There are many types of financial ratio analysis but those that will typically be used include:

· Liquidity

· Leverage

· Activity

· Profitability

· Growth

Income Statement Tips:

· All line items expressed as a % of revenue should divide by net revenue, not gross

· Break out all operating expenses as much as possible

· Break out interest expense and interest income

· Look at past trends in expenses as a % of revenue

· Find out components of COGS. Is a certain raw material expense about to increase a lot? Do they have a sourcing contract about to roll-off?

Balance Sheet Tips:

· For any ratio based on book value (shareholders’ equity), strip out goodwill. Use tangible book = shareholders’ equity – goodwill.

· For debt ratios, including capitalized leases

· Create a debt table. Is debt about to mature? Will the new rate be higher or lower? Check the maturity schedule.

“Liquidity ratios” gauge a company’s ability to meet short-term obligations. Credit analysts at banks use these ratios to monitor their corporate clients, and fixed income managers use them when analyzing companies.

**“Current Ratio” = ** **Current Assets**

** Current Liabilities**

The higher this ratio, the more liquid assets a company has to cover its short-term liabilities.

**“Quick Ratio” = ****Current Assets – Inventory**

** Current Liabilities**

This is a stricter gauge because inventory cannot be “quickly” liquidated to pay bills. A credit analyst would look at this in the context of inventory turns, also known as the “acid test” ratio.

“Leverage ratios” gauge a company’s risk in the context of its debt levels. Is it generating sufficient EBITDA (D&A is a non-cash expense) to meet its interest payments?

**Debt Multiple = ** **Avg. of Beg/End Year Total Debt**

** EBITDA**

**Interest Coverage = ** **EBITDA + Other Income**

** Interest**

**Cost of Debt = ** **Interest Expense**

** Avg. of Beg/End Year Total Debt**

Note: When calculating any ratio where the numerator is an income statement item and the denominator is a balance sheet item or vice versa, always use an average for the balance sheet item. Income is over some time; the balance sheet is a snapshot in time.

Activity ratios gauge a company’s efficient utilization of its assets.

**Inventory Turnover = ** **COGS**

** Avg. Inventory**

**Asset Turnover = ** **Revenue**

** Avg. Assets**

**Days in Receivables = ****Avg. Accounts Receivable**** x 360**

** Revenues**

**Days in Payables = ****Avg. Accounts Payable**** x 360**

**COGS**

__Example: __

How many times a year does a company turn over its inventory if:

Dec. 31, 2012 inventory = $100

Dec. 31, 2013 inventory = $120

COGS in 2013 income statement = $220

Inventory turnover = $220/(($100 + $120)/2) = 2x

In 2013, they sold twice the inventory they carried on average. So, they sold the entire beginning of year amount, manufactured a second batch, and sold that too.

“Profitability Ratios” gauge a company’s performance relative to its competitors, and to its historical results.

**Gross Margin = ** **Gross Profit**

**Revenue**

**EBIT (operating) Margin = ** **EBIT**

**Revenue**

**EBITDA Margin = ** **EBITDA**

**Revenue**

**Net Margin = ** **Net Income**

**Revenue**

Remember gross profit = revenue – COGS. EBIT = operating income. EBITDA = EBIT + D&A (from cash flow statement)

Annual growth, such as revenue or EPS growth, year over year is expressed in models as Y/Y.

If this year’s revenue = $100, last year’s = $90, the “year over year” growth rate was

$100/$90 - 1 = 11.1%

Sequential growth refers to a company’s quarterly results’ growth versus the prior quarter, 90 days prior.

If 3Q was $20, and 2Q was $19, the “sequential growth” was $20/$19 – 1 = 5.3%

Sequential growth rates are expressed in models as Q-Q and are looked at to gauge if growth is rising or slowing within a year. Quarterly results are also looked at on Y/Y basis, not just Q-Q.

Compounded Annual Growth Rate (CAGR, pronounced “kay-ger”) shows the average annual growth rate over some time longer than a year. For counting the number of years, let’s say it’s from 2005-2013, the number of years is 8, not 9. There are 9 years represented, but 8 years elapsed. For instance, from 2005 to 2006, 1 year elapsed, not 2 years.

__Example:__

2005 revenue = $10 2013 revenue = $30

2013 minus 2005 = 8 years

CAGR = $30/$10, to the power of (1/8) minus 1 CAGR is 15%

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