financial management dr. mari’e banikhaled 1. what is finance? finance can be defined as the...

Financial Management

Dr. Mari’e Banikhaled

1

What is Finance?

• Finance can be defined as the science and art of managing money

• finance involves the types of decisions: how firms raise money from investors, how firms invest money in an attempt to earn a profit, and how they decide whether to reinvest profits in the business or distribute them back to investors.

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Goal of the firm

The primary goal of financial management is to Maximize the wealth of the shareholders.

we argue that the primary goal of the firm, and also of managers, should be to maximize the wealth of the owners for whom it is being operated, or equivalently, by maximize the stock price.

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The Importance of Financial Statement Analysis

The analysis and interpretation of financial statements is useful in achieving several objectives:1) The evaluation of past performance.2) The assessment of current status.3) The prediction of future potential.4) Take the right decisions to maximize profits and resources.

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The Role of Financial Statement Analysis

Financial statement analysis is a business function that helps a company's top management assess business performance, evaluate operating activities and detect nonperforming segments or areas. Studying financial records also helps investors compare two or several corporations operating in the same industry or sector, and draw conclusions about their competitive standing and future profitability.

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Interested Parties

1. Shareholders: Shareholders are the owners of the company. Time and again, they may

have to take decisions whether they have to continue with the holdings of the company's share or sell them out. The financial statement analysis is important as it provides meaningful information to the shareholders in taking such decisions.

2. management:The management of the company is responsible for taking decisions and

formulating plans and policies for the future. They, therefore, always need to evaluate its performance and effectiveness of their action to realize the company's goal in the past. For that purpose, financial statement analysis is important to the company's management.

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Interested Parties

3. Creditors:The creditors are the providers of loan capital to the company. Therefore

they may have to take decisions as to whether they have to extend their loans to the company and demand for higher interest rates. The financial statement analysis provides important information to them for their purpose.

4. Investors:The prospective investors are those who have surplus capital to invest in

some profitable opportunities. Therefore, they often have to decide whether to invest their capital in the company's share. The financial statement analysis is important to them because they can obtain useful information for their investment decision making purpose.

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Interested Parties

5. Government:Government is interested to analyze the financial position in determining the amount of tax liability. It also helps for formulating effective plans and policies for economic growth.

6. Lenders : Lenders to the business like debenture holders, suppliers of loans and lease

are interested to know short term as well as long term solvency position of the entity.

7. Researchers: They are interested in financial statements in undertaking research work in

business affairs and practices

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Interested Parties

8. Employees :They are interested to know the growth of profit, They can Negotiating on

matters relating to salary, bonus and other benefits on the basis of information of the financial report.

9. Stock exchange : The stock exchange members take interest in financial statements for the

purpose of analysis because they provide useful financial information about companies.

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Bartlett Company Income Statement ($000)

For the year ended December 31 2012 2011

Sales revenue 3,074 2,567

Less: Cost of goods sold 2,088 1,711

Gross profit 986 856

Less: Operating expenses:

Selling expenses 100 108

General and administrative expenses 194 187

Lease expense 35 35

Depreciation expense 239 223

Total operating expenses 568 553

Operating profit (EBIT) 418 30310

Bartlett Company Income Statement ($000)

Less: Interest expenses 93 91

Net profit before taxes 325 212

Less: Taxes 29% 94 64

Net profit after taxes 231 148

Less: Preferred stock dividends 10 10

Earning available for common equity 221 138

Earning per share 2.90 1.81

Dividends per share 1.29 0.75

Market price 32.25 31.50

Principal payment 71 7111

Bartlett Company Balance Sheet ($000) for the year ended December 31

Current assetscash 363 288Marketable securities 68 51Account receivable 503 365Inventories 289 300Total current assets 1,223 1,004Gross fixed assets Land and buildings 2,072 1,903Machinery and equipment 1,866 1,693Furniture and fixtures 358 316Vehicles 275 314Other ( includes financial leases) 98 96Total gross fixed assets 4,669 4,322Less: Accumulated depreciation 2,295 2,056Net fixed assets 2,374 2,266Total assets 3,597 3,270

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Bartlett Company Balance Sheet ($000) for the year ended December 31

