Group
Ratios
1. Current Ratio
2. Quick Ratio
Liquidity
3. Cash Ratio
4. Cash Conversion Cycle (CCC)
CCC defined as IT+DSO-DPO
1. Inventory Turnover (IT)
2. Days of Sales Outstanding (DSO)
Operating
3. Days of Payables Outstanding (DPO)
Performance
4. Fixed Asset Turnover (FATO)
5. Total Asset Turnover (TATO)
Financial
Leverage
Profitability
Value
Creation
Function
These ratios tell how many liquid funds are
available to cover immediate liabilities, and
in the case of CCC, how long it takes to
recover cash after using it to purchase
inventory
These metrics tell how long inventory is
sitting unutilized, how long it is taking to
collect on receivable, how long payments are
being delayed, and how well the assets are
being utilized
1. Debt to Assets (D/A)
2. Debt to Equity (D/E)
3. Times Interest Earned (TIE)
4. EBITDA+Lease Coverage
The first two ratios reflect the amount of
leverage that the entity has, while the second
two tell how much buffer there exists in
making the fixed payments on this leverage.
1. Gross Profit Margin (GPM)
2. Operating Profit Margin (OPM)
3. Net Profit Margin (NPM)
4. Basic Earning Power (BEP)
5. Return on Invested Capital (ROIC)
6. Return on Assets (ROA)
7. Return on Equity (ROE)
All of these margins and returns tell us how
profitable the entity is, but from different
perspectives. The ROE should be broken
apart via the DuPont method to analyze if it
is NPM, TATO or leverage (A/E).
1.P/E Ratio
2.P/CF Ratio
3.P/BV Ratio
4.P/S Ratio
The ultimate goal of an entity is to increase
value for its investors. These ratios all reflect
the amount of value as represented by the
stock price (or market cap) against key
measures (i.e., earnings, cash flow, book
value, and sales).
©2011 Ben Etzkorn
Goal
All three ratios should be increased, but only
to peer group averages or internally
determined levels based on historic
fluctuations of funds and liabilities, whereas
CCC should be minimized.
Increase inventory turnover, decrease DSO,
increase DPO without upsetting vendors, and
increase FATO and TATO.
The amount of leverage taken on by the entity
is a function of their industry, so a peer group
average is a good target. But the entity must
be able to cover their fixed payments, so the
amount of leverage may best be determined
by the historic fluctuations in their free cash
flow available to investors, and whether their
anticipated FCFI is sufficient to cover their
fixed payments.
All of these profit margins and returns should
be increased if possible. BEP should exceed
the cost of debt, otherwise additional debt
should not be issued. Likewise, ROIC should
exceed the weighted average cost of capital
(WACC), otherwise no further capital
investments should be made in the entity.
The higher each of these ratios, the better. A
high P/E , P/CF and P/S reflect growth. P/BV
also reflects growth, but uniquely shows if
shareholder value has been created or
destroyed (i.e., a ratio of one is breakeven,
and a ratio greater than one is desired).