QUICK GUIDE TO INVESTMENT ACCOUNTING RATIOS
Don Gimpel’s Investopedia.com Notes
Edited by Sandra Kovach
- QUESTIONS AND GUIDE TO ANSWERS 1. Which is the single most important metric used to measure the investment
quality of a company?
See Cash Flow Indicator/Free Cash Flow.
2. What is the most conservative measure of liquidity?
See Liquidity/Cash Ratio.
3. What is a good measure of management’s performance?
See Profitability/Operating Profit Margin, OPM or Profitability/Net Profit Margin,
NPM.
4. What is the key factor in gauging profitability?
See Profitability/Return on Capital Employed, ROCE.
5. What is a good measure of a company’s ability to leverage debt?
See Debt/Debt-Equity Ratio, DER.
6. What is a good measure of a company’s financial fitness?
See Debt/Capitalization Ratio, CR.
7. What is the most conservative measure of a company’s funding ability?
See Cash Flow Indicator/CCCR or CAPEX + Cash Dividends Ratio.
8. How can you tell if a company is able to keep paying high dividends?
See the Cash Flow Indicator/Dividend Payout Ratio, the DPR.|
9. What’s the best measure of a company’s profitability?
See Investment Valuation/Price to Cash Flow.
10. Are there problems in using the P/E Ratio?
See comments in Investment Valuation/Price-Earnings Ratio
11. What is “The King of the (Investment) Value Factors.”
See comments in Investment Valuation/Price-Sales Ratio
1
QUICK GUIDE TO INVESTMENT ACCOUNTING RATIOS
These notes are based in part upon material found in www.investopedia.com/university/ratios
LIQUIDITY … A measure of a company’s ability to pay its short-term debts
Type/Measurement
Current Ratio, CR or
Current to Working
Cash Position
What it means
The proportion of current assets
available to cover current
liabilities. The higher the ratio,
the better
Quick Ratio, QR, or
Quick Assets Ratio,
QAR
This is a measure of the amount
of the most liquid assets to
cover current liabilities. The
higher the ratio the better.
Cash Ratio, CashR
A refinement of the current
ratio to cover current liabilities.
The higher the ratio the better.
The ratio
CR = N / D
N = Cash or cash equivalents + marketable
securities + receivables and inventory
D = Notes payable + current ST debt payables +
accrued expenses+ taxes
(1+5+2+3)/(35+11+32+34)
QR = N / D
N = Cash & Equivalents + ST Inventory +
Accounts Receivable
D = Current Liabilities
(1+3+2)/33
Comments
This method is flawed because a company
is a going concern and its ability to cover
it’s current debts is not really significant
CashR = N / D
N = Cash & Cash Equivalents + Invested Funds
D = Current Liabilities
1/33
The most conservative liquidity measure. It
is not realistic to have a CR>1 because it
might be considered poor asset utilization.
The most liquid assets available to cover
current liabilities. A more conservative
valuation than the Current Ratio. The
“quickness” of the ratio depends upon the
time required to collect receivables.
# Days a company’s cash is tied
up in production and sales. The
shorter the better.
Note: The numbers in column 3 refer to Balance Sheet or P&L line items.
Cash Conversion
Cycle, CCC
2
PROFITABILITY … A measure of a company’s valuation
Type/Measurement
Profit Margin, GPM
Operating Profit
M.,
OPM
Pretax Profit
Margin, PPM
Net Profit Margin,
NPM
What it means
These four ratios measure a
company’s ability to make
money. The higher the ratio
the better.
Effective Tax Rate,
ETR
Provides a good understanding
of a company’s tax rate.
Return on Assets,
ROA
This shows how profitable a
company is compared to total
assets. The higher the better.
This compliments the ROE by
adding debt liabilities.
Return on Capital
Employed,. ROCE
The ratio
GPM = Gross Profit / Net Sales
= ( 1 – Cost of Goods Sold / Net Sales)
16-COGS/16
OP = Gross Profit – Operating Expenses
(16-COGS)-36
OPM = OP / Net Sales
= (Gross Profit–Selling Exp.-GA ) / Net
sales
((16-COGS)-37-38)/16
PPM = Pretax Profit / Net Sales 17/16
NPM = Net Income / Net Sales 18/16
GA = General & Administrative Expenses
ETR = Income Tax Expenses / Pre Tax Income
20/17
ROA = Net Income / Average Total Assets
18/19 AVG
ROCE = Net Income + Capital Employed
18+(11+12AVG)+8AVG
Capital Employed = Avg. Debt + Average
Shareholders Equity
Comments
GPM measures how efficiently a
company uses its raw materials, labor
and mfg.-related assets.
