# Shared Flashcard Set

## Details

Ratios
Ratio definitions
15
Economics
12/15/2010

Term
 Working capital
Definition
 A measure of both a company's efficiency and its short-term financial health. The working capital ratio is calculated as: Positive working capital means that the company is able to pay off its short-term liabilities. Negative working capital means that a company currently is unable to meet its short-term liabilities with its current assets (cash, accounts receivable and inventory).Also known as "net working capital", or the "working capital ratio".
Term
 Current ratio
Definition
 What Does Current Ratio Mean?A liquidity ratio that measures a company's ability to pay short-term obligations. The Current Ratio formula is: Also known as "liquidity ratio", "cash asset ratio" and "cash ratio".Investopedia explains Current RatioThe ratio is mainly used to give an idea of the company's ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health, it does not necessarily mean that it will go bankrupt - as there are many ways to access financing - but it is definitely not a good sign.The current ratio can give a sense of the efficiency of a company's operating cycle or its ability to turn its product into cash. Companies that have trouble getting paid on their receivables or have long inventory turnover can run into liquidity problems because they are unable to alleviate their obligations. Because business operations differ in each industry, it is always more useful to compare companies within the same industry. This ratio is similar to the acid-test ratio except that the acid-test ratio does not include inventory and prepaids as assets that can be liquidated. The components of current ratio (current assets and current liabilities) can be used to derive working capital (difference between current assets and current liabilities). Working capital is frequently used to derive the working capital ratio, which is working capital as a ratio of sales.
Term
 Acid test ratio
Definition
 What Does Acid-Test Ratio Mean?A stringent test that indicates whether a firm has enough short-term assets to cover its immediate liabilities without selling inventory. The acid-test ratio is far more strenuous than the working capital ratio, primarily because the working capital ratio allows for the inclusion of inventory assets. Calculated by:Investopedia explains Acid-Test RatioCompanies with ratios of less than 1 cannot pay their current liabilities and should be looked at with extreme caution. Furthermore, if the acid-test ratio is much lower than the working capital ratio, it means current assets are highly dependent on inventory. Retail stores are examples of this type of business. The term comes from the way gold miners would test whether their findings were real gold nuggets. Unlike other metals, gold does not corrode in acid; if the nugget didn't dissolve when submerged in acid, it was said to have passed the acid test. If a company's financial statements pass the figurative acid test, this indicates its financial integrity.
Term
 Net profit Margin
Definition
 What Does Profit Margin Mean?A ratio of profitability calculated as net income divided by revenues, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings.Profit margin is very useful when comparing companies in similar industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage; a 20% profit margin, for example, means the company has a net income of \$0.20 for each dollar of sales. Also known as Net Profit Margin. Watch: Profit MarginInvestopedia explains Profit MarginLooking at the earnings of a company often doesn't tell the entire story. Increased earnings are good, but an increase does not mean that the profit margin of a company is improving. For instance, if a company has costs that have increased at a greater rate than sales, it leads to a lower profit margin. This is an indication that costs need to be under better control. Imagine a company has a net income of \$10 million from sales of \$100 million, giving it a profit margin of 10% (\$10 million/\$100 million). If in the next year net income rises to \$15 million on sales of \$200 million, the company's profit margin would fall to 7.5%. So while the company increased its net income, it has done so with diminishing profit margins.
Term
 inventory turnover return
Definition
 What Does Inventory Turnover Mean?A ratio showing how many times a company's inventory is sold and replaced over a period. the The days in the period can then be divided by the inventory turnover formula to calculate the days it takes to sell the inventory on hand or "inventory turnover days". Investopedia explains Inventory TurnoverAlthough the first calculation is more frequently used, COGS (cost of goods sold) may be substituted because sales are recorded at market value, while inventories are usually recorded at cost. Also, average inventory may be used instead of the ending inventory level to minimize seasonal factors.This ratio should be compared against industry averages. A low turnover implies poor sales and, therefore, excess inventory. A high ratio implies either strong sales or ineffective buying.High inventory levels are unhealthy because they represent an investment with a rate of return of zero. It also opens the company up to trouble should prices begin to fall.
