Profitability Ratios

1. Gross Profit Rate = Gross Profit ÷ Net Sales

Evaluates how much gross profit is generated from sales. Gross profit is equal to net sales (sales
minus sales returns, discounts, and allowances) minus cost of sales.
2. Return on Sales = Net Income ÷ Net Sales
Also known as "net profit margin" or "net profit rate", it measures the percentage of income
derived from dollar sales. Generally, the higher the ROS the better.
3. Return on Assets = Net Income ÷ Average Total Assets
In financial analysis, it is the measure of the return on investment. ROA is used in evaluating
management's efficiency in using assets to generate income.
4. Return on Stockholders' Equity = Net Income ÷ Average Stockholders' Equity
Measures the percentage of income derived for every dollar of owners' equity.

Liquidity Ratios
1. Current Ratio = Current Assets ÷ Current Liabilities
Evaluates the ability of a company to pay short-term obligations using current assets (cash,
marketable securities, current receivables, inventory, and prepayments).
2. Acid Test Ratio = Quick Assets ÷ Current Liabilities
Also known as "quick ratio", it measures the ability of a company to pay short-term obligations
using the more liquid types of current assets or "quick assets" (cash, marketable securities, and
current receivables).
3. Cash Ratio = ( Cash + Marketable Securities ) ÷ Current Liabilities
Measures the ability of a company to pay its current liabilities using cash and marketable
securities. Marketable securities are short-term debt instruments that are as good as cash.
4. Net Working Capital = Current Assets - Current Liabilities
Determines if a company can meet its current obligations with its current assets; and how much
excess or deficiency there is.

Management Efficiency Ratios

1. Receivable Turnover = Net Credit Sales ÷ Average Accounts Receivable
Measures the efficiency of extending credit and collecting the same. It indicates the average
number of times in a year a company collects its open accounts. A high ratio implies efficient
credit and collection process.
2. Days Sales Outstanding = 360 Days ÷ Receivable Turnover
Also known as "receivable turnover in days", "collection period". It measures the average
number of days it takes a company to collect a receivable. The shorter the DSO, the better. Take
note that some use 365 days instead of 360.
3. Inventory Turnover = Cost of Sales ÷ Average Inventory
 Represents the number of times inventory is sold and replaced. Take note that some authors use
Sales in lieu of Cost of Sales in the above formula. A high ratio indicates that the company is
efficient in managing its inventories.
4. Days Inventory Outstanding = 360 Days ÷ Inventory Turnover
Also known as "inventory turnover in days". It represents the number of days inventory sits in
the warehouse. In other words, it measures the number of days from purchase of inventory to the
sale of the same. Like DSO, the shorter the DIO the better.
5. Accounts Payable Turnover = Net Credit Purchases ÷ Ave. Accounts Payable
Represents the number of times a company pays its accounts payable during a period. A low
ratio is favored because it is better to delay payments as much as possible so that the money can
be used for more productive purposes.
6. Days Payable Outstanding = 360 Days ÷ Accounts Payable Turnover
Also known as "accounts payable turnover in days", "payment period". It measures the average
number of days spent before paying obligations to suppliers. Unlike DSO and DIO, the longer
the DPO the better (as explained above).
7. Operating Cycle = Days Inventory Outstanding + Days Sales Outstanding
Measures the number of days a company makes 1 complete operating cycle, i.e. purchase
merchandise, sell them, and collect the amount due. A shorter operating cycle means that the
company generates sales and collects cash faster.
8. Cash Conversion Cycle = Operating Cycle - Days Payable Outstanding
CCC measures how fast a company converts cash into more cash. It represents the number of
days a company pays for purchases, sells them, and collects the amount due. Generally, like
operating cycle, the shorter the CCC the better.
9. Total Asset Turnover = Net Sales ÷ Average Total Assets
Measures overall efficiency of a company in generating sales using its assets. The formula is
similar to ROA, except that net sales is used instead of net income.

