SOPHIA

FENG
FINANCIAL ANALYSIS
Tests of Profitability:

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1. Profit Margin (%)
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The percentage of each sales dollar, on avg, that represents profit. Higher ratio means higher operating
efficiency. But a high sales volume can compensate for low profit margin – therefore depends.

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2. Quality of Income (Abs Value)
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The company’s ability to transform net income into cash. A quality of income ratio that is higher than 1 is
considered to indicate high quality earnings. Higher ratio: the company is better at managing their Acc Rec.

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3. Fixed Asset Turnover (Abs Value)
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The company’s ability to transform net income into fixed assets. Higher ratio: better ability to effectively utilize
fixed assets to generate revenue. Can be compared to those of main competitors.

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4. Asset Turnover Ratio
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Used mostly for companies that hold large amounts of inventory and accounts receivable. Higher ratio shows
better ability in operating efficiently. Based on total asset instead of only fixed assets.

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5. Return On Equity (ROE)
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(%)

ROE measures a corporation's profitability by revealing how much profit a company generates with the money
shareholders have invested. The higher the ratio percentage, the more efficient management is in utilizing its
equity base and the better the return is to investors. (tells shareholders how effectively their money is being
employed)

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6. Return On Asset (ROA)
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(%)

OR Profit Margin * Asset Turnover (%)

The ROA figure gives investors an idea of how effectively the company is converting the money it has to invest
into net income. The higher, the better, because this means their asset turnover is more efficient. (compare it to
previous data or a similar company.)

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7. Profit Margin for ROA
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(%)

8. Financial Leverage ROE – ROA (%)

(ROE> ROI > ROA) It should be positive for the company should create a bigger return than the cost of
borrowing. Financial Leverage is positive when interest rate is lower than ROE. Investing efficiently OR
borrowing efficiently.

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9. Return on Capital Employed (ROCE)
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(%)

Should be higher than expected return on investment, here is when value is created. Bigger number indicates
less assets.




 SOPHIA FENG
FINANCIAL ANALYSIS

Test of Liquidity:

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1. Cash Ratio
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(Abs Value)

Adequacy of available cash. Measures cash availability to pay short term dept. A low current ratio might
indicate that the company might have problem paying back its debt, but a high current ratio might indicate
that the company is not using its current assets efficiently. (0.75 recommended. Hospitality:0.15)

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2. Quick Ratio
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(Abs Value)

Inventories and prepaid expenses are not included within quick assets. It is a measure of safety margin
available to meet a company’s current liabilities. Hospitality: 0.5. Measures the proportion of debt that is able
to be paid within 30 days.

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3. Current Ratio
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(Abs Value)

Tells us what part of our short term debt we are able to payback within the year. A low current ratio might
indicate that the company might have problem paying back its debt, but a high current ratio might indicate
that the company is not using its current assets efficiently. 2- financially conservative. Hospitality: 0.75

4. Working Capital Current Assets – Current Liabilities (Abs Value)

Indicates whether a company has enough short term assets to cover its short term debt. Anything below 1
indicates negative W/C (working capital). While anything over 2 means that the company is not investing
excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.

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5. Receivable Collection Period ∗ 365 (Days)
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How long it takes your customers to pay you

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6. Inventory Holding Period ∗ 365 (Days)
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How long it takes to turn over the inventory

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7. Payable Deferral Period ∗ 365 (Days)
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How long it takes you to pay your suppliers

8. Operating Cycle Receivable Collection Period + Inventory Holding Period – Payable deferred Period

Is not good when its positive, meaning that there are days you spend without having money.

9. Free Cash Flow = EBIT*(1-tax) + Depreciation – ∆WC (without cash) – investment + sale on NCA












 SOPHIA FENG
FINANCIAL ANALYSIS

Tests of Solvency:
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1. Time interest earned ratio
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(Abs Value)

Represents a margin of protection for creditors. A high ratio indicates a secure position for creditors. Should be
larger than 1 but the bank prefers 3. The higher the better because it means less risky for creditors.

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2. Debt to Equity ratio
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(Abs Value)

Represents the proportion of debt each dollar invested by shareholders. A high debt/equity ratio generally
means that a company has been aggressive in financing its growth with debt. Aggressive leveraging practices
are often associated with high levels of risk.


Market/ Investors ratio:
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1. Price/ Earnings (P/E) ratio
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(Abs Value)

Reflects the stock market’s assessment of a company’s future performance. A high ratio indicates that earnings
are expected to grow rapidly: the market has faith in the company. If you invest in a company with high P/E,
you don't earn a lot and it depends on the risk you take. If too high and real value does not match expectation,
the impact is drastic on the stock. Stocks with low potential tend to offer higher dividend yields.


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2. Dividend Yield ratio
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(%)

How much I earned physically. The higher the better but investors are willing to accept low dividend yield if
they expect that the price of stock will rise when they own it. Stocks with low growth potential tend to offer
higher dividend yields than do those with high growth potential.

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3. Earnings Per Share
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(Abs Value)

A measure of return on investment that is based on the number of shares outstanding. Represents return on
investment for shareholders. Can make it look better by purchasing Treasury Stock cuz TS does not go in
calculation. Should be careful whether its increase is caused by increase in net income or not.