Management has real control of OPM so
this is a good measure of performance.
PPM is similar to OPM.
NPM is the bottom line and a good
performance measure..
Some analysts prefer to use the pretax
profit instead of the net profit number for
the profitability.
This is best used for historical purposes
because businesses vary widely in their
Fixed Asset requirements.
Factoring debt liability into the total capital
provides a more comprehensive measure of
how well management is using debt. Focus
on ROCE as the key factor to gauge
profitability. ROCE should be >= a
company’s borrowing rate.
3
DEBT … A measure of how well a company is using outside assets in its operations.
Type/Measurement
Overview of Debt
Debt Ratio, DR
Debt-Equity Ratio,
DER
Capitalization
Ratio, CapR
Interest Coverage
Ratio, ICR
Cash Flow to Debt
Ratio, CFDR, or
Free Cash Flow to
Debt Ratio, FCFDR
What it means
The ratio
Comments
This measures the total debt to
total assets, a measure of a
company’s debt leverage. The
lower the better.
This is another leverage ratio.
This measures how much
suppliers, lenders, creditors
and obligors have committed
versus shareholders. The
lower the ratio.
This ratio provides a key
insight into a company’s use
of leverage. This is an
excellent measure of
investment quality. The
lower the ratio the better.
This determines how easily a
company can pay interest on its
debts. The higher the ratio the
better.
This ratio provides an
indication of a company’s
ability to cover its total debt
with its yearly cash flow. The
higher the ratio, the better.
DR = Total Liabilities / Total Assets
7/6
The Debt Ratio provides a quick take on a
company’s financial leverage.
DER = Total Liabilities / Shareholders Equity
7/8
An easy-to-calculate ratio provides a
general indication of a company’s
equity-liability relationship. DER
provides a more dramatic perspective on a
company’s leverage than DR.
CapR = LT Debt/(LT Debt + Shareholders
Equity)
12((12+8)
This measures financial fitness. One of
the more meaningful debt ratios.
EBIT – Earnings before Interest and Taxes
9
ICR = EBIT / Interest Expense
9/10
Total Debt = ST + LT debt
11+12
CFDR = Operating Cash Flow / Total Debt
Other = Redeemable Preferred Stock + 2/3 of
principal of non-cancellable operating leases.
13/(11+12)
FCFDR = Operating Cash Flow/(Total Debt +
Other)
13/(11+12)
When ICR < 1.5, the company’s ability to
meet its interest expenses is questionable.
A high double-digit ratio is a sign of
financial strength. A low ratio indicates too
much debt or weak cash flow generation.
4
OPERATING PERFORMANCE … A broad measures of a company’s operating health
Type/Measurement
What it means
The ratio
Fixed-Asset
This is a rough estimate of the
FAT = Revenue / (Property + Plant + Equipment)
Turnover, FAT
productivity of a company’s
14/15
fixed asset utilization. The
higher the ratio, the better.
Sales Revenue per
Employee, SRE
This a measure of personal
productivity as Net Sales per
Employee
SRE = Revenue / # Employees
= Net Sales / # Employees
14/#Employees
16/#Employees
Operating Cycle, OC
A measurement of management
performance similar to the
CCC. The fewer the # days, the
better.
OC = DIO + DSO – DPO
DIO = # Days Inventory outstanding =
Average Inventory divided by Cost of Sales/day
Average Inventory = (Io + Ie) / 2
Cost of Sales per day = Annual Cost of Sales/365
THINK OF THIS AS CASH
SENT OUT AND THE CASH
COLLECTED. MORE
IMPORTANT WITH THE
RETAIL SECTOR. LOOK
FOR THIS INFORMATION
IN THE NOTES
Comments
This measures a company’s efficiency in
managing fixed assets. Best used with
historical ratios to establish trends. This
ratio is highly dependent on the company’s
kind of business
Like others in this class, this measure is
highly dependent upon the nature of the
business. It is best used to determine
trends among competitors.
The more efficient the collection
operations, the better. The slower the
payables are paid, the better. The lower the
inventory to sales ratio, the better. When
using the OC, look for historical
consistency.
