FINANCIAL RATIOS A financial ratio (or accounting ratio) is a relative magnitude of two selected numerical values taken from

an enterprise's financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall f inancial condition of a corporation or other organization. Financial ratios may be used by managers within a firm, by current and potential shareholders (owners ) of a firm, and by a firm's creditors. Financial analysts use financial ratios to compare the strengths and weaknesses in various companies. If shares in a com pany are traded in a financial market, the market price of the shares is used in certain financial ratios. Ratios can be expressed as a decimal value, such as 0.10, or given as an equival ent percent value, such as 10%. Some ratios are usually quoted as percentages, e specially ratios that are usually or always less than 1, such as earnings yield, while others are usually quoted as decimal numbers, especially ratios that are usually more than 1, such as P/E ratio; these latter are also called multiples. Given any ratio, one can take its reciprocal; if the ratio was above 1, the reci procal will be below 1, and conversely. The reciprocal expresses the same inform ation, but may be more understandable: for instance, the earnings yield can be c ompared with bond yields, while the P/E ratio cannot be: for example, a P/E rati o of 20 corresponds to an earnings yield of 5%. Sources of data for financial ratios Values used in calculating financial ratios are taken from the balance sheet, in come statement, statement of cash flows or (sometimes) the statement of retained earnings. These comprise the firm's "accounting statements" or financial statem ents. The statements' data is based on the accounting method and accounting stan dards used by the organization. Purpose and types of ratios Financial ratios quantify many aspects of a business and are an integral part of the financial statement analysis. Financial ratios are categorized according to the financial aspect of the business which the ratio measures. Liquidity ratios measure the availability of cash to pay debt. Activity ratios measure how quickly a firm converts non-cash assets to cash ass ets. Debt ratios measure the firm's ability to repay long-term debt. Profitability ratios measure the firm's use of its assets and control of its ex penses to generate an acceptable rate of return. Market ratios measure investor response to owning a company's stock and also the cost of issuing stock. These are concerned with the return on investment for shareholders, and with th e relationship between return and the value of an investment in companys shares.

Financial ratios allow for comparisons between companies between industries between different time periods for one company between a single company and its industry average

Ratios generally are not useful unless they are benchmarked against something el se, like past performance or another company. Thus, the ratios of firms in diffe rent industries, which face different risks, capital requirements, and competiti on, are usually hard to compare. Accounting methods and principles Financial ratios may not be directly comparable between companies that use diffe rent accounting methods or follow various standard accounting practices. Most pu blic companies are required by law to use generally accepted accounting principl es for their home countries, but private companies, partnerships and sole propri etorships may not use accrual basis accounting. Large multi-national corporation s may use International Financial Reporting Standards to produce their financial statements, or they may use the generally accepted accounting principles of the ir home country. There is no international standard for calculating the summary data presented in all financial statements, and the terminology is not always consistent between companies, industries, countries and time periods. When it comes to investing, analyzing financial statement information (also know n as quantitative analysis), is one of, if not the most important element in the fundamental analysis process. At the same time, the massive amount of numbers in a company's financial statements can be bewildering and int imidating to many investors. However, through financial ratio analysis, you will be able to work with these numbers in an organized fashion. The objective of this tutorial is to provide you with a guide to sources of fina ncial statement data, to highlight and define the most relevant ratios, to show you how to compute them and to explain their meaning as investment evaluators. In this regard, we draw your attention to the complete set of financials for Zim mer Holdings, Inc. (ZMH), a publicly listed company on the NYSE that designs, ma nufactures and markets orthopedic and related surgical products, and fracture-ma nagement devices worldwide. We've provided these statements in order to be able to make specific reference to the account captions and numbers in Zimmer's finan cials in order to illustrate how to compute all the ratios. Among the dozens of financial ratios available, we've chosen 11 measurements tha t are the most relevant to the investing process. Earnings before Interest, Taxes, Depreciation and Amortization EBITDA EBITDA is essentially net income with interest, taxes, depreciation, and amortiz ation added back to it, and can be used to analyze and compare profitability bet ween companies and industries because it eliminates the effects of financing and accounting decisions. It is an indicator of a company's financial performance which is calculated in t he following EBITDA calculation:

This is a non-GAAP measure that allows a greater amount of discretion as to what is (and is not) included in the calculation. This also means that companies oft en change the items included in their EBITDA calculation from one reporting peri od to the next.

EBITDA first came into common use with leveraged buyouts in the 1980s, when it w as used to indicate the ability of a company to service debt. As time passed, it became popular in industries with expensive assets that had to be written down over long periods of time. EBITDA is now commonly quoted by many companies, espe cially in the tech sector - even when it isn't warranted. A common misconception is that EBITDA represents cash earnings. EBITDA is a good metric to evaluate profitability, but not cash flow. EBITDA also leaves out the cash required to fund working capital and the replacement of old equipment, whi ch can be significant. Consequently, EBITDA is often used as an accounting gimmi ck to dress up a company's earnings. When using this metric, it's key that inves tors also focus on other performance measures to make sure the company is not tr ying to hide something with EBITDA. The EBITDA of a company gives an indication on the operational profitability of the business, i.e. how much profit does it make with its present assets and its operations on the products it produces and sells, taking into account possible p rovisions that need to be carried out. A negative EBITDA indicates that a busine ss has fundamental problems. A positive EBITDA, on the other hand, does not nece ssarily mean that the business generates cash. This is because EBITDA ignores ch anges in Working Capital (usually needed when growing a business), capital expen ditures (needed to replace assets that have broken down), taxes, and interest. While the omission of taxes, interest, and amortization for the sake of comparis on of companies has some justification, some analysts do not support omission of capital expenditures when evaluating the profitability of a company: capital ex penditures are needed to maintain the asset base which in turn allows for profit . Warren Buffett famously asked, "Does management think the tooth fairy pays for capital expenditures?" Depreciation is often a very good approximation of the c apital expenditures required to maintain the asset base, so it has been argued t hat EBITA ("Earnings before Interest, Taxes and Amortization) would be a better indicator. EBITDA margin refers to EBITDA divided by total revenue (or "total output", "out put" differing "revenue" by the changes in inventory).

