FIN 7 Ratios - 25 Sample Ratio Calculations

Let's take a look at problem one, nine, a computing common financial ratios. This is our first, and I think only ratio question of the course ratios are very useful in financial analysis, and I just want to caution you, if you're ever doing financial analysis, you never just want to compare one ratio. You want to compute our ratios this year and compared to last year, or as we're doing this video, compare the ratios of one company to the ratios of another. So it's, it's always a comparison point that we're after here to really get information about the company. So here we go. Below is condensed information for the balance sheet and income statement of June enterprises. And there's our balance sheet and there is our income statement. Some additional information there. It says the CFO has required a list of key ratios from companies, big name competitor, and would like to know how June enterprises compares, compute the ratios below and comment on the liquidity, financial leverage, turnover, profitability and market value of June enterprises. Okay. So we've got a big, long list of ratios to compute. We've got our competitor numbers here. We're obviously going to be filling in our own numbers in the space provided here. Let's get after it. First, the current ratio. The current ratio measures the short-term debt paying ability. Do I have enough current assets? Those are things of value that are either cash today or going to become cash within the next 12 months. Or do I have enough to pay my current liabilities, my short-term bills? Let's take a look. Our current assets are right here. Our current liabilities right there. Oops, no, that's other. Sorry. Our total current liabilities are there. 3,600 divided by 1,500, 2.4. So I have 2.4 times the current assets as I do current liabilities. I am liquid, right? And how do I know? Well, compared to my competitor, I'm more liquid than them. I'm more able to cover my short-term debts. Let's do the quick ratio. The quick ratio is just a tougher version of the current ratio. It's also called sometimes the asset test ratio. It just says, listen, do the current ratio, but take inventory out of your current assets. Because if our company's in deep trouble, a lot of times when companies are in distress, they have a hard time selling their inventory. So it doesn't really count as an asset when you are in real distress. So take that out and see how you're doing. And so 3,600 minus 1,200 gives us 2,400 as our numerator divided by 1,500, so we're at 1.6. Little rule of thumb here is if it's one or more, you're doing okay. Even 0.8 or more, you're doing all right. So we are quite liquid as far as this goes. The cash ratio says, do you have enough cash to pay the bills? We're not expecting this to be covering all of our current liabilities. So in our case, I can see that it is, uh, 2,000 divided by 1,500, 1.33. So, uh, if worse came to worse, you know, we don't collect any of our receivables, we don't sell any of our inventories, we still just can pay all our bills for the next year, just with cash, uh, interval measure. This says, are we able to cover our costs? I almost treat this like a burn rate, you know, in a tech company, burning money. This is a measure of how quickly we're burning money. How quickly are we going to burn through our current assets given our costs and our operating costs would be. Our cost of goods sold is an operating cost and our operating expenses. I exclude from this interest because it's not operating and taxes again, not day-to-day operating costs. And I exclude depreciation. And the reason is this is a cash burn. So depreciation, although it's a cost, it's not one that's going to cause me to be illiquid, right? It's liquidity is like cash, like stuff and depreciation. We're not burning cash here. So it's COGS plus any operating expenses. In this case, our numerator is. Oh, sorry. Our numerator is current assets. Assets are 3,600. Maybe I'll highlight it yellow. And I'm going to divide by those costs that I've highlighted on the other side, which is 3,400. So, uh, current assets divided by, Oh, I missed one key step. I was like, I'm going to get a crazy number here daily. So this is yearly costs divided by 365 to get daily costs. So 3,400 divided by 365, my daily cost 9.315. Uh, and again, this is in millions. So, you know, it was a big company, $9 million a day in costs. Uh, so 3,600 divided by 9.315 gives us 386.5, 386.5 days. This is again, it says, well, if I was not making any sales, not bringing in money, I could pay my costs. I could pay my bills for over a year, 386 days. And again, every ratio so far I've compared favorable to my competitor. I'm doing better than my competitor. Uh, networking capital, the