The Financial Ratios Financial

The Financial Ratios Financial ratios can be somewhat loosely classified into different categories,
namely:
1. Profitability Ratios - help the analyst measure the profitability of the company
2. Leverage Ratios - also referred to as solvency ratios/ gearing ratios help us understand the
company’s long-term sustainability, keeping its obligation in perspective.
3. Valuation Ratios - the valuation ratio compares the cost of a security with the perks of owning the
stock
4. Operating Ratios - also called the ‘Activity Ratios’ measures the efficiency at which a business
can convert its assets (both current and noncurrent) into revenues.

The Profitability Ratios

1. EBITDA Margin (Operating Profit Margin)
EBITDA Margin tells us how profitable (in percentage terms) the company is at an operating level
= EBITDA / [Total Revenue – Other Income]
2. PAT Margin
PAT margin, all expenses are deducted from the Total Revenues of the company to identify the
overall profitability of the company.
= [PAT/Total Revenues]
3. Return on Equity (RoE)
It helps the investor assess the return the shareholder earns for every unit of capital invested
= [Net Profit / Shareholders Equity* 100]
‘DuPont Model’
DuPont Model breaks up the RoE formula into three components with each part representing a certain
aspect of business. The DuPont analysis uses both the P&L statement and the Balance sheet for the
computation.
ROE = Net Profit * Sales * Total Assets
Sales Total Assets Equity
(Profitability) (Asset Turnover) (Leverage Ratio)
4. Return on Asset (RoA)
IT evaluates the effectiveness of the entity’s ability to use the assets to create profits.
= [Profit after Tax / Total Assets]
 5. Return on Capital Employed (ROCE):
The Return on Capital employed indicates the profitability of the company taking into consideration
the overall capital it employs
= [Profit before Interest & Taxes / Overall Capital Employed]

The Leverage Ratios

6. Interest Coverage Ratio
The interest coverage ratio helps us understand how much the company is earning relative to the
interest burden of the company. This ratio helps us interpret how easily a company can pay its interest
payments
= [Earnings before Interest and Tax / Interest Payment]
7. Debt to Equity Ratio
It measures the amount of the total debt capital with respect to the total equity capital
= [Total Debt / Total Equity]
8. Debt to Asset Ratio
This ratio helps us understand the asset financing pattern of the company
= [Total Debt / Total Assets]
9. Financial Leverage Ratio
The financial leverage ratio gives us an indication, to what extent the assets are supported by equity
= [Total Asset / Total Equity]

The Operating Ratios

10. Fixed Assets Turnover
The ratio measures the extent of the revenue generated in comparison to its investment in fixed assets
= [Net Sales / Fixed Assets]
11. Inventory Turnover Ratio
If a company is selling popular products, then the goods in the inventory gets cleared rapidly, and the
company has to replenish the inventory time and again. This is called the ‘Inventory turnover’.
= [Net Sales / Inventory]
Inventory includes – raw materials + Work in Progress + Finished goods
  Inventory Number of days
While the Inventory turnover ratio gives a sense of how many times the company ‘replenishes’ their
inventory, the ‘Inventory number of Days’ gives a sense of how much time the company takes to
convert its inventory into cash.
= [365 / Inventory Turnover]

12. Accounts Receivable Turnover Ratio

The receivable turnover ratio indicates how many times in each period the company receives
money/cash from its debtors and customers.
= [Sales / Total Receivables]
 Days Sales Outstanding (DSO)
The days sales outstanding ratio illustrates the average cash collection period i.e. the time lag between
billing and collection
= [365 / Receivable Turnover Ratio]

The Valuation Ratio

13. Price to Sales (P/S) Ratio
This ratio compares the stock price of the company with the company’s sales per share.
= [Current Share Price / Sales per Share]
Sales per share = Total Revenues / Total number of shares
14. Price to Book Value (P/BV) Ratio
The P/BV indicates how many times the stock is trading over and above the book value of the firm
= [Current Share Price / Book Value]
BV = [Share Capital + Reserves (excluding revaluation reserves) / Total Number of shares]
The “Book Value” of a firm is simply the amount of money left on table after the company pays off
its obligations
15. Price to Earning (P/E) Ratio
The Ratio compares the relationship between market price per share and the profits per share.
= [Current Share Price / Earnings per Share]
EPS = [PAT / Number of shares]
Liquidity Ratio
16. Current Ratio
The compares the ratio between CA and CL
= [CA / CL]
17. Quick Ratio
It indicates the speed at which the liabilities can be met
= [ CA – Inventory / CL]

What Is the Time Value of Money (TVM)?

