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Click here to type page title,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,*,*,Ratio Analysis,BOS,Author:Collins Qian,Ratio Analysis,March 1998,1,Agenda,Using ratios,Types of key ratios,profitability,turnover,leverage,liquidity,coverage,Return on Equity,Ratio exercises,Forecasting exercise,Abbreviations,Key takeaways,2,Analyzing Ratios,Ratios in isolation are meaningless.A companys ratios must be examined over time and/or against its competitors ratios.,Historical comparison,Competitive comparison,Compare present ratios with same companys historical ratios,In stable situations,historical ratios may be used to project future performance,Compare a companys ratios with similar firms ratios or with industry averages at the same point in time,Look for trends,Look at relative performance,3,The Art of Ratio Analysis,Which ratios are most important in a given situation?,What items should be included/excluded in calculating the ratios?,How much influence does management have over the ratios?,What do the ratios say about the firms strategy?,Ratio analysis is an art as well as a science.,4,The Need for Judgment,Potential Problem,Management can substantially influence financials in the short term,Implications,Need to use judgment to understand financials,Ratio analysis requires keen judgment.,Financial statement data is historical,not pro forma,Cross-company comparisons are meaningless if adjustments are not made for different accounting conventions,The timing of the reporting period influences funds flows and requirements,Need to understand that history does NOT necessarily predict future,Need to be very sensitive about industry-specific seasonality and cyclicality,Need to standardize across companies to adjust for different accounting methods,5,Agenda,Using ratios,Types of key ratios,profitability,turnover,leverage,liquidity,coverage,Return on Equity,Ratio exercises,Forecasting exercise,Abbreviations,Key takeaways,6,Types of Ratios,Ratios help us understand how well a company is performing.Specifically,how much return is it generating with what level of risk?,How well does the company manage costs relative to revenues?,Return,Risk,Coverage,Interest charge,Fixed charge coverage,Liquidity,Current ratio,Quick ratio,Leverage,Asset to equity,Debt to equity,Debt to total capital,Turnover,Receivables,Inventory,Payables,Asset,Profitability,Operating margin,ROS,Gross margin,How effective is the company in managing its resources?,What are the respective claims of debt and equity owners?How risky is the business?,Is the company able to meet its short-term obligations?,Is the company able to meet its long-term obligations?,7,Profitability Ratios-Definitions,*,This is not a profitability ratio,but it does impact ROS,Profitability ratios use line items from the income statement.,Ratios,Definitions,Gross profit margin,(or gross margin),Sales-cost of goods sold,Sales,Operating profit margin,(or operating margin),Earnings before interest and taxes,Sales,Return on sales,(ROS),Profit after tax,Sales,Effective tax rate*,Taxes,Profit before tax,8,Profitability Ratios-Description,Profitability(or margin)ratios are a function of both the industry and a companys position within the industry,boundaries are set by the operating characteristics of the industry,within these boundaries profitability ratios are determined by a players relative position,Bain typically uses gross profit and operating profit to measure profitability,ROS can be altered by non-operating activities,such as sources of financing or tax rate manipulations,Extraordinary items,because they are for unusual events,such as discontinued items or asset sales,are excluded when we analyze the performance of the base business,Profitability ratios measure a firms ability to manage costs relative to revenues.,9,Profitability Ratios-Over Time,Gross profit margin,should stay constant or increase because cost of goods sold should be a constant percent of sales or should decrease as company gets price increases and/or volume discounts,Operating margin,should increase as fixed administrative and sales costs are spread over a greater number of units,Effective tax rate,should stay constant or decrease since a larger firm is able to take advantage of more tax shelters,As a company grows,its return on sales should increase.,Higher return on sales,10,Profitability Ratios-Market Leader,Gross profit margin,should be higher since a market leader can typically charge more for its goods and/or receive the greatest volume discounts from suppliers,Operating profit margin,should be significantly higher,because higher volume means fixed costs are spread over more units and because the gross profit margin is higher,There should be no significant difference in the,effective tax rate,Return on sales,should be significantly higher because the operating margin should be significantly higher,The market leader in an industry should have the best profitability ratios.,This
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