total assets ratio. So networking capital is current assets minus current liabilities. So current assets not divided by, but minus, so 3,600 minus 1,500, 2,100, all divided by total assets, which in this case is 7,700. So I'm going to divide by 7,700 and I get 0.270, 0.27, oops, 0.273, I suppose. And this is just a measure of what percentage of our assets is working capital short term, so it's a liquidity measure and we are bigger is more liquid. We're more liquid. So I can just conclude on this. We are significantly in a significantly more liquid and therefore better position than our competitor, as far as again, liquidity goes, okay. I'm going to slide over and we're going to do the same thing with leverage ratios. So I just scrolled the leverage ratios up to the top here and let's get after it. Total liabilities divided by total assets, total liabilities, where are you? Okay. I got current liabilities. I got long-term debt. There we go. So current plus long-term is total liabilities. We're going to divide that by total assets. So 1.5 plus 1.8 is 3,300 divided by 7,700 and I get 42.9%. So this is a measure of leverage, how much debt we're using. And I generally think smaller is better here. Certainly smaller is less risky and we are less leveraged than our competitor. And I view that as a good thing. And that's, that's debatable, but I do view that as a good thing. Okay. Next one is total liabilities divided by total assets, not total assets divided by shareholders equity. So again, uh, 3.3 million was our total liabilities. Our shareholders equity 4.4 million. So it's 0.75. Now you can see the big difference here with our more leveraged competitor, right? Uh, we've got more equity than we have debt. They've got way more debt than they have equity. Those two things should go together. We have less leverage. Equity multiplier, another measure of leverage, total assets divided by equity. So here is our total assets, 7.7 million divided by 4.4 million. And we get 1.75. Now you're going to notice something and you'll see this. If you do the V B version of the problem, and you'll see this. If you continue on this chapter in future questions, the debt to equity ratio is one less than the equity multiplier, equity multiplier is one more than debt to equity. Uh, I show in a future problem, sort of, um, algebraically why this is true and it is true. Uh, I'm not going to show it here, but there's, you know, it's just simple math because assets equals liabilities plus equity. So the way that works together is, um, makes this possible. Okay. Long-term debt as a percentage of, uh, long-term debt plus equity. So, okay. No long-term debt, uh, divided by long-term debt plus equity. So 1.8 million divided by 1.8 plus 4.4, that's 6.2 million. So 1.8, oops, zero there. 1, 8, 0, 0 divided by 6, 2, 0, 0, uh, 0.29, 0.29, 29.03%, 29.03%. Next EBIT divided by interest. There's my EBIT, there's my interest. Well, I can do this math in my head. It's 10. All right. EBIT divided by our interest is 10. This is, sorry, this is the interest coverage ratio. It's a measure of how able we are to pay our interest. Well, we, uh, with EBIT can cover our interest 10 times over. Now the next ratio says, well, you know, EBIT includes depreciation. I don't have to worry about depreciation if I'm paying bills because depreciation is a non-cash expense. So let's take that out of the equation, add it back into EBIT. So I ended up with 600 as my numerator divided by 50, 600 divided by 50 is 12. So again, 500 plus 100 divided by 50. Uh, I get 12 here, 12 times. Now, uh, as far as leverage goes, I am less leveraged than my competitor, right? I have less debt overall. Uh, interestingly though, they, even though they have way more debt are able to handle their interest load better than I am, and I think this is a harbinger. I think this is a sign of things to come. I don't know if I know how to pronounce that word, right? I don't even know if I use that word, right? Harbinger, harbinger, harbinger. I don't, harbinger. I don't even know what it means. I'm going to, I'm going to look at a harbinger of things to come. Skip ahead. Let's see. Oops. I don't want you to see my email. Harbinger. Harbinger, a person or thing that announces the approach of another. A forerunner of them. Yeah, this is a forerunner. This is a harbinger. Did I pronounce it right? Let's see. Yeah, I pretty much hit the nail on the head. Okay. I'm feeling, feeling better about things. A harbinger of things to come. And all that means is it's a forbearer of the fact that I think this company is going to be way more profitable than our company because their EBITs have got to be way higher because I would think their interest bill is higher too. They have way more debt. Uh, they must be more profitable