Ratio Analysis. Part 1.

By MM x ML
Income Statement (Revenue, Expenses, Profit)
Horizontal Compares accounts throughout the
(Y2-Y1)/(Y1)
Analaysis years

Everything put into percentage of Total

Vertical Analysis
Revenue
It measures how much out of every dollar of sales a company actually keeps in earnings. A higher profit margin indicates
Profit Margin 1 =Net Income / Net Sales Revenue a more profitable company that has better control over its costs compared to its competitors. Requires comparative
figure.
=Cash Flow from Operating Activities / Should be > 1. The higher, the better. Each dollar of income is supported by one dollar or more of cash flow from
Quality of Income
Net Income operations. OPERATING CASH FLOW HAS TO BE POSITIVE.
Fixed Asset =Net Sales Revenue / Average Net
Shows ability to use its fixed assets to generate revenue. Hospitality average: 0.4-0.5.
Turnover Fixed Assets
=Net Income / Average Equity
= (Net Income/Sales How much we earned for any $ investment by owners - The higher the ratio percentage, the more efficient management
ROE Profitability)*(Sales / Total assets is in utilizing its equity base and the better return is to investors. Important for Shareholders. Great comparison between
productivity)*(Total assets / firms. To be compared, at the end of a period, to expected return Ke.
Shareholders' Equity financial leverage)
Profit Margin 2 =(EBIT*(1-tax)) / Net Sales
ROA is split down in these 2 ratios in order to see how each one contributes to ROA.
Asset Turnover =Net Sales / Average Assets
Combines profitability and productivity. Shows how efficiently a company can use its assets to generate sales. i.e. how
=Profit Margin*Asset Turnover = many dollars of earnings it derives from each dollar of assets they control. It's a useful number for comparing competing
ROA
(EBIT*(1-tax)) / Average Assets companies in the same industry. Will depend on the industry; companies that require large initial investments will
generally have lower return on assets. ROAs over 5% are generally considered good.
One condition to be met: ROE > ROA > Interest paid on debt. Shows the relationship between the return on assets (all
Financial Leverage=ROE - ROA forms of funding) and the return on equity (only shareholders investment).Should be positive (Indicates that the
company creates a bigger return than the cost of borrowing).
=Total Assets - Short term liabilities =
Capital Employed OF THE LAST YEAR OBSERVED!
Long term liabilities + Equity
It is similar to ROA, but this takes into account sources of financing. The return on the capital employed is measured in
ROCE =(EBIT*(1-tax)) / Capital Employed
after tax terms.
Liquidity
=Current Assets / Current Liabilities
Ability of the firm to cover its short term debt. Hospitality average: 0.75. Depends on type of business. Better to compare
Current Ratio (DIVIDENDS PAYABLES: decide if
among companies.
include them or not)
=(Cash + Cash Equivalents +
Quick Ratio Ability to cover its immediate short term debts. Hospitality average: 0.5.
Receivables) / Current Liabilities
=(Cash + Cash Equivalents) / Current
Cash Ratio Measure cash available to pay short term debts. Hospitality average: 0.15.
Liabilities
Current Ratio expressed in dollars! Negative number is not bad. Better to compare same company throughout years. Its
Working Capital =Current Assets - Current Liabilities
shows if a company has enough current assets to cover its short term debts.
Average Collection =(Average Accounts Receivables /
Period Revenues)*# days business is open
Inventory Holding =(Average Inventory / COGS)*# days Result in days. The lower, the better, but depends on business. Are linked to the success/failure of Working Capital. (USE
Period business is open "x" TO FIND MISSING VALUE OF AVERAGE)
Payable Deferral =(Average Accounts Payable / COGS)*#
Period days business is open
Solvency
=(Net Income + Interest Expense +
Times Interest Ratio has to be > 1. Bank usually wants it > 3. Comparison between companies. The higher, the easier the access to a
Tax Expense) / Interest Expense =
Earned loan. Shows the firm ability to pay the cost of financing.
EBIT / Interest Expense
Debt-to-Equity Comparison between companies. Usually: 2/3 debt financed, 1/3 equity financed. Proportion of debt for each dollar
=Total Liabilities / Shareholders' Equity
Ratio invested by the shareholders.

