Financial Ratios Lecture Notes

Introduction to Financial Ratios

• Speaker: James, from Accounting Stuff
• Objective: Explain Financial Ratios, categorize them into five main groups, and demonstrate how to calculate 25 financial ratios in 25 minutes.

Understanding Financial Statements

• Primary Financial Statements:
  • Income Statement: Summarizes revenues and expenses over time.
  • Balance Sheet: Snapshot of assets, liabilities, and equity at a point in time.
  • Cash Flow Statement: Not primarily used for ratio analysis.
• Purpose: Financial Ratio Analysis compares different 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

• Measure: Efficiency in generating profit from revenue, assets, equity, and capital employed.
• Two Categories:
  • Margin Ratios:
    • Profit Margin = Profit / Revenue
    • 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
      • Use average Balance Sheet numbers for accuracy.
    • Return on Equity (ROE): Net Profit / Total Equity
    • Return on Capital Employed (ROCE):
      • Net Profit / (Total Assets - Current Liabilities)
      • Also calculated as Operating Profit / Capital Employed

Liquidity Ratios

• Measure: Ability to cover short-term debt obligations with assets.
• Key Ratios:
  • Cash Ratio: Cash / Current Liabilities
  • Quick Ratio: Liquid Assets / Current Liabilities
  • Current Ratio: Current Assets / Current Liabilities

Efficiency Ratios

• Measure: Effectiveness in selling inventory, collecting cash, and paying creditors.
• Categories:
  • 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: Inventory / Cost of Goods Sold x 365
    • Days Sales Outstanding: Accounts Receivable / Revenue x 365
    • Days Payable Outstanding: Accounts Payable / Cost of Goods Sold x 365

Leverage Ratios

• Measure: Risk from debt and ability to service it.
• Categories:
  • 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: Used by investors to evaluate a company's share price.
• Categories:
  • Earnings-Based Ratios:
    • Earnings per Share (EPS): Net Profit / Number of Common Shares
    • Price-to-Earnings Ratio (P/E Ratio): Share Price / EPS
    • Price-to-Earnings-to-Growth (PEG Ratio): P/E Ratio / Expected EPS Growth
  • Dividend-Based Ratios:
    • Dividends per Share (DPS): Dividends Paid / Number of Common Shares
    • Dividend Yield Ratio: DPS / Share Price
    • Dividend Payout Ratio: Dividends Paid / Net Profit

Conclusion

• Summary: Covered all main financial ratios and their purposes.
• Resources: Financial Ratios Cheat Sheets available on the speaker's website.