Term
 Return on equity for a full year
Definition
 What Does Return On Equity - ROE Mean?The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. ROE is expressed as a percentage and calculated as:Return on Equity = Net Income/Shareholder's EquityNet income is for the full fiscal year (before dividends paid to common stock holders but after dividends to preferred stock.) Shareholder's equity does not include preferred shares.Also known as "return on net worth" (RONW). Watch: Return On EquityInvestopedia explains Return On Equity - ROEThe ROE is useful for comparing the profitability of a company to that of other firms in the same industry.There are several variations on the formula that investors may use:1. Investors wishing to see the return on common equity may modify the formula above by subtracting preferred dividends from net income and subtracting preferred equity from shareholders' equity, giving the following: return on common equity (ROCE) = net income - preferred dividends / common equity.2. Return on equity may also be calculated by dividing net income by average shareholders' equity. Average shareholders' 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.3. Investors may also calculate the change in ROE for a period by first using the shareholders' equity figure from the beginning of a period as a denominator to determine the beginning ROE. Then, the end-of-period shareholders' equity can be used as the denominator to determine the ending ROE. Calculating both beginning and ending ROEs allows an investor to determine the change in profitability over the period.
Term
 Operating ratio
Definition
 What Does Operating Ratio Mean?A ratio that shows the efficiency of a company's management by comparing operating expense to net sales. Calculated as:Investopedia explains Operating RatioThe smaller the ratio, the greater the organization's ability to generate profit if revenues decrease. When using this ratio, however, investors should be aware that it doesn't take debt repayment or expansion into account.
Term
 Gross profit margin
Definition
 Indicates what the company's pricing policy is and what the true mark-up margins are.  GROSS INCOME/TOTAL REVENUES
Term
 Net profit margin
Definition
 What Does Profit Margin Mean?A ratio of profitability calculated as net income divided by revenues, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings.Profit margin is very useful when comparing companies in similar industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage; a 20% profit margin, for example, means the company has a net income of \$0.20 for each dollar of sales. Also known as Net Profit Margin. Watch: Profit MarginInvestopedia explains Profit MarginLooking at the earnings of a company often doesn't tell the entire story. Increased earnings are good, but an increase does not mean that the profit margin of a company is improving. For instance, if a company has costs that have increased at a greater rate than sales, it leads to a lower profit margin. This is an indication that costs need to be under better control. Imagine a company has a net income of \$10 million from sales of \$100 million, giving it a profit margin of 10% (\$10 million/\$100 million). If in the next year net income rises to \$15 million on sales of \$200 million, the company's profit margin would fall to 7.5%. So while the company increased its net income, it has done so with diminishing profit margins.
Term
 Return on investment
Definition
 What Does Return On Assets - ROA Mean?An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's annual earnings by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment".The formula for return on assets is:[image]Note: Some investors add interest expense back into net income when performing this calculation because they'd like to use operating returns before cost of borrowing.
Term
 Net Asset value per share
Definition
 What Does Net Asset Value Per Share - NAVPS Mean?An expression for net asset value that represents a fund's (mutual, exchange-traded, and closed-end) or a company's value per share. It is calculated by dividing the total net asset value of the fund or company by the number of shares outstanding. Also referred to as "book value per share".Calculated as:Investopedia explains Net Asset Value Per Share - NAVPSNAVPS is the value of a single unit, or share, of a fund. This figure for a mutual fund is the price at which shares are bought and sold. Because exchange-traded and closed-end funds are listed and traded as stocks, which are subject to market forces, their NAVPS and buying/selling prices per share can be divergent.In the context of corporate financial statements of publicly traded companies, the NAVPS, more commonly referred to as book value per share, is usually below the market price per share. The historical cost accounting principle, which tends to understate certain asset values, and the supply and demand forces of the marketplace generally push stock prices above book value per share valuations.
Term
 Book value equity per share
Definition
 What Does Book Value Of Equity Per Share - BVPS Mean?A financial measure that represents a per share assessment of the minimum value of a company's equity. More specifically, this value is determined by relating the original value of a firm's common stock adjusted for any outflow (dividends and stock buybacks) and inflow (retained earnings) modifiers to the amount of shares outstanding.Calculated as:Investopedia explains Book Value Of Equity Per Share - BVPSWhile book value of equity per share is one factor that investors can use to determine whether a stock is undervalued, this metric should not be used by itself as it only presents a very limited view of the firm's situation. BVPS provides a snap shot of a firm's current situation, but considerations of the firm's future are not included. For example, XYZ Corp, a widget producing company, may have a share price that is currently lower than its BVPS. This may not indicate that the XYZ is undervalued, because looking ahead, the growth opportunities for the company are vastly limited as fewer and fewer people are buying widgets.
