Financial Ratios - 2

Efficiency Ratio
• The efficiency ratio is typically analyzes how
well a company uses its assets and liabilities
internally.

• An efficiency ratio can calculate the turnover

of receivables, the repayment of liabilities, the
quantity and usage of equity, and the general
use of inventory and machinery.
 What Does an Efficiency Ratio Tell You?

• Efficiency ratios, also known as activity

ratios, are used by analysts to measure the
performance of a company's short-term or
current performance.
 What Does an Efficiency Ratio Tell You?

• An efficiency ratio measures a company's ability to

use its assets to generate income.
• For example, an Efficiency Ratio often looks at
various aspects of the company, such as the time it
takes to collect cash from customers or the amount
of time it takes to convert inventory to cash.
• This makes efficiency ratios important, because an
improvement in the efficiency ratios usually
translates to improved profitability.
What Does an Efficiency Ratio Tell You?
• These ratios can be compared with peers in the
same industry and can identify businesses that
are better managed relative to the others.

• Some common efficiency ratios are accounts

receivable turnover, fixed asset turnover, sales
to inventory, sales to net working capital,
accounts payable to sales and stock turnover
ratio.
• Efficiency ratios measure a company's ability to use
its assets and manage its liabilities effectively.
• The inventory turnover ratio is used to determine if
sales are enough to turn or use the inventory.
• A high asset turnover ratio means the company uses
its assets efficiently, while a low ratio means its
assets are being used inefficiently.
• The receivables turnover ratio measures a company's
efficiency to collect debts and extend credit.
 Inventory Turnover Ratio
• Managing inventory levels is important for
companies to show whether sales efforts are
effective or whether costs are being
controlled.

• The inventory turnover ratio is an important

measure of how well a company generates
sales from its inventory.
 Inventory Turnover Ratio
• Inventory turnover is the number of times a
company sells and replaces its stock of goods
during a period.

• Inventory turnover provides insight as to how

the company manages costs and how effective
their sales efforts have been.
 Inventory Turnover Ratio
• The higher the inventory turnover, the better
since a high inventory turnover typically
means a company is selling goods very quickly
and that demand for their product exists.

• Low inventory turnover, on the other hand,

would likely indicate weaker sales and
declining demand for a company’s products.
 Inventory Turnover Ratio
• Inventory turnover provides insight as to whether
a company is managing its stock properly.
• The company may have overestimated demand
for their products and purchased too many goods
as shown by low turnover.
• Conversely, if inventory turnover is very high, they
might not be buying enough inventory and may
be missing out on sales opportunities.
 Inventory Turnover Ratio
• Inventory turnover ratio also shows whether a
company’s sales and purchasing departments
are in sync.
• Ideally, inventory should match sales. It can be
quite costly for companies to hold onto
inventory that isn’t selling.
• Alternatively, for a given amount of sales, using
less inventory to do so will improve inventory
turnover.
 Fixed Asset Turnover Ratio
• Fixed-asset turnover is the ratio of sales (on
the profit and loss account) to the value of
fixed assets (on the balance sheet).
• It indicates how well the business is using its
fixed assets to generate sales.
• A declining ratio may indicate that the
business is over-invested in plant, equipment,
or other fixed assets.
 Fixed Asset Turnover Ratio
• The Fixed Asset Turnover Ratio reveals how
efficient a company is at generating sales from
its existing fixed assets.

• A higher ratio implies that management is

using its fixed assets more effectively.
 Receivable Turnover Ratio
• The Accounts Receivable Turnover Ratio is an
accounting measure used to quantify a company's
effectiveness in collecting its receivables.
• The ratio shows how well a company uses and
manages the credit it extends to customers and
how quickly that short-term debt is collected or is
paid.
• The Receivables Turnover Ratio is also called the
Accounts Receivable Turnover Ratio.
 Receivable Turnover Ratio
• A high receivables turnover ratio can indicate
that a company’s collection of accounts
receivable is efficient and that the company
has a high proportion of quality customers
that pay their debts quickly.
 Receivable Turnover Ratio
• A low receivables turnover ratio might be due
to a company having a poor collection
process, bad credit policies, or customers that
are not financially viable or creditworthy.

• A company’s receivables turnover ratio should

be monitored and tracked to determine if a
trend or pattern is developing over time.
 Accounts Payable Turnover Ratio
• The Accounts Payable Turnover Ratio is
a short-term liquidity measure used to
quantify the rate at which a company pays off
its suppliers.

• Accounts payable turnover shows how many

times a company pays off its accounts payable
during a period.
 Accounts Payable Turnover Ratio

• Ideally, a company wants to generate enough

revenue to pay off its accounts payable
quickly, but not so quickly the company misses
out on opportunities because they could use
that money to invest in other endeavours.
 Earnings Per Share

• Earnings per share (EPS) is calculated as a

company's profit divided by the outstanding
shares of its common stock.

• The resulting number serves as an indicator of

a company's profitability.
 Earnings Per Share

• The higher a company's EPS, the more

profitable it is considered.

• EPS indicates how much money a company

makes for each share of its stock and is a
widely used metric for corporate profits.
 Earnings Per Share
• A higher EPS indicates more value because
investors will pay more for a company with
higher profits.

• EPS can be arrived at in several forms, such as

excluding extraordinary items or discontinued
operations, or on a diluted basis.
 Price-Earnings Ratio
• The price-to-earnings ratio (P/E ratio) is the
ratio for valuing a company that measures its
current share price relative to its per-share
earnings (EPS).