Market/Investor Ratios
=Net Income / Average Number of Comparison between companies. But: ratio can be controlled by buying back treasury! Measure return of investment for
EPS
Shares Outstanding for the Period shareholders.
Price-to-Earnings =Current Market Price per Share / The higher, the longer it will take to recover your investment (result in years!). Measures the relation between the
Ratio Earnings per Share current share price and the earning x share. Indicates market expectations.
Dividend Yield =Dividends (Payable!) per Share /
Physical monetary dollar return. Shows the return in term of dividends.
Ratio Market Price per Share

FREE CASH FLOW & INCOME STATEMENT

FCF = EBIT – (TAX x EBIT) + Depreciation – Investments – Change in WC

=(EBIT*(1-tax)) + Depreciation -
Changes in Working Capital without cash
Free Cash Flow
- Purchase of Fixed Assets + Receipt
from Sales of Fixed Asset
Working Capital (WC)
Change in WC
Link between SCF and FCF:
1. Change in Cash.
2. Remove Impact of Financing C.F.
3. Add back (Interest*(1-tax%)).
4. Result=FCF. *FCF-(Difference cash - Financing) = Int.*(1-tax%).
*Difference cash - Financing+ Int.*(tax%)=FCF.
=SUM(Acc Rec + Inventory + Prepaids) – SUM(Acc. Pay + Accrueds)
Subtract Year from Year. Obviously, in Year 1 there is no change in WC.
WC2 – WC1
WC3 – WC2

When Calculating IRR in Part 3:

0 1 2 3
IRR Negative value (initial investment) 200 350 …

=IRR(array)

If my Cash Flow will grow by 1% after 4th year:

=4th Free Cash Flow x ((1+1%)/(WACC – 1%)
***In order to recalculate NPV and IRR, add old 4th year FCF value to calculated perpetuity. Build new table:
0 1 2 3 4
Perpetuity Negative value Value Value Value Value
Negative value Same Same Same Value + Perpetuity

=IRR(array)
INCOME STATEMENT

EBITDA Revenue – SUM(whole array below)

Depreciation Initial Investment/Useful life of assets or EBITDA – EBIT
EBIT EBITDA – Depreciation
Interest Possible Debt Table to find Interest:
Years 1 2 3
Debt Investment x Debt %
Interest Debt x Interest Rate on Debt
Reimbursement Debt / No. of Years

EBT EBIT – Interest

TAX EBT x Tax Rate
Net Income EBT - TAX

Financial Math. Part 2.

Future value How much will my investment (PV) be in n years, at interest rate of i?
FV = PV*(1 + i)n
(1 + i) Investment for one period at an interest rate
(1+ n)n Capitalization factor (compounding the money in the future) FV/PV = (1+ n)n
Annually Annual payment of 12% annual: 12%. Nper: No of years x 1.
Semi annually Semi annual payment of 12% annual: 6%. Nper: No of years x 2.
Quarterly Quarterly payment of 12% annual: 3%. Nper: No of years x 4.
Monthly Monthly payment of 12% annual: 1%. Nper: No of years x 12.
Present value To have FV in n years, at interest rate i, how much money do I need to have now?
PV = FV (1 + i)n = FV*(1/(1 + i)n)

(1 + i)-n Discount factor (discounting money back to present)

Excel
=RATE o “Payout” is the FV value, when looking for Rate or PV
o “Price sold for today” the PV value should be negative in the formula

=IRR o When calculating IRR DO NOT forget Year 0!

Year 0 Year 1 Year
2
This value 1000 ...
is negative!

