Financial Ratios Lecture Notes

Introduction

• Presenter: James from Counting Stuff
• Topic: Financial Ratios
• Objective: Explain and breakdown financial ratios into five main groups and demonstrate how to calculate 25 financial ratios in 25 minutes.
• Resources: Financial ratios cheat sheets available on the website.

Financial Statements

• Main Financial Statements:
  • Income Statement: Summary of revenues and expenses over time.
  • Balance Sheet: Snapshot of assets, liabilities, and equity at a point in time.
  • Cash Flow Statement: Usually not needed for most financial ratios.

What is Financial Ratio Analysis?

• Comparison of one line item to another in financial statements, typically expressed as percentages.
• Used over time and across businesses.

Types of Financial Ratios

1. Profitability Ratios
2. Liquidity Ratios
3. Efficiency Ratios
4. Leverage Ratios
5. Price Ratios

Profitability Ratios

• Purpose: Measure how efficiently profit is generated from revenue, assets, equity, and capital employed.
• Types:
  • Margin Ratios:
    • Gross Profit Margin: Gross Profit / Revenue
    • Operating Profit Margin: Operating Profit / Revenue
    • Net Profit Margin: Net Profit / Revenue
  • Return Ratios:
    • Return on Assets (ROA): Net Profit / Total Assets
    • Return on Equity (ROE): Net Profit / Total Equity
    • Return on Capital Employed (ROCE): Operating Profit / Capital Employed

Liquidity Ratios

• Purpose: Measure ability to cover short-term debts.
• Types:
  • Cash Ratio: Cash / Current Liabilities
  • Quick Ratio: (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities
  • Current Ratio: Current Assets / Current Liabilities

Efficiency Ratios

• Purpose: Measure effectiveness at inventory turnover, cash collection, and creditor payments.
• Types:
  • Turnover Ratios:
    • Inventory Turnover Ratio: Cost of Goods Sold / Inventory
    • Receivables Turnover Ratio: Revenue / Accounts Receivable
    • Asset Turnover Ratio: Revenue / Total Assets
    • Payables Turnover Ratio: Cost of Goods Sold / Accounts Payable
  • Cash Conversion Cycle:
    • Days Sales of Inventory (DSI): Inventory / Cost of Goods Sold × 365
    • Days Sales Outstanding (DSO): Accounts Receivable / Revenue × 365
    • Days Payable Outstanding (DPO): Accounts Payable / Cost of Goods Sold × 365

Leverage Ratios

• Purpose: Measure the level of debt and ability to service it.
• Types:
  • Balance Sheet Ratios:
    • Debt to Assets (DTA): Total Liabilities / Total Assets
    • Debt to Equity (DTE): Total Liabilities / Total Equity
  • Income Statement Ratios:
    • Interest Coverage Ratio: Operating Profit / Interest Expenses
    • Debt Service Coverage Ratio: EBITDA / Total Debt Service

Price Ratios

• Purpose: Used by investors to evaluate share price.
• Types:
  • Earnings-Based Ratios:
    • Earnings Per Share (EPS): Net Profit / Number of Common Shares Outstanding
    • Price to Earnings Ratio (PE): Share Price / EPS
    • Price to Earnings to Growth (PEG): PE / EPS Growth
  • Dividend-Based Ratios:
    • Dividends Per Share (DPS): Dividends Paid / Number of Common Shares Outstanding
    • Dividend Yield Ratio: DPS / Share Price
    • Dividend Payout Ratio: Dividends Paid / Net Profit

Conclusion

• Covered 25 financial ratios across five groups.
• Cheat sheets summarizing this information are available on the website.

Final Notes

• Remember to subscribe to the channel for more detailed videos on each ratio.
• The cheat sheets can be used as a reference guide for financial ratio analysis.