Liabilities and Stockholder’s Equity 2012 2011Current liabilitiesAccount payable 382 270Notes payable 79 99Accruals 159 114Total current liabilities 620 483Long-term debt (include financial leases ) 1,023 967Total liabilities 1,643 1,450Stockholder’s equityPreferred stock-cumulative 5%, $100 par, 2000 shares authorized and issued 200 200Common stock - $2.50 par, $100,000 shares authorized, shares issued and outstanding in 2012: 76,262; in 2011: 76,244 191 190

Paid in capital in excess of par on common stock 428 418Retained earnings 1,135 1,012Total stockholder’s equity 1,954 1,820Total liabilities and stockholder’s equity 3,597 3,270 13

Weight Rules

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Methods of Financial Statement Analysis

Sometimes it can be difficult to interpret in a meaningful way all the dollar amounts presented in a set of financial statements. For example, if one company has liabilities of $10,000 and another company has liabilities of $10,000,000; is the first company less risky? Maybe or maybe not, it depends in part on the size of the company ( how much in assets does each company have) and the company’s industry.

A useful way to analyze financial statements is to perform either a horizontal analysis or a vertical analysis of the statements. These types of analysis help a financial statement reader compare companies of different sizes, which can be difficult to do when the dollar amounts vary significantly, and evaluate the performance of a company over time.

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Methods of Financial Statement Analysis

A financial statement contains important information for both internal and external users. Creditors, investors, managers and executives. They need this information to make informed business decisions.

There are three methods for analyzing such financial statements :1. Horizontal Analysis or Trend Percentages2. Vertical Analysis3. Ratios Analysis

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Horizontal Analysis

Horizontal Analysis

horizontal analysis refers to a type of fundamental analysis in which a financial analyst uses certain financial data to assess a company’s performance over time.

The analyst compares the same items or ratios for a particular company over a period of time in order to assess the company’s growth during that time.

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Horizontal Analysis

Absolute Dollars:One method of performing a horizontal financial statement analysis

compares the absolute dollar amounts of certain items over a period of time.

Percentage :The other method of performing compares the percentage

difference in certain items over a period of time. The dollar amount of the change is converted to a percentage change.

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Horizontal Analysis

Calculating Change in Dollar Amounts:

Calculating Change as a Percentage:

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Horizontal Analysis

Balance Sheet …Assets

Horizontal Analysis … Assets

Increase ( Decrease ) . . .

2012 2011Amount

(000) %

Current assetscash 363 288 75 $ 26%

Marketable securities 68 51Account receivable 503 365Inventories 289 300Total current assets 1,223 1,004Gross fixed assets Land and buildings 2,072 1,903Machinery and equipment

1,866 1,693

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75 $ / 288 $ * %100 = 26 %

363 $ – 288 $ = 75 $



2012 2011Amount

(000) %

Current assetscash 363 288 75 $ % 26

Marketable securities 68 51 17 $ % 33.33

Account receivable 503 365 138 $ % 37.80

Inventories 289 300 -11 $ % -3.66

Total current assets 1,223 1,004 219 $ % 21.8

Gross fixed assets Land and buildings 2,072 1,903 169 $ % 8.88

Machinery and equipment

1,866 1,693 173 $ % 10.21

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2012 2011 Amount(000) %

Furniture and fixtures 358 316 42 $ % 12.26

Vehicles 275 314 -39 $ % -12.42

Other ( includes financial leases)

98 96 2 $ % 2.08

Total gross fixed assets 4,669 4,322 347 $ % 8.02

Less: Accumulated depreciation

2,295 2,056 239 $ % 11.62

Net fixed assets 2,374 2,266 108 $ % 4.76

Total assets 3,597 3,270 327 $ % 10

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Horizontal Analysis

Let’s apply the same procedures to the liabilities and stockholders’ equity sections of the balance sheet.

Horizontal Analysis

Balance Sheet … Liabilities and Shareholder Equity

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Horizontal Analysis … Liabilities and Shareholder Equity

Increase ( Decrease ) . .

