Ratios CFA - Kaplan page 112

1 ) Activity Ratios
2) Liquidity Ratios
3) Solvency Ratios
4) Profitability Ratios
5) Valuation Ratios

1) Activity Ratios

1.1 Receivable Turnover

1.1.1 Days of sale outstanding
1.2 Inventory Turnover
1.2.1 Days of inventory on hand
1.3 Payable Turnover
1.3.1 Numbers of days payables
1.4 Total asset Turnover
1.5 Fixed asset turnover
1.6 working capital turnover

1.1 Receivable Turnover

Annual Sales
Average Receivables

1.1.1 Days of Sale outstanding

365
Receivable Turnover

Note Collection period too high means customer are too slow in paying their bill.
Collection period too low means credit policy too rigorous.

1.2 Inventory Turnover

Cost of goods sold

Average inventory

1.2.1 Days of Inventory on hand

365
Inventory Turnover

Note A hight period means too much capital is tied up in inventory and inventory is obsolete.
A low period means the firm have indeaquate stock on hand.
 1.3 Payable Turnover

Purhcase
Average Trade payables

1.3.1 Number of days payables

365
Payable Turnover

Purchase = Ending Inventory - Beginning Inventory + COGS

1.4 Total Asset Turnover

1.4.1 Revenue
Average Total Assets

Note Low asset turnover ratio means too much capital tied up in its asset base.
High asset turnover ratio means too few assets for potential sales.

1.5 Fixed Asset Turnover

1.5.1 Revenue
Average Net fixed Assets

Note Low asset turnover ratio means too much capital tied up in its asset base.
High asset turnover ratio means the firm has obsolete asset.

1.6 Working capital Turnover

1.6.1 Revenue
Average working capital

Working capital = Currrent assets - Current liabilities

2) Liquidity Ratios

2.2 Current Ratios

2.3 Quick Ratios
2.4 Cash Ratios
2.5 Defensive Interval
2.6 Cash Conversion Cycle

2.2 Current Ratios

Current Assets
Current Liabilites
 The higher the current ratios the company will be able to pay the short term bills.
A current ratio of less than 1 means the company is facing liquidity crisis.

2.3 Quick Ratios

Cash + Marketable securities + receivables

Current Liabilities

The higher the current ratios the company will be able to pay the short term bills.

2.4 Cash Ratios

Cash + Marketable securities

Current Liabilities

The higher the current ratios the company will be able to pay the short term bills.

2.5 Defensive interval

Cash + Marketable securities + receivables

Average daily expenditure

Expenditure includes cash expenses for cogs, sg&a and research and development.

2.6 Cash Conversion Cycle

Cash Conversion Cycl = days of sale outstanding + days of inventory on hand - numbers of days payable

High cash conversion cycle are considered undesirable.

3) Solvency Ratios
(include debt ratios and coverage ratios)

3.1 Debt to Equity

3.2 Debt to Capital
3.3 Debt to Assets
3.4 Debt to EBITDA
3.5 Interest coverage
3.6 Financial leverage
3.7 Fixed charge coverage

3.1 Debt to Equity - leverage ratio

Total debt
Total shareholder's equity
 Increase or decrease in this ratio suggest a greater or lesser reliance on debt as a source of financing.

3.2 Debt to Capital - leverage ratio

Total debt
Total debt + Total shareholder's equity

Increase or decrease in this ratio suggest a greater or lesser reliance on debt as a source of financing.

3.3 Debt to Assets - leverage ratio

Total debt
Total assets

Increase or decrease in this ratio suggest a greater or lesser reliance on debt as a source of financing.

3.4 Debt to EBITDA

Total debt
EBITDA

3.5 Financial leverage ratio - leverage ratio

Average total assets

Average total equity

Greater use of debt financing increase financial leverage

3.6 Interest coverage ratio

Earning before interest and tax

Interest payment

The lower this ratio, the more likely the firm will have difficulty meeting its debt payment.

3.7 Fixed charge coverage

Earning before interest and tax + Lease payment

Interest payment + Lease payment

4) Profitability Ratios

4.1 Net profit margin

4.2 Gross profit margin
4.3 Operating profit margin
4.4 Pretax margin
4.5 Return on Asset
4.6 Operating return on asset
4.7 Return on total capital
4.8 Return on Equity
4.9 Return on commom equity

4.1 Net profit margin

Net Income
Revenue

Analysis should be concerned if this ratio too low.

Gross profit = net sales - COGS

Operating profits = Earning before interest and tax
net income = Earning after tax but befire dividends
total capital = long term debt + sjort term debt + common and preferred equity
total capital = total asset

Operating cash flow + Investing Cash Flow + Financing Cash Flow = Change in cash flow + beginning balance = E

4.2 Gross profit margin

Gross profit
Revenue

Analysis should be concerned if this ratio too low.