DSO = # Days Receivable’s Outstanding =
Average Accounts Receivable/Net Sales per day
Avg. Acct. Rec = (Initial + Final)Acct. Rec. / 2
Net Sales / Day = Annual Net Sales / 365
DPO = # Days Payables Outstanding =
Avg. Accts. Payable / Cost of Sales per day
Avg. Acct. Payable = (Init. + Final ) Payables/2
Cost of Sales/Day = Annual Cost of Sales / 365
5
CASH FLOW INDICATOR … A measure of how efficiently a company uses its cash assets
Type/Measurement
Operating Cash Flow
to Sales Ratio,
OCF/S
Free Cash Flow to
Operating Cash
Flow, FCF/OCF
Cash Flow
Coverage Ratio,
CCCR
Dividend Payout
Ratio, DPR
What it means
The Operating Cash Flow to
Sales Ratio measures how the
cash generated from operations
varies over time. Generally, the
greater the ratio, the better.
This is the fraction of cash
flow available for expansion,
acquisitions and/or financial
stability to enable a company
to weather difficult
conditions. The higher the
ratio, the better.
These are measures of the
ability of a company’s OCF to
meet its obligations. The
higher the ratio the better.
Measures the fraction of
earnings allocated for cash
dividends. This is a measure
of how well earnings support
the dividend payment. The
smaller the ratio the better.
The ratio
OCF/S = Operating Cash Flow / Sales
OCF is taken from the Cash Flow Statement.
Net Sales is taken from the Income Statement
13/16
FCF/OCF=(1–Capital Exp./Operating Cash
Flow)
1-(17/13)
STDC = OCF / ST Debt 13/11
CEC = OCF / Cap. Exp. 13/17
DC = OCF / Cash Dividends 13/21
CAPEX + Cash Dividends Ratio =
OCF / (Cash Expenditures + Cash Dividends )
13/17+21
DPR = Dividends per Common Share
Earnings per Share
(21/24)/(18/24)
Comments
There are three sources of cash flow: (1)
from operations, (2) from Investing and (3)
from Financing. Use only the part derived
from operations, which is usually the
foremost source of cash.
Many investment institutions value Free
Cash Flow ahead of earnings as the single
most important financial metric used to
measure the investment quality of a
company.
These ratios determine the company’s
funding ability. The last ratio is a really
stringent measure that puts cash to the
ultimate test. It is “free cash flow on
steroids” and indicates high investment
quality
This ratio is only used for dividend
paying companies. Look for consistent
or steadily increasing ratios. Be
skeptical of excessively high dividends
because the company might not be able
to keep it up triggering a sharp stock
price decline.
6
INVESTMENT VALUATION … A measure of how an investment is valued
Type/Measurement
Per Share Data
Price to Book Value
Ratio, PB
What it means
The ratio
Comments
This ratio is how many times a
company’s stock value is
trading per share compared to a
company’s book value per share
PB = Stock Price / Shareholder’s Equity per share
23/(8/24)
Price to Cash Flow
Ratio, PCF
This ratio is used to evaluate
an investment’s
attractiveness. The lower the
ratio the better.
PCF = Stock price / Operating Cash Flow per
share
23/(13/24)
Price to Earnings
Ratio, PE
This is the best known
investment valuation
indicator.
PE = Stock Price / Earnings per share
23/(18/24)
Substitutions for the denominator include:
TTM = Trailing Twelve-month Earnings/Share
Obtain from 25 Price/Sales Ratio
FEPS = Estimate future 12-month
Earnings/Share Obtain from 22 Earnings per
Share Growth – Growth is an estimate
When a company’s stock price is less than
it’s book value then (1) the stock is
undervalued and represents a buying value
or (2) if that evaluation is correct, the
investment will be perceived as a losing
proposition or at best a stagnant investment
This ratio is similar to PB but many
analysts consider it more reliable for
evaluating acceptability of current
pricing because it is not as easily
manipulated.
This ratio is often optimistic during bull
markets and pessimistic during bear
markets. It should be looked at
skeptically particularly if forward
earnings estimates are used. High P/Es
imply a growth company where potential
investors are willing to pay extra for
potential growth. This ratio is highly
sensitive to changes in accounting
practices.
Price to Earnings to
Growth Ratio, PEG
The PEG Ratio is a refinement
of the PE Ratio made by
including the growth factor in
the denominator into the current
valuation. It measures the
degree to which high PE’s and
growth are correlated.
PEG = PE / G
(23/(18/24))/22
Here, G is the E/S Growth.
This is a variation of Graham-Dodds valuation
equation P = aE*(1 + bG) rewritten to the form
+ (P/E) / (a*(1 + bG ))
Graham and Dodd found that the constants a and b
depend upon the company’s specific industrial
classification.
If the PEG = 1. the market is currently
valuing a stock in accordance with the
stock’s current estimated earning per share
growth. If the value is <L1, the stock is
undervalued and if >1, overvalued. The
PEG Ratio determines the degree of
reliability of the assumption that high
prices and growth are related. It is
common to encounter estimates of a
company’s future growth that are incorrect.