Use Apart from the use mentioned above, EBITDA is widely used in loan covenants, mos tly in the following two metrics: 1. Leverage: Debt/EBITDA. This metric measures the amount of debt in relati on to the EBITDA, i.e. how does the debt relate to the operational profit genera ting ability of the company. Whilst there is no absolute target and whilst lever age ratios differ widely, it can probably be argued that a leverage >3 is unheal thy for most businesses. 2. Interest Cover: (EBITDA/Interest Expense). This metric measures the abil ity of a company to generate profit out of its operations to cover interest paym ents. Again there is no absolute target for this value, as the ratio that is req uired obviously depends on taxes, working capital needs, capital expenditures an d the repayment needs of the principal. However, it is clear that a ratio <1 is not sustainable for long. Misuse EBITDA has increasingly become the key metric to show the "intrinsic operational performance" of the business, i.e. the performance when all costs that do not o ccur in the normal course of business (e.g. restructuring costs, ramp-up costs, consulting fees for special projects, special legal fees, ...) are ignored. Whil

st this is helpful in general, it is often misused by declaring too many cost it ems as "one-offs" and thus boosting profitability. The resulting metric when suc h "non-normal" costs have been deducted should be called "adjusted EBITDA" or si milar, but this "adjusted" nature is often times not shown sufficiently clearly. Because EBITDA (and its variations) are not measures generally accepted under U. S. GAAP, the U.S. Securities and Exchange Commission requires that companies reg istering securities with it (and when filing its periodic reports) reconcile EBI TDA to net income in order to avoid misleading investors.

In another attempt to boost EBITDA, some companies have reverted to activate dev elopment efforts in the profit and loss statement. This effectively increases to tal output and hence increases EBITDA. Such development costs are then recorded as capital expenditures. A view on EBITA as discussed above would hence eliminat e such an artifact. Difference between EBITDA and Revenue Revenue is the total money that a company generates through its business. EBITDA is the company's profit from that revenue after expenses but before taxes and s uch are subtracted.

Profit before Tax PBT It is a profitability measure that looks at a company's profits before the compa ny has to pay corporate income tax. This measure deducts all expenses from reven ue including interest expenses and operating expenses, but it leaves out the pay ment of tax. Also referred to as "earnings before tax ". This measure combines all of the company's profits before tax, including operati ng, non-operating, continuing operations and non-continuing operations. PBT exis ts because tax expense is constantly changing and taking it out helps to give an investor a good idea of changes in a company's profits or earnings from year to year. Profit In accounting, profit is the difference between the purchase and the component c osts of delivered goods and/or services and any operating or other expenses.

There are several important profit measures in common use. Gross profit equals sales revenue minus cost of goods sold (COGS), thus removing only the part of expenses that can be traced directly to the production or purc hase of the goods. Gross profit still includes general (overhead) expenses like R&D, S&M, G&A, also interest expense, taxes and extraordinary items. Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) equals

sales revenue minus cost of rtization, depreciation and d to pay interest and repay tax is calculated, the debt

goods sold and all expenses except for interest, amo taxes. It measures the Cash earnings that can be use the principal. Since interest is paid before income holder can ignore taxes.

Earnings Before Interest and Taxes (EBIT) or Operating profit equals sales reven ue minus cost of goods sold and all expenses except for interest and taxes. This is the surplus generated by operations. It is also known as Operating Profit Be fore Interest and Taxes (OPBIT) or simply Profit Before Interest and Taxes (PBIT ). Earnings Before Taxes (EBT) or Net Profit Before Tax equals sales revenue minus cost of goods sold and all expenses except for taxes. It is also known as pre-ta x book income (PTBI), net operating income before taxes or simply pre-tax Income . Earnings After Tax or Net Profit After Tax equals sales revenue after deducting all expenses, including taxes (unless some distinction about the treatment of ex traordinary expenses is made). In the US, the term Net Income is commonly used. Income before extraordinary expenses represents the same but before adjusting fo r extraordinary items. Earnings After Tax (or Net Profit After Tax) minus payable dividends becomes Ret ained Earnings. To accountants, Economic Profit, or EP, is a single-period metric to determine t he value created by a company in one periodusually a year. It is Earnings After T ax less the Equity Charge, a risk-weighted cost of capital. This is almost ident ical to the economists' definition of economic profit. There are analysts who see benefit in making adjustments to economic profit such as eliminating the effect of amortized goodwill or capitalizing expenditure on brand advertising to show its value over multiple accounting periods. The underl ying concept was first introduced by Schmalenbach, but the commercial applicatio n of the concept of adjusted economic profit was by Stern Stewart & Co. which ha s trade-marked their adjusted economic profit as Economic Value Added (EVA). Economists define also the following types of profit: Abnormal profit (or Supernormal profit) Subnormal profit Monopoly profit (or Super profit) Optimum Profit is a theoretical measure and denotes the "right" level of profit a business can achieve. In business, this figure takes account of marketing stra tegy, market position, and other methods of increasing returns above the competi tive rate.