• The price-to-earnings ratio is also sometimes

known as the price multiple or the earnings
multiple.
 Price-Earnings Ratio
• The price-earnings ratio (P/E ratio) relates a
company's share price to its earnings per share.
• A high P/E ratio could mean that a company's
stock is over-valued, or else that investors are
expecting high growth rates in the future.
• Companies that have no earnings or that are
losing money do not have a P/E ratio since
there is nothing to put in the denominator.
 Price-Earnings Ratio
• P/E ratios are used by investors and analysts to
determine the relative value of a company's
shares in an apples-to-apples comparison.
• It can also be used to compare a company
against its own historical record or to compare
aggregate markets against one another or over
time.
• Two kinds of P/E ratios - forward and trailing P/E
– are used in practice
 Price-Earnings Ratio
• These two types of EPS metrics factor into the
most common types of P/E ratios: the 
forward P/E and the trailing P/E.

• A third and less common variation uses the

sum of the last two actual quarters and the
estimates of the next two quarters
 Forward P/E Ratio
• The forward (or leading) P/E uses future
estimated earnings guidance rather than trailing
figures.

• This forward-looking indicator is useful for

comparing current earnings to future earnings
and helps provide a clearer picture of what
earnings will look like – without changes and
other accounting adjustments.
 Trailing P/E Ratio
• The trailing P/E relies on past performance by
dividing the current share price by the total EPS
earnings over the past 12 months.
• Some investors prefer to look at the trailing P/E
because they don't trust forecasted earnings
estimates.
• The trailing P/E also has its share of
shortcomings – namely, a company’s past
performance doesn’t signal future behaviour.
 Dividend Payout Ratio
• The dividend payout ratio is the ratio of the
total amount of dividends paid out to
shareholders relative to the net income of the
company.
• It is the percentage of earnings paid to
shareholders in dividends.
• It is sometimes simply referred to as the
'payout ratio.‘
 Dividend Payout Ratio
• The amount that is not paid to shareholders is
retained by the company to pay off debt or to
reinvest in core operations.

• The dividend payout ratio provides an indication

of how much money a company is returning to
shareholders versus how much it is keeping on
hand to reinvest in growth, pay off debt, or add
to cash reserves (retained earnings).
 Dividend Payout Ratio
• If a company pays out some of its earnings as
dividends, the remaining portion is retained
by the business. To measure the level of
earnings retained, the retention ratio is
calculated.
 Dividend Payout Ratio
• Several considerations go into interpreting the
dividend payout ratio, most importantly the
company's level of maturity.

• A new, growth-oriented company that aims to

expand, develop new products, and move into
new markets would be expected to reinvest
most or all of its earnings and could be forgiven
for having a low or even zero payout ratio.
 Dividend Yield Ratio

• The dividend yield is the ratio of a company's

annual dividend compared to its share price.
The dividend yield is represented as a
percentage and is calculated as follows:
 Dividend Yield Ratio

• The dividend yield is the estimated one-year

return of an investment in a stock-based only
on the dividend payment. Note that many
stocks do not pay dividends.
 Dividend Yield Ratio

• Mature companies tend to pay higher

dividends.

• Higher dividend yields aren’t always attractive

investment opportunities, as its dividend yield
could be elevated due to a declining stock
prices.
 Price to Book Value Ratio

• Companies use the price-to-book ratio (P/B

ratio) to compare a firm's market
capitalization to its book value.

• It's calculated by dividing the company's stock

price per share by its book value per share
(BVPS).
What is book value of a share?
Balance Sheet
 Price to Book Value Ratio

• The P/B ratio measures the market's valuation

of a company relative to its book value.
• The market value of equity is typically higher
than the book value of a company,
• P/B ratio is used by value investors to identify
potential investments.
• P/B ratios under 1 are typically considered so
 What is PEG Ratio?
• The price/earnings to growth ratio (PEG ratio) is a
stock's price-to-earnings (P/E) ratio divided by the
growth rate of its earnings for a specified time
period.

• The PEG ratio is used to determine a stock's value

while also factoring in the company's expected
earnings growth and is thought to provide a more
complete picture than the P/E ratio.
 PEG Ratio
• The PEG ratio enhances the P/E ratio by
adding in expected earnings growth into the
calculation.

• The PEG ratio is considered to be an indicator

of a stock's true value, and similar to the P/E
ratio, a lower PEG may indicate that a stock is
undervalued.
 Enterprise Value
• Enterprise value (EV) is a measure of a company's
total value, often used as a more comprehensive
alternative to equity market capitalization.
• EV includes in its calculation the market
capitalization of a company but also short-term
and long-term debt as well as any cash on the
company's balance sheet.
• Enterprise value is a popular metric used to value
a company for a potential takeover.
Balance Sheet
 Benefits of Enterprise Value multiple
• Just like the P/E ratio (price-to-earnings), the
lower the EV/EBITDA, the cheaper the valuation
for a company.
• Although the P/E ratio is typically used as the
go-to-valuation tool, there are benefits to using
the P/E ratio along with the EV/EBITDA.
• For example, many investors look for companies
that have both low valuations using P/E and
EV/EBITDA and solid dividend growth.
 Advantages of Ratio Analysis
• Forecasting and Planning
• Budgeting
• Measurement of Operating Efficiency
• Communication
• Control of Performance and Cost
• Inter-firm Comparison
• Indication of Liquidity Position
• Indication of Long-term Solvency Position
 Advantages of Ratio Analysis
• Indication of Overall Profitability
• Signal of Corporate Sickness
• Aid to Decision-making
• Simplification of Financial Statements
 Limitations of Ratio Analysis
• Historical Information
• Different Accounting Policies
• Quantitative Analysis
• Window-Dressing
• Changes in Price Level
• Seasonal Factors Affect Financial Data