Debt to Equity Ratio

Debt to Equity Ratio Definition:
Debt to equity ratio defined as an indication of management’s reliance to finance its asset on debt rather than on equity. It measures a company’s capacity to repay its creditors. The debt to equity ratio varies with different industry and company. Comparing the ratio with industry peers is a better benchmark.

Debt to Equity Ratio Meaning:
The debt ratio means an indication of the gearing level of a company. A high ratio means that a company may be over-leveraged with debt. This can result in high insolvent risk since excessive debt can lead to a heavy debt repayment burden. However, when a company chooses to rely largely on equity, they may lose the tax reduction benefit of interest payments. In a word, a company must consider both risk and tax issues to get an optimal debt to equity ratio explanation that suits their needs.

Debt to Equity Ratio Formula:
The debt to equity ratio formula is listed below:

Debt to equity ratio equation = total debt / total equity

Debt to Equity Ratio Calculation:
Debt to equity ratio calculations are a matter of simple arithmetic once the propper information is complied. Debts will include both current liabilities and long term liabilities.

Equity will include goods and property your business owns, plus any claims it has against other entities.

Example: a company has $10,000 in total debt, and $40,000 in total shareholders equity.

Debt to equity ratio = 10,000 / 40,000 = 0.25

This means that a company has $0.25 in debt for every dollar of shareholders’ equity.

Debt to Equity Ratio Example:
Shari has started a residential real estate company which has grown to success. Though the market is tough, Shari has protected her cash account in order to deal with what the future holds. Shari now needs to perform debt to equity analysis to make sure she has not become over-leveraged in her company. This could cause problems with bank loans, her company free cash flow, and more.

Shari contacts her controller for debt to equity accounting questions. She knows that there is no debt to equity calculator, so she is willing to wait for some concrete results.

$10,000 in total debt and $40,000 in total shareholders equity.

Debt to equity ratio = $10,000 / $40,000 = $0.25

Her controller finds that she is in perfect standing. Her company, though near its limit, does not have too much debt. It has enough cash to survive common issues which face the residential real estate industry.

She is satisfied that she has followed the path of a responsible business owner. She is so used to putting out fires that she is content with the status quo of her company making regular monthly profits. Shari looks forward to her next quarter.

Source:--------->wikiCFO

Return on Asset Analysis

Return on Asset Definition:
Return on asset (ROA) reveals how much profit a company earned in comparison to its overall asset. The value of ROA varies from industry and company. In general, the higher the value, the better a company is.


Return on Asset Formula:
Return on Asset = Net income ÷ Average asset


Or = Net profit margin * Asset turnover


Return on Asset Calculation:
Example: a company has $2,000 in net income, and $20,000 in average asset. Return on equity = 2,000 / 20,000 = 10%


This means that has $0.1 of net income for every dollar of asset invested.


Applications:
Return on assets measures profit against the assets a company used to generate revenue. It is an important indicator of the asset intensity of a company. A lower ratio means a company is more asset-intensive, and vice versa. And a more asset-intensive company needs more money to continue generating revenue. Return on asset ratio is useful for investors to assess a company’s financial strength and efficiency to use resources. It is also very important for management to measure its performance against its planned business goals, or market competitors .

Source:--------->wikiCFO

Return on Capital Employed (ROCE)

Return on Capital Employed (ROCE): The return on capital employed ratio is used as a meaurement between earnings, and the amount invested into a project or company.

Return on Capital Employed (ROCE) Meaning:
The return on capital employed is very similar to the return on assets (ROA), but is slightly different in that it incorporates financing. Because of this the ROCE calculation is more meaningful than the ROA. The ROCE is generally used to find out how efficient and profitable a company is from year to year. As it is a percentage a company can locate problems or areas of improvement with the fluctuation of this ratio from year to year.

Return on Capital Employed (ROCE) Equation:
The return on capital employed equation is as follows:

ROCE = EBIT or NI/(Total Assets - Current Liabilities)

Note: The earnings before interest and taxes, known as the operating income, is normally used, but people can also use the Net Income if they would like to incorporate the net interest and taxes into the ROCE formula.