Liabilities and Stockholder’s Equity

2012 2011Amount

(000) %

Current liabilities

Account payable 382 270 112 $ % 41.48

Notes payable 79 99 -20 $ % -20.02

Accruals 159 114 45 $ % 39.47

Total current liabilities 620 483 137 $ % 28.36

Long-term debt 1,023 967 56 $ % 5.79

Total liabilities 1,643 1,450 193 $ % 13.31

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Horizontal Analysis … Liabilities and Shareholder Equity


2012 2011 Amount (000) %

Stockholder’s equityPreferred stock 200 200 ---- ----

Common stock 191 190 1 $ % 0.52

Paid in capital in excess of par on common stock

428 418 10 $ % 2.39

Retained earnings 1,135 1,012 123 $ % 12.15

Total stockholder’s equity 1,954 1,820 134 $ % 7.36

Total liabilities and stockholder’s equity

3,597 3,270 327 $ % 10

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Horizontal Analysis

Now, Let’s apply the same procedures to the income statement.

Horizontal Analysis

Income Statement

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Horizontal Analysis … Income Statement


For the year ended December 31

2012 2011Amount

(000) %

Sales revenue 3,074 2,567 507 $ % 19.75

Less: Cost of goods sold 2,088 1,711 377 $ % 22

Gross profit 986 856 130 $ % 15.18


Selling expenses 100 108 8 $ % 7.40

General and administrative expenses

194 187 7 $ % 3.74

Lease expense 35 35 ---- ----

Depreciation expense 239 223 16 $ % 7.17

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Horizontal Analysis … Income Statement


2012 2011 Amount(000) %

Total operating expenses 568 553 15 $ % 2.71

Operating profit (EBIT) 418 303 115 $ % 37.95

Less: Interest expenses 93 91 2 $ % 2.19

Net profit before taxes 325 212 113 $ % 53.30

Less: Taxes 29% 94 64 30 $ % 46.87

Net profit after taxes 231 148 83 $ % 56.08

Less: Preferred stock dividends 10 10 ---- ----

Earning available for common equity

221 138 83 $ % 60.14

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Percentage Changes

Trend analysis calculates the percentage change over time in given financial statement items for one account over a period of time of two years or more.

Owners and managers often use financial trend analysis to review several periods at one time and discover if---in financial terms---their company is growing or shrinking.

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Vertical Analysis

Vertical Analysis

The vertical analysis compares each separate figure to one specific figure in the financial statement. The comparison is reported as a percentage.

vertical analysis refers to the representation of assets, liabilities and equities as a percentage of the whole. These three major balance sheet categories are added up, and each one is expressed as the percent of the total it represents. Vertical analysis can be useful in comparing companies of different sizes, as it makes it easy to see which company has a greater percentage of liabilities as opposed to equity, or which company has more assets, relative to liabilities and equity.

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Vertical Analysis

Balance Sheet:Performing vertical analysis of the balance sheet involves comparing

each balance sheet item to total assets. Each item is then reported as a percentage of total assets. For example, if cash equals $5,000 and total assets equals $25,000, then cash would be reported as 20% of total assets.

Income Statement :Performing vertical analysis of the income statement involves

comparing each income statement item to sales. Each item is then reported as a percentage of sales. For example, if sales equals $10,000 and operating expenses equals $1,000, then operating expenses would be reported as 10% of sales.

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Vertical Analysis

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Vertical Analysis

Balance Sheet …Assets

Vertical Analysis… Assets

2012 2011Percentage of total asset 2012

Percentage of total asset2011

Current assetscash 363 288 %10 % 8.80

Marketable securities 68 51Account receivable 503 365Inventories 289 300Total current assets 1,223 1,004Gross fixed assets Land and buildings 2,072 1,903Machinery and equipment

1,866 1,693

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( 288 / 3270 ) * %100 = %8.80

( 363 / 3597 ) * %100 = %10


2012 2011Percentage of total asset 2012

Percentage of total asset2011

Current assetscash 363 288 % 10 % 8.80

Marketable securities 68 51 % 1.89 % 1.55

Account receivable 503 365 % 13.98 % 11.16

Inventories 289 300 % 8.03 % 9.17

Total current assets 1,223 1,004 % 34 % 30.70

Gross fixed assets Land and buildings 2,072 1,903 % 57.6 % 58.19

Machinery and equipment

1,866 1,693 % 51.87 % 51.77

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2012 2011 Percentage of total asset 2012

Percentage of total asset 2011

Furniture and fixtures

358 316% 9.95 % 9.66

Vehicles 275 314 % 7.64 % 9.60

Other ( includes financial leases)