4.3 Operating profit margin

Operating Income or EBIT

Revenue Revenue

Analysis should be concerned if this ratio too low.

4.4 Pretax Margin

EBT
Revenue

4.5 Return on Assets

Net Income
Average total Assets

Net Income + Interest expense (1- tax rate)

Average total Assets

4.6 Operating return on Assets

 Oprating Income (or) EBIT
Average total Assets

4.7 Return on total capital

EBIT
Average total capital

4.8 Return on Equity

Net Income
Average total equity

4.9 Return on common equity

Net Income - preferred dividends

Average common equity

Free cash flow to Equity

FCFE = cash flow from operation - fixed capital investment + net borrowing

common- size income statement ratios = income statement account

sales

common- size balance sheet ratios = balance sheet account

total assets

common- size cash flow ratios = cash flow statement account

revenue

DuPont Analysis

ROE = Net Income

Average Equity

Net Income x Revenue

Revenue Average Equity
(Net profit margin) (equity turnover)

Net Income x Revenue x Average total assets

Revenue Average total assets Equity

(Net profit margin) (Asset turnover) (leverage ratio)

 Net Income x EBT x EBIT
EBT EBIT Revenue

(Tax burden) (Interest Burden) (EBIT margin)

(1- tax rate)

Net Realizable value = expected sale price - (estimated selling cost + completion cost)

If NRV < Inventory value , Inventory is written down to NRV. And loss is recognised in income statement.
If there is recovery in value, the inventory can be written up and the gain is recognised in the income statement

Ending Inventory = Beginning Invenotry + Purchase - COGS

FIFO COGS = LIFO COSG - (Ending LIFO reserve - Beginning LIFO reserve)

FIFO Inventory = LIFO Inventory + LIFO reserve

FIFO Net Income = LIFO Net Income + Increase in LIFO reserve x (1-Tax rate)

FIFO RE = LIFO RE + LIFO reserve x (1- Tax rate)

Identifiable Intangible asset Intangible asset with finite useful life is amortised and tested for imp
patents,trademarks and copyrights

Unidentifiable Intangible asst Intangible asset with infinite useful life is not amortised. Must be tes
goodwill Goodwill is not amortized but must be tested for impairment at leas

Depreciation Methods

1) Straight-line depreciation
2) Accelerated depreciation
3) Units-of-production method

1) Straight-line depreciation
Depreciation expenses = original cost - salvage value =
depreciation life

2) Accelerated depreciation - double-declining balance

Depreciation expenses = 2 x book value at the beginn

depreciation life in years

3) Units-of-production method
original cost - salvage value x output units in the period
Depreciation expenses = life in output units

Example : Alternative depreciation method in page 362 CFA

Estimate of remaining useful life = Net plant and equipment

Annual depreciation expenses

Net plant and equipment = Gross P&E - Accumulated depreciation

Estimated average total useful life = Estimates of the average remaining useful life + average

Average age of the assets = Accumulated depreciation

Annual depreciation expenses

Impairment

Asset is impaired when when its carrying value (original cost - accumulated depreciation ) exceeds the recovera
The recoverable amount is the greater of (its fair value less any selling costs) and its value in use.
The value in use is the present value of its future cash flow stream from continued use.

If impaired, the asset’s value must be written down on the balance sheet to the recoverable amount.

An impairment loss, equal to the excess of carrying value over the recoverable amount, is recognized in the inco

The impairment of intangible assets with finite lives affects: both the balance sheet and the income statement
The carrying amount of the asset on the balance sheet is reduced by the amount of the impairment loss, and th

IFRS do not require acquisition dates to be disclosed.

IFRS do not require fair value of intangible assets to be disclosed.

Impairment = max(Fair value less costs to sell; Value in use) – Net carrying amount

long-lived intangible assets under US GAAP

Under US GAAP, companies are required to disclose the estimated amortization expense for the next five fiscal

Under US GAAP, there is no reversal of impairment losses.

Gain or loss on the sale = Sale proceeds – Carrying amount

= Sale proceeds – (Acquisition cost – Accumulated depreciation)

What Is Capitalize?
To capitalize is to record a cost or expense on the balance sheet for the purposes of delaying full recognition of
Revaluation
if the fair value at the first revaluation date is greater than carrying value, the difference is recorded as revaluati

Income tax enpenses = Tax payable + DTL - DTA

Deferred Tax Liabilities = Balance sheet amounts that result from an excess of income tax exp

Deferred tax assets = Balance sheet amounts that result from an excess of income taxes p

Deferred Tax Liabilities = Balance sheet amounts that result from an excess of income tax ex
--Liabilities
revenue areoccur when in the income statement before they are included on the tax return due to temporary
recognised

- Expenses (or losses) are tax deductible before they are recognized in the income statement.

