Definitions & Formulas

7/29/2019 Definitions & Formulas

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Hafiz M Usman

Definitions & Formulas Related to Ratios Analysis

Ratio Analysis Ratio analysis is basically used to understanding the financial health

of a business entity. With the help of ratios we can easily calculate from

current year performance of the companies and are then compared to

previous years. Ratio analysis conducts a quantitative analysis of

information in a companys financial statements.

These Ratios are most commonly used in banking sector can be divided into

five main categories;

Liquidity Ratios Leverage Ratios

Profitability Ratios

Activity Ratios

Market Ratios

A) Liquidity Ratios

Liquidity Ratios are used to determine a company's ability to meet its short

terms obligations.

These include;

1) Current Ratio

2) Acid Test Ratio

3) Working capital

Current Ratio

What Does Current Ratio Mean?

A liquidity ratio that measures a company's ability to pay short-term

obligations.

Also known as "liquidity ratio", "cash asset ratio" and "cash ratio".

OR

It is a measure of general liquidity and is most widely used to make the

analysis for short term financial position or liquidity of a firm. It is

calculated by dividing the total of the current assets by total of the current

liabilities.


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Hafiz M UsmanFormula = Current Assets / Current Liabilities

This ratio answer in Times

Acid Test Ratio

What DoesAcid-Test RatioMean?

A stringent indicator that determines whether a firm has enough short-term

assets to cover its immediate liabilities without selling inventory.

Also known as the "Acid-test ratio" or the "Quick assets ratio" or Liquidity

ratio.

OR

An indicator of a company's short-term liquidity. The quick ratio measures a

company's ability to meet its short-term obligations with its most liquidassets. The higher the quick ratio, the better the position of the company.

Formula = Current Assets Inventories Prepaid Expense / Current

Liabilities

OR

Acid TestRatio = Quick Assets / Current Liabilities

Quick Assets = Current assets - (Stock + Prepaid Expenses)


Working Capital

What Does Working Capital Mean?

A measure of both a company's efficiency and its short-term financial health.

Also called net current assets or current capital.

OR

The cashavailable forday-to-dayoperations of an organization.Net liquid

assets computed by deducting current liabilities from current assets. Theamount of available working capital is a measure of a firm'sability to meet

its short-term obligations.

Formula = Current Assets Current Liabilities

This ratio answer in Rs
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B) Leverage Ratios

Leverage ratios measure the degree of protection of suppliers of long term

funds.

These include:1) Times Interest Earned

2) Debt Ratio

3) Debt / Equity Ratio

4) Debt to Tangible Net worth Ratio

5) Total Capitalization Ratio

Times Interest Earned

What Does Times Interest Earned - TIE Mean?A metric used to measure a company's ability to meet its debt obligations. It

is calculated by taking a company's earnings before interest and taxes

(EBIT) and dividing it by the total interest payable on bonds and other

contractual debt.

OR

The times interest earned ratio indicates the extent of which earnings are

available to meet interest payments. The times interest earned ratio is an

Indicator of a companys ability to meet the interest payments on its debt.

Formula = Earning Before Income Tax (EBIT) + Interest Expense / Interest

Expense


Debt Ratio

What Does Debt Ratio Mean?

A ratio that indicates what proportion of debt a company has relative to its

assets. The measure gives an idea to the leverage of the company along withthe potential risks the company faces in terms of its debt-load.

OR

Debt ratio indicates the percentage of a company's assets that are provided

via debt or liability.

Formula = Total Liabilities / Total Assets
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This ratio answer in %

Debt/Equity RatioWhat Does Debt/Equity Ratio Mean?

It indicates what proportion of equity and debt the company is using to

finance its assets.

A measure of a company's financial leverage.

Formula = Total Liabilities / Total Shareholder Equity


Debt to Tangible Net worth Ratio

What Does Tangible Net Worth Mean?

A measure of the physical worth of a company, which does not include any

value derived from intangible assets such as copyrights, patents and

intellectual property. Tangible net worth is calculated by taking a firm's total

assets and subtracting the value of all liabilities and intangible assets.

Formula = Total Debt / Tangible Net Worth

Tangible Net Worth = Total Assets Intangible Assets Total Liabilities


Total Capitalization Ratio

What Does Long-Term Debt To Capitalization Ratio Mean?

The capitalization ratio measures the debt component of a company's capital

structure, or capitalization (i.e., the sum of long-term debt liabilities and

shareholders' equity) to support a company's operations and growth.

