhaustive. • A firm’s fiscal year end often corresponds to the point in time at which business activity is at its lowest. Hence, ratios calculated using internal data at different points in the year may differ significantly from those based on published financial statements.

Pictorial Summary of Common Financial Ratios Asset Return to Liquidity Debt Management Management Profitability Investors

Short Run Liquidity of Amount of Coverage of Operating Margins Returns Earnings per Solvency Current Debt Debt Efficiency Share Assets

Current ratio Collection Debt to assets Times interest Receivable Gross profit ROIC ROE period earned turnover margin

Quick ratio Days Debt to CFO to Inventory Operating Cash ROA ROCE inventory equity interest turnover profit margin held

Cash ratio Days Long term CFO to debt Fixed asset Net profit ROA Dividend payables debt to total turnover margin yield outstanding capital

CFO ratio Net trade Cash flow Asset ROE Dividend cycle adequacy turnover payout

Defensive Return on P/E interval assets

(Not all ratios are represented in this picture; some ratios pertain to more than one category.)

Page 1 of 5 FSA formulas

Numerator Liquidity Ratios Interpretation and benchmark Denominator Short-term debt paying ability. Current assets less current liabilities = Current assets “working capital,” the relatively liquid portion of an enterprise that serves Current ratio = as a safeguard for meeting unexpected obligations arising within the Current liabilities ordinary operating cycle of the business.

Benchmark: PG, HA, ROT (>2) Cash + marketable securities + net receivables Immediate short-term liquidity Quick (acid-test) ratio = Benchmark: PG, HA, ROT (>1) Current liabilities Cash + marketable securities More conservative than quick ratio as it excludes net receivables (all of Cash ratio = which may not be collected) Current liabilities Benchmark: PG, HA, ROT (>40-50%) CFO Ability to repay current liabilities from operations CFO ratio = Benchmark: PG, HA, ROT (>40-50%) Average current liabilities 365 X Quick ratio numerator Conservative view of firm’s liquidity. Compares currently available quick Defensive interval = sources of cash with estimated outflows needed to operate. (Cash burn rate) Projected expenditures (= COGS + Other Benchmark: PG, HA operating expenses except depreciation) Note: you may have used a different definition from corporate finance. Working capital = Current assets – Current liabilities Please use this definition for FSA.

Abbreviations for benchmarks: ROT: rule of thumb. EB: economic benchmark. PG: peer group average. HA: firm’s historical average. Note: The rule of thumb numbers vary significantly depending on whose “thumbs” we are talking about. Provided here are the often-seen numbers. Industry peer and firms’ historical average are always useful benchmarks.

Page 2 of 5 FSA formulas

Numerator Activity Ratios Interpretation and Benchmark Denominator Net sales Liquidity of receivables Receivable turnover = Benchmark: PG, HA Average net trade receivables Effectiveness of firm’s credit policies and level of investment in 365 receivables needed to maintain firm’s sales level. Average Average receivables collection day = number of days until A/R collected. Receivable turnover Benchmark: PG, HA Cost of goods sold (COGS) Liquidity of inventory Inventory turnover = Benchmark: PG, HA Average total inventory 365 Average number of days inventory held until sold. Average days inventory in stock = Benchmark: PG, HA Inventory turnover COGS + change in inventory = Purchases Importance as source of financing for operating activities Payables turnover = Benchmark: PG, HA Average accounts payable 365 Average number of days until payables are paid Average days payables outstanding = Benchmark: PG, HA Payables turnover Indicates the days in the normal operating cycle. Operating cycle = Receivables collection days + Inventory holding days Benchmark: PG, HA Indicates the days in the normal cash conversion cycle of the firm. Net trade cycle or cash cycle = Operating cycle - Average days payables outstanding Benchmark: PG, HA Net sales Amount of operating capital needed to maintain a given sales level Working capital turnover = Benchmark: PG, HA Average working capital Net sales Efficiency of fixed assets (productive capacity) in generating sales Fixed asset turnover = Benchmark: PG, HA Average net fixed assets Net sales Efficiency of asset use in sales generation Asset turnover = Benchmark: PG, HA Average total assets Accumulated depreciation Estimate of how long the average fixed asset has been held. Average PPE age = Benchmark: PG, HA Depreciation expense Estimate the average useful (depreciable) life of PPE assets. If Ending balance of gross PPE annual data are used this ratio estimates the number of years of Average PPE useful life = estimated useful life. Depreciation expense Benchmark: PG, HA Page 3 of 5 FSA formulas