Accounting profits should include economic profits, which are also called econom ic rents. For instance, a monopoly can have very high economic profits, and thos e profits might include a rent on some natural resource that firm owns, whereby that resource cannot be easily duplicated by other firms.

Return on Average Capital Employed ROACE It is a financial ratio that shows profitability compared to investments made in new capital. "Return on average capital employed" is calculated as: EBIT Average Total Assets - Average Current Liabilities Total Assets - Current Liabilities = Capital Employed It differs from the "return on capital employed" (ROCE) calculation, in that it takes the average of the opening and closing capital for a period of time, as op posed to only the capital figure at the end of the period. Return on average capital employed is a useful ratio when analyzing businesses i n capital-intensive industries, such as oil. Businesses that are able to squeeze higher profits from a smaller amount of capital assets will have a higher ROACE than businesses that are not as efficient in converting capital into profit. Investors should be careful when using the ratio since capital assets, such as a refinery, can be depreciated over time. If the same amount of profit is made fr om an asset each period, the asset depreciating will make ROACE increase because it is less valuable. This makes it look as if the company is making good use of capital, though it is really not making any additional investments. The formula (Expressed as a %) It is similar to Return on Assets (ROA), but takes into account sources of finan cing. Net Operating Profit After Tax (NOPAT) is equal to EBIT * (1 - tax) -- the return on the capital employed should be measured in after tax terms. Operating income In the numerator we have Net Operating Profit After Tax, i.e. operating profit o r EBIT (earnings after tax). Capital employed In the denominator we have net assets or capital employed instead of total asset s (which is the case of Return on Assets). Capital Employed has many definitions . In general it is the capital investment necessary for a business to function. It is commonly represented as total assets less current liabilities (or fixed as sets plus working capital). ROCE uses the reported (period end) capital numbers; if one instead uses the ave rage of the opening and closing capital for the period, one obtains Return on Av erage Capital Employed (ROACE). Application ROCE is used to prove the value the business gains from its assets and liabiliti es. A business which owns lots of land but has little profit will have a smaller ROCE to a business which owns little land but makes the same profit. It basical ly can be used to show how much a business is gaining for its assets, or how muc h it is losing for its liabilities. Drawbacks of ROCE The main drawback of ROCE is that it measures return against the book value of a

ssets in the business. As these are depreciated the ROCE will increase even thou gh cash flow has remained the same. Thus, older businesses with depreciated asse ts will tend to have higher ROCE than newer, possibly better businesses. In addi tion, while cash flow is affected by inflation, the book value of assets is not. Consequently revenues increase with inflation while capital employed generally does not (as the book value of assets is not affected by inflation). Return On Average Capital Employed (ROCE) Return on average capital employed is a performance measure ratio. From the pers pective of the business segments, ROCE is annual business segment earnings divid ed by average business segment capital employed (average of beginning- and end-o f-year amounts). These segment earnings include ExxonMobils share of segment earn ings of equity companies, consistent with our capital employed definition, and e xclude the cost of financing. The Corporations total ROCE is net income excluding the after-tax cost of financing, divided by total corporate average capital emp loyed. The Corporation has consistently applied its ROCE definition for many yea rs and views it as the best measure of historical capital productivity in our ca pital-intensive, long-term industry, both to evaluate managements performance and to demonstrate to shareholders that capital has been used wisely over the long term. Additional measures, which are more cash-flow based, are used to make inve stment decisions.

(millions of dollars) 2008 2006 2005 Return on Average Capital Employed Net income 45,220 36,130 Financing costs (after tax) Gross third-party debt (343 (264 ) (261 ) ExxonMobil share of equity companies ) (156 ) All other financing costs net 499 (35 Total financing costs 79 817 ) 25,330 ) (144 1,485 )

2007 2004 40,610 39,500

(461 (325 )

(339 ) ) 378 (275 )

) (185 268 (204 )

(440

(268

Earnings excluding financing costs 39,421

44,403 36,570 25,598

40,885

Average capital employed 122,573

129,683 116,961 107,339 31.3

128,760 34.2 % %

Return on average capital employed corporate total 31.8 % 32.2 % 23.8 %

Return on Net Worth- RONW The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. RONW is expressed as a percentage and calculated as: Return on Net Worth= Net Income/Shareholder's Equity Net income is for the full fiscal year (before dividends paid to common stock ho lders but after dividends to preferred stock.) Shareholder's equity does not inc lude preferred shares. Also known as return on equity (ROE). The ROE is useful for comparing the profitability of a company to that of other firms in the same ind ustry. There are several variations on the formula that investors may use: 1. Investors wishing to see the return on common equity may modify the formula a bove by subtracting preferred dividends from net income and subtracting preferre d equity from shareholders' equity, giving the following: return on common equit y (ROCE) = net income - preferred dividends / common equity. 2. Return on equity may also be calculated by dividing net income by average sha reholders' equity. Average shareholders' equity is calculated by adding the shar eholders' equity at the beginning of a period to the shareholders' equity at per iod's end and dividing the result by two. 3. Investors may also calculate the change in ROE for a period by first using th e shareholders' equity figure from the beginning of a period as a denominator to determine the beginning ROE. Then, the end-of-period shareholders' equity can b e used as the denominator to determine the ending ROE. Calculating both beginnin g and ending ROEs allows an investor to determine the change in profitability ov er the period. Return on equity (ROE) measures how much a company earns within a specific perio d in relation to the amount that's invested in its common stock.It is calculated by dividing the company's net income before common stock dividends are paid by the company's net worth, which is the stockholders' equity.If the ROE is higher than the company's return on assets, it may be a sign that management is using l everage to increase profits and profit margins.In general, it's considered a sig n of good management when a company's performance over time is at least as good as the average return on equity for other companies in the same industry. It is publicly-traded company's earnings divided by the amount of money invested in stock, expressed as a percentage. This is a measure of how well the company is investing the money invested in it. A high return on equity indicates that th e company is spending wisely and is likely profitable; a low return on equity in dicates the opposite. As a result, high returns on equity lead to higher stock p rices. Some analysts believe that return on equity is the single most important indicator of publicly-traded companies' health.

