2.
Technische Universität München
Liquidity analysis: Length of cash cycle
 Operating cycle of a merchandising
firm: number of days it takes to sell
inventory + number of days until the
resulting receivables are converted to
cash
 Cash cycle: Number of days a
company’s cash is tied up by its
current operating cycle
 Merchandising firm ► only finished
goods inventory
 Manufacturing firm ► inventory held
through three stages:
 raw material
 work in progress
 finished goods
Handout Problem Set 1: Financial Ratios
Inventory
storage
Acquisition of
inventory
Days payables
outstanding
Cash
collection
7
Sale
Prof. Dr. Gunther Friedl – SS 2012
Technische Universität München
Value-Based Management: Lecture 1
8
Prof. Dr. Gunther Friedl – SS 2012
2.
Technische Universität München
Cash cycle for Dell computers: Negative cash cycles
 Dell has a negative cash cycle:
 Dell manufactures and ships directly to its customers only after an order is
received ► minimal inventory days
 Its customers pay on time ► low receivable collection period
 Dell takes its time in paying its suppliers because of its market power ►
longer period of days in accounts payable
Fiscal Year Ended
2/3/06
1/28/05
Days of sales in accounts receivables
Days of supply in inventory
Days in accounts payable
29
4
(77)
27
4
(73)
27
3
(70)
Cash cycle
(44)
(42)
(40)
Handout Problem Set 1: Financial Ratios
9
1/30/04
Prof. Dr. Gunther Friedl – SS 2012
2.
Technische Universität München
Ratios for liquidity analysis: working capital ratios





Cash and cash equivalents
Marketable securities
Accounts receivable
Inventories
Prepaid expenses
Current Ratio 
Ratios for
cash
obligations
Cash flow
from
operations
Current
assets
Current
liabilities

Short-term debt

Accounts payable

Accrued liabilities
Current Assets
Current Liabilities
Cash  Marketable Securities  Accounts Receivable
Current Liabilities
 More conservative
Cash  Marketable Securities
Cash Ratio 
Current Liabilities
 Most conservative
Quick Ratio 
Cash Flow from Operations Ratio 
Handout Problem Set 1: Financial Ratios
Cash Flow from Operations
Current Liabilities
 Actual cash flows
10
Prof. Dr. Gunther Friedl – SS 2012
2.
Technische Universität München
Question 1: Calculate the cash cycle and the following liquidity
ratios for Microsoft
2011
Microsoft
2010
Average no. of days inventory in stock
(plus) Days of receivables outstanding
Length of operating cycle
(minus) Payables outstanding
Length of cash cycle
Current ratio
Quick ratio
Cash ratio
Cash from operations ratio
Handout Problem Set 1: Financial Ratios
11
Prof. Dr. Gunther Friedl – SS 2012
3.
Technische Universität München
Ratios for long-term debt and solvency analysis
Debt to Total Capital 
Debt ratios
Interest
coverage
ratios
Capital
expenditure
and CFO-todebt ratios
Total Debt (Current  Long - Term)
Total Capital (Debt  Equity)
Total Debt
Debt to Equity 
Total Equity
Times Interest Earned 
Earnings Before Interest and Taxes (EBIT)
Interest Expense
 Ability to meet
interest payments
Capital Expenditure Ratio 
CFO to Debt 
Handout Problem Set 1: Financial Ratios
 Level of risk
borne by a firm
CFO
Total Debt
Cash from Operations (CFO)
 Ability to finance
Capital Expenditures
investments and
generate cash for
debt repayment
12
Prof. Dr. Gunther Friedl – SS 2012
3.
Technische Universität München
Question 1: Calculate the following debt ratios for Microsoft
Microsoft
2011
2010
2009
0
1,000
2,000
+ Long-term debt
11,921
4,939
3,746
= Total debt
11,921
5,939
5,746
+ Total equity
57,083
46,175
39,558
= Total capital
69,004
52,114
45,304
Short-term debt
Debt to equity
Debt to capital
Times interest earned
Capital expenditure ratio
Cash flow from
operations(CFO) to debt
All numbers in $ millions
Handout Problem Set 1: Financial Ratios
13
Prof. Dr. Gunther Friedl – SS 2012
Technische Universität München
Handout Problem Set 1: Financial Ratios
14
Prof. Dr. Gunther Friedl – SS 2012
4.
Technische Universität München
Ratios for profitability analysis: return on sales
Gross (profit)
margin
Operating
margin
Gross Margin 
Operating Margin 
Operating Income
Sales
Margin before
Interest & Tax
Margin Before Interest and Tax 
Profit margin
Profit Margin 
Handout Problem Set 1: Financial Ratios
 Relationship between sales
and manufacturing costs
Gross Profit
Sales
Net income
Sales
EBIT
Sales
 Profitability from operations
 Independent of finance and tax
position
 Net of all expenses
15
Prof. Dr. Gunther Friedl – SS 2012
4.
Technische Universität München
Ratios for profitability analysis: return on investment
Return on
Assets
Return on
Total Capital
Return on
Equity
ROA 
EBIT
Average Total Assets
 Pretax
ROA 
Net Income  After - Tax Interest Cost
Average Total Assets
 After-tax (takes into account
the tax shield of debt)
ROTC 
EBIT
Average (Total Debt  Stockholder' s Equity)
 Pretax (after-tax calculation
is similar to the above one)
ROE 
Pretax Income
Average Stockholder' s Equity
 Pretax
ROE 
Net Income
Average Stockholder' s Equity
 After-tax
Handout Problem Set 1: Financial Ratios
16
Prof. Dr. Gunther Friedl – SS 2012
4.
Technische Universität München
Question 1: Calculate the following profitability ratios for
Microsoft
2011
Microsoft
2010
Gross margin (%)
Operating margin (%)
Profit margin (%)
ROA pre-interest and pretax (%)
ROTC pre-interest and pretax (%)
ROE after tax (%)
Handout Problem Set 1: Financial Ratios
17
Prof. Dr. Gunther Friedl – SS 2012
Technische Universität München
Ratios: an integrated analysis