98 96 % 2.72 % 2.93

Total gross fixed assets

4,669 4,322 % 129.80 % 132.17

Less: Accumulated depreciation

2,295 2,056 % 63.80 % 62.87

Net fixed assets 2,374 2,266 % 65.99 % 69.29

Total assets 3,597 3,270

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Vertical Analysis

Balance Sheet… Liabilities and

Shareholders Equity

Vertical Analysis… Liabilities and Shareholder Equity

Liabilities and Stockholder’s Equity

2012 2011



Current liabilitiesAccount payable 382 270 % 10.61 % 8.25

Notes payable 79 99 % 2.19 % 3.02

Accruals 159 114 % 4.42 % 3.48

Total current liabilities

620 483 % 17.23 % 14.77

Long-term debt 1,023 967 % 28.44 % 29.57

Total liabilities 1,643 1,450 % 45.67 % 44.34

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Vertical Analysis… Liabilities and Shareholder Equity

2012 2011 Percentage of total asset 2012


Stockholder’s equity

Preferred stock 200 200 % 5.56 % 6.11

Common stock 191 190 % 5.30 % 5.81

Paid in capital in excess of par on common stock

428 418 % 11.89 % 12.78

Retained earnings 1,135 1,012 % 31.55 % 30.94

Total stockholder’s equity

1,954 1,820 % 54.32 % 55.65

Total liabilities and stockholder’s equity

3,597 3,270

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Vertical Analysis

Income Statement

Vertical Analysis … Income Statement


2012 2011Percentage of net sales 2012

Percentage of net sales 2011


Less: Cost of goods sold 2,088 1,711 % 67.92 % 66.65

Gross profit 986 856


Selling expenses 100 108General and administrative expenses

194 187

Lease expense 35 35

Depreciation expense 239 223

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(2088 / 3074 ) * %100 = %67.92

( 1711 / 2567 ) * %100 = %66.65



2012 2011Percentage of net sales 2012



Less: Cost of goods sold 2,088 1,711 % 67.92 % 66.65

Gross profit 986 856 % 32.07 % 33.34


Selling expenses 100 108 % 3.25 % 4.20

General and administrative expenses

194 187 % 6.31 % 7.28

Lease expense 35 35 % 1.13 % 1.36

Depreciation expense 239 223 % 7.77 % 8.68

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2012 2011 Percentage of net sales 2012


Total operating expenses

568 553 % 18.47 % 21.54

Operating profit (EBIT) 418 303 % 13.59 % 11.80

Less: Interest expenses 93 91 % 3.02 % 3.54

Net profit before taxes 325 212 % 10.57 % 8.25

Less: Taxes 29% 94 64 % 3.05 % 2.49

Net profit after taxes 231 148 % 7.51 % 5.76

Less: Preferred stock dividends

10 10 % 0.32 % 0.38

Earning available for common equity

221 138 % 7.18 % 5.37

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Differences Between Vertical and Horizontal Analysis

The main difference is that while horizontal analysis compares the figures under different heads in the income statement and the balance sheet, vertical analysis represents each figure as a percentage of the total along with the change in both over the past year. So, in vertical analysis, the figures are not only compared to the past year, but they are also represented as a percentage of the total cost or total assets/liabilities as may be the case.

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Ratios Analysis

Ratios Analysis

The ratios analysis is the most powerful tool of financial statement analysis. its simply means one number expressed in terms of another.

A ratio is a statistical measurement by means of which relationship between two or various figures can be compared or measured. Ratios can be found out by dividing one number by another number.

The calculation of various ratios obtained from the financial statements provide information about the strengths and weaknesses to specific areas of the business and assess the effectiveness of their management decisions.

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Classification of Ratios

Ratios can be broadly classified into four groups:1- Liquidity Ratios2- Activity Ratio3- Profitability Ratio4- Debt Ratio5- Market Ratio

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Liquidity Ratios

Liquidity Ratios

The liquidity of a firm is measured by its ability to satisfy its short-term obligations as they come due.

Liquidity Ratios include :1. Current Ratio 2. Quick Ratio3. Cash Ratio

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Current Ratio

An indication of a company’s ability to meet short-term debt obligations, the higher the ratio, the more liquid the company, the less the profitability.

