Ratio Analysis

Types of Ratios

Types of Ratios
Profitability ratio Activity ratio Liquidity ratio Leverage ratio Return ratio Valuation ratio

Profitability ratios
Profitability is the ability of a business to earn The overall measure of success of a business is the profitability Which results from the effective use of its resources

Profitability ratios are:

Gross Profit Ratio

Operating Profit Margin

Net Profit Margin

Profit and Loss Statement

A financial statement that summarizes the revenues, costs and expenses incurred during a specific period of time - usually a year

Sales Less: Cost of Goods Sold

Top Line

Less: Selling and Admin Exp

Operating Profit Less: Interest Less: Depreciation Less: Taxes Net Profit Bottom Line Middle Line

Apple
Product Portfolio iPhone Laptop iPad Desktop

Steve Jobs, Co-founder, Chairman and CEO

Are the Sales growing?

Sales = Selling Price x No of units sold Find the growth rate sales (10%, 15%, 18%, etc.) To know whether it is good or bad, compare the growth rate over a 5 years period Growing Sales is better or decreasing????? Also, compare the sales growth vis-a-vis the industry

Revenues
(Currency in million of U.S $)
Sales
2007 2008
37,491

2009
42,905

2010
65,225

2011
108,249

Growth in Sales

14.44%

52.02%

65.96%

120,000 100,000 80,000 US$m 60,000 40,000 20,000 2008

Sales Revenue (US$m)

Sales growth (or increase in sales) is one of the parameter to check the performance of the company
Apple

Apple revenues showed an impressive CAGR of 30%

2009

2010

2011

Cost of Goods Sold & Selling Expenses

COGS is the costs that go into creating the products that a company sells; therefore, the only costs included in the measure are those that are directly tied to the production of the products.

Raw Materials

Power & Fuel

Salaries

Other Manufacturing Expenses Advertisement

Carriage Inward

Wages Travelling Exp of Salesman

Miscellaneous Expenses

Revenue, COGS and Operating Expenses

Apple - Millions of U.S. Dollars

Revenues TOTAL REVENUES

2008 37,491.00 37,491.00

2009 42,905.00 42,905.00

2010 65,225.00 65,225.00

2011 108,249.00 108,249.00

Cost of Goods Sold GROSS PROFIT Selling General & Admin Expenses, Total R&D Expenses OTHER OPERATING EXPENSES, TOTAL

24,294.00 13,197.00 3,761.00 1,109.00 4,870.00

25,683.00 17,222.00 4,149.00 1,333.00 5,482.00

39,541.00 25,684.00 5,517.00 1,782.00 7,299.00

64,431.00 43,818.00 7,599.00 2,429.00 10,028.00

OPERATING INCOME

8,327.00 11,740.00 18,385.00

33,790.00

COGS , R&D and SG&A expenses as percentage of sales

COGS as % of Sales
65% 64% 63% 62% 61% 60% 59% 58% 57% 56% 2008 2009 2010 2011 4% 3% 3% Apple 2% Apple

R&D as % of Sales

2%
1% 1% 0% 2008 2009 2010 2011

Apple managed to reduce its COGS as a % of Sales during recession time as well, one of the reason could be Apple was focusing only on ipod Apple spent only 2% of sales on Research & Development which is an important area of the technology firm

SG&A expenses as % of Sales

12% 10% 8% 6% 4% 2% 0% 2008 2009 2010 2011 Apple

Is the company profitable?

Profit to be analyzed
Operating Profit Net Profit

For analyzing a company stock, we primarily look at Operating Profit However, we don't look at Operating Profit as an absolute figure We always convert it to Operating profit Margin (OPM) Operating Profit Margin (%) = (Operating Profit/Sales) *100
OPM indicates the operating efficiency of the company (how well the company can convert its sales into profits) Once we calculate the OPM, we compare the OPM over a 5year timeframe as well as with the industry

Operating Profit Margin

OPM
Apple

2008 2009 2010 2011

35%

OPM %
30% 25% 20% 15% Apple

22% 27% 28% 31%

Significance of the OPM (i.e. what does the OPM mean?)

10% 5% 0% 2007 2008 2009 2010 2011

High OPM A high operating profit margin means that the company has managed to control its operating cost and has strong productivity This results in higher efficiency Low OPM A low OPM indicates high operating costs, lower efficiency Looking at the operating efficiency, Apple improved its operational efficiency during the period from a low of 22% to 31%

Net Profit Margin

Net Profit is referred as Bottom Line From operating profit, expenses such as depreciation, interest and taxes are deducted to arrive at Net Profit. However, we don't look at Net Profit as an absolute figure We always convert it to Net Profit Margin (NPM)

Net Profit Margin (%) = (Net Profit/ Sales) *100

NPM being higher is not necessarily good thing NPM being low is not necessarily bad thing

NPM if high or low, we need to identify , what is company reasons why NPM is low or high, what company is doing about it?
NPM mainly depends on Interest and depreciation For eg: NPM is low because of interest and depreciation expense, which means that the company is in growth stage or expansion mode

Calculation of NPM
Sales Sales 2007 2008 37,491 2009 42,905 2010 65,225 2011 108,249