Numerator Profitability Ratios Interpretation and Benchmark Denominator Net income Profitability of all equity investors’ investment Return on equity (ROE) = Benchmark: EB (Cost of equity capital), PG, HA Average total shareholders’ equity Net Income + Interest expense * (1-tax rate) Overall profitability of assets. Sometimes called return on investment (ROI). Return on assets (ROA) = Benchmark: EB (WACC), PG, HA Average total assets NOPAT = EBIT * (1- tax rate) Overall profitability of invested capital. Sometimes called return on capital Return on invested capital (ROIC) = employed (ROCE) or return on net operating assets (RNOA). (See Course Note for details) Average invested capital Benchmark: EB (WACC), PG, HA Net sales – COGS = Gross margin Captures the relation between sales generated and manufacturing (or merchandising) Gross profit margin on sales = costs Net sales Benchmark: PG, HA EBIT Measures profitability independently of an enterprise’s financing and tax positions Operating Margin = Benchmark: PG, HA Net sales Net income Net income generated by each sales dollar Net profit margin on sales = Benchmark: PG, HA Net Sales CFO Measures return on assets on “cash” basis. Cash return on assets = Benchmark: PG, HA Average total assets Net income less preferred dividends Net income earned per common share Earnings per share (EPS) = Benchmark: PG, HA Weighted common shares outstanding Market price of stock Ratio of market price to earnings per share Price earnings ratio (P-E) = Benchmark: PG, HA Earnings per share Market value of equity Ratio of the market’s valuation of the enterprise to the book value of the enterprise Market to book ratio = on its financial statements. Book value of equity Benchmark: PG, HA Cash dividends paid on common equity Percentage of earnings distributed as cash dividends. Note: Some firms/analysts Dividend Payout = calculate this using cash dividends declared in the numerator instead. Net income Benchmark: PG, HA Cash dividends paid per share of common equity Percentage of share price distributed as cash dividends Dividend Yield = Benchmark: PG, HA Price per share

Page 4 of 5 FSA formulas

Numerator Solvency Ratios Interpretation and Benchmark Denominator Percentage of total assets provided by creditors. Total debt is a subset of total Total debt liabilities. Typically, you sum total long term debt and the current portion of long Debt to total assets = term debt in the numerator. Other additions might be made: notes payable, Total assets capital leases, and operating leases if capitalized. Benchmark: EB (optimal capital structure), PG, HA Total debt Percentage of total assets provided by owners. Debt to equity = Benchmark: EB (optimal capital structure), PG, HA Total shareholders’ equity Degree to which enterprise uses owners’ capital to finance assets. We’ll calculate Total (average) assets this ratio using the averages of the balance sheet accounts to facilitate our ratio Financial leverage = decomposition. Total (average) shareholders’ equity Benchmark: EB (optimal capital structure), PG, HA EBIT Ability to meet interest payments as they mature. EBIT is sometimes called Times interest earned (TIE) = Operating Income. Interest expense Benchmark: PG, HA, ROT (minimal 2-4) Ability to meet interest payments from operating cash flow. Some analysts CFO + interest and taxes paid in cash calculate the numerator using CFO + interest expense + tax expense. This CFO to interest = calculation is less internally consistent as what we are striving for in the Interest expense numerator is a cash flow number, not a mix of cash flow and accruals. Benchmark: PG, HA, ROT (>=2-4) CFO + interest and taxes paid in cash Ability to repay total liabilities in a given year from operations. See caveat above CFO to debt = regarding numerator. Average total liabilities Benchmark: PG, HA, ROT (?) CFO Measures how many times capital expenditures, debt repayments, cash dividends Cash flow adequacy = covered by CFO. CAPEX + debt and dividends payments Benchmark: PG, HA, ROT (1) Common shareholders’ equity Amount each share would receive if company were liquidated at the amounts Book value per share = reported on the balance sheet Outstanding shares Benchmark: none Operating cash flow + accruals = operating earnings. This ratio gives an CFO indication of how much CFO differs from operating earnings due to accounting CFO to Operating earnings = accruals. Operating earnings Benchmark: PG, HA, ROT (>1).

Page 5 of 5 FSA formulas