This ratio also a known as: (Capital Assets Ratio , Liquidity Ratio)

The ratio is calculated as follows:

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Current Ratio

In the long-term very high current ratio may affect profitability. Suppose industry criteria was 1 :

A ratio below criteria represents liquidity riskiness as there is an insufficient current asset to cover current liabilities, Current ratios above criteria is acceptable levels.

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Quick ratio

The quick ratio is similar to the current ratio except that it excludes inventory, inventory is typically sold on credit, which means that it becomes an account receivable before being converted into cash.


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Quick ratio

Suppose industry criteria was 1.20 :

A high Quick ratio is an indication that the firm is liquid and has ability to meet its current liabilities.

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Cash Ratio

It measures the firm’s ability to repay current liabilities by only using its cash and cash equivalents, the cash ratio does not include inventory or accounts receivable in the equation (Cash equivalents are assets which can be converted into cash quickly ) .


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Cash Ratio Assume marketable securities convertible to cash now, and notes

receivable 30$ are discount at the bank with 7% interest rate for 8 months:

Suppose industry criteria was 0.84

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Preferable to be higher than criteria.The higher the cash ratio the lower the profitability, the lower the risk.

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Activity Ratios

Activity Ratios

Measure the speed with which various accounts are converted into sales or cash—inflows or outflows.

Activity Ratios include :1. Account Receivable Turnover 8. Cash Conversion Cycle 2. Inventory Turnover 9. Total Assets Turnover3. Account Payable Turnover 10. Fixed Assets Turnover4. Average Collection Period 11. Working Capital Turnover5. Inventory Conversion Period 12. Net Working Capital

Turnover6. Average Payment Period 13. Working Assets Turnover7. Operating Cycle 14. Common Equity Turnover

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Account Receivable Turnover The ratio of the number of times that accounts receivable amount

is collected during the year.

The purpose of this ratio is to measure the liquidity of the receivables or to find out the period over which receivables remain uncollected.

A higher ratio implies that a company is efficient in collecting its accounts receivables; a low ratio is an indicator that a company may need to reassess its accounts receivables procedures in order to improve timely collections of accounts receivables.

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Account Receivable Turnover


Assume 50% from sale on credit:

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Account Receivable Turnover

It is useful to compare this ratio against industry criteria, suppose industry criteria was 4 :

The higher the account receivable turnover than industry criteria is more favorable.

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Inventory Turnover

The inventory turnover ratio measures the number of times a company sells its inventory during the year, its Measures Company’s efficiency in turning its inventory into sales.

Higher inventory turnover ratios are considered a positive indicator of effective inventory management, it indicate that the product is selling well, However, a higher inventory turnover ratio does not always mean better performance. It sometimes may indicate inadequate inventory level, which may result in decrease in sales.

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Inventory Turnover• A low turnover implies poor sales and, therefore, excess

inventory. • A high ratio implies either strong sales or ineffective buying.• The ratio is calculated as follows:

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Inventory Turnover

Suppose industry criteria was 8

The higher the turnover than industry criteria is more favorable.

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Account Payable Turnover

Used to measure the length of time that is needed for a company to repay its creditors.

Many companies extend the period of credit turnover, lower accounts payable turnover ratio getting extra liquidity. It is a sign that the company is taking longer to pay off its creditors.

A figure for purchases is usually not available. Therefore, purchases are usually estimated as a percentage of cost of goods sold.

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Higher ratio means that the company is paying of creditors quickly.


Assume 75% from cost of goods sold on credit:

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Suppose industry criteria was 3:

The lower the account payable turnover than industry criteria is more favorable.

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Average Collection Period

The average amount of time needed to collect accounts receivable. It represents the average number of days for which a firm has to wait before its debtors are converted into cash.

The length of the collection period indicates the effectiveness with which a firm's management grants credit and collects from debtors. A short period is favorable because the firm obtains cash more quickly for reinvestment or for paying its own bills.

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It is important to keep the ratio as low as possible.

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Suppose industry criteria was 90 days:

The lower the ratio than industry criteria is the better.

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Inventory Conversion Period It is relationship between total days in year and inventory

turnover ratio, it measure the length of time required to produce and sell the product.

This ratio is simply the inverse of the Inventory Turnover Ratio, if the inventory turnover decreases; the inventory conversion period will increase.

Inventory conversion period is the part of cash conversion cycle. If this period is very high, it will increase the time to complete the cash conversion cycle. It means, there will be more liquidity risk in that level of inventory.