than us, but let's see how that goes. So as far as debt paying ability goes, I would say we have a nicer looking balance sheet. We have less financial leverage, but they kind of tip your hat to them for interest coverage. But I think we are doing better at the top. So this one may be a minus for us. This one is a plus for us. And I, I would say overall, as far as leverage goes, we are less leveraged than they are. Okay. Uh, turnover ratio. So this is, uh, uh, these are all efficiency ratios. How well do we sell through our inventories? How well do we collect our receivables? Any turnover you're going to want to see bigger, uh, bigger is better. So, uh, let's do the first one, COGS divided by inventory. Uh, again, if you've taken this with me before, if you've done ratios with me before, you'll know, I calculate this slightly different in accounting. I follow along with just textbooks in the field and in finance and accounting, they will say COGS divided by average inventory and take the average from two years. And in my finance textbooks, they just give you one year of data and you just use the one year. And so be it, as long as you're being consistent, I don't think it's a huge deal. Uh, 2200 divided by 12, uh, 12, 1.83 times. So we're very close to our competitor here. Not a huge difference, but they're doing better than us. They're collecting more regularly than us. And I think that drives home in this next ratio, 365 divided by the inventory turnover, 365 divided by 1.83, 199.5 days, this is saying how long is it taking us to sell our inventory, uh, how long is it sitting on the shelf or in a warehouse somewhere for us, it's about 200 days for them. It's 187. They're selling quicker than us. That's better. So we're doing worse. Sales divided by, uh, AR for, uh, receivables turnover. There's our sales. That's our AR 4,000 divided by 300, 13.33 times bigger is better. And I think again, this next ratio will drive it home. Divide 365 divided by 13.333. I get 27.38. What does this tell us? It tells us on average, when somebody owes us money, it's taking us 27 days to collect the money. Our competitors, 45 days, again, a measure of management efficiency and maybe policy. Uh, sales divided by networking capital. So, uh, let's see how we do here. Sales 4,000 networking capital is again, current assets minus current liabilities. So 3,600 minus 1,500 is 2,100 is my denominator 2,100. My numerator 4,000, 4,000 divided by 2,100 bigger is going to be better here, 1.9 times, uh, for the competitor for us 1.905 times. And our competitor 6.67 times, it means how effectively are you using your working capital to generate sales? They're doing a much better job as we predicted their income statement. I predict is way better than ours. That's just the vibe I'm getting from the ratios we've seen so far. Uh, next sales divided by fixed assets. How well are we using our fixed assets to generate sales? Uh, sales divided by where they're fixed assets. There they are. Uh, so 4,000 divided by 4,100, 0.975, 976, 0.976 times. So for every dollar I have invested in assets, I generate 97 cents in sales. My competitor generates a dollar in sales. So they're doing marginally better than us. This is interesting, uh, that it was close. Uh, okay, let's keep going. Sales divided by total assets. Our sales are 4,000. Our total assets, 7,700, 4,000 divided by 7,700, 0.519, 0.519. For every dollar I have invested in assets, I generate 50 cents in sales. That's what we're learning here. And again, the competitor is doing better, marginally better total assets divided by sales, capital intensity ratio. How many dollars worth of assets does it take to generate a sale? This is just the inverse of the previous one. Uh, so, uh, sales or assets rather 7,700 divided by sales 4,000 and I get 1.925. So it takes me a dollar and 90 cents of assets to generate a dollar in sales. You would rather this number be lower. So almost across the board, outside of receivables collections, my competitor is doing better here. So, uh, relative position we're doing worse as far as, uh, this goes. As far as, uh, turnover ratio goes, and this is measures of operational efficiency, right? Are we using our assets efficiently selling through inventories as well? Are we, uh, stocking the right amounts of inventory? Are we collecting receivables? Well, that's okay. One last page of ratios. We got three categories though. Let's start with profitability ratios predicted. We do worse. Maybe we aren't going to do, let's see. Um, net income divided by sales. First one is our profit margin. So for every dollar I sell, how many dollars in profit do I produce? 