Term
 Earnings per share
Definition
 What Does Earnings Per Share - EPS Mean?The portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company's profitability.Calculated as:When calculating, it is more accurate to use a weighted average number of shares outstanding over the reporting term, because the number of shares outstanding can change over time. However, data sources sometimes simplify the calculation by using the number of shares outstanding at the end of the period.Diluted EPS expands on basic EPS by including the shares of convertibles or warrants outstanding in the outstanding shares number. Watch: Earning Per ShareInvestopedia explains Earnings Per Share - EPSEarnings per share is generally considered to be the single most important variable in determining a share's price. It is also a major component used to calculate the price-to-earnings valuation ratio. For example, assume that a company has a net income of \$25 million. If the company pays out \$1 million in preferred dividends and has 10 million shares for half of the year and 15 million shares for the other half, the EPS would be \$1.92 (24/12.5). First, the \$1 million is deducted from the net income to get \$24 million, then a weighted average is taken to find the number of shares outstanding (0.5 x 10M+ 0.5 x 15M = 12.5M).An important aspect of EPS that's often ignored is the capital that is required to generate the earnings (net income) in the calculation. Two companies could generate the same EPS number, but one could do so with less equity (investment) - that company would be more efficient at using its capital to generate income and, all other things being equal, would be a "better" company. Investors also need to be aware of earnings manipulation that will affect the quality of the earnings number. It is important not to rely on any one financial measure, but to use it in conjunction with statement analysis and other measures
Term
 Price earnings (P/E) Ratio
Definition
 What Does Price-Earnings Ratio - P/E Ratio Mean?A valuation ratio of a company's current share price compared to its per-share earnings.Calculated as: For example, if a company is currently trading at \$43 a share and earnings over the last 12 months were \$1.95 per share, the P/E ratio for the stock would be 22.05 (\$43/\$1.95). EPS is usually from the last four quarters (trailing P/E), but sometimes it can be taken from the estimates of earnings expected in the next four quarters (projected or forward P/E). A third variation uses the sum of the last two actual quarters and the estimates of the next two quarters. Also sometimes known as "price multiple" or "earnings multiple". Watch: PE RatioInvestopedia explains Price-Earnings Ratio - P/E RatioIn general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the whole story by itself. It's usually more useful to compare the P/E ratios of one company to other companies in the same industry, to the market in general or against the company's own historical P/E. It would not be useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a technology company (high P/E) to a utility company (low P/E) as each industry has much different growth prospects. The P/E is sometimes referred to as the "multiple", because it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay \$20 for \$1 of current earnings.It is important that investors note an important problem that arises with the P/E measure, and to avoid basing a decision on this measure alone. The denominator (earnings) is based on an accounting measure of earnings that is susceptible to forms of manipulation, making the quality of the P/E only as good as the quality of the underlying earnings number.
Term
 Dividend Yield
Definition
 What Does Dividend Yield Mean?A financial ratio that shows how much a company pays out in dividends each year relative to its share price. In the absence of any capital gains, the dividend yield is the return on investment for a stock. Dividend yield is calculated as follows: Watch: Dividend YieldsInvestopedia explains Dividend YieldDividend yield is a way to measure how much cash flow you are getting for each dollar invested in an equity position - in other words, how much "bang for your buck" you are getting from dividends. Investors who require a minimum stream of cash flow from their investment portfolio can secure this cash flow by investing in stocks paying relatively high, stable dividend yields.To better explain the concept, refer to this dividend yield example: If two companies both pay annual dividends of \$1 per share, but ABC company's stock is trading at \$20 while XYZ company's stock is trading at \$40, then ABC has a dividend yield of 5% while XYZ is only yielding 2.5%. Thus, assuming all other factors are equivalent, an investor looking to supplement his or her income would likely prefer ABC's stock over that of XYZ.
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