Financial Ratios Used In BSG-Online

Profitability Ratios (as reported on pages 2 and 5 of the Footwear
Industry Report) •
Earnings per share (EPS) is defined as net income divided by the number of shares of stock issued to stockholders. Higher EPS values indicate the company is earning more net income per share of stock outstanding. Because EPS is one of the five performance measures on which your company is graded (see p. 2 of the FIR) and because your company has a higher EPS target each year, you should monitor EPS regularly and take actions to boost EPS. One way to boost EPS is to pursue actions that will raise net income (the numerator in the formula for calculating EPS). A second means of boosting EPS is to repurchase shares of stock, which has the effect of reducing the number of shares in the possession of shareholders—net income divided by a smaller number of shares yields a bigger EPS. Return on average equity (ROE) ROE is defined as net income divided by the average amount of shareholders’ equity investment—the average amount of shareholders’ equity investment is equal to the sum of shareholder equity at the beginning of the year and the end of the year divided by 2. Total shareholder equity at the end of the year turns out to be larger than total shareholder equity at the beginning of the year whenever the company’s dividend payments are less than its net profits (such that some earnings are retained in the business—all retained earnings add to the amount of shareholders’ equity). Higher ROE values indicate the company is earning more after-tax profit per dollar of equity capital provided by shareholders. Because ROE is one of the five performance measures on which your company is graded (see p. 2 of the FIR), and because your company’s annual target ROE is 15%, you should monitor ROE regularly and take actions to boost ROE. One way to boost ROE is to pursue actions that will raise net income (the numerator in the formula for calculating ROE). A second means of boosting ROE is to repurchase shares of stock, which has the effect of reducing shareholders’ equity investment in the company (the denominator in the ROE calculation), thus producing a higher ROE percentage. Operating profit margin is defined as operating profit divided by net revenues (where net revenues represent the dollars received from footwear sales, after exchange rate adjustments). A higher operating profit margin (shown on p. 5 of the FIR) is a sign of competitive strength and cost competitiveness. The bigger the percentage of operating profit to net revenues, the bigger the margin for covering interest payments and taxes and moving dollars to the bottom-line. A company with a bolded number for the operating profit margin shown in the bottom section of page 5 of the FIR has the best operating profit margin of any company in the industry. Companies whose operating profit margin numbers are shaded have sub-par margins, thus signaling a need for management to work on improving profitability. Net profit margin is defined as net profit (or net income or after-tax income, all of which mean the same thing) divided by net revenues, where net revenues represent the dollars received from footwear sales after exchange rate adjustments. The bigger a company’s net profit margin (its ratio of net profit to net revenues), the better the company’s profitability in the sense that a bigger percentage of the dollars it collects from footwear sales flow to the bottom-line. A company’s net profit margin represents the percentage of revenues that end up on the bottom line. A company