Asset Turnover It is the amount of sales generated for every dollar's worth of assets. It is ca lculated by dividing sales in dollars by assets in dollars. Formula: Also known as the Asset Turnover Ratio. Asset turnover measures a firm's efficiency at using its assets in generating sa les or revenue - the higher the number the better. It also indicates pricing str ategy: companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover. Asset turnover is a financial ratio that measures the efficiency of a company's use of its assets in generating sales revenue or sales income to the company. Companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover. Companies in the retail indust ry tend to have a very high turnover ratio due mainly to cut throat and competit ive pricing. "Sales" is the value of "Net Sales" or "Sales" from the company's income stateme nt "Average Total Assets" is the average of the values of "Total assets" from the c ompany's balance sheet in the beginning and the end of the fiscal period. It is calculated by adding up the assets at the beginning of the period and the assets at the end of the period, then dividing that number by two. Asset turnover This ratio considers the relationship between revenues and the total assets empl oyed in a business. A business invests in assets (machinery, inventories etc) i n order to make profitable sales, and a good way to think about the asset turnov er ratio is imagining the business trying to make those assets work hard (or swe at) to generate sales. In terms of where to get the numbers: Revenue obviously comes from the income statement Net assets = total assets less total liabilities The resulting figure is expressed as a number of times per year Particular care needs to be taken with the asset turnover ratio. For example: The number will vary enormously from industry to industry. A capital-intensive b usiness may have a much lower asset turnover than a business with low net assets but which generates high revenues. The asset turnover figure for a specific business can also vary significantly fr om year to year. For example, a business may invest heavily in new production ca pacity in one year (which would increase net assets) but the revenues from the e xtra capacity might not arise fully until the following year The asset turnover ratio takes no direct account of the profitability of the rev enues generated

Inventory Turnover

It is 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."Although the first calculation is more frequently used, COGS (cost of goo ds sold) may be substituted because sales are recorded at market value, while in ventories are usually recorded at cost. Also, average inventory may be used inst ead of the ending inventory level to minimize seasonal factors. This ratio should be compared against industry averages. A low turnover implies poor sales and, therefore, excess inventory. A high ratio implies either strong sales or ineffective buying.High inventory levels are unhealthy because they rep resent an investment with a rate of return of zero. It also opens the company up to trouble should prices begin to fall. In accounting, the Inventory turnover is a measure of the number of times invent ory is sold or used in a time period such as a year. The equation for inventory turnover equals the cost of goods sold divided by the average inventory. Invento ry turnover is also known as inventory turns, stock turn, stock turns, turns, an d stock turnover.

The formula for average inventory: The average days to sell the inventory is calculated as follows:

Application in Business A low turnover rate may point to overstocking, obsolescence, or deficiencies in the product line or marketing effort. However, in some instances a low rate may be appropriate, such as where higher inventory levels occur in anticipation of r apidly rising prices or expected market shortages. Conversely a high turnover rate may indicate inadequate inventory levels, which may lead to a loss in business as the inventory is too low. This often can result in stock shortages. Some compilers of industry data (e.g., Dun & Bradstreet) use sales as the numera tor instead of cost of sales. Cost of sales yields a more realistic turnover rat io, but it is often necessary to use sales for purposes of comparative analysis. Cost of sales is considered to be more realistic because of the difference in w hich sales and the cost of sales are recorded. Sales are generally recorded at m arket value, i.e. the value at which the marketplace paid for the good or servic e provided by the firm. In the event that the firm had an exceptional year and t he market paid a premium for the firm's goods and services then the numerator ma y be an inaccurate measure. However, cost of sales is recorded by the firm at wh at the firm actually paid for the materials available for sale. Additionally, fi rms may reduce prices to generate sales in an effort to cycle inventory. In this article, the terms "cost of sales" and "cost of goods sold" are synonymous.

An item whose inventory is sold (turns over) once a year has higher holding cost than one that turns over twice, or three times, or more in that time. Stock tur nover also indicates the briskness of the business. The purpose of increasing in ventory turns is to reduce inventory for three reasons. Increasing inventory turns reduces holding cost. The organization spends less mo ney on rent, utilities, insurance, theft and other costs of maintaining a stock of good to be sold. Reducing holding cost increases net income and profitability as long as the reve nue from selling the item remains constant. Items that turn over more quickly increase responsiveness to changes in customer requirements while allowing the replacement of obsolete items. This is a major concern in fashion industries.

When making comparison between firms, it's important to take note of the industr y, or the comparison will be distorted. Making comparison between a supermarket and a car dealer, will not be appropriate, as supermarket sells fast moving good s such as sweets, chocolates, soft drinks so the stock turnover will be higher. However, a car dealer will have a low turnover due to the item being a slow movi ng item. As such only intra-industry comparison will be appropriate.