Financial analysis requires a review of three interrelationships among ratios:
 Economic relationships:
► Example: Higher sales are generally associated with higher investment in working
capital components such as receivables and inventory. Ratios comprising these elements
should be correlated
 Overlap of components:
► Identical terms in the numerator or denominator of different ratios
► A term in one ratio being a subset or component of another ratio
► Aggregations like the total assets turnover as aggregation of inventory, accounts
receivable, and fixed asset turnover
 Ratios as composites of other ratios, e.g., ROA = profitability x turnover
 Implications of these interrelationships:
► Disaggregation of a ratio into its components allows us to gain insights into factors affecting a
firm’s performance
 Ratio differences can highlight the economic characteristics and strategies of
 The same firm over time
 Firms in the same industry
 Firms in different industries
 Firms in different countries
Handout Problem Set 1: Financial Ratios
18
Prof. Dr. Gunther Friedl – SS 2012
Technische Universität München
Analysis of firm performance
Disaggregation
of ROA
Relationship
between ROE
and ROA
ROA  Total Asset Turnover  Return on Sales  A firm’s overall profitability
is the product of an activity
Sales Operating Income


ratio and a profitability ratio
Sales
Assets

Debt 
ROE  ROA  ROA - Cost of Debt  
  Benefits from financial
Equity


leverage
ROE  Profitability  Activity  Solvency
Disaggregation
of ROE

 Standard duPont analysis
Income Sales Assets


Sales Assets Equity
Net Income EBT EBIT Net Income



EBT
EBIT Sales
Sales
Handout Problem Set 1: Financial Ratios
19
 Extended duPont analysis
Prof. Dr. Gunther Friedl – SS 2012
Technische Universität München
Appendix: The income statement – some definitions







Sales revenue is income from sales (gross revenue) minus cost associated with things like
returned or undeliverable merchandise (synonyms: sales, net sales, revenue, net revenue).
Sales cost are expenses directly related to creating the goods or services being sold (like the
cost of raw materials, salaries of persons turning raw materials into sellable goods, depreciation
of equipment); not included are expenses like R&D, marketing, and interest payments on debt.
Synonyms: cost of sales, cost of goods sold (CoGS).
Gross profit (synonym: sales profit) = sales revenue – sales cost
Operating expenses are expenses associated with running a business but not (necessarily)
considered directly applicable to the current line of goods and services being sold. These
include Sales and Marketing, R & D, and General and Administrative costs (including the
salaries of people working in these areas).
Operating income = gross profit – operating expenses. Operating income is the pre-tax, preinterest profit from the company's “operations”. Synonymous to EBIT, if the firm has no
nonoperating income.
Recurring income refers to a company’s income by recurring activities and excludes the
impact of transitory or random components which should not be regarded as components of
permanent or sustainable income (unusual or infrequent items).
Earnings (synonym: net income or profit) = total income minus total expenses. "Net income" is
used for after-tax profit before paying dividends; this is the number that's carried to the top of
the cash flow statement.
Handout Problem Set 1: Financial Ratios
20
Prof. Dr. Gunther Friedl – SS 2012