Ratios: 5 categories
Liquidity (3)
“To cover current liabilities
like salaries”
Current ratio =
current assets
current liabilities
-How many times can I
cover current liabilities
using current assets
- disadvantages:
Not all assets liquid but
most of liabilities is liquid
Quick ratio =
C . assets−Inventory
current liabilities
Cash ratio =
Cash+ MS
current liabilities
MS: Marketable Securities
that any assets as liquid as
cash
Activity (5)
“The company’s ability to
collect receivables and sell
inventories”
Inventory turnover
COGS
Avg . Inventory
Avg. Age of inventory
Avg. Days on hand =
365
Inventory turnover
Number of days to sell
inventory
Avg. collection period
(A/R)
CCC: Cash Conversion
Cycle
A /R
Sales per day
Avg. Payment Period (A/P)
A/P
Purchased per day
-It is better to be: Avg.
Payment Period > Avg.
collection period
Total Assets Turnover
Sales
Total Assets
-The better the ratio is
great, the better is the
usage of assets
Debt (2)
“The company’s ability to
cover long term liabilities”
Debt Ratio =
Total Liabilities
Total Assets
Example: Total assets =
1,000,000 & Total
liabilities = 400,000 so the
Debt Ratio = 40%
It means 40% of assets are
from liabilities “not my
money” and 60% from
owners’ equity “my
money”
Times interest earned
EBIT
Ratio =
Interest
But the ratio also including
A/R not just liquid cash
Profitability (6) Market (2)
Gross Profit Margin = Market to book “MB”=
Gross Profit Current Share Price
Sales Net book value per share
That gross profit = Sales –
COGS Or
Compare with industry
Market Capitalization
average.
If ratio 60%: means for Net book value
each 1 EGP sales, it cost Where the “net book
me 0.4 EGP, or I earn 0.6 value” = total assists –
EGP total liabilities
“COGS” A low ratio (less than 1)
could indicate that the
Operating Profit Margin = stock is undervalued (i.e. a
bad investment), and a
Operating Expecses OEhigher ratio (greater than
Sales 1) could mean the stock is
Where: OE = GP – EBIT overvalued (i.e. it has
Profits from operation performed well).
“Operation Cost”
Net Profit Margin = Price to earn ration “P/E”
Net Profit =
Current Share Price
Sales
“Net Profit” Earning per share EPS
If a company was currently
trading at a P/E multiple of
20x, the interpretation is
EPS = Earnings per share that an investor is willing
Net Profit to pay $20 for $1 of
No . of shares current earnings.
ROA = Return on assets
Net Profit
Total Assets
ROE= Return on equity
ROI= Return on
investment
Net Profit
Total Equity
This ratio can be
compared with bank
interest rate, could most
important ratio.
Debt Advantages:

Example:

Company A Company B
Debt Ratio 0% Debt 50% Debt
EBIT
(Earnings before interest and 100 100
tax)
- Interest 0 50
EBT
100 50
(Earnings before tax)
-Tax (20%) 20 10
NI (Net income) 80 40

1) Tax Shield Effect: When increase debt, interest increases so reduce tax legally.
2) Debt financing is cheaper than equity

Debt Disadvantage:

1) Bankruptcy risk

Optimal capital structure “Save Zone for Debt”

- Stable Earnings
- Liquidity “Specially Cash”