See Value Line’s reports that are available
free at most public libraries.
7
Price to Sales Ratio,
P/S
Dividend Yield, DY
Enterprise Value
Multiple, EVM, in
years
A stock valuation indicator
similar to the P/E Ratio
except it measures valuation
against Annual Sales. The
lower the ratio, the better.
A measure of valuation as the
annual dividend per share
divided by the stock price per
share
P/S = Stock price per share / Net Sales per share
23/(16/24)
This is the ratio of the
“enterprise value” by EBITDA.
It measures how long it would
take for an acquisition to pay
off its costs.
EVM = EV / EBITDA
EV = Market Capitalization + Debt + Minority
Interest + Preferred Stock – Cash – Cash
Equivalents.
EBITDA = Earnings before Interest, Taxes,
Depreciation and Amortization
DY = Ann. Dividend/Share / Stock Price per Share
(21/24)/23
According to James O’Shaughghnessy
author of “What Works on Wall Street,”
this ratio is “The King of Value
Factors.” It beats all others and does so
consistently.
This measure depends on the nature of the
company’s business, whether it’s “value”
or “growth” oriented, earnings, cash-flow
and dividend policies. The value of this
indicator depends on whether the investor
favors value or growth.
The EVM is influenced by investor
sentiment and market conditions. It
measures the value of a company as a
going concern.
(23*24)/21+(11+12)+26-27
8
QUICK GUIDE TO INVESTMENT ACCOUNTING RATIOS
- ABBREVIATIONS CAPEX Capital Expenditure Coverage
CapR Capitalization Ratio
CashR Cash Ratio
CCC
Cash Conversion Cycle
CFDR Cash Flow to Debt Ratio
CR
Current Ratio
DC
Dividend Coverage
DER
Debt-Equity Ratio
DIO
# Days Inventory Outstanding
DPO
# Days Payables Outstanding
DPR
Dividend Payout Ratio
DR
Debt Ratio
DSO
# Days Receivables Outstanding
DY
Dividend Yield
EBIT Earnings Before Interest and Taxes
EBITDA Earnings before Interest, Taxes,
Depreciation and Amortization
EPS
Earnings (ex post) earnings per share
ETR
Effective Tax Rate
EV
Enterprise Value
EVM Enterprise Value Multiple
FAT
Fixed-Asset Turnover
FCF
Free Cash Flow
FCF/OCF Free Cash Flow to OCF Ratio
FCFDR
FEPS
G
GPM
ICR
NPM
OC
OCF
OCF/S
OPM
PB
PCF
PE
PEG
PPM
QAR
QR
ROA
ROCE
S
SRE
STDC
TTM
Free Cash Flow to Debt Ratio
Forward (ex ante) Earnings per share
Earnings per share growth
Gross Profit Margin
Interest Coverage Ratio
Net Profit Margin
Operating Cycle, Days
Operating Cash Flow
Operating Cash Flow to Sales
Operating Profit Margin
Price to Book Ratio
Price to Cash Flow Ratio
Price to Earnings Ratio
Price to Earnings Growth Ratio
Pretax Profit Margin
Quick Assets Ratio
Quick Ratio
Return on Assets
Return on Capital Employed
Sales, Net
Net Sales per Employee
Short-term Debt Coverage
Trailing 12-Month (Earnings per share)
9
QUICK GUIDE TO INVESTING ACCOUNTING RATIOS
- LOCATION OF BALANCE SHEET AND PROFIT/LOSS STATEMENT ITEMS ITEM
Accounts Receivable
Assets, Total
Book Value
Capital Employed
Capital Expenditures
Cash
Cash, Dividends
Cash, Equivalents
Cash, Flow
Cash, Free Cash
Cash Flow, Operating
Cost of Goods Sold
Debt, Average
Debt, Current Short-Term
Debt, Long-Term
Dividend Payout Ratio
Dividend Yield
Earnings
Earnings per Share Growth
Employees, number
Enterprise Value
Enterprise Value Multiple
Expense, Accrued
Expense, General & Administrative (GA)
Expense, Income Tax
Expense, Interest
Expense, Operating
Expense, Selling
Income, Net
Income, Pre-Tax
Inventory
Invested Funds
Liabilities, Current
Liabilities, Total
Minority Interest
Notes payable
Preferred Stock, redeemable
Price to Sales Ratio
Property, Plant & Equipment
Profit, Gross
Profit, Pretax
Receivables
Sales, Net
Securities, Marketable
Shareholders Equity, Average
Taxes Payable