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Inventory Conversion Period


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Inventory Conversion Period


The lower the Inventory conversion period ratio than criteria is the better.

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Average Payment Period

The number of days a company take to pay off credit purchases.

A short average payment period means you turn over credit relatively quickly. A long payment period means you take longer to pay off creditors.

Some companies would prefer a longer time to repay creditor, short period may mean that you are not able to use cash flow for further investment or to issue dividend payments to shareholders.

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The higher the average payment period than industry criteria is more favorable

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Operating Cycle

A firm’s operating cycle (OC) is the time from the beginning of the production process to collection of cash from the sale of the finished product.

it refers to the delay between the buying of raw materials and the receipt of cash from sales proceeds. In other words, operating cycle refers to the number of days taken for the conversion of cash to inventory through the conversion of accounts receivable to cash.

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Operating Cycle


A long operating cycle means that less cash is available to meet short term obligations.

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Operating Cycle


Operating cycle prefer to be less than industry criteria

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Cash Conversion Cycle

The length of time in days that it takes for a company to convert resource inputs into cash flows.

The CCC does this by following the cash as it is first converted into inventory and accounts payable, through sales and accounts receivable, and then back into cash.

In order to reduce the cash conversion cycle (increase current cash on hand) a firm can either decrease Inventory Days, decrease Average Collection Period or increase Days Payable Outstanding. By doing one, or a combination of these, a firm will increase the amount of cash on hand and may be able to use this to pay of current liabilities or use this cash for Expenses, growth or dividend payments.

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Cash Conversion CycleThe company benefits by slowing down payment of account payable to

its suppliers, because that allows the company to make use of the money for longer.

High CCC refers to quickly a company to convert its products into cash through sales. The shorter the cycle is the less time capital is tied up in the business process.

As a rule, the lower the CCC , the better. This is because as the cash conversion cycle shortens, cash becomes free for a company to invest in new equipment or other activities to rise investment return.

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The company with lowest CCC is the better.

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Total Assets Turnover

The total asset turnover ratio measures the ability of a company to use its assets to efficiently generate sales. This ratio considers all assets; current and fixed.


A high ratio indicates that the company is using its assets efficiently to increase sales, while a low ratio indicates the opposite.

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Total Assets Turnover


The higher the total Asset turnover is the more effective use of the company's investments total assets. A higher asset turnover ratio than industry criteria is the better.

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Fixed Assets Turnover

Measures a firm's ability to generate net sales from fixed-asset investments.


A higher fixed-asset turnover ratio means a company uses its fixed assets more efficiently to generate sales, which can lead to higher profits.

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Fixed Assets Turnover


The higher the ratio is the better.

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Working Capital Turnover This ratio indicates the number of times the working capital is

turned over in the year. Its measure the efficiency a firm is using its current assets to generate revenue.

This ratio also a known as: (Current Assets Turnover, Liquidity Assets Turnover)


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Working Capital Turnover


A higher ratio indicates efficient utilization of working capital, and low ratio indicates inefficient utilization of working capital.

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Net Working Capital Turnover

The net working capital turnover ratio is a measure how hard our working capital is "working" for the firm. Net Working capital is what you have left over after the company pays its short-term debt obligations.

The net working capital turnover ratio is the one that helps in establishing a relationship between the net working capital and net sales.


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Net Working Capital Turnover


Generally, the higher the ratio is the better.

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Working Assets Turnover

The ability of the company to generate revenues from its working assets.


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Working Assets Turnover

Assume 10% from total assets non performing assets

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Common Equity Turnover

Measure how well a company uses its stockholders' equity to generate revenue.


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Common Equity Turnover


The higher the ratio than criteria is the more efficiently a company is using its capital.

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Profitability Ratios


Profitability Ratios: the firm’s ability to generate profit from used all resources.

The difference between profitability and turnover that the turnover of a business is the amount of revenue it has earned in a particular accounting period. The profit is the amount remaining after deducting from the turnover the expenses incurred in earning it.

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Profitability Ratios include :1. Gross Profit Margin2. Operating Profit Margin3. Net Profit Margin4. Return on Common Equity5. Return on Preferred Stock6. Return on Total Equity7. Return on Total Assets

8. Basic Earning Power9. Earning Per Share (EPS)

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Gross Profit Margin The gross profit margin ratio measures how efficiently a company

uses its resources, materials, and labor in the production process by showing the percentage of net sales remaining after subtracting the cost of making and selling a product .