Leverage Ratios
1. Debt Ratio = Total Liabilities ÷ Total Assets
Measures the portion of company assets that is financed by debt (obligations to third parties).
Debt ratio can also be computed using the formula: 1 minus Equity Ratio.
2. Equity Ratio = Total Equity ÷ Total Assets
Determines the portion of total assets provided by equity (i.e. owners' contributions and the
company's accumulated profits). Equity ratio can also be computed using the formula: 1
minus Debt Ratio.
The reciprocal of equity ratio is known as equity multiplier, which is equal to total assets divided
by total equity.
3. Debt-Equity Ratio = Total Liabilities ÷ Total Equity
 Evaluates the capital structure of a company. A D/E ratio of more than 1 implies that the
company is a leveraged firm; less than 1 implies that it is a conservative one.
4. Times Interest Earned = EBIT ÷ Interest Expense
Measures the number of times interest expense is converted to income, and if the company can
pay its interest expense using the profits generated. EBIT is earnings before interest and taxes.

Valuation and Growth Ratios

1. Earnings per Share = ( Net Income - Preferred Dividends ) ÷ Average Common
Shares Outstanding
EPS shows the rate of earnings per share of common stock. Preferred dividends is deducted from
net income to get the earnings available to common stockholders.
2. Price-Earnings Ratio = Market Price per Share ÷ Earnings per Share
Used to evaluate if a stock is over- or under-priced. A relatively low P/E ratio could indicate that
the company is under-priced. Conversely, investors expect high growth rate from companies
with high P/E ratio.
3. Dividend Pay-out Ratio = Dividend per Share ÷ Earnings per Share
Determines the portion of net income that is distributed to owners. Not all income is distributed
since a significant portion is retained for the next year's operations.
4. Dividend Yield Ratio = Dividend per Share ÷ Market Price per Share
Measures the percentage of return through dividends when compared to the price paid for the
stock. A high yield is attractive to investors who are after dividends rather than long-term capital
appreciation.
5. Book Value per Share = Common SHE ÷ Average Common Shares
Indicates the value of stock based on historical cost. The value of common shareholders' equity
in the books of the company is divided by the average common shares outstanding.
Comprehensive Outline for Economic Concepts and Theory

Supply and Demand

o The market matches buyers and sellers of good and services.

o Demand is the quantity of a good or service that consumers are willing and able to purchase
at various prices.
 Law of demand  - the price of a product and the quantity demanded are inversely
related.
 Substitution effect - when prices decrease, buyer will enter the market. The product
will be cheaper relative to other goods and is substituted for them.
 Income effect - people buy more when prices are lower.
 Normal goods - commodities for which demand is negatively related
to income.
 Inferior goods - commodities for which demand is negatively related
to income.
 Substitutes - increase is price of one product will generate an increase in
demand for another.
 Complements - increase in the price for one product will generate a decrease
in demand for another. Bread prices go up, jelly demand goes down
o Demand curves
 Elasticity of demand - the parentage change in quantity demanded divided by the
percentage change in price.
o Supply is the amount of goods or services that producers are willing to offer at a given price.
 Law of supply - the price of a product and the quantity supplied are positively related.
 Price elasticity of supply - percentage change in quantity supplied divided by the
percentage change in price. 
 Equilibrium - the point at which the demand and supply curves intersect.
o Law of diminishing returns - a fixed amount of production resources, the addition
of increments of labor will produce diminishing returns.
o Law of diminishing marginal utility  - useful will decline as consumers acquired additional
units of a product.