Return on Capital Employed (ROCE) Example:
Tim found that the ROCE last year is 16%. He would like to compare this number to the current ROCE. He begins by finding the following numbers in the Balance Sheet as well as the Income Statement:

Net Income = $50,000
Total Assets = $360,000
Current Liabilities = $35,000

ROCE = $50,000/($360,000 - $35,000) = 15%

Note: The drop in this number means that Tim's company is not as efficient as it used to be or that it decreased it current liabilities.

 Source:--------->wikiCFO

Return on Invested Capital (ROIC)

Return on Invested Capital (ROIC):
The return on invested capital is the percentage amount that a company is making for every percentage point over the [Cost of Capital|Weighted Average Cost of Capital (WACC). More specifically the return on investment capital is the percentage return that a company makes over its invested capital. However, the invested capital is measured by the monetary value needed, instead of the assets that were bought. Therefore invested capital is the amount of long-term debt plus the amount of common and preferred shares.

Return on Invested Capital (ROIC) Formula:
The Return on invested capital formula is as follows:

Net Operating Profit After Tax (NOPAT)/Invested Capital = ROIC

NOPAT - This is the operating profit in the income statement minus taxes. It should be noted that the interest expense has not been taken out of this equation.

Invested Capital - This is the total amount of long term debt plus the total amount of equity, whether it is from common or preferred. The last part of invested capital is to subtract the amount of cash that the company has on hand.

Return on Invested Capital (ROIC) Example:
Bob is in charge of Rolly Polly Inc., a company that specializes in heavy agricultural and construction equipment. Bob has been curious as to how his company has been performing as of late and decides to look at the company's return on invested capital analysis. Surprisingly, the company does not keep track of the return on invested capital ratio. Bob decides that he will go ahead and run the ROIC analysis, and obtains the following information:

Long-term debt - $25 million
Shareholder's Equity - $75 million
Operating Profit - $20 million
Tax Rate - 35%
WACC - 11%

plugging these numbers into the formula Bob finds the following:

$20 million - (20 million * 35%) = $13 million

$13 million/($25 milion + $75 million) = .13 or 13% = ROIC.

Source:--------->wikiCFO

Return on Equity (ROE)

Return on Equity Definition:
Return on equity, defined also as return on net worth (RONW), reveals how much profit a company earned in comparison to the money a shareholder has invested.

Return on Equity Explanation:
Return on equity, explained as a measure of how well a company uses investment dollars to generate profits, is more important to a shareholder than return on investment (ROI). It tells investors how effectively their capital is being reinvested. A company with high return on equity is more successful to generate cash internally. Investors are always looking for companies with high and growing returns on equity. However, not all high ROE companies make good investments. The better benchmark is to compare a company’s return on equity with its industry average. The higher the ratio, the better a company is.

Return on Equity Formula:
The return on equity formula listed below forms a simple example for solving ROE problems.

Return on Equity Ratio = Net income ÷ Average shareholders equity

When solving return on equity, equation solutions only form part of the problem. One must be able to apply the equation to a variety of different and changing scenarios.

Return on Equity Calculation:
Average shareholders' equity, or return on equity, is calculated by adding the shareholders' equity at the beginning of a period to the shareholders' equity at period's end and dividing the result by two. No simple return on equity calculator can complete the job that a solid understanding of ROE can.

Example: a company has $6,000 in net income, and $20,000 in average shareholders’ equity.

Return on equity: $6,000 / $20,000 =30%

This means that a company has $0.3 of net income for every dollar that has been invested by shareholder.

Return on Equity Example:
Melanie, after seeing success in her corporate career, has left the comfortable life to become an angel investor. She has worked dilligently to select companies and their managers, hold these managers accountable to their promises, provide advice and mentoring, and lead her partners to capitalization while minimizing risk. At this stage, Melanie is ready to receive her pay-out. Melanie wants to know her Return on Equity ratio for one of her client companies.

Melanie begins by finding the net income and average sharholder's equity for the venture. Looking back to her records, Melanie has invested $20,000 in the business. Her net income from it is $6,000 per year. Performing her return on equity analysis yields these results:

Return on equity: $6,000 / $20,000 =30%

Melanie is happy with her results. Purposefully starting small, she has built the experience and confidence to be successful. She can now move on to bigger and better deals.