A high gross profit margin ratio indicates that a business can make a reasonable profit on sales.

Low profit margin implies that the business is unable to control production costs, or that a low amount of earnings are generated from revenues.

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Gross Profit Margin


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Gross Profit Margin

Suppose industry criteria was 70%

A company with a higher gross profit margin than its competitors and industry criteria is more efficient.

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Operating Profit Margin

The operating profit margin measures the percentage of each sales dollar remaining after all costs and expenses other than interest, taxes, and preferred stock dividends are deducted.


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Operating Profit Margin

Operating margin can be used to compare a company with its competitors. Suppose industry criteria was 25%

A high operating profit margin is preferred because if the operating profit margin is increasing, the company is earning more per dollar of sales.

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Net Profit Margin The net profit margin measures the percentage of each sales

dollar remaining after all costs and expenses, including interest, taxes, and preferred stock dividends have been deducted.

The higher the margin is the more effective the company in converting revenue into actual profit.


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Net Profit Margin

We must compare net profit margin between companies in the same industry, suppose industry criteria was 30%

Higher ratio refer to higher efficient a company than other competitors in generating profits.

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Return On Common Equity The return on common equity (ROCE) measures the return earned

on the common stockholders’ investment in the firm.

A variation of the Return on Equity formula which subtracts preferred dividends from net income and preferred equity from shareholders' equity. This variation shows the effect of common shares on profitability.

A company with high return on equity is more successful in generating cash internally. Investors are always looking for companies with high and growing returns on common equity.

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Return On Common Equity


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Return On Common Equity

A company’s return on common equity must compares with its industry average, suppose industry criteria was 12%

The higher the ratio is the better, the owners are preferred the higher this return.

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Return On Preferred Stock


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Return On Total Equity It measures a firm's efficiency at generating profits from every

unit of shareholders' equity.

Investors usually look for companies with returns on equity that are high and growing.


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Return On Total EquitySuppose industry criteria was 20 %

The benefit comes from the earnings reinvested in the company at a high ROE rate, which in turn gives the company a high growth rate. The benefit can also come as a dividend on common shares or as a combination of dividends and reinvestment in the company.

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Return On Total Assets

often called the return on investment (ROI), measures the overall effectiveness of management in generating profits with its available assets.


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Return On Total Assets


A high ratio indicates that the business is earning more money and investing less on assets.

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Basic Earning Power

This ratio indicates the ability of the firm's assets to generate operating income. Calculated by dividing earnings before interest and tax (EBIT) by performing assets. The ratio indication of how effectively assets are used to generate earnings.


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Basic Earning Power

Or

Assume 10% from total assets non performing assets

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Basic Earning Power


The higher the ratio the higher the profitability.

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Earning Per Share (EPS)

The firm’s earnings per share is generally interest to present or prospective stockholders and management, EPS represents the amount of earnings per each outstanding share of a company's stock.


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Earning Per Share (EPS)The earnings per share is a good measure of profitability and when

compared with EPS of similar companies it gives a view of the comparative earnings or earnings power of the firm.

Suppose industry criteria was 3 :

A company with a high earnings per share ratio is capable of generating a significant dividend for investors, The chances of getting high return on investment is maximum if you invest in the stocks of a company having a high earnings per share ratio.

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Debt Ratios

Debt Ratios

Measures the firm’s ability to serve the debt.

In general, the more debt the greater the financial leverage.

Financial leverage is the magnification of risk and return through the use of fixed-cost financing, such as debt and preferred stock.

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Debt Ratios Debt Ratios include : 1. Debt Ratio2. Short Debt Ratio3. Long Debt Ratio4. Debt to Equity Ratio5. Short Debt to Equity6. Long Debt to Equity7. Equity to Debt8. Times Interest Earned Ratio9. Fixed Payment Coverage

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Debt RatioDebt ratio measures the percent of total funds provided by creditors.

it includes both current liabilities and long-term debt.

Creditors prefer low debt ratios; but owners may seek high debt ratios to magnify their earnings.

Some advantages of higher debt levels are:1. The deductibility of interest from business expenses can provide

tax advantages. 2. Returns on equity can be higher.3. Debt can provide a suitable source of capital to start or expand a

business.