Deferred tax assets = Balance sheet amounts that result from an excess of income taxes

Revenues (or gains) are taxable before they are recognized in the income statement.
Expenses (or losses) are recognized in the income statement before they are tax deductible.

Deferred tax assets are expected to provide future tax savings, while deferred tax liabilities are expected to res

Effective tax rate = income tax expenses

pretax income

Valuation allowance. Reduction of deferred tax assets (contra account) based on the likelihood that the future

Increase valuation allowance > decrease DTA > Increase income tax expenses > decrease net income

Tax loss carryforwards : a tax provision that allows firms to carry forward losses from prior years to offset futu

Tax base is the amount that will be deducted on the tax return in the future as the economics benefits of the as
The carrying value is the value of asset reported on the financial statements net of depreciation and amortizatio
If tax base > carrying value, DTA is created.

Decrease in DTL creates lower income tax expenses.

Decrease in DTA creates higher income tax expenses.

accelearated depreciation for tax purpose > lower taxble income > lower tax payable
A permanent difference is a difference between taxable income and pretax income that will not reverse in the f

A temporary difference refers to a difference between the tax base and the carrying value of an asset or liability

Tax payable = Tax base

Tax expenses = carrying value

Bond

A bond is a contractual promise between a borrower and a lender.

Two types of payments are involved: (1) periodic interest payments, and (2) repayment of principal at maturity.

Face value also know as maturity value or par value is the amount of principle that will be paid to bondholder a

The coupon rate is the interest rate stated in the bond that is used to calculate the coupon payments.

The coupon payments are the periodic interest payments to the bondholders and are calculated by multiplying

Market rate = cupon rate , the bond is a par bond (priced at face value)
Market rate > cupon rate , the bond is a discount bond (priced below par)
Market rate < cupon rate , the bond is a premium bond (priced above par)

Zero cupon bond = pure discount bond

Interest expense = find PV first and multiply PV with interest rate

carrying value = find PV first and <PV+interest expenses- PMT>

The amortization of the premium equals the interest payment minus the interest expense. The interest paymen
as the carrying amount decreases. As a result, the amortization of the premium increases each year.

Amortization premium = interest payment - interest expense

Operating lease is similar to renting an asset.

Finance lease is similar to purhcase of as asset.

Conservative accounting > if tend to decrease the company's reported earning

Aggressive accounting > if tend to increase the company's reported earning
- numbers of days payables
rce of financing.

rce of financing.

rce of financing.
erred equity

w + beginning balance = Ending cash balance

Average total assets

(leverage ratio)
 x Revenue x Average total assets
Average total assets Equity

(EBIT margin) (asset turnover) (financial leverage)

st + completion cost)

income statement.
d in the income statement by reducing cogs by the amount of recovery.

mortised and tested for impairment.

not amortised. Must be tested for impairment at least annually.

ted for impairment at least annually.

cost - residual
useful life

book value at the beginning of year x (more depreciation expenses in early years)

output units in the period (Depreciation expense is higher in periods of high usage)
ning useful life + average age of the assets

tion ) exceeds the recoverable amount.

alue in use.

verable amount.

nt, is recognized in the income statement.

and the income statement.

he impairment loss, and the impairment loss is reported on the income statement.

nse for the next five fiscal years.

elaying full recognition of the expense

nce is recorded as revaluation surplus, a component of equity, so net income is nor affected.

n excess of income tax expense over taxes payable that are expected to result in future cash outflows.

n excess of income taxes payable over tax expense that are expected to be recovered from future operations. Can also result from tax

n excess of income tax expense over taxes payable that are expected to result in future cash outflows.
x return due to temporary differences.

n excess of income taxes payable over tax expense that are expected to be recovered from future operations. Can also result from

bilities are expected to result in future cash out flows.

e likelihood that the future tax bene

ase net income

m prior years to offset future profits, and, therefore, lower future income taxes

onomics benefits of the asset are realised.

preciation and amortization.
hat will not reverse in the future.

value of an asset or liability that will result in taxable amounts or deductible amounts in the future.

nt of principal at maturity.

ill be paid to bondholder at maturity. The face value is used to calculate the cupon payment.

oupon payments.

calculated by multiplying the face value by the coupon rate.

ense. The interest payment is constant and the interest expense decreases
ases each year.
ns. Can also result from tax loss carryforwards

tions. Can also result from tax loss carryforwards

 Straight line
accumulated
$2,300 $550 $550
$1,750 $550 $1,100
$1,200 $550 $1,650
$650 $550 $2,200

