Financial Ratios Lecture Notes

Introduction

• Presenter: James
• Topic: Financial Ratios
• Overview: Explanation of financial ratios, categorized into five main groups, and calculation of 25 financial ratios in 25 minutes.
• Thanks to channel members for support.

Financial Statements

• Financial Ratio Analysis: Begins with financial statements summarizing financial activities.
• Main Financial Statements:
  • Income Statement: Summarizes revenues and expenses over a period.
  • Balance Sheet: Snapshot of assets, liabilities, and equity at a point in time.
  • Cash Flow Statement: (Not directly covered, but relevant).

What is Financial Ratio Analysis?

• Definition: Compares the size of one line in a financial statement against another.
• Typically presented as percentages (multiplied by 100).
• Purpose: Analyzes financial ratios over time and across businesses.

Types of Financial Ratios

• Five Main Groups:
  1. Profitability Ratios
  2. Liquidity Ratios
  3. Efficiency Ratios
  4. Leverage Ratios
  5. Price Ratios

Profitability Ratios

• Purpose: Measure efficiency in generating profit.
• Types:
  • Margin Ratios: Convert revenue into profit.
    • Gross Profit Margin: Gross Profit / Revenue
      • Gross Profit = Revenue - Cost of Sales
    • Operating Profit Margin: Operating Profit / Revenue
    • Net Profit Margin: Net Profit / Revenue
  • Return Ratios: Measure net profit relative to assets, equity, or capital employed.
    • Return on Assets (ROA): Net Profit / Total Assets
    • Return on Equity (ROE): Net Profit / Total Equity
    • Return on Capital Employed (ROCE): Net Profit / Capital Employed
      • Capital Employed = Total Assets - Current Liabilities

Liquidity Ratios

• Purpose: Assess ability to cover short-term debt obligations.
• Calculations:
  • Cash Ratio: Cash / Current Liabilities
  • Quick Ratio: (Liquid Assets) / Current Liabilities
  • Current Ratio: Current Assets / Current Liabilities

Efficiency Ratios

• Purpose: Measure effectiveness in selling inventory and cash collection.
• 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: Average days to convert investments into cash.
    • Formula: Days Sales of Inventory + Days Sales Outstanding + Days Payable Outstanding
      • Days Sales of Inventory: (Inventory / Cost of Goods Sold) * 365
      • Days Sales Outstanding: (Accounts Receivable / Revenue) * 365
      • Days Payable Outstanding: (Accounts Payable / Cost of Goods Sold) * 365

Leverage Ratios

• Purpose: Evaluate risk by analyzing debt relative to assets.
• Types:
  • Balance Sheet Ratios:
    • Debt to Assets Ratio (DTA): Total Liabilities / Total Assets
    • Debt to Equity Ratio (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: Help investors evaluate share prices.
• Types:
  • Earnings-Based Ratios:
    • Earnings Per Share (EPS): Net Profit / Common Shares Outstanding
    • Price to Earnings Ratio (P/E): Share Price / EPS
    • Price to Earnings to Growth Ratio (PEG): P/E Ratio / Expected EPS Growth
  • Dividend-Based Ratios:
    • Dividends Per Share (DPS): Dividends Paid / Common Shares Outstanding
    • Dividend Yield Ratio: DPS / Share Price
    • Dividend Payout Ratio: Dividends Paid / Net Profit

Conclusion

• Summary of all financial ratios covered.
• Cheat sheets available on the website for further details.
• Encouragement to subscribe for more content.