Hult International Business School - London

Accounting for Managers

Handout 8 – Tools for Financial Analysis

Fall 2023

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Financial Analysis
Financial metrics / margins / ratios help us analyze the
strengths and weaknesses of a business.
They can be grouped together based on the type of
information they provide.
They matter differently to different users.
• Liquidity Ratios;
• Profitability Metrics;
• Efficiency Metrics (Assets);
• Efficiency Metrics (Working Capital);
• Shareholder Metrics;
• Returns;
• Leverage & Solvency (Risk).
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Financial Ratios, Metrics, Margins (I)
Liquidity Ratios:
1. Current Ratio
→ Current Assets / Current Liabilities
• Shows whether or not a business has enough potential cash to cover
the liabilities due within the next year;

2. Quick Ratio (Acid Test)

→ Cash + Sh. T. Investments + A/R / Current Liabilities
• Stricter version of the Current Ratio; (eliminates the least liquid assets
(Inventory and Other Current Assets) from the calculation.

3. Cash Ratio
→ Cash + Cash Equivalents / Current Liabilities
• A very strict test of liquidity; (focusing only on cash and cash like
items), very sensitive to small changes.
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Financial Ratios, Metrics, Margins (II)
Profitability Metrics (%s):
4. Gross Profit Margin
→ (Net Revenues – COGS) / Net Revenues
• Measures how much of every $ of revenues is left (after covering costs
to either purchase or produce goods or services sold).

5. EBITDA Margin (sometimes called Operating “Cash Flow”

Margin)
→ EBITDA / Net Revenues
• Measures how much of every $ of revenues ends up as earnings
before interest, tax, depreciation & amortization (for the period).
6. EBIT Margin (Operating Income Margin)
→ EBIT / Net Revenues
• Measures how much of every $ of revenues ends up as operating profit
(for the period). -4-
Financial Ratios, Metrics, Margins (III)
Profitability Metrics (%s):
7. Pre Tax Income Margin (PTI Margin)
→ Profit before Tax/ Net Revenues
• Measures how much of every $ of revenues ends up as pre tax income
(for the period).

8. Net Profit Margin

→ Net Income / Net Revenues
• Measures how much of every $ of revenues ends up as profit (for the
period).

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Financial Ratios, Metrics, Margins (IV)
Efficiency Metrics (Assets):
9. Total Asset Turnover
→ Net Revenues / (Average) Total Assets.
• Measures the revenues generated per $ of assets.
• * Average = (Beginning Assets + Ending Assets ) / 2

10. Fixed Asset Turnover

→ Net Revenues / (Average) Net Fixed Assets.
• Measures the revenues generated per $ invested in PP&E.
• * Average = (Beginning Assets + Ending Assets ) / 2

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Financial Ratios, Metrics, Margins (V)
Efficiency Metrics (Working Capital - A/Receivables):
11. A/R Turnover
→ Net Revenues / (Average) A/R
• Measures how many times (in the period) the average A/R are
recorded and collected.

12. Average Collection Period (Day Revenues in A/R)

→ A/R / (Net Revenues / 365)
• Measures how long on average it takes for a customer to pay its
outstanding accounts.

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Financial Ratios, Metrics, Margins (VI)
Efficiency Metrics (Working Capital - Inventory):
13. Inventory Turnover
→ COGS / (Average) Inventory.
• Measures how many times (during the period) the average inventory
was sold.
• * Average = (Beginning Assets + Ending Assets ) / 2

14. Average Inventory Selling Period (Day COGS in Inventory)

→ Inventory / (COGS / 365)
• Measures how long on average it takes for the company to turn
inventory into revenues.

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Financial Ratios, Metrics, Margins (VII)
Efficiency Metrics (Working Capital – A/Payables):
15. A/P Turnover
→ COGS / (Average) A/P
• Measures how many times (in the period) the average A/P are paid.

16. Average Payment Period (Day COGS in A/P)

→ A/P / (COGS / 365)
• Measures how long on average it takes for management to pay its
trade accounts.

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Financial Ratios, Metrics, Margins (VIII)
Shareholder Metrics (Equity):
17. Earnings per Share (EPS)
→ Net Income / (Average) Number of Shares*
• Measures how much the business has earned (for shareholders) for
each share.
• * Shares = (Common Stock Outstanding)

18. Price to Earnings Ratio (P/E)

→ Share Price / Earnings per Share
• Measures the market price/cost of earnings.

19. Dividend Yield Ratio

→ Dividend per Share / Share Price
• Measures the dividend return on price of stock.

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Financial Ratios, Metrics, Margins (IX)
Metrics of Returns (%s):
20. Return on Equity (ROE)
→ Net Income / (Average) Shareholder’s Equity
• Measures how much the business has earned (for shareholders) for
each $ invested (by shareholders).

21. Return on Invested Capital (ROIC)

→ (Net Income + Int. Expense after tax) / (Sh. Equity + Debt)
• Measures how much the business has earned (investors) for each $
invested (by investors).

22. Return on Assets (ROA)

→ Net Income / (Average) Total Assets
• Measures how much the business has earned (for shareholders) for
each $ invested.
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Financial Ratios, Metrics, Margins (X)
Leverage Ratios (Risk):

23. Debt to Equity Ratio (D/E)

→ Debt / Shareholder’s Equity
• Measures how much debt business uses relative to the equity
component of the capital base invested in the business.

24. Debt to Capital Ratio (D/C)

→ Debt / (Debt + Shareholder’s Equity)
• Measures how much debt business uses relative to the whole capital
base invested in the business.

24. Times Interest Earned Ratio (TIE)

→ EBIT / (Interest Expense)
• Compares the income available to pay interest (EBIT) to annual
interest obligations. -12-