Liquidity

Liquidity refers to the firms ability to fund its current operations.

There are two common measures used to analyze liquidity.
Current Ratio =

Current Assets
Current Liabilities

where Current Assets include Cash, Marketable Securities, Inventory, Accts Receivable, and
Other Current Assets and Current Liabilities are liabilities due within the next year.

Quick Ratio =

Cash and Marketable Securities

Current Liabilities

For firms with negative earnings, the potential for cash flow problems
can also be identified using the Cash Burn Rate:
Cash Burn Rate =

Cash
EBITDA

where EBITDA<0

Leverage and Solvency

To what extent is the firm using debt vs. equity financing and is the
firm able to meet its debt obligations?
Debt to Capital =

Debt
1
= 1
Debt
Debt + Equity
1 + Equity

Debt to Equity =

Debt
Debt to Capital
=
Equity 1 Debt to Capital

Times Interest Earned =

EBIT
Interest Expense

Liquidity and Leverage for Home Depot

Calculate each of the liquidity and leverage measures using Home

Depots Financial Statements (use beginning period or average
balance sheet values when comparing income statement and balance
sheet numbers).

Liquidity:
Current Ratio =

18000
= 1.392
12931

Quick Ratio =

600 + 14
= 0.047
12931

Leverage:
Debt to Capital =

11661
= 31.78%
11661 + 25030

Times Interest Earned =

Debt to Equity =

11661
= 46.59%
25030

9673
= 24.676
392

Efficiency

How effective is the firm in using its assets to generate sales and in
turning sales into cash?
Inventory Turnover =

Cost of Goods Sold

Inventory

Days in Inventory =

Accts Rec Turnover =

Sales
Accts Rec

Avg Collection Period =

Total Asset Turnover =

Sales
Total Assets

Total Capital Turnover =

Sales
Total Capital

Inventory
365
=
Avg Daily COGS Inv TO

Accts Rec
365
=
Avg Daily Sales Accts Rec TO

LT Operating Asset Turnover =

Working Capital Turnover =

Sales
LT Operating Assets

Sales
Noncash Working Capital

Efficiency for Home Depot

Calculate each of the efficiency measures using Home Depots

Financial Statements (use beginning period or average balance sheet
values when comparing income statement and balance sheet numbers).
Inventory Turnover =

61054
= 5.355
11401

Days in Inventory =

Accts Rec Turnover =

90837
= 37.912
2396

Avg Collection Period =

365
= 68.159
5.355

365
= 9.628
37.912

Total Asset Turnover =

90837
= 2.042
44482

LT Operating Asset Turnover =

Total Capital Turnover =

90837
= 3.018
3185 + 26909

Working Capital Turnover =

90837
= 3.648
24901

90837
= 29.733
14539 - 11488

Profitability

Profitability relative to sales:

Gross Profit Margin =

OperatingMargin =

Sales - COGS
Sales

Net Profit Margin =

Net Income
Sales

OperatingProfit EBIT(1 T)
=
Sales
Sales

Profitability relative to assets:

Return on Assets (ROA) =

Net Income
Total Assets

Return on Equity (ROE) =

Net Income
Book Value of Equity

Return on Capital (ROC) =

Net Operating Profit

EBIT(1 T)
=
Operating Capital
Debt + Equity

or

EBIT(1 - T)
Total Assets

Profitability (continued)

Return on Capital can be decomposed as follows:

Return on Capital (ROC) =

EBIT(1 T)
Sales
EBIT(1 - T)

Book Value of Capital Sales Book Value of Capital

= After-tax Operating Margin Capital Turnover Ratio

Return on Equity can be decomposed as follows:

Return on Equity (ROE) =

Net Income
Net Income
Sales
Total Assets
=

Book Value of Equity

Sales
Total Assets
Equity

= Profit Margin Asset Turnover Financial Leverage

Return on Equity (ROE) =

Net Income
Debt
= ROC +
(ROC i(1 T) )
Book Value of Equity
Equity

= ROC + (Leverage Spread )

Profitability for Home Depot

Calculate Return on Capital and its components using Home Depots

financial statements.
Return on Capital (ROC) =

9673(1 .3811) 9673(1 - .3811)

90837

3185 + 26909
90837
3185 + 26909

= 19.89% = 6.59% 3.018

Calculate Return on Equity and its components using Home Depots

financial statements.
Return on Equity (ROE) =

5761 5761 90837 44482

=

26909 90837 44482 26909

= 21.41% = 6.34% 2.042 1.653

Return on Equity (ROE) =

3185
5761
(19.89% 11.46%(1 .3811) )
= 19.89% +
26909
26909

= 21.41% = 19.89% + 11.84%(19.89% 7.09%)