 GDP and Business Cycles

o National income - the measure of the output and performance of a nations’
economy.
 Gross domestic product (GDP) - the total market value of all final goods
and services produced within the US whether domestic or foreign during a year.
 Gross national product (GNP) - value of output produced with the US
owned resources regardless of their location. GNP is GDP plus output of US
owned resources abroad minus foreign owned resources in the US.
 Measurement of GDP can use one of two approaches.
 Income approach - GDP is sum of various types of income such
as wages, interest, rents, indirect business taxes, net foreign income.
  Expenditure approach  - GDP is sum of spending such as
personal consumption spending, gross private domestic investment,
government purchases, net exports.
 Net domestic product - GDP - deprecation (consumption of fixed assets)
 National income - NDP + US net income earned abroad - indirect
business taxes such as sales taxes.
 Personal income  - NI  - corporate taxes  - social security contributions 
+ transfer payments
 Disposable income - PI - personal income taxes
o Business cycles
 Peak phase - economy has reached its highest level of production (GDP).
 Trough - low levels of economic activity and under use of resources.
 Recovery (expansion) - increasing economic activity.
 Recession - activity severely contracts.
 Depression - conditions are similar but longer lasting.
o Economic indicators
 Consumer price index (CPI) - based on prices of 364 goods and services
over time.
 Leading indicators such as new orders, building permits, weekly production.
 Lagging indicators - unemployment consumer credit,
o Employment
 Natural rate of unemployment - the long-term rate that would exist even
if there were no cyclical unemployment.
 Full employment - when the real rate of unemployment is equal to the
natural rate.
 Frictional unemployment - employees are between jobs.
 Structural unemployment - includes those who have skills but do not
match the required skill levels. by employers.
 Cyclical unemployment - downturn in the business cycle.

 Fiscal Economics
o Deals with the ability of the economy to generate and maintain full employment
over the long run without government intervention.  Three assumptions about this
theory.
 The difference between savings plans and investment plans is fundamental
to an understanding of changes in the level of income.
 Price flexibility cannot be relied upon to provide full employment.
 Equilibrium GDP does not necessarily provide full employment.
o Multiplier - a change in consumption, investment, net exports or government
spending results in a multiplied change in equilibrium GDP.
 Marginal propensity to consume (MPC) - the percentage of additional
income that is consumed.
 Marginal propensity to save (MPS) - the percentage of additional income
that is saved.
 MPC + MPS = 1 or MPS = 1 - MPC
 Money and the Economy
o M1 - coins and currency, checking deposits
o M2 - M1 plus savings, small time deposits, money market accounts.
o Monetary policy by the FED is designed to control the economy through the
supply of money in the banking system.  Tools to accomplish this are:
 Reserves
 Discount rates

 Unemployment, Inflation, Deflation, Government

o Unemployment   - types
 Frictional - caused by the normal workings of the labor market.
 Structural - aggregate demand is sufficient to provide full employment but
the distribution of demand does not relate to labor force.
 Cyclical
 Seasonal
 Regional
 Technological.
o Inflation
 Cost-push - increased production costs are passed on to the consumer.
 Demand-pull - demand for goods and services is excessive.
 Consumer price index
o Government’s role
 Taxation
 Progressive
 Regressive
 Proportional
 Direct taxes are paid by the taxpayer directly such as income taxes.
 Indirect  taxes  are  paid  by  someone  else  even  though  the  individual 
will eventually pay the taxes.

 International Trade
o Comparative  advantage  -  countries  should  produce  products  when  they  have 
the competitive advantage for sale and buy when they do not.
 Production possibilities curve - represents the tradeoffs between two
alternative goods that can be produced from the same amount of resources.

 Trade Barriers
o The following items are barriers to successful trade.
 Tariffs - consumption taxes to restrict imports.
 Antidumping taxes
 Import quotas
 Embargo - total ban on some kinds of imports.

 Foreign Currency Rates and Markets

o Exchange rate determination
  Spot rate - rate paid for immediate delivery of a currency.
 Forward exchange rate - future price of currency.
o Avoiding the problem through hedging.
 Purchased or selling forward contracts.

 Balance of Payments
o Balance of trade is difference between total exports and imports of goods.