Ratios

Ratios show the relationships between certain components of the two financial statements we have just reviewed.

The ratio can be a powerful tool for you to use to understand the underlying reasons the financial structure, condition and trends of your customer. When you analyze ratios, however, you must relate your customer's ratios historical performance to the ratios of their competitors or their industry. Ratios are always "compared to what" and should never be taken at face value on a stand-alone basis.

Typically you will find ratios discussed in the financial highlights, historical summary of financial data and the management discussion and analysis sections. The ratios that we will be looking at to help you to identify trends and potential business issues within your accounts will be:

  • Market Ratios - the market's anticipation of the stock's performance
  • Operating Ratios - measuring how profitable the company is based on how well it uses its resourses
  • Efficiency Ratios - measuring the speed/activity with which the company can turn its assets into cash

Market Ratios

Earnings per Share (EPS) the portion of a company's profit assigned to each share of stock

       EPS = Net Income ÷ Total Outstanding Shares of Stock

Price Earnings (P/E) the relationship between a company's price per share and the earnings per share (EPS)

       P/E = Market Price of One Share ÷ EPS

Price per Sales (P/S) the relationship between a company's price per share and the total sales per share

       P/S = Market Price of One Share ÷ Total Sales per Share

Operating Ratios

Gross Profit Margin (GPM) the gross income expressed as a percentage of sales

       GPM = Revenue (Sales) - Cost of Goods Sold ÷ Revenue (Sales)

Operating Profit Margin (OPM) the operating income expressed as a percentage of sales

       OPM = Operating Income ÷ Revenue (Sales)

Return on Sales (ROS) or Net Profit Margin (NPM) the net income expressed as a percentage of sales

       NPM (ROS) = Net Income ÷ Revenues (Sales)

Return on Equity (ROE) A measurement of return on investment expressed as net income for a specific period as a percentage of equity.

       ROE = Net Income ÷ Total Shareholder Equity

Return on Assets (ROA) A measurement of return on investment expressed a net income for a specific period as a percentage ofassets.

       ROA = Net Income ÷ Total Assets

Efficiency Ratios

Inventory Turns the average rate that inventory moves out of the business and is replaced during a specific period.

       Inventory Turns = Cost of Goods Sold ÷ Total Inventory

Days Inventory expresses inventory turns in terms of the number of days it takes for inventory to turn

       Days inventory = 365 ÷ Inventory Turns

Days Sales Outstanding (DOS) (aka: Days Receivables) the average time it takes for receivables to be collected (turned into cash) by the company

       DOS = Accounts Receivable ÷ (Total Sales ÷ 365)