1. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego 10

2. Session Ten Topics Introducing ratio analysis Introducing ratio analysis Short-term solvency (liquidity) Short-term solvency (liquidity) Long-term solvency Long-term solvency Working Capital Ratios (see Session Five & Six) Working Capital Ratios (see Session Five & Six) Financial efficiency Financial efficiency Using ratio analysis Using ratio analysis Brealey, Myers: Chapter “Analyzing Financial Performance” (pp. 765 -773)

3. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Liquidity ratios Current ratio: Current ratio: current assets/current liabilities current assets/current liabilities mind you: in this case (as oppose to NWC) a short term debt is included mind you: in this case (as oppose to NWC) a short term debt is included Quick ratio (ACID - test) Quick ratio (ACID - test) Cash + short term securities + receivables/ current liabilities: Cash + short term securities + receivables/ current liabilities: mind you: sometimes it is said that the only difference lays in not including inventories – in many cases it’s true but often misleading mind you: sometimes it is said that the only difference lays in not including inventories – in many cases it’s true but often misleading

4. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Solvency ratios Gearing (debt/equity) ratio: Gearing (debt/equity) ratio: Debt, including leases /equity Debt, including leases /equity mind you: various authors exclude short-term debt (Brealey, Myers including) – in US practice it is reasonable but in many cases short term debt is very important mind you: various authors exclude short-term debt (Brealey, Myers including) – in US practice it is reasonable but in many cases short term debt is very important Interests coverage Interests coverage EBIT (Earnings Before Interest and Taxes)/ interests & other debt related costs: EBIT (Earnings Before Interest and Taxes)/ interests & other debt related costs: mind you: banks charge provisions and other which are not disclosed as interests but other financial costs – on the other side financial costs may include net results on currency rates mind you: banks charge provisions and other which are not disclosed as interests but other financial costs – on the other side financial costs may include net results on currency rates

5. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Financial Efficiency Ratios Gross Margin: Gross Margin: EBIT (if possible before overheads)/revenues EBIT (if possible before overheads)/revenues mind you: sometimes quite difficult to be established directly from P&L mind you: sometimes quite difficult to be established directly from P&L Return on assets Return on assets EBIT/ total assets EBIT/ total assets Return on equity Return on equity Net profit/ equity Net profit/ equity

6. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Financial efficiency The second DuPont formula The second DuPont formula ROE = Net profit/Equity (average) ROE = Net profit/Equity (average) ROA = Net profit/Total Assets (average) ROA = Net profit/Total Assets (average)Therefore: ROE=ROA*(Total assets/equity)

7. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego DuPont Formula (Expanded) ROE = net income / (shareholder's) equity Net income = net profit marigin * turnover Mind you: turnover equals sales revenues Asset turnover = turnover/total assets therefore: Total asset = turnover/asset turnover Equity multiplier = total assets/equity Therefore: Equity = total asset/equity multiplier=(turnover/asset turnover)/equity multiplier ROE = net profit marigin * turnover/(turnover/asset turnover)/equity multiplier ROE = (net profit marigin) * (asset turnover) * (equity multiplier)

8. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego DuPont Formula (Meaning) ROE = (net profit marigin) * (asset turnover) * (equity multiplier) Shareholders are better off, if: 1) 1) Products sold bring high marigin (revenues are well above total costs) 2) 2) Assets are heavily utilized – 1 USD in asses brings high revenues 3) 3) Debt financing is heavily used (subject of one of the next classes)