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Debt Ratio


the lower the ratio, the more conservative policy.

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Debt RatioSuppose industry criteria was 0.50

The lower the ratio, the less leverage; and the stronger its equity position.

In general, the higher the ratio, the higher the profitability, the greater the risk.

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Short Debt Ratio

Short-term debt describes liabilities that are due to be paid within one year; it indicates whether a firm will be able to satisfy its current financial obligations.


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Long Debt Ratio

Long debt ratio an indication of what portion of a company's total assets is financed from long term debt.


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Long Debt Ratio


The higher the level of long term debt is the more important for a company to have positive revenue and steady cash flow.

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Debt to Equity Ratio

The debt-equity ratio is another leverage ratio that compares a company's total liabilities to its total shareholders' equity, It shows the extent to which shareholders' equity can fulfill a company's obligations to creditors in the event of a liquidation.


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Debt to Equity RatioSuppose industry criteria was 80%

Higher debt-to-equity ratio means that the business relies more on external lenders, the higher the ratio the higher the risk, the higher the profitability.

Investing in a company with a higher debt/equity ratio may be riskier, especially in times of rising interest rates.

A lower the ratio means that a company is using less leverage and has a stronger equity position.

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Short Debt to Equity

This ratio explains the proportion of short debt and equity that the company is using to finance its operations.


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Long Debt to Equity

Long debt to equity explains the relationship between long-term debts as related to that contributed by owners (investors).

Long debt to equity expresses the degree of protection provided by the owners for the long-term creditors.


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Long Debt to Equity

A company with a high long-term debt to equity is considered to be highly leveraged. Generally, companies with higher ratios are thought to be more risky because they have more liabilities and less equity.


The higher the ratio, the higher the risk, the higher the profitability.

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Equity to Debt

The Equity to Total Debt ratio measures how much debt the company can have and still be able to meet debt obligations with its equity.


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Equity to DebtSuppose industry criteria was 1.25

High ratio is considered to be lower leveraged.

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Times Interest Earned Ratio

Times interest earned ratio is another debt ratio that measures how well a company can meet its interest expense obligations. Sometimes called the interest coverage ratio.


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Times Interest Earned RatioSuppose industry criteria was 9 :

A high ratio means that a company is able to meet its interest obligations because earnings are significantly greater than annual interest obligations.

A lower times interest earned ratio means fewer earnings are available to meet interest payments.

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Fixed Payment Coverage

Measures the firm’s ability to meet all fixed-payment obligations, includes loan interest and principal, lease payments, and preferred stock dividends.

The result of the fixed payment coverage ratio is the number of times the company can cover its fixed charges per year.

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Fixed Payment Coverage

The lower the ratio the greater the risk to both lenders and owners.


A higher ratio indicates that the company is able to pay its fixed charges, while a lower ratio indicates the opposite.

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Market Ratios

Market Ratios

An equation that compares the current stock price to a financial indicator on the company's financial statements.

Market-value ratios are calculated based on the figures expressed in a company's financial statements for a given period

Market Ratios include :1. Price/Earnings (P/E) Ratio2. Market/Book (M/B) Ratio

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Price/Earnings (P/E) Ratio The P/E ratio measures the amount that investors are willing to

pay for each dollar of a firm’s earnings.

The P/E looks at the relationship between the stock price and the company’s earning.

The level of this ratio indicates the degree of confidence that investors have in the firm’s future performance. The higher the P/E ratio, the greater the investor confidence.

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Price/Earnings (P/E) Ratio


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Price/Earnings (P/E) Ratio

Suppose industry criteria was 11

A high P/E usually indicates that the market will pay more to obtain the company's earnings because investors believe the ability of firm to increase its earnings.

A low P/E indicates that the market has less confidence that the firm's earnings will increase.

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Market/Book (M/B) Ratio

Market/book ratio is a useful way of measuring your company’s performance and making quick comparisons with competitors.

It is an essential figure to potential investors and analysts because it provides a simple way of judging whether a company is undervalued or overvalued.

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A higher P/B ratio could mean that the stock is overvalued

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financial management dr. mari’e banikhaled 1. what is finance? finance can be defined as the...

Documents

financial position

financial records

companys management

companys goal

interested parties

important information

business performance

types of decisions