Source:--------->wikiCFO

Inventory Turnover Ratio Analysis

Inventory Turnover Ratio Definition:
Inventory turnover ratio, defined as how many times the entire inventory of a company has been sold during an accounting period, is a major factor to success in any business that holds inventory. It shows how well a company manages its inventory levels and how frequently a company replenishes its inventory. In general, a higher inventory turnover is better because inventories are the least liquid form of asset. A useful tool in measuring and managing inventory turns is a Flash Report!

Inventory Turnover Ratio Explanation:
Inventory turnover ratio explanations occur very simply through an illustration of high and low turnover ratios. Despite this, many businesses do not survive due to issues with inventory.

A low inventory turnover ratio shows that a company may be overstocking or deficiencies in the product line or marketing effort. It is a sign of ineffective inventory management because inventory usually has a zero rate of return and high storage cost.

Higher inventory turnover ratios are considered a positive indicator of effective inventory management. However, a higher inventory turnover ratio does not always mean better performance. It sometimes may indicate inadequate inventory level, which may result in decrease in sales.

Inventory Turnover Ratio Formula:
The two main inventory turnover ratio formulas are listed below:

Inventory turnover = Sales / Inventory

Or Inventory Turnover = Cost of good sold / Average inventory

Inventory Turnover Ratio Calculation:
Inventory turnover ratio calculations may appear intimidating at first but are fairly easy once a person understands the key concepts of inventory turnover.

Example: assume annual credit sales are $10,000, and inventory is $5,000. The inventory turnover is: 10,000 / 5,000 = 2 times

Example: assume cost of goods sold during the period is $10,000 and average inventory is $5,000. Inventory turnover ratio: 10,000 / 5,000 = 2 times

This means that there would be 2 inventory turns per year. That is a company would take 6 months to sell and replace all inventories.

Inventory Turnover Ratio Example:
Derek owns a retail clothing store which sells the best designer attire. Derek, an avid fan of fashion, has worked in the apparel industry for quite a while and is well suited for the operations of his company.

Still, Derek has a little to learn about the business of retail clothing. He has been studying the subject with passion and wants to grow his business. From his study he has realized that inventory turnover is the key to his business.

Derek first talks to his accountant for inventory turnover ratio analysis. This requires somewhat of an expert because the matter is more complicated than the abilities simple, web-based inventory turnover ratio calculator. His accountant comes up with a figure which Derek would like to increase.

annual credit sales are $10,000 and inventory is $5,000

The inventory turnover is: 10,000 / 5,000 = 2 times

Derek decides, from this, that he needs to make some changes. He aligns a few strategies to move his products. First, he considers marking-down styles from the previous season as each season approaches. Similarly, he considers product give-aways with minimum transaction amounts. Derek considers the option of spreading contests and deals on social networking websites. He finishes his evaluation by finding ways to turn his extra inventory into a tax write-off.

Derek is pleased because he is applying his newly found skills and knowledge to better his business. Derek looks forward to the future.

Source------------->wikiCFO 

Operating Cycle Ratio

Operating Cycle Formula:
Operating cycle calculations are completed simply with this formula:

Operating cycle = DIO + DSO - DPO

Where

DIO represents days inventory outstanding

DSO represents day sales outstanding

DPO represents days payable outstanding

Operating Cycle Calculation:
Calculating operating cycle may seem daunting but results in extremely valuable information.

DIO = (Average inventories / cost of sales) * 365 DSO = (Average accounts receivables / net sales) * 365

DPO = (Average accounts payables / cost sales) * 365

Example: What is the operating cycle of a business? A company has 90 days in days inventory outstanding, 60 days in days sales outstanding and 70 in days payable outstanding.

Operating cycle = 90 + 60 - 70 = 80

This means that on average it takes 80 days for a company to turn purchasing inventories into cash sales. In regards to accounting, operating cycles are essential to maintaining levels of cash necessary to survive. Maintaining a beneficial net operating cycle ratio is a life or death matter.