Companies having the highest ratios of production costs to net revenues are candidates for being caught in a profit squeeze. A company’s cost of pairs sold includes all production-related costs. Net sales revenues represent the dollars received from both branded and private-label footwear sales after exchange rate adjustments. is a low marketing cost percentage coupled with high sales.with a bolded number for the net profit margin shown in the bottom section of page 5 of the FIR signifies the best net profit margin of any company in the industry. Companies with shaded numbers have sub-par net profit margins. However. and freight charges on pairs shipped from plants to distribution warehouses. Net sales revenues represent the dollars received from both branded and private-label footwear sales after exchange rate adjustments. and above-average market share (all sure signs that a company has a cost-effective marketing strategy and is getting a nice bang for the marketing dollars it is spending). any exchange rate adjustments on pairs shipped to distribution warehouses. if coupled with low unit sales volumes. marketing. This ratio is calculated by dividing total marketing costs by net sales revenues. This ratio is calculated by dividing total costs of goods sold by net sales revenues. Operating Ratios (as reported on the Comparative Performances page of the Footwear Industry Report) Financial The ratios relating to costs and profit as a percentage of net revenues that are at the bottom of page 5 of the FIR are of particular interest because they indicate which companies are most cost efficient and have the best profit margins: • • • • Cost of pairs sold as a percent of net revenues. This ratio is calculated by dividing administrative costs by net sales revenues. Production costs at such companies are usually too high relative to the price they are charging (their strategic options for boosting profitability are to cut costs. A low percentage of marketing expenses to net revenues relative to other companies signals good efficiency of marketing expenditures (more revenue bang for the buck). marketing. Marketing expenses as a percent of net revenues. any tariff payments. Net sales revenues . Low percentages for the cost of pairs sold are generally preferable to higher percentages because they signal that a bigger percentage of the revenue received from footwear sales is available to cover delivery. provided unit sales volumes are attractively high. The optimal condition. Warehouse expenses as a percent of net revenues. with any remainder representing pre-tax profit. raise prices. Administrative expenses as a percent of net revenues. indicating that a smaller proportion of revenues is required to cover the costs of warehouse operations (which leaves more room for covering other costs and earning a bigger profit on each unit sold). This ratio is calculated by dividing total warehouse expenses by net sales revenues. administrative. Net sales revenues represent the dollars received from both branded and private-label footwear sales after exchange rate adjustments. and administrative costs and interest costs and still have a comfortable margin for profit. high revenues. and interest costs. or try to make up for thin margins by somehow selling additional units). with margins over and above production-related costs that are too small to cover delivery. generally signals that a company is spending too little on marketing. therefore. thus signaling a need for management to work on improving profitability. a low percentage of marketing costs. A low percentage of warehouse expenses to net revenues is preferable to a higher percentage.

35 is considered “good”.10 to achieve an A+ credit rating and a debt-asset ratio of about 0. Ratios that are shaded designate companies with sub-par ratios and generally indicate that management needs to work on improving that measure of cost competitiveness. The interest coverage ratio is defined as annual operating profit divided by annual interest payments. • .20 to . (c) the current portion of long-term loans that are due and payable. An interest coverage ratio of 2.0 is considered much more satisfactory for companies in the footwear industry because of earnings volatility over each year.represent the dollars received from both branded and private-label footwear sales after exchange rate adjustments. Operating profit is reported on the Income Statement and on p.25 to achieve an A– credit rating (unless the interest coverage ratios are in the 5 to 10 range and the default risk ratio is above 3. Credit Rating Ratios (as reported on the Comparative Financial Performances page of the Footwear Industry Report) Three financial measures are used to determine your company’s credit rating: • The debt-to-assets ratio is defined as all loans outstanding divided by total assets —both numbers are shown on the company’s balance sheet.0 is considered “rock-bottom minimum” by credit analysts. interest payments are reported on the Income Statement. It usually takes a double-digit times-interest-earned ratio to secure an A– or higher credit rating. and (d) any overdraft loans that are due and payable—all these amounts are reported on the company’s balance sheet. and the relatively unproven management expertise at each company. A low ratio of administrative costs to net sales revenues signals that a company is spreading administrative costs out over a bigger volume of sales. as is the amount of total assets (total assets is also reported on page 5 of the FIR). A coverage ratio of 5.50 (or 50%) are generally alarming to creditors and signal “too much” use of debt and creditor financing to operate the business.00. Bolded numbers in any of the four cost/expense ratio columns at the bottom of page 5 of the FIR signify companies with industry-best ratios. it will take a debt-to-assets ratio close to 0. (b) long-term bank loans outstanding. 5 of the FIR. intense competitive pressures which can produce sudden downturns in a company’s profitability. A debt-to-assets ratio of . Debt-to-asset ratios above 0. As a rule of thumb.00). although such a debt level could still produce a B+ or A– credit rating if a company can maintain with very strong interest coverage ratios (say 8. since this credit measure is strongly weighted in the credit rating determination.0 to 10. All loans outstanding include (a) 1-year loans outstanding. Your company’s interest coverage ratio is used by credit analysts to measure the “safety margin” that creditors have in assuring that company profits from operations are sufficiently high to cover annual interest payments.0 or higher) and default risk ratios above 3. Companies with a high percentage of administrative costs to net revenues generally need to pursue additional sales or market share or risk squeezing profit margins and being at a cost disadvantage to bigger-volume rivals (although a higher administrative cost ratio can sometimes be offset with lower costs/ratios elsewhere).