Debtors Turnover Ratio / Accounts Receivable Turnover Ratio A concern may sell goods on cash as well as on credit. Credit is one of the impo rtant elements of sales promotion. The volume of sales can be increased by follo wing a liberal credit policy. The effect of a liberal credit policy may result in tying up substantial funds o f a firm in the form of trade debtors (or receivables). Trade debtors are expect ed to be converted into cash within a short period of time and are included in c urrent assets. Hence, the liquidity position of concern to pay its short term ob ligations in time depends upon the quality of its trade debtors. Debtors turnover ratio or accounts receivable turnover ratio indicates the veloc ity of debt collection of a firm. In simple words it indicates the number of tim es average debtors (receivable) are turned over during a year. Formula of Debtor s Turnover Ratio: Debtors Turnover Ratio = Net Credit Sales / Average Trade Debtors

The two basic components of accounts receivable turnover ratio are net credit an nual sales and average trade debtors. The trade debtors for the purpose of this ratio include the amount of Trade Debtors & Bills Receivables. The average recei vables are found by adding the opening receivables and closing balance of receiv ables and dividing the total by two. It should be noted that provision for bad a nd doubtful debts should not be deducted since this may give an impression that some amount of receivables has been collected. But when the information about op ening and closing balances of trade debtors and credit sales is not available, t hen the debtors turnover ratio can be calculated by dividing the total sales by the balance of debtors (inclusive of bills receivables) given and formula can be

written as follows. Debtors Turnover Ratio = Total Sales / Debtors Significance of the Ratio Accounts receivable turnover ratio or debtors turnover ratio indicates the numbe r of times the debtors are turned over a year. The higher the value of debtors t urnover the more efficient is the management of debtors or more liquid the debto rs are. Similarly, low debtors turnover ratio implies inefficient management of debtors or less liquid debtors. It is the reliable measure of the time of cash f low from credit sales. There is no rule of thumb which may be used as a norm to interpret the ratio as it may be different from firm to firm. An accounting measure used to quantify a firm's effectiveness in extending credi t as well as collecting debts. The receivables turnover ratio is an activity rat io, measuring how efficiently a firm uses its assets. Formula:

Some companies' reports will only show sales - this can affect the ratio dependi ng on the size of cash sales. By maintaining accounts receivable, firms are indirectly extending interest-free lo ans to their clients. A high ratio implies either that a company operates on a c ash basis or that its extension of credit and collection of accounts receivable is efficient. A low ratio implies the company should re-assess its credit policies in order to ensure the timely collection of imparted credit that is not earning interest fo r the firm. The Accounts Receivable Turnover measures the number of times Accounts Receivabl e were collected during a period. This period can be any length of time, such as monthly, quarterly, or yearly. The Accounts Receivable Turnover ratio is also a measure of how well the company can collect sales on credit from its customers. The Average Collection Period is a similar measurement, and estimates the avera ge number of days it takes for a company to collect on its credit sales. Accounts Receivable Turnover is found by adding the starting and ending values o f accounts receivable, then dividing by two. The Net Sales is then divided by th is average Accounts Receivable value. Another way to write this equation is: Net Sales [ (Starting Accounts Receivable + Ending Accounts Receivable) / 2] A high, or increasing Accounts Receivable Turnover is usually a positive sign showing the company is successfully executing its credit policies and quickly tu rning its Accounts Receivable into cash. Being able to efficiently collect on it s credit sales is important for any company, and each company has to find a bala nce between extending credit to other companies to encourage more sales, yet not be too forthcoming wi th credit, as the sheer number of credit accounts can become a problem when tryi ng to manage all of them. A possible negative aspect to an increasing Accounts Receivable Turnover is the company may be too strict in its credit policies and missing out on potential sa les. Although companies may play it safe and restrict credit sales to prevent ab

use, a better approach would be to evaluate potential companies wishing to recei ve sales on credit and start with smaller credit values. Once companies have gai ned a reputation of keeping their promise, the company extending credit can incr ease the amount of credit.

Dividend Payout Ratio It is the percentage of earnings paid to shareholders in dividends. Calculated as: The payout ratio provides an idea of how well earnings support the dividend paym ents. More mature companies tend to have a higher payout ratio.In the U.K. there is a similar ratio, which is known as dividend cover. It is calculated as earni ngs per share divided by dividends per share. Dividend payout ratio is the fraction of net income a firm pays to its stockhold ers in dividends:

The part of the earnings not paid to investors is left for investment to provide for future earnings growth. Investors seeking high current income and limited c apital growth prefer companies with high Dividend payout ratio. However investor s seeking capital growth may prefer lower payout ratio because capital gains are taxed at a lower rate. High growth firms in early life generally have low or ze ro payout ratios. As they mature, they tend to return more of the earnings back to investors. Note that dividend payout ratio is calculated as DPS/EPS. According to Financial Accounting by Walter T. Harrison, the calculation for the payout ratio is as follows: Payout Ratio = (Dividends - Preferred Stock Dividends)/Net Income The dividend yield is given by earnings yield times DPR: Impact of buybacks Some companies chose stock buybacks as an alternative to dividends, in such case s this ratio becomes less meaningful. One way to adapt it using an augmented pay out ratio: Augmented Payout Ratio = (Dividends + Buybacks)/ Net Income for the same period

Earnings per Share EPS It is the portion of a company's profit allocated to each outstanding share of c ommon stock. Earnings per share serve as an indicator of a company's profitabili ty. Calculated as:

When calculating, it is more accurate to use a weighted average number of shares outstanding over the reporting term, because the number of shares outstanding c an change over time. However, data sources sometimes simplify the calculation by using the number of shares outstanding at the end of the period. Diluted EPS expands on basic EPS by including the shares of convertibles or warr ants outstanding in the outstanding shares number. Earnings per share are genera lly considered to be the single most important variable in determining a share's price. It is also a major component used to calculate the price-to-earnings val uation ratio. For example, assume that a company has a net income of $25 million. If the compa ny pays out $1 million in preferred dividends and has 10 million shares for half of the year and 15 million shares for the other half, the EPS would be $1.92 (24/12.5). First, the $1 million is deducted from the net income to get $24 million, and then a weighted average is taken to find the number of s hares outstanding (0.5 x 10M+ 0.5 x 15M = 12.5M). An important aspect of EPS that's often ignored is the capital that is required to generate the earnings (net income) in the calculation. Two companies could ge nerate the same EPS number, but one could do so with less equity (investment) that company would be more efficient at using its capital to generate income and , all other things being equal would be a "better" company. Investors also need to be aware of earnings manipulation that will affect the quality of the earning s number. It is important not to rely on any one financial measure, but to use i t in conjunction with statement analysis and other measures. Earnings per share (EPS) is the amount of earnings per each outstanding share of a company's stock. In the United States, the Financial Accounting Standards Board (FASB) requires c ompanies' income statements to report EPS for each of the major categories of th e income statement: continuing operations, discontinued operations, extraordinar y items, and net income. Calculating EPS The EPS formula does not include preferred dividends for categories outside of c ontinued operations and net income. Earnings per share for continuing operations and net income are more complicated in that any preferred dividends are removed from net income before calculating EPS. This is because preferred stock rights have precedence over common stock. If preferred dividends total $100,000, then t hat is money not available to distribute to each share of common stock. Earnings per Share (Basic Formula) Earnings per Share (Net Income Formula) Earnings per Share (Continuing Operations Formula)

Only preferred dividends actually declared in the current year are subtracted. T he exception is when preferred shares are cumulative, in which case annual divid

ends are deducted regardless of whether they have been declared or not. Dividend s in arrears are not relevant when calculating EPS. Earnings per share (EPS) are the profit attributable to shareholders (after inte rest, tax, minority interests and everything else) divided by the number of shar es in issue. It is the amount of a company's profits that belong to a single ord inary share. Companies are required to publish the statutory (also called basic) EPS but there are a number of adjusted EPS numbers that are more useful to investors. The most common alternative EPS numbers used are adjusted or headline EPS and di luted EPS. Uses of EPS The most common use of EPS is to calculate the PE ratio, which puts EPS into con text by comparing it to the share price. There are a number of variants of the P E ratio, using past earnings, forecast earnings, or the average over many years. Trends in EPS are also an important measure of growth EPS growth is combined wit h PE in the PEG ratio. It is also used to screen for growth companies. EPS growt h is a key measure of management performance as shows how much money the company is making for shareholders, not only because of changes in profits, but also af ter all the effects of new share issues (this is particularly important when gro wth is acquisitive).

Price-Earnings Ratio - P/E Ratio It is a valuation ratio of a company's current share price compared to its per-s hare earnings. Calculated as: Market Value per Share Earnings per Share (EPS) For example, if a company is currently trading at $43 a share and earnings over the last 12 months were $1.95 per share, the P/E ratio for the stock would be 22 .05 ($43/$1.95). EPS is usually from the last four quarters (trailing P/E), but sometimes it can be taken from the estimates of earnings expected in the next four quarters (proj ected or forward P/E). A third variation uses the sum of the last two actual qua rters and the estimates of the next two quarters. Also sometimes known as "price multiple" or "earnings multiple". In general, a high P/E suggests that investors are expecting higher earnings gro wth in the future compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the whole story by itself. It's usually more useful to compare the P/E ratios of one company to other companies in the same industry, to the ma rket in general or against the company's own historical P/E. It would not be useful for investors using the P/E ratio as a basis for their investment to compare the P/E

of a technology company (high P/E) to a utility company (low P/E) as each indus try has much different growth prospects. The P/E is sometimes referred to as the "multiple", because it shows how much in vestors are willing to pay per dollar of earnings. If a company were currently t rading at a multiple (P/E) of 20, the interpretation is that an investor is will ing to pay $20 for $1 of current earnings. It is important that investors note an important problem that arises with the P/ E measure, and to avoid basing a decision on this measure alone. The denominator (earnings) is based on an accounting measure of earnings that is susceptible to forms of manipulation, making the quality of the P/E only as good as the qualit y of the underlying earnings number. Versions There are multiple versions of the P/E ratio, depending on whether earnings are projected or realized, and the type of earnings. "Trailing P/E" uses per-share net income for the most recent 12 month period, di vided by the weighted average number of common shares in issue during the period . This is the most common meaning of "P/E" if no other qualifier is specified. M onthly earnings data for individual companies are not available, and in any case usually fluctuate seasonally, so the previous four quarterly earnings reports a re used and earnings per share are updated quarterly. Note, each company chooses its own financial year so the timing of updates will vary from one to another.