Source------------->wikiCFO 

Accounts Payables(AP) Analysis

Accounts Payable Turnover Definition:
The accounts payable turnover ratio indicates how many times a company pays off its suppliers during an accounting period. It measures how a company manages paying its own bills. A higher ratio is generally more favorable as payables are being paid more quickly. When placed on a trend graph accounts payable turnover analysis becomes simplified: the line raises and lowers just as the ratio does. Common adaptations used to calculate accounts payable turnover yield results like accounts payable turnover ratio in days, ap turnover in days, and more. A useful tool in managing and measuring the efficiency of paying bills is a Flash Report.

Accounts Payable Turnover Formula:
A solid grasp of the accounts payable turnover ratio formula is of utmost importance to any business person. Though some ratios may or may not apply to different business models everyone has bills to pay. The need to understand ap turnover is universal.

Accounts payable turnover = Cost of goods sold / Average accounts payable

Or = Credit purchases / average accounts payable.

Purchases = Cost of goods sold + ending inventory - beginning inventory.

Accounts Payable Turnover Calculation:
Accounts payable turnover is calculated by dividing total purchases made from suppliers by the average accounts payable amount during the same period.

Average Accounts payable is the average of the opening and closing balances for Accounts payable.

In real life, sometimes it is hard to get the number of how much of the purchases were made on credit. Investors can assume that all purchases are credit purchase as a shortcut. When this is done, it is important to remain consistent if the ratio is compared to that of other companies.

Example: assume annual purchases are $100,000; accounts payable at the beginning is $25,000; and accounts payable at the end of the year is $15,000.

The accounts payable turnover is: 100,000 / ((25,000 + 15,000)/2) = 5 times

An accounts payable turnover days formula is a simple next step.

365 days per year / 5 times per year = 73 days

Slightly different methods are applied to calculate ap days, ap turnover ratio in days, and other important metrics.This article outlines the fundamentals of how to calculate ap turnover.

Source------------->wikiCFO  

Accounts Receivables(AR) Analysis

Accounts receivable Turnover ratio Defination:
Accounts receivable Turnover ratio indicates how many times the accounts receivable have been collected during an accounting period. It can be used to determine if a company is having difficulties collecting sales made on credit. The higher the turnover, the faster the business is collecting its receivables. It can be expressed in many forms including accounts receivable turnover rate, accounts receivable turnover in days, accounts receivable turnover average, and more. A useful tool in managing and improving accounts receivable turnover is the Flash Report.

Accounts Receivable Turnover Meaning:
Accounts receivable turnover measures how efficiently a company uses its asset. It is an important indicator of a company's financial and operational performance. Many companies even have an accounts receivable allowance to prevent cashflow issues.

A high accounts receivable turnover indicates an efficient business operation or tight credit policies or a cash basis for the regular operation.

A low or declining accounts receivable turnover indicates a collection problem from its customer. Also, there is an opportunity cost of holding receivables for a longer period of time. Company should re-evaluate its credit policies to ensure timely receivable collections from its customers.

Accounts Receivable Turnover Formula:
A profitable accounts receivable turnover ratio formula creates survival and success in business. Phrased simply, an accounts receivable turnover increase means a company is more effectively processing credit. An accounts receivable turnover decrease means a company is seeing more delinquent clients. It is quantified by the accounts receivable turnover rate formula.


Accounts Receivable Turnover = Annual credit sales / Average accounts receivable.

Accounts Receivable Turnover Calculation:
Average Accounts Receivable is the average of the opening and closing balances for Accounts Receivable.
In real life, sometimes it is hard to get the number of how much of the sales were made on credit. Investors can use total sales as a shortcut. When this is done, it is important to remain consistent if the ratio is compared to that of other companies.
Example: assume annual credit sales are $10,000, accounts receivable at the beginning is $2,500, and accounts receivable at the end of the year is $1,500.

 


Source------------->wikiCFO The accounts receivable turnover is: 10,000 / ((2,500 + 1,500)/2) = 5 times.