The time value of money (TVM) is the concept that money you have now is worth more than the
identical sum in the future due to its potential earning capacity. This core principle of finance holds
that provided money can earn interest, any amount of money is worth more the sooner it is received.
TVM is also sometimes referred to as present discounted value.
What is Annuity due and Annuity Regular?
Regular annuity is a series of equal payments made at the end of consecutive periods over a fixed
length of time. While the payments in a regular annuity can be made as frequently as every week, in
practice, they are generally made monthly, quarterly, semi-annually, or annually.
Annuity due is an annuity whose payment is due immediately at the beginning of each period. A
common example of an annuity due payment is rent, as landlords often require payment upon the start
of a new month as opposed to collecting it after the renter has enjoyed the benefits of the apartment
for an entire month.
Give the distinction between Present Value and Present Value of an annuity
Present value (PV) is the current value of a future sum of money or stream of cash flows given a
specified rate of return. Future cash flows are discounted at the discount rate, and the higher the
discount rate, the lower the present value of the future cash flows. Determining the appropriate
discount rate is the key to properly valuing future cash flows, whether they be earnings or obligations.
PV= FV / (1+r)n
where:
FV=Future Value
r=Rate of return
n=Number of periods

The present value of an annuity is the current value of future payments from an annuity, given a
specified rate of return, or discount rate. The higher the discount rate, the lower the present value of
the annuity.
Because of the time value of money, money received today is worth more than the same amount of
money in the future because it can be invested in the meantime. By the same logic, Rs. 5,000 received
today is worth more than the same amount spread over five annual instalments of Rs 1,000 each.
Give the distinction between Future Value and Future Value of an annuity
Future value (FV) is the value of a current asset at a future date based on an assumed rate of growth.
The future value (FV) is important to investors and financial planners as they use it to estimate how
much an investment made today will be worth in the future. Knowing the future value enables
investors to make sound investment decisions based on their anticipated needs. However, external
economic factors, such as inflation, can adversely affect the future value of the asset by eroding its
value.
FV= I *(1+(R*T) for simple interest
FV= I *(1+R)T for compound interest
where:
I = Investment Amount
R = Interest Rate
T = Number of years
The future value of an annuity is the value of a group of recurring payments at a certain date in the
future, assuming a particular rate of return, or discount rate. The higher the discount rate, the greater
the annuity's future value.
Because of the time value of money, money received or paid out today is worth more than the same
amount of money will be in the future. That's because the money can be invested and allowed to grow
over time. By the same logic, a lump sum of Rs 5,000 today is worth more than a series of five Rs
1,000 annuity payments spread out over five years.
P= (PMT * (1+r)n-1) / r
What Is a Sinking Fund and Loan Amortization?
A sinking fund is a fund containing money set aside or saved to pay off a debt or bond. A company
that issues debt will need to pay that debt off in the future, and the sinking fund helps to soften the
hardship of a large outlay of revenue. A sinking fund is established so the company can contribute to
the fund in the years leading up to the bond's maturity.
Loan Amortization a type of loan with scheduled, periodic payments that are applied to both the loan's
principal amount and the interest accrued. An amortized loan payment first pays off the relevant
interest expense for the period, after which the remainder of the payment is put toward reducing the
principal amount.

What is the Payback Period?

The payback period refers to the amount of time it takes to recover the cost of an investment. Simply
put, the payback period is the length of time an investment reaches a break-even point.
What Is the Discounted Payback Period?
The discounted payback period is a capital budgeting procedure used to determine the profitability of
a project. A discounted payback period gives the number of years it takes to break even from
undertaking the initial expenditure, by discounting future cash flows and recognizing the time value of
money. The metric is used to evaluate the feasibility and profitability of a given project.
What is Net Present Value (NPV)?
Net present value (NPV) is the difference between the present value of cash inflows and the present
value of cash outflows over a period of time. NPV is used in capital budgeting and investment
planning to analyse the profitability of a projected investment or project.

What Is Internal Rate of Return – IRR?

The internal rate of return (IRR) is a metric used in capital budgeting to estimate the profitability of
potential investments. The internal rate of return is a discount rate that makes the net present value
(NPV) of all cash flows from a particular project equal to zero. IRR calculations rely on the same
formula as NPV does.
What Is a MIRR?
The modified internal rate of return (MIRR) assumes that positive cash flows are reinvested at the
firm's cost of capital and that the initial outlays are financed at the firm's financing cost. By contrast,
the traditional internal rate of return (IRR) assumes the cash flows from a project are reinvested at the
IRR itself. The MIRR, therefore, more accurately reflects the cost and profitability of a project
What Is the Profitability Index (PI)?
The profitability index (PI), alternatively referred to as value investment ratio (VIR), or profit
investment ratio (PIR), describes an index that represents the relationship between the costs and
benefits of a proposed project, using the following ratio:
PI= PV of Future Cash Flows / Initial Investment