Formula = Long Term Debt / (Long Term Debt + Shareholder Equity)

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Hafiz M UsmanC) Profitability Ratios

Profitability ratios measure the earning ability of a firm.

These include:

1) Net Profit Margin2) Return on Assets

3) DuPont Return on Assets

4) Operating Income Margin

5) Return on Operating Assets

6) Return on Total Equity

7) Gross Profit Margin

Net Profit Margin

What Does Profit MarginMean?A ratio of profitability calculated as net income divided by revenues, or net

profits divided by sales. It measures how much out of every dollar of sales a

company actually keeps in earnings.

Profit margin is very useful when comparing companies in similar

industries.

Formula = (Net Income / Net Sales) x 100


Return on Assets

What Does Return On Assets - ROA Mean?

An indicator of how profitable a company is relative to its total assets. ROA

gives an idea as to how efficient management is at using its assets to

generate earnings or revenues.

Formula = (Net Income / Total Assets) x 100


DuPont Return on Assets

What Does DuPont Identity Mean?

An expression that breaks return on equity (ROE) down into three parts:


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Hafiz M Usmanprofit margin, total asset turnover and financial leverage. It is also known as

"DuPont Analysis".

Formula = (Net Income / Sales) x (Sales / Total Assets) x 100


Operating Income Margin

What Does Operating Margin Mean?

A ratio used to measure a company's pricing strategy and operating

efficiency.

Formula = Earning before Interest and Taxes (EBIT) / Net Sales x 100


Return on Operating Assets

The return on operating assets measure only includes in the denominator

those assets actively used to create revenue. This focuses management

attention on the amount of assets actually required to run the business, so

that it has a theoretical targeted asset level to achieve. A typical result of this

measurement is an ongoing campaign to eliminate unnecessary assets.

Formula = Earnings before Interest and Taxes / Operating Assets x 100

OR

Formula = Net Income / Operating Assets x 100


Return on Total Equity

What Does Return On Equity - ROE Mean?

The amount of net income returned as a percentage of shareholders

equity. Return on equity measures a corporation's profitability by revealing
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invested.

Formula = Net Income / Total Equity x 100


Gross Profit Margin

What Does Gross Profit Margin Mean?

The gross profit margin is a measurement of a company's manufacturing and

distribution efficiency during the production process. The gross profit tells

an investor the percentage of revenue / sales left after subtracting the cost of

goods sold.

Formula = Gross Profit / Net Sales x 100


D) Activity Ratios

Activity ratios measure a firm's ability to convert different accounts within

theirbalance sheets into cash or sales.

These include:

1) Total Assets Turnover

2) Fixed Assets Turnover

Total Assets Turnover

What Does Asset Turnover Mean?

The total asset turnover ratio measures the ability of a company to use its

assets to generate sales. The total asset turnover ratio considers all assetsincluding fixed assets, like plant and equipment, as well as inventory and

accounts receivable.

Formula = Net Sales / Total Assets

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Fixed Assets Turnover

What Does Fixed-Asset Turnover Ratio Mean?

The fixed-asset turnover ratio measures a company's ability to generate netsales from fixed-asset investments - specifically property, plant and

equipment - net of depreciation. A higher fixed-asset turnover ratio shows

that the company has been more effective in using the investment in fixed

assets to generate revenues.

Formula = Net Sales / Fixed Assets


E) Market Ratios

Market ratios are commonly used by the investors to assess the performance

of a

business as an investment and also the cost of issuing stock.

These include:

1) Dividend per share

2) Earning per Share

3) Price/Earning Ratio

Dividend per Share

What Does Dividend Per Share - DPS Mean?

The the sum of declared dividends for every ordinary share issued. Dividend

per share (DPS) is the total dividends paid out over an entire year (including

interim dividends but not including special dividends) divided by the

number of outstanding ordinary shares issued.

Formula = Total Dividend / Number of Shares Outstanding


Earning per Share

What Does Earnings Per Share - EPS Mean?


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Hafiz M UsmanThe portion of a company's profit allocated to each outstanding share of

common stock. Earnings per share serves as an indicator of a company's

profitability.

OR

Earnings per share (EPS) is the amount of earnings per each outstandingshare of a company's stock.

Formula = Net Income / Number of Share Outstanding


Price/Earning Ratio

What Does Price-Earnings Ratio - P/ERatioMean?A valuation ratio of a company's current share price compared to its per-

share earnings.

Formula = Market Value per Share / Earning per Share


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