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RATIOS
Presented to you by: SIM A. BELSONDRA
Financial Ratios
FOUR BASIC TYPES - most commonly used for each - can
be used for some financial companies.
LIQUIDITY
• Current ratio = Current Assets / Current Liabilities
MANAGEMENT SKILL
• Total Asset Turnover = Sales / Total Assets
FINANCIAL RISK
• Debt Ratio = Debt / Assets
• Times Interest Earned = Net Operating Income /
Interest Expense
Leverage and interest-paying ability - used for financials.
Depository Institutions -
Banks, S&L, Credit Unions
Financial Statements
• National-charter banks must submit uniform accounting
statements to the Comptroller of the Currency.
• State charter banks submit accounting statements to their
state regulator.
PROFITABILITY
Interest Margin to Earning Assets =
(Interest Income-Interest Expense)/Earning Assets
• Profit Margin = Net Income/Total Operating Income
• Return on Earning Assets = Net Income/Earning Assets
• Return on Equity = Net Income/Equity
FINANCIAL RISK
• When a loan is made, the bank earns interest above the risk-
free rate. The premium above the risk-free rate is a premium
for bearing risk as well as compensation for analyzing the
and monitoring the borrower’s financial condition.
Loan rate = risk-free rate + risk premium and compensation
Effect of Loans vs. Guarantees
on Financial Statements
1. The effects of loans - transparent.
• The loan appears as an asset on the balance sheet.
• A loan loss reserve appears as a contra-asset that
reduces the loan value by an amount to cover the
expected loss on the loan - a risk measure.
• Interest is collected periodically and appears on the
balance sheet.
2. The effects of loan guarantees - opaque
• Off-balance sheet “intangible” liability - no contingent
liability is booked. Footnote should provide some info.
• Large up-front fee may appear immediately on income
statement or periodic fee shows up over time.
3. The cash payment for the guarantee goes to the cash
account and a portion of the payment appears as a reserve for
default and the rest goes to equity. The size of the reserve is
supposed to be commensurate with risk of the borrower.
4. Problems with guarantees
• Guarantor may reserve too little when loan is not on
balance sheet.
• If reserve is set properly, competitor lenders are able to
see the value you place on particular customer’s
creditworthiness.
Insurance Companies
FINANCIAL STATEMENTS
• State insurance regulators require annual reports based on
statutory accounting practices (SAP).
• Reports are similar across states and focus on the balance
sheet to help assure solvency for policyholders.
• A.M. Best provides “Best’s Insurance Reports” which rate
insurance company financial strength.
• Ratios used by best include operating, profitability,
leverage, liquidity ratios - specific to insurance type.
• Annual reports filed with the SEC follow GAAP.
Insurance Ratios
MANAGEMENT EFFICIENCY
• Loss Ratio = Incurred Losses/Premiums Earned
• Expense Ratio = (Sales + Service Expenses)/Premiums
Earned
• Dividend Ratio = Dividends/Premiums Earned
• Combined Ratio=Loss Ratio+Expense Ratio-Dividend
Ratio
• Combined Ratio after Dividends =Loss Ratio+Expense
Ratio
• If the Combined Ratio after Dividends exceeds 1, then the
company must rely on investment income for profit.
Note: Earned premiums are premiums paid on policies with
time elapsed - unearned premiums are paid but no time
elapsed.
PROFITABILITY
• Investment Return =Net Investment Income/Premiums
Earned
• Operating Ratio = Combined Ratio After Dividends -
Investment Return
• Overall Profitability = 100 - Operating Ratio
• Return on Revenues = Net Income / Revenues
• Return on Equity = Net Income / Equity
Other issues in financial analysis of Insurance Companies
Examine
Examine
Investments Investments
Financing Financing