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Ratio Analysis Doc-tutorial

Uploaded by

ynpq6zqvzy
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© © All Rights Reserved
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Download as DOCX, PDF, TXT or read online on Scribd
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1.

Liquidity ratios, which give an idea of the firm’s ability to pay off debts that

are maturing within a year.

2. Asset management ratios, which give an idea of how efficiently the firm is

using its assets.

3. Debt management ratios, which give an idea of how the firm has financed its

assets as well as the firm’s ability to repay its long-term debt.

4. Profitability ratios, which give an idea of how profitably the firm is operating

and utilizing its assets.

5. Market value ratios, which give an idea of what investors think about the firm

and its future prospects.

Profitability Ratios

A group of ratios that show the combined effects of liquidity, asset management, and debt on operating
results.

Operating Margin

This ratio measures operating income, or EBIT, per dollar of sales; it is calculated by dividing operating
income by sales.
Profit Margin

This ratio measures net income per dollar of sales and is calculated by dividing net income by sales.

Return on Total Assets (ROA)

The ratio of net income to total assets; it measures the rate of return on the firm’s assets.
Return on Common Equity (ROE)

The ratio of net income to common equity; it measures the rate of return on common stock holders’
investment.

Return on Invested Capital (ROIC)

The ratio of after-tax operating income to total invested capital; it measures the total return that the
company has provided for its investors.
Basic Earning Power (BEP) Ratio

This ratio indicates the ability of the firm’s assets to generate operating income; it is calculated by
dividing EBIT by total assets.
Profitability Ratios:

Profitability ratios show how well a company is doing at making a profit. They combine information from
the income statement (sales, expenses, profits) and sometimes the balance sheet (assets). Here are
some key ones:

1. Operating Margin:

Formula:

Operating Margin=Operating Income/ (EBIT)Sales

Meaning: It shows how much profit the company makes from its core operations for every dollar of
sales.

Example: If a company makes $10 from sales and $1 from operating profit (EBIT), the operating
margin is:

Analysis: A higher margin means the company controls its costs well and makes more profit from its
core activities.

2. Profit Margin:

Formula:

Profit Margin=Net Income/Sales

Meaning: This shows how much of each sales dollar is left as profit after all expenses (including
interest and taxes).

Example: If a company has $3,000 in sales and $117.5 in net income, the profit margin is:

Analysis: If the company has a low profit margin, like 3.9%, it might be spending too much on costs or
interest. A high debt load often reduces the profit margin.

3. Return on Assets (ROA):

Formula:

ROA=Net Income/Total Assets

Meaning: This ratio shows how efficiently the company is using its assets to generate profit.

Example: If the company has $117.5 in net income and $2,000 in total assets, the ROA is:

Analysis: A higher ROA means the company is getting more profit out of each dollar of assets.
4. Return on Equity (ROE):

Formula:

ROE=Net Income/Common Equity

Meaning: This measures how much profit a company generates with the money shareholders have
invested.

Example: If the company has $117.5 in net income and $940 in equity, the ROE is:

Analysis: Higher ROE is good for shareholders because it means the company is generating more profit
with their investment.

5. Return on Invested Capital (ROIC):

Formula:

ROIC=EBIT×(1−Tax Rate)/Total Invested Capital (Debt + Equity)

Meaning: ROIC tells us how well the company is using its capital (both debt and equity) to generate
profit.

Example: If EBIT is $170.3, tax rate is 40%, and total invested capital is $1,800, the ROIC is:

Analysis: Higher ROIC means the company is using both debt and equity efficiently to generate profits.
Market Value Ratios

Ratios that relate the firm’s stock price to its earnings and book value per share.

Price/Earnings (P/E) Ratio

The ratio of the price per share to earnings per share; shows the dollar amount investors will pay for $1
of current earnings.
Market/Book (M/B) Ratio

The ratio of a stock’s market price to its book value.


Enterprise Value/EBITDA (EV/EBITDA) Ratio

The ratio of a firm’s enterprise value relative to its EBITDA.


1. Price/Earnings (P/E) Ratio

Formula: P/E Ratio=Price per Share/Earnings per Share (EPS)

What it tells us: This ratio shows how much investors are willing to pay for every $1 of the company's
earnings. If the P/E ratio is high, it usually means investors expect the company to grow a lot in the
future.

a company’s stock price is $20 and its earnings per share is $2, the P/E ratio is 10. This means investors
are willing to pay $10 for every $1 the company earns. If the ratio is lower than similar companies, it
might indicate that investors don’t have as much confidence in this company's growth or stability.

2. Market/Book (M/B) Ratio

Formula: M/B Ratio=Market Price per Share/Book Value per Share

What it tells us: This compares the market value of a company to its book value (the value of the
company’s assets minus its liabilities). A ratio above 1 means investors think the company is worth more
than its actual assets, which suggests strong future growth.

If a company's stock is priced at $30 and the book value is $15 per share, the M/B ratio is 2. This means
investors are willing to pay $2 for every $1 of assets the company owns. A higher M/B ratio usually
indicates a strong, respected company, while a lower ratio might signal lower investor confidence.

3. Enterprise Value to EBITDA (EV/EBITDA) Ratio

Formula: EV/EBITDA Ratio=Enterprise Value (EV)/EBITDA

What it tells us: This ratio looks at the company’s overall value (market value of equity plus debt
minus cash) compared to its earnings before interest, taxes, depreciation, and amortization (EBITDA). It
helps compare companies with different levels of debt.

If a company's enterprise value is $10 million and its EBITDA is $2 million, the EV/EBITDA ratio is 5. A
lower ratio compared to competitors suggests the company might be undervalued.

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