=NPER o To find out Nbr of payments (usually have to convert to number of years!)
o If there is an annual investment, in the formula put “-“ before the PMT value
=PV o You know it’s PV when question is “What is maximum price you pay today?”:
Investment Rate Nper PMT FV PV
A ???
o =-PV(rate,nper,pmt,fv) DO NOT forget the minus before the function!
o When looking for PV with payments at the end of years 1-4, list them in order:
1 2 3 4
150 200 350 …
=NPV(rate, array)
o “Payout” is the FV value, when looking for PV or Rate
o “Pays a return of X”, X will be the PMT value
 Annuity A series of equal payments at fixed intervals for a specified number of periods
• Ordinary Annuity: end of the period (PV: 0 Type: 0)
• Annuity Due: beginning of each period (PV: 0 Type: 1)
BONDS
! DO NOT forget “-“, before PVs in bond formulas (e.g. =NPER(Market Rate, PMT, -PV, FV)
PV Price today
o Price will be given in %, need to convert => price % x par value
FV Par-value
Rate Market rate
PMT Coupon rate
o Coupon rate will be given in %, need to convert => coupon rate x par value
o To convert to coupon rate: PMT / FV
NPER Maturity
!!! Do not forget to convert to years!!! Because NPER varies, depending on the frequency of compounding.
Premium: above par
Discount: below par
Maturity: bond’s life
YTM: yield to maturity (market’s expectation)
REMEMBER BOND PRICES ARE IN %s !!!
YTM To calculate YTM, you need the following:
1) Par Value of the bond (FV)
2) Price (-PV)
3) Maturity (NPER)
4) Coupon Rate (PMT) x 10
PERPETUITIES A stream of Cash Flows that lasts forever (If I leave $6,250 under annual 8% rate forever , $500 is a perpetuity)
PVt = FVt+1 / i Regular perpetuity (same amount of cash) Cash will be received next year
PV = FVt x (1 + g) / i x g Growth perpetuity (amount of cash grows at a constant growth rate) Cash will be received next year

Financial Analysis. PART 3.
Balance of Debt = Debt % x Initial Investment
At the End of the Year
Balance of Equity =Net Income + ( Equity % x Initial Investment)
At the End of the Year
Book Value of a Company Shares Outstanding x Share Price at Beginning

Capital Employed Debt + Equity

Cost of Equity (Ke) % Risk Free Rate + (Market Risk Premium * Beta Company)
Cost of Debt (Kd) Interest expense of Current Year / Balance of debt (loan) from previous year
Cost Capital Cost of Equity + Cost of Debt
Economic Value Added (EVA) (ROCE – WACC) x Capital Employed
Normal number
***ROCE = (EBIT*(1-tax)) / Capital Employed
Market Value at the End Shares outstanding x Share Price at End
Net Present Value 1. Estimate FCF
=NPV 2. Convert FCF into current value NPV > 0: Value Creation = Accept NPV < 0: Value destruction = Reject
3. NPV = PV of FCF – Initial Project
Investment
Internal Rate Return IRR > Cost of Capital Value Creation
=IRR IRR < Cost of Capital Value NPV = 0 = IRR
Destruction
IRR = Cost of Capital Transfer of Value
***Do NOT FORGET to change one of the signs, when selecting the values
Conditions to meet for NPV=IRR: 1. Projects must be independent. Decision to accept or reject one project does not affect the decision to accept or reject other project. 2. Cash flows
from the project must be conventional: one sign change ( - + + +)
Net Cost of Debt (Net Kd) % Cost of Debt * (1 – Tax Rate)
Proportion of Debt % for WACC Debt (look for real number NOT %)/( Debt + Equity)
Proportion of Equity % for WACC Equity (look for real number NOT %)/( Debt + Equity)
Proportion of Mortgage Full Mortgage / (Full Mortgage + Full Long Term Debt Amount)
ROCE % ROCE = (EBIT*(1-tax)) / Capital Employed
WACC % (Cost of Equity Ke * Proportion of Equity) + (Net Cost of Debt * Proportion of Debt)
or Ke x Proportion of Equity + Proportion of Debt x Interest Rate x (1-Tax Rate)
***Block Cell
Working capital Inventory – Acc. Pay

To find WACC: Invest, not invest, irrelevant…

1) Calculate Cost of Equity (Ke) • EPS > Dividend Per Share Irrelevant
2) Calculate Debt + Equity • Accounting value > market value Irrelevant
3) Proportion of Equity = Equity Balance at End / Capital Employed • No. of shares outstanding Irrelevant
4) Proportion of Debt = Debt Balance at End / Capital Employed • Kd > ROCE Do not invest
! DO NOT multiply given %s by the Capital Employed in order to find the Proportion of either Equity or Debt. • ROE < ROA Do Not Invest
!! Careful when dragging the row for WACC and others, because two different groups have different taxes and such. Also, while • IRR > WACC Invest
dragging, block the right cells. • NPV > 0 Invest
• ROCE > Cost of Capital Invest
• EVA > 0, Value creation
• ROE > Ke, Value creation

























PART 1.

FREE CASH FLOW