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| Net Working Capital to total Assets |
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| LONG-TERM SOLVENCY MEASURES |
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| are intended to address the firm’s long-term ability to meet its obligations, or, more generally, its financial leverage. These are sometimes called financial leverage ratios or just leverage ratios. |
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| Debt–equity ratio = Total debt/Total equity |
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Equity multiplier = Total assets/Total equity
The fact that the equity multiplier is 1 plus the debt–equity ratio is not a coincidence:
=(Total equity + Total debt)/Total equity
The thing to notice here is that given any one of these three ratios, you can immediately calculate the other two; so, they all say exactly the same thing |
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| Times interest earned Ratio |
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| ASSET MANAGEMENT, OR TURNOVER, MEASURES |
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| What they are intended to describe is how efficiently or intensively a firm uses its assets to generate sales. |
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| days’ sales in inventory: |
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[image]
We now look at how fast we collect on those sales |
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Day's Sales in Receivables
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[image]
Therefore, on average, Prufrock collects on its credit sales in 30 days. For obvious reasons, this ratio is frequently called the average collection period (ACP) |
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NWC Turnover
Net working capital turnover |
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[image]
This ratio measures how much “work” we get out of our working capital. Once again, assuming we aren’t missing out on sales, a high value is preferred |
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[image]
In other words, for every dollar in assets, Prufrock generated $.64 in sales. |
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| they are intended to measure how efficiently a firm uses its assets and manages its operations. The focus in this group is on the bottom line, net income. |
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[image]
This tells us that Prufrock, in an accounting sense, generates a little less than 16 cents in profit for every dollar in sales. |
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a measure of profit per dollar of assets. It can be defined several ways, but the most common is this:
[image] |
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is a measure of how the stockholders fared during the year. Because benefiting shareholders is our goal, ROE is, in an accounting sense, the true bottom-line measure of performance. ROE is usually measured as follows:
[image] |
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| Our final group of measures is based, in part, on information not necessarily contained in financial statements—the market price per share of stock. Obviously, these measures can be calculated directly only for publicly traded companies |
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[image]
Because the PE ratio measures how much investors are willing to pay per dollar of current earnings, higher PEs are often taken to mean the firm has significant prospects for future growth. Of course, if a firm had no or almost no earnings, its PE would probably be quite large; so, as always, care is needed in interpreting this ratio. |
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In some cases, companies will have negative earnings for extended periods, so their PE ratios are not very meaningful. A good example is a recent start-up. Such companies usually do have some revenues, so analysts will often look at the price–sales ratio:
Price–sales ratio = Price per share/Sales per share |
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Notice that book value per share is total equity (not just common stock) divided by the number of shares outstanding. |
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