Net Profit
NPM

6,119
16%

8,235
19%

14,013
21%

25,922
24%

Apples focus on cost efficiency combined with innovative marketing

strategies keeping a tight control on the budget has helped it emerge not
only unscathed through the recession, but actually profit through it

Activity Ratios
Activity ratios measure the efficiency or effectiveness with which a concern manages its resources or assets Activity ratios are also known as turnover ratios as they indicate the speed with which assets are converted or turned over into sales

Activity ratios are:

Inventory Turnover Debtors Turnover Average Collection Period Creditors Turnover Average Payment Period

Calculation of Inventory Days

Apple
Cost of Goods sold

2007

2008 24,294 509

2009 25,683 455 482 53 7

2010 39,541 1,051 753 53 7

2011 64,431 776 914 71 5

Inventories Avg Inventory Inv turnover Ratio Inventory days

The success of iphone and ipad both contributed to a higher inventory turnover ratio, leading to lower inventory carrying costs, with average inventory days controlled at 7 days

Calculation of Debtors Days/ Collection Period

Debtors Days 2007 2008 2009 2010 2011

Sales
Accounts receivables Avg receivables Debtor t/o = sales/avg) Debtor days

37,491
2422

42,905
3361 2,892 15 25

65,225
5510 4,436 15 25

108,249
5369 5,440 20 18

Apple managed to keep its debtor days low, ensuring quick collection of funds and were tightly managed at 25

Calculation of Creditors Days/ Payment Period

Creditors Days
Cost of Goods sold

2007

2008

2009

2010

2011

24,294
5,520

25,683
5,601 5,560.5 4.62 79.02

39,541
12,015 8,808 4.49 81.31

64,431
14,632 13,323.5 4.84 75.48

Accounts Payable Avg a/c payable Creditor t/o Creditor days

It managed to gain better credit period from its suppliers during the economic recession and stretched to the 70s
Both Debtors and creditors days were giving sufficient leverage with its working capital management

Balance Sheet
Analyzing the Balance Sheet

1 2 3 4 5 6

Sources of Funds Equity Reserves Debt

Total Liabilities (1+2+3) Application of Funds Fixed Assets Current Assets Current Liabilities Total Assets (5+6-7)

7
8

Total Liabilities = Total Assets

Equity and Reserves

Equity is the OWNED FUND Total Equity = Equity Share Capital Share Capital = No of Shares * Face Value

It signifies Example : Company A has an equity base of Rs 30Cr Company B has an equity base of 60 Cr So Company B is larger in capacity compared to Company A

Reserves
Reserves are retained earnings of the business
Retained earnings is the last item in the P&L statement. And this figure is carried over into the Balance Sheet "under Reserves"

Debt
Total Debt = Secured + Unsecured Loans If a company has huge debt amount, than company is liable to pay debt amount and interest, even if it is making less profits or losses. So, huge debt is not good for a company And if a company has no or less debt than the company has to pay higher taxes, this can be explained with the following example: Taxes are paid on profits Company A Zero debt, So no interest Profit Rs 1,00,000 Company A will pay higher taxes compared to Company B Company B Debt is there so paying interest of Rs 20,000 Profit Rs 1,00,000

Less: Interest

0
Rs 1,00,000

Less: Interest

20,000
Rs 80,000

So Company A has to pay taxes on Rs 1,00,000

Whereas Company B has to pay taxes on Rs 80,000

Reserves & Debt

Is it good to have more loans or more reserves? Obviously its good to have more reserves, to have more owned fund rather than borrowed fund (loans) Does the company have sufficient reserves? Reserves indicate that whether the company will be able to repay its borrowed funds Compare reserves with loans. If reserves are higher or equal to loan amount, this means that company can easily pay off its loan, when required

Application of Funds
Fixed Assets Those assets which are purchased for the purpose of operating the business but not for resale (Which we hold for more than one year) Example: Land, Building, Machinery, etc. Current Assets Those assets which can be converted into cash within short period of time (Which we hold for less than one year) Example: Cash, Debtors, Closing Stock, Short term investments Current Liabilities A company's debts that are due within one year. Example: Creditors, Bills Payable, Bank Overdraft

Reserves Deployed
How are the reserves deployed? Are the reserves liquid or illiquid? Reserves can be deployed in investments

Liquid assets are those that you can easily and efficiently exchange for another asset or good.
Cash is the classic example. To qualify as liquid, you must be able to sell the asset quickly. Liquid Assets: Cash, short term investments, fixed deposits Illiquid assets which cannot easily be sold or exchanged for cash quickly because of a lack of ready and willing investors or speculators to purchase the asset. Illiquid Assets: Building, Machinery, Capital Work in Progress, Loans and Advances

Keeping the Balance Sheet Strong

Short term assets
Apple

2007

2008
22,111

2009
23,464

2010
25,620

2011
25,952

Expansion focus
Net Property Plant & Equipment Apple Making the right investments Investments Apple 2007 2008 2009 2010 2,379 10,528 25,391 2011 55,618 2007 2008 2,455 2009 2,954 2010 4,768 2011 7,777

The Net Property, plant and equipment figures reveal that Apple has made significant addition to its equipment during the down turn, gearing it suitably for the upturn in the economy.