LOCATION
Balance Sheet/Assets/Current Assets
Balance Sheet/Assets/Total Assets
Balance Sheet/Equity
Balance Sheet/Equity
Balance Sheet/Fixed Assets/Property
Balance Sheet/Current Assets/Cash
Income Statement/Footnotes/Dividends per share
Balance Sheet/Assets/Current Assets/Cash & Cash Equivalents
Cash Flow Statement
Cash Flow Statement
Cash Flow Statement
Income Statement/Expenses/Total
Balance sheet/Liabilities and Equity/Long-Term Liabilities./LT
Balance sheet/Liabilities/Current portion of bank loans
Balance Sheet/Liabilities & Equity/LT/Bank Loans
Income Statement/ Footnotes
Income Statement/Footnotes
Income Statement/Net Earnings
Income Statement/Footnotes
Personnel Records
Income Statement/Total Expenses
Income Statement/Expenses/G&A
Income Statement/Scheduled Expenses
Income Statement/Scheduled Expenses
Income Statement/Variable Expenses
Income Statement/Variable Expenses
Income Statement/Net Earnings
Income Statement/Net Earnings
Balance Sheet/Assets/Current Assets/Inventory
Income Statement/Operating Income/Interest Income
Balance Sheet/Liabilities & Equity/Current Liabilities/Total
Balance Sheet/Liabilities & Equity/Total Liabilities
Balance Sheet/Liabilities & Equity/Current Liabilities/Current
Portion of Bank Loans
Balance Sheet/Equity
Income Statement/Footnote
Balance Sheet/Assets/Fixed Assets/Property, Plant and Equipment
Income Statement/Gross Profits
Income Statement/Profit
Balance Sheet/Assets & Equity/Current Assets/Acct. Receivable
Income Statement/Revenues/Sales Net
Balance Sheet/Assets/Current Assets/Cash & Cash Equivalents
Balance Sheet/Equity/Per share capital
Balance Sheet/Liabilities and Equity/Current and Long Term
Liabilities/Taxes Payable
10
INCOME (PROFIT & LOSS) AND QUICK CASH FLOW STATEMENTS
REVENUES
Net Operating Sales
Other Income
14
TOTAL REVENUE
QUICK GUIDE REFERENCE
Net sales
Interest Income
Total revenue
9 EXPENSES
36
Operating Total
37
Selling
38
G&A
TOTAL EXPENSES
Expenses, operating
Selling expense
General & Administrative Expense
Total expenses
16
EBITDA
Earnings before Interest, Taxes, Depreciation &
Amortization
SCHEDULED EXPENSES
Interest
Depreciation and Amortization
17
Pre-tax Profit
20
Taxes
TOTAL SCHEDULED EXPENSES
10
18
21
24
23
22
25
Pre-tax Profit
NET EARNINGS
Net Earnings
NOTES
Cash dividends
Average # shares outstanding in period
Stock price at close of period
Earnings per share growth
Price/Sales Ratio
CASH FLOW
CASH FLOW
+ Net Earnings
+ Depreciation and Amortization
- Change in working capital
- Funds Invested in Period
13
QUICK CASH FLOW
Quick Cash Flow
11
BALANCE SHEET AND SHAREHOLDERS EQUITY
ASSETS
1
2
3
4
5
6
CURRENT ASSETS
Cash & Cash equivalents
Accounts Receivable
Inventory
Prepaid expenses
Securities, marketable
Other current assets
15
FIXED ASSETS
Property, Plant and Equipment
QUICK GUIDE REFERENCE
27
Cash & Cash Equivalents
Accounts Receivable, Receivables
Securities, marketable
17
Capital expenditures (fixed asset
purchases)
19
Total Assets
34
35
Taxes payable
Notes payable
11
Current short-term debt, Liabilities-current
12
Debt, long-term
24
Shareholders equity per share
15
Preferred stock redeemable
Goodwill
Other intangible fixed assets
6
TOTAL ASSETS
LIABILITIES AND SHAREHOLDERS EQUITY
8
9
10
30
32
33
CURRENT LIABILITIES
Accounts Payable
Current Income Taxes
Current portion of bank loans
Short-term provisions
Other
Total Short-term Liabilities
LONG TERM LIABILITIES
Bank loans
Issued debt securities
Deferred tax liability
26
Provisions – minority interest
7
Total Long-term Liabilities
TOTAL LIABILITIES
EQUITY
Per Share capital
Capital reserves
Revaluation reserves
Retained profits
Preferred stock redeemable
NOTES
Book value
Book value
12