Quick Ratio Analysis

Quick Ratio Definition:
The quick ratio, defined also as the acid test ratio, reveals a company's ability to meet short-term operating needs by using its liquid assets . It is similar to the current ratio, but is considered a more reliable indicator of a company’s short-term financial strength. The difference between these two is that the quick ratio subtracts inventory from current assets  and compares the quick asset to the current liabilities . Similar to the current ratio, value for the quick ratio analysis varies widely by company and industry. In theory, the higher the ratio is, the better the position of the company is. However, a better benchmark is to compare the ratio with the industry average.

Quick Ratio Explanation:
Quick ratios are often explained as measures of a company’s ability to pay their current debt liabilities without relying on the sale of inventory. Compared with the current ratio, the quick ratio is more conservative because it does not include inventories which can sometimes be difficult to liquidate. For lenders, the quick ratio is very helpful because it reveals a company’s ability to pay off under the worst possible condition.


Although the quick ratio gives investors a better picture of a company’s ability to meet current obligations the current ratio, investors should be aware that the quick ratio does not apply to the handful of companies where inventory is almost immediately convertible into cash (such as retail stores and fast food restaurants).

Quick Ratio Formula:
The current ratio formula is:
Current ratio = (Current assets – Inventories) / Current liabilities
Or = Quick assets / Current liabilities
Or = (Cash + Accounts Receivable + Cash equivalents) / Current liabilities


Source--------->wikiCFO

Current Ratio Analysis

Current Ratio Definition:
Current ratio, defined also as the working capital ratio, reveals company's ability to meet its short-term maturing obligations. Values for the current ratio vary by company and industry. In theory, the larger the ratio is, the more liquid the business is. However, comparing to the industry average is a better way to judge the performance. Current ratio, quick ratio, and other terms are common measurements of cash in a company.

Current Ratio Explanation:
Current ratios are commonly explained as a measure of a company's ability to pay the current debt liabilities. For the lenders, current ratio is very helpful for them to determine whether a company has a sufficient level of liquidity to pay liabilities. They would prefer a high current ratio since it reduces their risk. For the shareholders, current ratio is also important to them to discover the weakness in the financial position of a business. They would prefer a lower current ratio so that more of the company’s assets can be used for growing business. Although current ratio is an indicator of liquidity, investors should be aware that it can not give us the comprehensive information about company’s liquidity. Every industry has its own norms of current ratio. The better way to evaluate it is to check a company’s current ratio against its industry average. More importantly, investors should look at the trend of the current ratio of the company, types of current assets the company has and how quickly these can be converted into cash to meet company’s current liabilities.

Current Ratio Formula:The current ratio formula is: Current ratio = Current assets / Current liabilities


Current Ratio Calculation:
Current assets , when calculated dilligently, represent cash and other assets that will be converted into cash within one year. It normally included cash, marketable securities, accounts receivable and inventories.


Current liabilities represent financial obligations that come due within one year. It normally included accounts payable, notes payable, short-term loans, current portion of term debt, accrued expenses and taxes.


Example: a business has $5,000 in current assets and $2,500 in current liabilities. Current ratio = 5,000 / 2,500 = 2 This means that for every dollar in current liabilities, there is $2 in current assets.


Current Ratio Example:
Desmond has started a scrap metal recycling company called Scrapco. Desmond has made a comfortable living for himself by conducting business with accountability and professionalism in an industry where this is not always the case. Recently, the scrap metal market has experienced some distress and prices have varied much more than before. This has caused his cash stockpiles to vary within the market. As a result, Desmond is worried that he may not be able to meet obligations on the debt financing he has taken for his company equipment, mainly processing machines for the commodities he recieves from individuals to put onto the market.


Desmond decides to do a little research and finds out that this issue is a financial ratio called "current ratio". He then extends his research to using search engines for the keyword "current ratio calculator". Unsatisfied with the outcome, Desmond speaks to his accountant. His accountant performs the current ratio calculation below:


If:
Current Assets = $5,000
Current Liabilities = $2,500


Current ratio = 5,000 / 2,500 = 2


This means that for every dollar in current liabilities, there is $2 in current assets.


Desmond is happy to hear that he has little to worry about. He would like to increase his current ratio but is comforted by where Scrapco stands. Desmond knows that lack of cash is one of the main reasons why businesses fail and resolves to decrease unnecessary expenditures and pay more attention to his cash holdings.