25 50

DDB
accumulated
$2,300 $1,150 $1,150
$1,150 $575 $1,725
$575 $288 $2,013
$288 $144 $2,156

accumulated
DDB $2,300 $1,150 $1,150
Straight lin $1,150 $350 $1,500
Straight lin $800 $350 $1,850
Straight lin $450 $350 $2,200

unit of production
accumulated
$2,300 $550 $550
$1,750 $825 $1,375
$925 $550 $1,925
$375 $275 $2,200

exercises
pg 362 cfa 0.2
200000 80000 80000 120000
120000 48000 128000 72000
72000 24000 152000 48000
48000 24000 176000 24000
24000 12000 188000 12000
 200000 80000 80000 120000
120000 48000 128000 72000
72000 28800 156800 43200
43200 17280 174080 25920
25920 10368 184448 15552

0.17 0.333333
100 33.3 33.3 66.7
66.7 22.2111 55.5111 44.4889
44.4889 14.8148 70.3259 29.6741
29.6740963 9.881474 80.20738 19.79262
0

6 0.166667 0.333333
600000 199800 199800 400200 200000
400200 133266.6 333066.6 266933.4 266693.3
266933.4 88888.82 421955.4 178044.6
178044.5778 59288.84 481244.3 118755.7

600000 100000 100000 500000

500000 100000 200000 400000 -81244.27
400000 100000 300000 300000
300000 100000 400000 200000
nbv
$1,750
$1,200
$650
$100

nbv
$1,150
$575
$288
$144

nbv 200 boxes in the first year, 300 in the

$1,150 second year, 200 in the third year, and 100 in the fourth year
$800
$450
$100

nbv
$1,750
$925
$375
$100
Corporate Governance

- the system of internal control and procedures manage within organization.

- in order to minimise and manage the conflicting interest between insiders and external shareholders

Company’s stakeholder groups, and compare interests of stakeholder groups.

principal-agent conflict

information asymmetry

Stakeholder management
1 legal infrastructure
2 contractual infrastructure
3 organizational infrastructure
4 Governmental infrastructure

Annual general meeting

Proxy
- meaning she assigns her right to vote to another who will attend the meeting

Board Committees

audit committee
governance committee
nominations committee
compensation committee or remuneration committee
risk committee
investment committee

Board Structure

one-tier board
independent directors
two-tier board
staggered board

Board Responsibilities
1 Selecting senior management
2 Setting the strategic direction for the company
3 Approving capital structure changes
4 Reviewing company performance and implementing any necessary corrective steps.
5 Planning for continuity of management and the succession of the CEO and other senior mangers
6 Establishing, monitoring, and overseeing the firm's internal control and risk management system
7 Ensuring the quality of the firm's financial reporting and internal audit and oversight of t

Board Committees
1 audit committee
2 governance committee
3 nominations committee - for election
4 compensation committee or remuneration committee
5 risk committee
6 investment committee

Acquisitions, mergers, takeovers, and amendments to the company bylaws often require a supermajority of mo

Positive screening does not exclude any sectors but seeks to invest in the companies with the best practices.
Negative screening typically excludes some sectors.
Thematic investing refers to making an investment in a company or project in order to advance specific social o

Net Present Value

Internal Rate of Return

CF0 = Initial investment outlay (negative cash outflow)

CFt =after-tax cash flow at time t(can be positive or negative)
k = required rate of return for project

A positive NPV project is expected to increase shareholder wealth, a negative NPV project is expected to decrea
zero NPV project has no expected effect on shareholder wealth.

For independent projects, the NPV decision rule is simply to accept any project with a positive NPV and to rejec

IRR
PV(Inflows) = PV(outflows)

If IRR > the required rate of return, accept the project.

If IRR < the required rate of return, reject the project.

The minimum IRR, above which a project will be accepted, is often referred to as the hurdle rate. Projects with
accepted, while those with IRRs below this rate will not be accepted.

A key advantage of NPV is that it is a direct measure of the expected increase in the value of the firm.

A key advantage of IRR is that it measures profitibility as a percentage, showing the return on each dollar invest

WACC = Wd(Kd(1-t))+(Wps)(Kps) + (Wce)(Kce)

Kps = Dps/P
Kce = Rf + B(E(Rmkt)- Rf)

Adjusted beta= 2/3 * unadjusted beta + 1/3

DOL = Q(P-V)
Q(P-V)-F
 shareholders

her senior mangers

 anagement system
7

ften require a supermajority of more than 50% for passage.

mpanies with the best practices.

order to advance specific social or environment goals.

NPV project is expected to decrease shareholder wealth, and a

ct with a positive NPV and to reject any project with a negative NPV.

o as the hurdle rate. Projects with IRRs above this rate will be

in the value of the firm.

ng the return on each dollar invested.