325 divided by 4,000. Okay. Yeah. We are significantly worse than our competitor here. Uh, uh, 8.125% versus 17%. They're double, right? Like for every dollar they sell, they make 17 cents for every dollar we sell, we make eight cents is way worse. Um, return on assets, net income divided by total assets and net income divided by total assets. 325 divided by 7,700. Uh, 4.2, 2%, oops, 10, 4.22% versus 11%. We're way less profitable again, right? Where this is how effectively you're using your assets to generate a profit. You know, how many dollars worth of assets does it take for you to generate a dollar in profit? So, uh, for every dollar I've invested in assets, I generate 4 cents of profit, not great compared to my competitor. Uh, net income divided by shareholders, equity 325 divided by 4,400, uh, 7.4%. We'll call it 7. Let's go at 7.39%. And that compares very unfavorably to our competitor at 44%. So they are pulling the doors off us as far as profitability goes. We're not nearly as profitable as our main competitor. Okay. Market value. How much does the stock market like us? That's what I consider this first one. And it's market price divided by earnings per share. Our market price is 45 bucks. Our earnings per share. Now the market price is just right there. Our earnings per share is two. So 45 divided by 2.17. They're giving us a 20.7 times multiple. So we don't earn very well, but the stock market seems to like us for some reason. This is, um, you know, I'd buy the competitor stock. If I were looking at an investment, they're much more profitable, but there could be some other reason, right? There might be a, we might be based in a country that's politically more stable where they're in a less stable country. There might be regulators taking a good look at their business and maybe a threatening, uh, lawsuits against them. Who knows, right? There's myriad reasons why one company might have a higher price to earnings ratio than other, but all else equal, you're happier if the stock market values. And it means there's something that investors think you have going for you and hopefully you do. Okay. The next ratio market price per share, 45 bucks divided by book value per share. So same 45 bucks book value per share is our equity divided by the number of shares outstanding 4, 4 0 divided by 150 million shares. Outstanding 4, 4 0. This is a million. So that's why we do that straight calculation. Our book value per share is $29.33. So 45 divided by 29.3, uh, 1.5, 3, 1.5, 3. So ours is a little bit worse here. Our book value is, uh, maybe higher than that of our competitor last one. And this is just trying to figure out why ROE is so much worse or so different. Right. It explains the difference in ROE and does it in an interesting, I think a very nice way. So we take the pieces of ROE. This is called the DuPont identity. So let's take those pieces for us. Profit margin. So our profit margin is right here. 8.125%. We're going to multiply that by asset turnover. Find the asset turnover, total asset turnover. Here it is 0.519. We're going to multiply that by the equity multiplier and our equity multiplier is right here, 1.75. So there we go. And, uh, let's multiply those through 0.08125 times 0.519. Times 1.75. And what we find is we get 7.38%. This is our return on equity, right? It's it's off by 0.01%, 7.38%. And that's off by again, 0.01%. Even though it should match, it should be RO, ROE. It's just some roundings going on. So let's look at the pieces and see if we can piece together what's happening, our profit margin, 8%. Competitor's profit margin, 17%. So that's one reason their ROE is higher. Their profit margin is way higher. Asset turnover, 0.5 versus 0.6. Not that different, but then equity multiplier, way different. Ours is 1.75. There's 4.03. There's double ours. So the two reasons that we're doing worse than our competitor, one, they're just better at generating profit than us, right there, there, um, when they make a dollar in sales, they generate a higher profit margin on double ours. And the second is, and this was a choice. They're more highly leveraged than us, right? They have, uh, more debt, less equity. And that means they have a higher equity multiplier. So the leverage thing might be a choice, but you can certainly see they're outperforming us financially to, uh, result in double the profit margin. Okay. We have done all of the ratios and for goodness sakes, where are we in the video? 24 minutes. If you've hung in there for 24 minutes, I hope it's been useful to you. And if it's been useful to you, for goodness sakes, if it hasn't been useful to you, please watch some other channel, I'm not trying to waste your time here, but if it has been useful, don't be shy about smashing one of those buttons for me, a huge favor to me. All right. Have a great day. Thanks for watching and I'll see you in the next video. Bye for now.