"Trailing P/E from continued operations" uses operating earnings, which exclude earnings from discontinued operations, extraordinary items (e.g. one-off windfal ls and write-downs), and accounting changes. "Forward P/E": Instead of net income, this uses estimated net earnings over next 12 months. Estimates are typically derived as the mean of those published by a select group of analysts (selection criteria are rarely cited). Interpretation By comparing price and earnings per share for a company, one can analyze the mar ket's stock valuation of a company and its shares relative to the income the com pany is actually generating. Stocks with higher (or more certain) forecast earni ngs growth will usually have a higher P/E, and those expected to have lower (or riskier) earnings growth will usually have a lower P/E. Investors can use the P/ E ratio to compare the value of stocks: if one stock has a P/E twice that of ano ther stock, all things being equal (especially the earnings growth rate), it is a less attractive investment. Companies are rarely equal, however, and compariso ns between industries, companies, and time periods may be misleading. P/E ratio in general is useful for comparing valuation of peer companies in similar sector or group. It is usually not enough to look at the P/E ratio of one company and determine its status. Usually, an analyst will look at a company's P/E ratio com pared to the industry the company is in, the sector the company is in, as well a s the overall market. Effect of leverage P/E ratios are highly dependent on capital structure. Leverage (i.e. debt taken on by the company) affects both earnings and share price in a variety of ways, i ncluding the leveraging of earnings growth rates, tax effects and impacts on the risk of bankruptcy, and can sometimes dramatically affect the company's results . For example, for two companies with identical operations and taxation regime, and trading at typical P/E ratios, the company with

a moderate amount of debt will commonly have a lower P/E than the one with no de bt, despite having a slightly higher risk profile, slightly more volatile earnin gs and (if earnings are increasing) a slightly higher earnings growth rate. At higher levels of leverage (where the risk of bankruptcy forces up debt costs) or if profits decline substantially (driving up the P/E ratio) the indebted fir m will have a higher P/E ratio than an unleveraged firm. To try to eliminate these leverage effects and better compare the values of the underlying operating assets, it is often preferable to use multiples based on th e enterprise value of a company, such as EV/EBITDA, EV/EBIT or EV/NOPAT. The P/E ratio in business culture The P/E ratio of a company is a major focus for many managers. They are usually paid in company stock or options on their company's stock (a form of payment tha t is supposed to align the interests of management with the interests of other s tock holders). The stock price can increase in one of two ways: either through i mproved earnings or through an improved multiple that the market assigns to thos e earnings. In turn, the primary driver for multiples such as the P/E ratio is t hrough higher and more sustained earnings growth rates. Consequently, managers have strong incentives to boost earnings per share, even in the short term, and/or which improve long term growth rates. This can influen ce business decisions in several ways: If a company is looking to acquire companies with a company with a higher P/E ra tio than its own it will usually prefer paying in cash or debt rather than in st ock. Although in theory the method of payment makes no difference to value, doing it this way will offset or avoid earnings di lution (see accretion/dilution analysis). Conversely, companies with higher P/E ratios than their targets will be more tem pted to use their stock as a means of payment for acquisitions. Companies with high P/E ratios but volatile earnings may be tempted to find ways to smooth earnings and diversify risk - this is the theory behind building cong lomerates Conversely, companies with low P/E ratios may be tempted to acquire small high g rowth businesses in an effort to "rebrand" their portfolio of activities and bur nish their image as growth stocks and thus obtain a higher PE rating. Companies will try to smooth earnings, for example by "slush fund accounting" (h iding excess earnings in good years to cover for losses in lean years). Such mea sures are designed to create the image that the company always slowly but steadi ly increases profits, with the goal to increase the P/E ratio. Companies with low P/E ratios will usually be more open to leveraging their bala nce sheet. As seen above, this mechanically lowers the PE ratio, which means the company looks cheaper than it did before leverage, and also improves earnings g rowth rates. Both of these factors will help drive up the share price.

Current Ratio It is a liquidity ratio that measures a company's ability to pay short-term obli gations. The Current Ratio formula is:

Also known as "liquidity ratio", "cash asset ratio" and "cash ratio". The ratio is mainly used to give an idea of the company's ability to pay back it s short-term liabilities (debt and payables) with its short-term assets (cash, i nventory, receivables). The higher the current ratio, the more capable the compa ny is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health, it does not necessarily mean that it will go bankrupt - as there are many ways to access financing - but it is definitely not a good sign. The current ratio can give a sense of the efficiency of a company's operating cy cle or its ability to turn its product into cash. Companies that have trouble ge tting paid on their receivables or have long inventory turnover can run into liq uidity problems because they are unable to alleviate their obligations. Because business operations differ in each industry, it is always more useful to compare companies within the same industry. This ratio is similar to the acid-test ratio except that the acid-test ratio doe s not include inventory and prepaids as assets that can be liquidated. The compo nents of current ratio (current assets and current liabilities) can be used to d erive working capital (difference between current assets and current liabilities ). Working capital is frequently used to derive the working capital ratio, which is working capital as a ratio of sales. The current ratio is a financial ratio that measures whether or not a firm has e nough resources to pay its debts over the next 12 months. It compares a firm's c urrent assets to its current liabilities. The current ratio is an indication of a firm's market liquidity and ability to m eet creditor's demands. Acceptable current ratios vary from industry to industry and are generally between 1.5 and 3 for healthy businesses. If a company's curr ent ratio is in this range, then it generally indicates good short-term financia l strength. If current liabilities exceed current assets (the current ratio is b elow 1), then the company may have problems meeting its short-term obligations. If the current ratio is too high, then the company may not be efficiently using its current assets or its short-term financing facilities. This may also indicat e problems in working capital management. Low values for the current or quick ratios (values less than 1) indicate that a firm may have difficulty meeting current obligations. Low values, however, do no t indicate a critical problem. If an organization has good long-term prospects, it may be able to borrow against those prospects to meet current obligations. So me types of businesses usually operate with a current ratio less than one. For e xample, if inventory turns over much more rapidly than the accounts payable beco me due, then the current ratio will be less than one. This can allow a firm to o perate with a low current ratio. If all other things were equal, a creditor, who is expecting to be paid in the n ext 12 months, would consider a high current ratio to be better than a low curre nt ratio, because a high current ratio means that the company is more likely to meet its liabilities which fall due in the next 12 months. You should view the r elation between the operation cycle period and the current ratio.

