Commonly Used Ratios

TheThe 19991999 andand 19981998 balancebalance sheetssheets forfor HomeHome DepotDepot areare presentedpresented next.next. WeWe willwill bebe referringreferring toto thesethese financialfinancial statementsstatements throughoutthroughout thethe ratioratio analyses.analyses.

Home Depot

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Comparative Statements HOME DEPOT Comparative Balance Sheets (Condensed) Amounts in Millions 1999 1998 Assets Cash and Cash Equivalents$ 62 $ 172 Receivables, net 469 556 Merchandise inventories 4,293 3,602 Other Current Assets 109 130 Total Current Assets 4,933 4,460 Property and Equipment, at cost 9,422 7,487 Less Accumulated Depreciation 1,262 978 Net Property and Equipment 8,160 6,509 Other Assets 372 260 Total Assets$ 13,465 $ 11,229

Continued Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Comparative Statements HOME DEPOT Comparative Balance Sheets (Condensed) Amounts in Millions 1999 1998 Liabilities Current Liabilities$ 2,857 $ 2,456 Noncurrent Liabilities 1,868 1,675 Total Liabilities 4,725 4,131 Stockholders' Equity Common Stock, $.05 par 74 73 Paid-in Capital 2,854 2,626 Retained Earnings 5,876 4,430 Accumulated Other Comprehensive Income (61) (28) Total 8,743 7,101 Less: Treasury Stock 3 3 Total Stockholders' Equity 8,740 7,098 Total Liabilities & Stockholders' Equity$ 13,465 $ 11,229

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Tests of Profitability

ProfitabilityProfitability isis aa primaryprimary measuremeasure ofof thethe overalloverall successsuccess ofof aa company.company. Now,Now, let’slet’s looklook atat thethe profitabilityprofitability ratiosratios forfor HomeHome DepotDepot forfor 1999.1999.

Home Depot

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Return on Equity

Income Return on Equity = Average Owners’ Equity

$1,614 Return on Equity = = 20.4% ($8,740 + $7,098) ÷ 2

ThisThis measuremeasure indicatesindicates howhow muchmuch incomeincome waswas earnedearned forfor everyevery dollardollar investedinvested byby thethe owners.owners.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Return on Assets

Income + Interest Expense (net of tax) Return on Assets = Average Total Assets

$1,614 + ($37 ×(1 - .34)) Return on Assets = = 13.3% ($13,465 + $11,229) ÷ 2 Corporate tax rate is 34 percent.

ThisThis ratioratio isis generallygenerally consideredconsidered thethe bestbest overalloverall measuremeasure ofof aa company’scompany’s profitability.profitability.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Financial Leverage

Financial = Return on Equity – Return on Assets Leverage

7.1% = 20.4% – 13.3%

FinancialFinancial leverageleverage isis thethe advantageadvantage oror disadvantagedisadvantage thatthat occursoccurs asas thethe resultresult ofof earningearning aa returnreturn onon equityequity thatthat isis differentdifferent fromfrom thethe returnreturn onon assets.assets.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Earnings per Share (EPS)

Income EPS = Average Number of Shares of Common Stock Outstanding

$1,614 EPS = = $1.10 (1,471 + 1,459) ÷ 2

EarningsEarnings perper shareshare isis probablyprobably thethe singlesingle mostmost widelywidely watchedwatched financialfinancial ratio.ratio.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Quality of Income

Quality Cash Flow from Operating Activities = of Income Net Income

Cash Flow from Operating Activities

Net Income$ 1,614 Add: Depreciation 373 Deferred Income Tax Expense 7 Decrease in Receivables, net 85 Increase in Current Liabilities 536 Deduct: Increase in Merchandise Inventories (698) Cash Flow from Operating Activities$ 1,917

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Quality of Income

Quality Cash Flow from Operating Activities = of Income Net Income

Quality $1,917 = = 1.19 of Income $1,614

AA ratioratio higherhigher thanthan 11 indicatesindicates higher-qualityhigher-quality earnings.earnings.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Profit Margin

Profit Income (before Extraordinary Items) = Margin Net Sales

Profit $1,614 = = 5.3% Margin $30,219

ThisThis ratioratio describesdescribes aa company’scompany’s abilityability toto earnearn incomeincome fromfrom sales.sales.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Fixed Asset Turnover Ratio

Fixed Net Sales Revenue Asset = Turnover Average Net Fixed Assets

Fixed $30,219 Asset = = 4.12 Turnover ($8,160 + $6,509) ÷ 2

ThisThis ratioratio measuresmeasures aa company’scompany’s abilityability toto generategenerate salessales givengiven anan investmentinvestment inin fixedfixed assets.assets.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Tests of Liquidity

TestsTests ofof liquidityliquidity focusfocus onon thethe relationshiprelationship betweenbetween currentcurrent assetsassets andand currentcurrent liabilities.liabilities. Now,Now, let’slet’s looklook atat thethe liquidityliquidity ratiosratios forfor HomeHome DepotDepot forfor 1999.1999.

Home Depot

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Cash Ratio

Cash Cash + Cash Equivalents = Ratio Current Liabilities

Cash $62 = = 0.022 : 1 Ratio $2,857

ThisThis ratioratio measuresmeasures thethe adequacyadequacy ofof availableavailable cash.cash.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Current Ratio

Current Current Assets = Ratio Current Liabilities

Current $4,933 = = 1.73 : 1 Ratio $2,857

ThisThis ratioratio measuresmeasures thethe abilityability ofof thethe companycompany toto paypay currentcurrent debtsdebts asas theythey becomebecome due.due.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Quick Ratio (Acid Test)

Quick Quick Assets = Ratio Current Liabilities

Quick $531 = = .19 : 1 Ratio $2,857 Quick assets are Cash, Accounts Receivable, and Notes Receivable, and Short-term Investments.