Source--------->wikiCFO

EPS Ratio Analysis

Earnings per Share (EPS) Defintion:
The earnings per share or EPS is the amount of profit that accrues to each shareholder based on their percentage ownerships or amount of shares owned within the company.

Earnings per Share (EPS) Explained:
The earnings per share ratio is often a good measure of how a company is doing from year to year and is used by many investors in the market. However, companies know that the EPS is often a measure of how they are handling their businesses. This leads several companies to manipulate the earnings per share ratio. The ratio can be manipulated if the company were to buy or sell its own shares in the market, referred to as Treasury Stock. The net income aspect can also be manipulated through the recognition of revenue as well as other ways.

Earnings per Share (EPS) Formula:
The earnings per share equations is as follows:


(Net Income - Preferred Dividends)/Shares Outstanding

Earnings per Share (EPS) Example:
Tim is trying to calculate the EPS for Wawadoo Inc. He was given the following information to solve the problem.


Operating Income - $350,000
Interest expense - $20,000
Tax rate - 34%
Shares outstanding - 100,000 common (no preferred)


Tim will make the EPS calculation as follows:


$350,000 - (350,000 * .34) - $20,000 = $211,000 = Net Income


$211,000/100,000 = $2.11/share = EPS


Source--------->wikiCFO

P/E Ratio Analysis

Price Earnings Ratio Defination:
Price earnings ratio (P/E ratio), defined easily as an indicator of how much investors pay for a share compared to the earnings a company generates per share, is as important in stock trading as it is in equity financing markets. It tells investors how expensive a stock is. The higher the P/E ratio, the more the market is willing to pay for each dollar of annual earnings.


Price Earnings Ratio Meaning:
Price earnings ratio, meaning an indicator to measure a company’s market performance, is one of the many financial ratios used to evaluate an equity investments in private or public markets alike. Companies with high P/E ratios are more likely to be considered risky investments than those with low P/E ratios because a high P/E ratio means high expectations for a company’s potential earnings growth. Since P/E ratio varies from industries to industries, it is more valuable to comparing P/E ratios of companies within the same industry or against a company’s historical P/E ratios.

Price Earnings Ratio Formula:
Price earnings ratio = Market price per share ÷ Earnings per share
(Or )
Price earnings ratio = Average total common stock ÷ Net Income


As you can see, one is more suited to public and one to private equity markets. When the market price or earnings per share are not evident, as with the sale of a private corporation, the second option is a simpler choice.

Price Earnings Ratio Calculation:
Price earnings ratio calculations are, at their core, a basic division problem.


Example: assume $20 in market price per share and $5 in earnings per share.


Price earnings ratio = 20 / 5 = 4


This means that investors pay $4 for every dollar of earnings that a company generates.

Price Earnings Ratio Example:
After years of working Barbara has become a professional investor. Barbara makes an effort to diversify her portfolio across all types of investment: stocks, bonds, real estate, angel investment, and more. To Barbara, the most important aspect of investment is knowing what to expect. She likes to get her hands dirty in her work: she skips the web and is her own price earnings ratio calculator.


Barbara has decided to sit down and evaluate her stocks. She prepares her tools, a warm cup of coffee, and her mindset. She begins by looking through her public stock portfolio as a whole. Satisfied with her efforts, Barbara wants to dig deeper into the performance of her portfolio companies. She wants to know the price earnings ratio of s&p 500 stocks which she owns. Her average results are listed below:


$20 in average market price per share and $5 in average earnings per share.


Average price earnings ratio = $20 / $5 = $4


Barbara's price earnings ratio analysis yields these results. She moves on to evaluating her price earnings ratio history for her stocks as an angel investor. Her work sheds light on the results below:


$20 in average total common stock and $5 in average net income.


Average price earnings ratio = $20 / $5 = $4


Price earnings ratio, Dow Jones and small boutique alike, is an equation that gives an important evaluation of the performance of a company an investor has owner's equity in. Barbara is happy that she can make a living using her natural skills and talents.


Source:--------->wikiCFO