Analysis Current ratio matches current assets with current liabilities and tells us wheth er the current assets are enough to settle current liabilities. Current ratio be low 1 shows critical liquidity problems because it means that total current liab ilities exceed total current assets. General rule is that higher the current rat io better it is but there is a limit to this. A current ratio higher than 2.5 mi ght indicate existence of idle or underutilized resources in the company. Example On December 31, 2010 Company B had total asset of $150,000, equity of $75,000 an d non-current assets and non-current liabilities of $50,000 each. Calculate the current ratio. Solution To calculate current ratio, we need to calculate current assets and current liab ilities first: Current Assets = Total Asset Non-Current Assets = $150,000 $50,000 = $100,000 Total Liabilities = Total Assets Total Equity = $150,000 $75,000 = $75,000 Current Liabilities = $75,000 $50,000 = $25,000 Current Ratio = $100,000/$25,000 = 4.00

Debt/Equity Ratio It is a measure of a company's financial leverage calculated by dividing its tot al liabilities by stockholders' equity. It indicates what proportion of equity a nd debt the company is using to finance its assets. 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 perso nal financial statements as well as corporate ones. A high debt/equity ratio generally means that a company has been aggressive in f inancing its growth with debt. This can result in volatile earnings as a result of the additional interest expense. If a lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing. If this were to increase earnings by a greater amount th an the debt cost (interest), then the shareholders benefit as more earnings are being spread among the same amount of shareholders. However, the cost of this de bt financing may outweigh the return that the company generates on the debt thro ugh investment and business activities and become too much for the company to ha ndle. This can lead to bankruptcy, which would leave shareholders with nothing. The debt/equity ratio also depends on the industry in which the company operates . For example, capitalintensive industries such as auto manufacturing tend to have a debt/equity ratio above 2, while personal computer companies have a debt/equity of under 0.5. The debt-equity ratio is another leverage ratio that compares a company's total liabilities to its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligors have committed to the company versus what the shareholders have committed.

To a large degree, the debt-equity ratio provides another vantage point on a com pany's leverage position, in this case, comparing total liabilities to sharehold ers' equity, as opposed to total assets in the debt ratio. Similar to the debt r atio, a lower the percentage means that a company is using less leverage and has a stronger equity position. Variations A conservative variation of this ratio, which is seldom seen, involves reducing a company's equity position by its intangible assets to arrive at a tangible equ ity, or tangible net worth, figure. Companies with a large amount of purchased g oodwill form heavy acquisition activity can end up with a negative equity positi on. Commentary The debt-equity ratio appears frequently in investment literature. However, like the debt ratio, this ratio is not a pure measurement of a company's debt becaus e it includes operational liabilities in total liabilities. Nevertheless, this easy-to-calculate ratio provides a general indication of a co mpany's equity-liability relationship and is helpful to investors looking for a quick take on a company's leverage. Generally, large, well-established companies can push the liability component of their balance sheet structure to higher per centages without getting into trouble. The debt-equity ratio percentage provides a much more dramatic perspective on a company's leverage position than the debt ratio percentage. For example, IBM's d ebt ratio of 69% seems less onerous than its debt-equity ratio of 220%, which me ans that creditors have more than twice as much money in the company than equity holders (both ratios are for FY 2005). Usage Preferred shares can be considered part of debt or equity. Attributing preferred shares to one or the other is partially a subjective decision but will also tak e into account the specific features of the preferred shares. When used to calculate a company's financial leverage, the debt usually includes only the Long Term Debt (LTD). Quoted ratios can even exclude the current porti on of the LTD. The composition of equity and debt and its influence on the value of the firm is much debated and also described in the Modigliani-Miller theorem . Financial analysts and stock market quotes will generally not include other type s of liabilities, such as accounts payable, although some will make adjustments to include or exclude certain items from the formal financial statements. Adjust ments are sometimes also made to, for example, exclude intangible assets, and th is will affect the formal equity; debt to equity (dequity) will therefore also b e affected. Financial economists and academic papers will usually refer to all liabilities a s debt, and the statement that equity plus liabilities equals assets is therefor e an accounting identity (it is, by definition, true). Other definitions of debt to equity may not respect this accounting identity, and should be carefully com pared.

Conclusion The financial ratios are used by debt issuers, business insiders, and stock pick ers. Ratios measure many aspects of the business but are not used in isolation f rom the statements. Financial ratios are considered an essential part of the financial statement. Th e results of a ratio give ascend to the question why. This is needed to answer t he ratios comparisons. 1. Between companies, industries, time periods. 2. Between companies and the industry. Ratios firm different industries which face different risks like capital require ments and competition that are not always comparable. Relationships with financial ratios demonstrates the different aspects within sm all business operations. Elements from the balanced sheet and income sheet are e xtracting particular points that focus the mind. Small Business owners and manag ers with the financial ratio tool can measure their progress against internal go als that competitors and the industry can determine. Tracking various ratios over time is a very powerful way to identify as they dev elop. Ratios are used by bankers, investors, and analysts to evaluate various attribut es of a companies financial strength and operations. Ratios are determined by dividing one by the other and are usually expressed as a percent. One of the most widely used forms of financial analysis is the use of ratios. Th ey can provide data that is useful for investment decisions. They can also hel p internal management of an organization gain an awareness of their company's st rengths and weaknesses. And, if we can find weaknesses, we can move to correct t hem before severe harm is done.