Liquidity
‹
Liquidity refers to the firm’s ability to fund its current operations.
There are two common measures used to analyze liquidity.
Current Ratio =
Current Assets
Current Liabilities
where Current Assets include Cash, Marketable Securities, Inventory, Accts Receivable, and
Other Current Assets and Current Liabilities are liabilities due within the next year.
Quick Ratio =
‹
Cash and Marketable Securities
Current Liabilities
For firms with negative earnings, the potential for cash flow problems
can also be identified using the Cash Burn Rate:
Cash Burn Rate =
Cash
EBITDA
where EBITDA<0
Leverage and Solvency
‹
To what extent is the firm using debt vs. equity financing and is the
firm able to meet its debt obligations?
Debt to Capital =
Debt
1
= 1−
Debt
Debt + Equity
1 + Equity
Debt to Equity =
Debt
Debt to Capital
=
Equity 1 − Debt to Capital
(
Times Interest Earned =
)
EBIT
Interest Expense
1
Liquidity and Leverage for Home Depot
‹
Calculate each of the liquidity and leverage measures using Home
Depot’s Financial Statements (use beginning period or average
balance sheet values when comparing income statement and balance
sheet numbers).
‹
Liquidity:
Current Ratio =
‹
18000
= 1.392
12931
Quick Ratio =
600 + 14
= 0.047
12931
Leverage:
Debt to Capital =
11661
= 31.78%
11661 + 25030
Times Interest Earned =
Debt to Equity =
11661
= 46.59%
25030
9673
= 24.676
392
Efficiency
‹
How effective is the firm in using its assets to generate sales and in
turning sales into cash?
Inventory Turnover =
Cost of Goods Sold
Inventory
Days in Inventory =
Accts Rec Turnover =
Sales
Accts Rec
Avg Collection Period =
Total Asset Turnover =
Sales
Total Assets
Total Capital Turnover =
Sales
Total Capital
Inventory
365
=
Avg Daily COGS Inv TO
Accts Rec
365
=
Avg Daily Sales Accts Rec TO
LT Operating Asset Turnover =
Working Capital Turnover =
Sales
LT Operating Assets
Sales
Noncash Working Capital
2
Efficiency for Home Depot
‹
Calculate each of the efficiency measures using Home Depot’s
Financial Statements (use beginning period or average balance sheet
values when comparing income statement and balance sheet numbers).
Inventory Turnover =
61054
= 5.355
11401
Days in Inventory =
Accts Rec Turnover =
90837
= 37.912
2396
Avg Collection Period =
365
= 68.159
5.355
365
= 9.628
37.912
Total Asset Turnover =
90837
= 2.042
44482
LT Operating Asset Turnover =
Total Capital Turnover =
90837
= 3.018
3185 + 26909
Working Capital Turnover =
90837
= 3.648
24901
90837
= 29.733
14539 - 11488
Profitability
‹
Profitability relative to sales:
Gross Profit Margin =
OperatingMargin =
‹
Sales - COGS
Sales
Net Profit Margin =
Net Income
Sales
OperatingProfit EBIT(1− T)
=
Sales
Sales
Profitability relative to assets:
Return on Assets (ROA) =
Net Income
Total Assets
Return on Equity (ROE) =
Net Income
Book Value of Equity
Return on Capital (ROC) =
Net Operating Profit
EBIT(1 − T)
=
Operating Capital
Debt + Equity
or
EBIT(1 - T)
Total Assets
3
Profitability (continued)
‹
Return on Capital can be decomposed as follows:
Return on Capital (ROC) =
⎞
EBIT(1 − T)
Sales
⎛ EBIT(1 - T) ⎞ ⎛
⎟
=⎜
⎟×⎜
Book Value of Capital ⎝ Sales ⎠ ⎜⎝ Book Value of Capital ⎟⎠
= After-tax Operating Margin × Capital Turnover Ratio
‹
Return on Equity can be decomposed as follows:
Return on Equity (ROE) =
Net Income
Net Income
Sales
Total Assets
=
×
×
Book Value of Equity
Sales
Total Assets
Equity
= Profit Margin × Asset Turnover × Financial Leverage
Return on Equity (ROE) =
Net Income
Debt
= ROC +
(ROC − i(1 − T) )
Book Value of Equity
Equity
= ROC + (Leverage × Spread )
Profitability for Home Depot
‹
Calculate Return on Capital and its components using Home Depot’s
financial statements.
Return on Capital (ROC) =
9673(1 − .3811) ⎛ 9673(1 - .3811) ⎞ ⎛
90837
⎞
=⎜
⎟
⎟×⎜
3185 + 26909 ⎝
90837
⎠ ⎝ 3185 + 26909 ⎠
= 19.89% = 6.59% × 3.018
‹
Calculate Return on Equity and its components using Home Depot’s
financial statements.
Return on Equity (ROE) =
5761 ⎛ 5761 ⎞ ⎛ 90837 ⎞ ⎛ 44482 ⎞
=⎜
⎟×⎜
⎟×⎜
⎟
26909 ⎝ 90837 ⎠ ⎝ 44482 ⎠ ⎝ 26909 ⎠
= 21.41% = 6.34% × 2.042 × 1.653
Return on Equity (ROE) =
3185
5761
(19.89% − 11.46%(1 − .3811) )
= 19.89% +
26909
26909
= 21.41% = 19.89% + 11.84%(19.89% − 7.09%)
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