A Brief on Corporate Finance Ratios

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economic risk+operational risk = business risk + financial risk = total firm’s risk

EVA = EBIT – TAX = the aftertax operating profit (sometimes referred to as net operating profit after taxes or NOPAT) * Less the dollar cost of the capital employed to finance these assets = COST OF CAPITAL

Invested Capital =
Cash +
Net fixed assets +
WCR (investment the firm must make to support its operating cycle is the sum of its inventories and accounts receivable minus its accounts payable) WCR = (Accounts receivable + Inventories + Prepaid expenses) – (Accounts payable + Accrued expenses). Cash-to-cash period = cash collected from customers – cash paid to suppliers

Matching strategy = match the lifetime of an asset with its financing source WCR is mainly a lt investment as it remains on the BS indefinitely- permanent part to be financed with LT finance, and seasonal part with ST finance Liquidity issues arising from matching issues – the higher the proportion of WCR financed with LTF, the higher the liquidity Net long-term financing (NLF) = Long-term debt + Owners’ equity – Net fixed assets Net short-term financing (NSF) = Short-term debt – Cash

Net long-term financing working capital requirement
Percentage of working capital financed long term
* Liquidity position will improve if:
* Long-term financing increases, and/or
* Net fixed assets decrease, and/or
* WCR decreases
Effect on WCR:
* Economic sector (WCR/sales – evaluate overall efficiency with which the co’s operating cycle is managed) * Managerial efficiency
* WCR/sales – evaluate overall efficiency with which the co’s operating cycle is managed * Inventory turnover = COGS/Ending inv – efficiency with which inventories are managed * average collection period = days sales not collected at BS date – AR / Avg daily sales (Sales/365) * avg payment period = purchases not paid – AP / Avg daily purchases (COGS+ change inventories)/365 * Level and growth of sales – WCR is expected to grow at the same rate – an unexpected growth in Sales may lead to liquidity problems Liquidity analysis

* NWC =[Current assets –Current liabilities]1
* NWC =[Long-term financing2 – Net fixed assets]3
* Current ratio = Current assets / Current liabilities * Quick ratio = (Cash + Accts receivable)/ Current liabilities

* Current ratio
* Often said that the larger the current ratio, the more liquid the firm is * However, a firm’s current ratio can be increased by * Having clients pay their bills as late as possible * Maximizing inventories

* Paying the firm’s suppliers in a hurry
* These strategies obviously would not increase the firm’s liquidity * Therefore, the current ratio cannot be considered a reliable measure of liquidity * Acid test or quick ratio

* Although the quick ratio is an improvement over the current ratio, it still emphasizes a liquidation view of the firm * Also, a firm’s inventories (which are excluded from the quick ratio on the assumption that they are less liquid than receivables) are often as liquid as the firm's receivables NOCF = Sales – COGS – SG&A expenses – Tax expenses - WCR EBIT + Depreciation expenses = Sales – COGS – SG&A expenses Sum of the net cash flows from operating and investment activities (AKA: free cash flow)

NOCF = Margin – Investment

Profitability analysis
* Depending on responsibility:
* Sales manager: ROS
* Manager operating unit: ROA
* CEO: ROE = Earnings after tax / owners’ equity
* (most comprehensive as considers operational, financial and investment aspect, plus tax-related issues) * Impact of operating decisions on ROE – disposal/ acq FA, mgmt of operating assets

operating profitability
* ROIC = EBIT Invested Capital...
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