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Financial Ratios

Performance Ratios

Book Value Per Common Share
A measure used by owners of common shares in a firm to determine the level of safety associated with each individual share after all debts are paid accordingly.

Total Shareholder Equity - Preferred Equity
Total Outstanding Shares
Cash Return On Assets Ratio
A ratio used to compare a businesses performance among other industry members. The ratio can be used internally by the company's analysts, or by potential and current investors. The ratio does not however include any future commitments regarding assets, nor does it include the cost of replacing older ones.


Cash Flow from Operations 
 Total Assets

Activity Ratios

Asset Turnover
The amount of sales generated for every dollar's worth of assets. It is calculated by dividing sales in dollars by assets in dollars.



This ratio is more useful for growth companies to check if in fact they are growing revenue in proportion to assets.

Also known as the "Asset Turnover Ratio".

Average Collection Period
The approximate amount of time that it takes for a business to receive payments owed, in terms of receivables, from its customers and clients.

Calculated as:
   Days x AR  
 Credit Sales

Days = Total amount of days in period
AR = Average amount of accounts receivables
Credit Sales = Total amount of net credit sales during period

Inventory Turnover
A ratio showing how many times a company's inventory is sold and replaced over a period. The days in the period can then be divided by the inventory turnover formula to calculate the days it takes to sell the inventory on hand or "Inventory Turnover Days."
However, it may also be calculated as:

    Cost Of Good Sold   
 Average Inventory


Debt Ratio
A financial ratio that measures the extent of a company’s or consumer’s leverage. The debt ratio is defined as the ratio of total debt to total assets, expressed in percentage, and can be interpreted as the proportion of a company’s assets that are financed by debt.
  Total Debt   
Total Assets

The higher this ratio, the more leveraged the company and the greater its financial risk. Debt ratios vary widely across industries, with capital-intensive businesses such as utilities and pipelines having much higher debt ratios than other industries like technology. In the consumer lending and mortgage businesses, debt ratio is defined as the ratio of total debt service obligations to gross annual income.

Debt/Equity Ratio
A measure of a company's financial leverage calculated by dividing its total liabilities by stockholders' equity. It indicates what proportion of equity and debt the company is using to finance its assets.

     Total Liabilities      
Shareholders Equity

Note: Sometimes only interest-bearing, long-term debt is used instead of total liabilities in the calculation.

Also known as the "Personal Debt/Equity Ratio", this ratio can be applied to personal financial statements as well as corporate ones.

Liquidity Warnings

Acid-Test Ratio
A stringent indicator that determines whether a firm has enough short-term assets to cover its immediate liabilities without selling inventory. The acid-test ratio is far more strenuous than the working capital ratio, primarily because the working capital ratio allows for the inclusion of inventory assets.

Calculated by:
  (Cash + Account Receiveable + Short Term Investments) 
Current Liabilities

Interest Coverage Ratio
A ratio used to determine how easily a company can pay interest on outstanding debt. The interest coverage ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) of one period by the company's interest expenses of the same period:
Interest Expense

Working Capital

A measure of both a company's efficiency and its short-term financial health. The working capital ratio is calculated as:
Current Assets - Current Liabilities

This ratio indicates whether a company has enough short term assets to cover its short term debt. Anything below 1 indicates negative W/C (working capital). While anything over 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.

Also known as "Net Working Capital", or the "Working Capital Ratio".

DuPont Analysis

A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are measured at their gross book value rather than at net book value in order to produce a higher return on equity (ROE). It is also known as "DuPont identity".

DuPont analysis tells us that ROE is affected by three things:
- Operating efficiency, which is measured by profit margin
- Asset use efficiency, which is measured by total asset turnover
- Financial leverage, which is measured by the equity multiplier

ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity Multiplier (Assets/Equity)

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The need of institutional investors, such as pension funds, for objective information about investment managers —their people, products, processes, performance and principles —has led to the development of the institutional investment consulting industry.

Consultants can provide a useful service, often if pushed to go beyond mere support for ideas already grasped.

But they might just be needed to give credibility, especially to bodies like pension committees of boards of directors, where the staff people need more “cover.”
This relatively new focus of investor enthusiasm is always exciting with something happening all the time, somewhere in the world, promising the opportunity for huge profits.

However, emerging market investing may be a long-term cyclical phenomenon and not a steady, one-way path to riches. Certainly, the emerging market investment phase of more than the last decade is over.

Not only has capital been destroyed and confidence shattered but the idea of capital flows for superior return from developed countries to needy, developing ones is gone.
The “efficient market hypothesis” (EMH) says that at any given time, asset prices fully reflect all available information —that price movements do not follow any patterns or trends.

This means that past price movements cannot be used to predict future price movements. Rather, prices follow what is known as a “random walk,” an intrinsically unpredictable pattern.

In the world of the strong form EMH, trying to beat the market becomes a game of chance not skill.

A central challenge to the EMH is the existence of market anomalies: reliable, widely known and inexplicable patterns in returns, such as the “January effect.” In reality, markets are neither perfectly efficient nor completely inefficient.

All are efficient to a certain degree, but some more than others.
There are essentially two ways of analyzing investments: fundamental analysis and technical analysis. With the former, investors try to calculate the value of an asset, comparing the present value of the likely future cash flows with its current price.

With the latter, they focus exclusively on the asset’s price data, asking what its past price behaviour indicates about its likely future price behaviour. Market strategists believe that history tends to repeat itself.

They make price predictions on the basis of published data, looking for patterns and correlations, assessing trends, support and resistance levels.

The true objective of technical analysis is to determine whether or not the ingredients of a healthy bull market are present — and to watch out for possible warning flags before a major decline or bear strikes.
A caricature of the investment world divides it into two camps: value investors, who buy stocks that have fallen in price in the belief that the rest of the market has missed a bargain; and growth or momentum investors, who buy stocks that have gone up in the hope that they turn out to have been “cheap at any price.”

Value investors dispute the efficient market hypothesis, which suggests that prices reflect all available information, and see investment opportunities created by discrepancies between stock price and the underlying value of company assets.
The role of derivatives for managing risk through the financial markets is frequently misunderstood. Yet these instruments — futures, options and a multitude of variations are packages of the basic components of risk: they more than anything else traded come close to the theoretically ideal instruments for the trading of risk.

Derivatives can turn stocks into bonds and vice versa, and can pinpoint, very precisely, specific risks and returns that are packaged within a complex structure.

Risk management is essential in a modern market economy.

Forecasts can be injurious to your wealth
Dean LeBaron, b. 1933, investment manager and contrarian thinker