then you and you co-managers need to take calculated action to get those ratios up as rapidly as possible. A company with a default risk ratio below 1. At the least. A bolded number in the current ratio column designates the company with the best/highest current ratio. Fewer days of inventory are usually better up to a point (but keeping too few pairs in inventory impairs the delivery times to footwear retailers and runs the risk of not having enough pairs in inventory to fill retailer orders should sales prove to be higher than expected). a current ratio in the 1.0 and 3. your company’s current ratio should be greater than 1.5 range provides a much healthier cushion for meeting current liabilities. However.0 and higher are classified as “low risk” because their free cash flows are 3 or more times the size of their annual principal payments). Thus. Other Financial Ratio Measures (as reported on the Comparative Financial Performances page of the Footwear Industry Report) • The current ratio equals current assets divided by current liabilities. If any of the credit rating measures for your company have a shaded or highlighted background. Ratios in the 5. this equates to: number of branded pairs in inventory ÷ [number of branded pairs sold ÷ 365]. Companies with a default risk ratio between 1. Days of inventory equals the number of branded pairs in inventory at the end of the year divided by the number of branded pairs sold per day in the prior year. • .0 to 10. can be sufficient to knock a company’s credit rating down a notch.• The default risk ratio is defined as free cash flow divided by the combined annual principal payments on all outstanding loans.5 to 2. then the company can maintain a higher debt-to-assets ratio without greatly impairing its credit rating.0 range are far better yet. weakness on just one of the three measures. companies with shaded current ratios need to work on improving their liquidity if the number is below 1. The interest coverage ratio and the default risk ratio are the two most important measures in determining a company’s credit rating.0 is automatically assigned “high risk” status (because it is short of cash to meet its principal payments) and cannot be given a credit rating higher than C+. and companies with a default ratio of 3. as long as a company is financially strong in its ability to service its debt—as measured by the interest coverage ratio and the default risk ratio. Bolded numbers on the credit rating measures indicate credit rating strength relative to rival companies. In formula terms. particularly the two most important ones. This credit measure also carries a high weighting in the credit rating determination. Weakness on two or three can reduce the rating by several notches. Free cash flow is equal to net profit plus depreciation minus dividend payments. It measures the company’s ability to generate sufficient cash to pay its current liabilities as they become due.5.0.0 are designated as “medium risk”.

• The dividend yield is defined as the dividend per share divided by the company’s current stock price. rather than sporadically). but the increases need to be at least $0. In GLO-BUS. The dividend payout ratio thus represents the percentage of earnings after taxes paid out to shareholders in the form of dividends. It shows what return (in the form of a dividend) a shareholder will receive on their investment in the company if they purchase shares at the current stock price. Dividends in excess of earnings are unsustainable and thus are viewed with considerable skepticism by investors—as a consequence. then you should consider a dividend cut until earnings improve. you should consider the merits of keeping your company’s dividend payments high enough to produce an attractive yield compared to other companies. However. A rising dividend has a positive impact on your company’s stock price (especially if the dividend is increased regularly. A dividend yield below 2% is considered “low” unless a company is rewarding shareholders with nice gains in the company’s stock price price. unless the company has paid off most of its loans outstanding and has a comfortable amount of cash on hand to fund growth and contingencies. • . you do not want to boost your dividend so high (just for the sake of maintaining a record of dependable dividend increases) that your dividend payout ratio becomes excessive. A dividend yield greater than 5% is “considered “high” by real world standards and is attractive to investors looking for a stock that will generate sizable dividend income. Dividend increases should be justified by increases in earnings per share and by the company’s ability to afford paying a higher dividend. as explained below.05 per share to have much impact on the stock price. The dividend payout ratio is defined as total dividend payments divided by net profits (or the dividend per share divided by earnings per share—both calculations yield the same result). a company’s dividend payout ratio should be less than 75% of net profits (or EPS). Generally speaking. dividend payouts in excess of 100% have a negative impact on the company’s stock price. If your company’s dividend payout exceeds 100% for more than a year or two.

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