Académique Documents
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Fall 2019
Bruce Tavel
Financial Ratios
• Designed to summarize a company’s market valuation, profitability,
efficiency, capital structure, and liquidity
• Analysts use financial ratios to compare the strength and weaknesses
within and between various companies and industries
• Ratios will be used to project items within our financial model
• Types of ratios:
• Profitability ratios
• Measure of success, company’s use of its assets and control of its expenses to generate an
acceptable rate of return over a given period of time
• Liquidity ratios
• Measure of a company’s short term ability to pay its obligations
• Leverage ratios
• Measure of a company’s ability to service its debt; degree of financial leverage
• Efficiency ratios
• Measure how effective a company’s use of its assets
Profitability Ratios
• Return on Assets(ROA) = Net Income / Total Assets
• Measures the effectiveness of a company’s assets to create profits
• Return on Equity(ROE) = Net Income / Shareholders’ Equity
• Used by investors to determine the amount of return received from their
investment
• Net Profit Margin(NPM) = Net Income / Net Sales
• Measures the proportion of net sales that is turned into profit
• Operating Profit Margin(OPM) = EBIT / Net Sales
• Measures profit from standard operations, excludes debt financing
Leverage Ratios
• Debt Ratio = Total Liabilities / Total Assets
• Measures percentage of assets obtained on credit
• Long Term Debt to Equity Ratio = Long Term Debt / Shareholders’ Equity
• Measures financial leverage; extent to fund operations with debt rather than equity
• Lets create current and alternative scenarios for our Template Solution Model ,varying :
• Price Growth
• COGS as a PCT of Revenue
• Dividends Per Share Growth
Instead of creating different scenarios we can create a datatable enabling us to understand the
marginal impact of one or two input variables (line items) on other model variables or ratios.
• Let us create a range of values for COGS as a Pct of Revenue for our 2014E model and examine
the impact on selected financial ratios:
• Specifically, Excel Datatable Report shows these desired results:
• Return on Assets (ROA) = Net Income / Total Assets
• Return on Equity (ROE) = Net Income / Shareholder’s Equity
• EBITDA Margin %
• EPS (Earnings Per Share) Growth Y/Y
• Also, Let us create a range of values for COGS as a Pct of Revenue and SG&A as a Pct of
Revenue for our 2014E model and examine the impact on ROA
DATATABLE-ONE-WAY EFFECT OF COGS/REV ON PROFITABILITY MEASURES
FORECAST: 2014E
OUTPUT:
INPUT: ROA ROE EBITDA_MARGIN EPS_GROWTH
COGS/REV 18.7% 19.8% 53.5% 10.4%
20% 20.3% 21.4% 58.5% 21.5%
21% 20.0% 21.1% 57.5% 19.3%
22% 19.7% 20.8% 56.5% 17.1%
23% 19.4% 20.5% 55.5% 14.9%
24% 19.0% 20.2% 54.5% 12.6%
current value= 25% 18.7% 19.8% 53.5% 10.4%
26% 18.4% 19.5% 52.5% 8.2%
27% 18.1% 19.2% 51.5% 6.0%
28% 17.8% 18.8% 50.5% 3.7%
29% 17.4% 18.5% 49.5% 1.5%
30% 17.1% 18.2% 48.5% -0.7%
DATATABLE-TWO-WAY
SG&A/REV
OUTPUT: ROA 18.7% 10% 11% 12% 13% 14% 15% 16%
The process of recalculating outcomes under alternative assumptions to determine the impact of
a variable under sensitivity analysis is useful for many reasons, including:
• Testing the robustness of our model in the presence of uncertainty.
• Increased understanding of the relationships between input and output variables in our model
• Uncertainty reduction, through the identification of model inputs that cause significant
uncertainty in the output and should therefore be the focus of close attention
• Model simplification – fixing model inputs that have no effect on the output, or identifying and
removing redundant parts of the model
• Enhancing communication between analysts and decision makers (e.g. by making
recommendations more credible, understandable, persuasive).
• Finding regions in the space of input factors for which the model output is either maximum or
minimum or meets some optimum criterion
• In case of calibrating models with large number of parameters, a primary sensitivity test can
ease the calibration stage by focusing on the sensitive parameters.
Financial Ratios: Model: Comments (cont’d)
Benchmark Analysis:
There are three principal benchmarks used in ratio analysis
Financial ratios can be looked at as time series, or in comparison to another company in the
same industry, or against industry averages
Time series analysis:
• How has selected ratios changed over time ? Are things better or worse ?
E.g., Is gross margin going down, are receivable days lengthening ?
Competition:
• Comparing specific company ratios with that of a competitor.
If we manage our company such that it has higher ROA than competitors it suggests that we
manage our resources better.
Industry:
• Industry wide average ratios are published and can give an analyst a good starting point in
evaluating a company’s financial health. Ratios vary widely by industry, for example, high debt
/ equity is common in the automobile industry, indicating leverage, high ROE but low ROA