ThisThis ratioratio isis likelike thethe currentcurrent ratioratio butbut measuresmeasures thethe company’scompany’s immediateimmediate abilityability toto paypay debts.debts.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Receivable Turnover

Receivable Net Credit Sales = Turnover Average Net Trade Receivables

$30,219 Receivable = = 59 times Turnover ($469 + $556) ÷ 2

ThisThis ratioratio measuresmeasures howhow quicklyquickly aa companycompany collectscollects itsits accountsaccounts receivable.receivable.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Average Age of Receivables

Average Age Days in Year = of Receivables Receivable Turnover

365 Average Age = = 6.2 days of Receivables 59

ThisThis ratioratio measuresmeasures thethe averageaverage numbernumber ofof daysdays itit takestakes toto collectcollect receivables.receivables.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Inventory Turnover

Inventory Cost of Goods Sold = Turnover Average Inventory

Inventory $21,614 = = 5.5 times Turnover ($4,293 + $3,602) ÷ 2

ThisThis ratio ratio measures measures howhow quickly quickly thethe company company sells sells its its inventory. inventory.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Average Days’ Supply in Inventory

Average Days’ Days in Year Supply in = Inventory Turnover Inventory

Average Days’ 365 Supply in = = 66 days Inventory 5.5

ThisThis ratioratio measuresmeasures thethe averageaverage numbernumber ofof daysdays itit takestakes toto sellsell thethe inventory.inventory.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Tests of Solvency and Equity Position

TestsTests ofof solvencysolvency measuremeasure aa company’scompany’s abilityability toto meetmeet itsits obligations.obligations.

Now,Now, let’slet’s looklook atat thethe solvencysolvency ratiosratiosfor for HomeHome DepotDepot forfor 1999.1999.

Home Depot

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Times Interest Earned

Times Net Interest Income Tax ++ Interest = Income Expense Expense Earned Interest Expense

Times $1,614 + $37 + $1,040 Interest = = 72.7 Earned $37

ThisThis ratioratio indicatesindicates aa marginmargin ofof protectionprotection forfor creditors.creditors.

Cash Flow from Operating Activities Cash = Before Interest and Taxes Coverage Interest Paid

Cash Flow from Operating Activities

Net Income$ 1,614 Add: Depreciation 373 Deferred Income Tax Expense 7 Decrease in Receivables, net 85 Increase in Current Liabilities 536 Deduct Increase in Merchandise Inventories (698) Cash Flow from Operating Activities$ 1,917 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Cash Coverage

Cash Flow from Operating Activities Cash = Before Interest and Taxes Coverage Interest Paid

Cash $1,917 + $37 + $1,040 = = 80.9 Coverage $37

ThisThis ratioratio comparescompares thethe cashcash generatedgenerated withwith thethe cashcash obligationsobligations ofof thethe period.period.

Debt/Equity Total Liabilities = Ratio Owners’ Equity

Debt/Equity $4,725 = = 0.54 Ratio $8,740

ThisThis ratio ratio measures measures the the amount amount of of liabilitiesliabilities that that exists exists for for each each $1 $1 investedinvested by by the the owners. owners.

MarketMarket teststests relaterelate thethe currentcurrent marketmarket priceprice ofof aa shareshare ofof stockstock toto anan indicatorindicator ofof thethe returnreturn thatthat mightmight accrueaccrue toto thethe investor.investor.

Now,Now, let’slet’s looklook atat thethe marketmarket teststestsfor for HomeHome DepotDepot forfor 1999.1999.

Home Depot

Current Market Price Per Share P/E Ratio = Earnings Per Share

$62 P/E Ratio = = 56.4 $1.10

A recent price for Home Depot stock was $62 per share.

ThisThis ratioratio measuresmeasures thethe relationshiprelationship betweenbetween thethe currentcurrent marketmarket priceprice ofof thethe stockstock andand itsits earningsearnings perper share.share.

Dividend Dividends Per Share = Yield Market Price Per Share

Dividend $0.23 = = 0.37% Yield $62

HomeHome DepotDepot paidpaid dividendsdividends ofof $.23$.23 perper shareshare whenwhen thethe marketmarket priceprice waswas $62$62 perper share.share.

ThisThis ratioratio isis oftenoften usedused toto comparecompare thethe dividend-payingdividend-paying performanceperformance ofof differentdifferent investmentinvestment alternatives.alternatives. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Miscellaneous Ratios

FinancialFinancial analystsanalysts maymay calculatecalculate manymany otherother financialfinancial ratiosratios toto helphelp evaluateevaluate andand comparecompare investmentinvestment opportunities.opportunities.

Now,Now, let’slet’s looklook atat bookbook valuevalue perper shareshare asas anan exampleexample ofof suchsuch aa ratioratio forfor HomeHome DepotDepot forfor 1999.1999. Home Depot

Book Value Common Stock Equity = per Share Number of Shares of Common Stock Outstanding

Book Value $8,740 = = $5.94 per Share 1,471

BookBook valuevalue perper shareshare measuresmeasures thethe owners’owners’ equityequity inin termsterms ofof commoncommon stockstock outstanding.outstanding. BookBook valuevalue perper shareshare hashas nono relationshiprelationshipto to marketmarket value.value.

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