Profitability ratios: What is it?

Profitability ratios measure a companys ability to generate earnings relative to sales, assets and equity. These ratios assess the ability of a company to generate earnings, profits and cash flows relative to relative to some metric, often the amount of money invested. They highlight how effectively the profitability of a company is being managed. Common examples of profitability ratios include return on sales, return on investment, return on equity, return on capital employed (ROCE), cash return on capital invested (CROCI), gross profit margin and net profit margin. All of these ratios indicate how well a company is performing at generating profits or revenues relative to a certain metric. Different profitability ratios provide different useful insights into the financial health and performance of a company. For example, gross profit and net profit ratios tell how well the company is managing its expenses. Return on capital employed (ROCE) tells how well the company is using capital employed to generate returns. Return on investment tells whether the company is generating enough profits for its shareholders. For most of these ratios, a higher value is desirable. A higher value means that the company is doing well and it is good at generating profits, revenues and cash flows. Profitability ratios are of little value in isolation. They give meaningful information only when they are analyzed in comparison to competitors or compared to the ratios in previous periods. Therefore, trend analysis and industry analysis is required to draw meaningful conclusions about the profitability of a company. Some background knowledge of the nature of business of a company is necessary when analyzing profitability ratios. For example sales of some businesses are seasonal and they experience seasonality in their operations. The retail industry is example of such businesses. The revenues of retail industry are usually very high in the fourth quarter due to Christmas. Therefore, it will not be useful to compare the profitability ratios of this quarter with the profitability ratios of earlier quarters. For meaningful conclusions, the profitability ratios of this quarter should be compared to the profitability ratios of similar quarters in the previous years

Cash Return on Capital Invested (CROCI)

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Definition

Cash return on capital invested (CROCI) is metric that compares the cash generated by a company to its equity. It is also sometimes known as cash return on cash invested. It compares the cash earned with the money invested. This is a cash flow based measure as opposed to earnings based metric. Cash flow based metrics are more important for the investors because it is ultimately the cash that matters to the investors. Besides, cash flow based measures are superior to earnings based measures because the earnings can be manipulated with the help of accounting policies. A positive point about the cash return on capital employed is that it removes the effect of non-cash expenses such as depreciation and amortization. These non-cash items are of less significance to the investors because they are ultimately interested in the cash flows. This metric was developed by the Deutsche Bank Group and it is based on an economic profit model. Although there are no standards but the higher this measure is the better it is. A company with a higher cash return on capital invested is a good investment opportunity. Calculation (formula) Cash return on capital invested is calculated by dividing the earnings before interest, taxes, depreciation and amortization by the total capital invested. Cash Return on Capital Invested = EBITDA / Capital Invested The capital invested is defined as the equity capital and preferred shares. Long term loans are also included in the capital employed. Sometimes it is also referred to as capital employed. It can be calculated from the balance sheet by adding equity and long-term loans. Another method of calculating capital invested is by subtracting the current liabilities from the total assets. Norms and Limits

Financial Analysis Report

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What is a Financial Analysis Report?

Comprehensive financial analysis reports accentuate the strengths and weaknesses of a company. Communicating the companys strengths and weaknesses in an accurate and honest manner is helpful in convincing the investors to invest in your business. A financial analysis report is, basically, a document that attracts high interest of investors as it contains a detailed appraisal of a companys financial health. How to write a Financial Analysis Report 1. Start the report with an Executive Summary of important findings from the financial analysis. Also state the time period focused by the study in addition to identifying the firm requesting the report. 2. Set up an introduction emphasizing the objectives of the report. Also define financial terms necessary for understanding those objectives. 3. Move on to a section with Resources title. Give a general description of the analyzed data and where has it been sourced from. Some examples of resource include balance sheets, income statements, operating costs, inventory ratios, and warehouse statistics. 4. Further describe the resources under the heading Method of Collecting Data. Mention whether the data was received from different sources, like government agencies or departments within the firm. Also explain each sources method for reporting data. Explain about the method of accounting analysis for these distinct reporting methods. 5. Title the next section as Significant Financial Events and under this section, enlist the events which occurred during the studied time period and which altered results. 6. Proceed with a section titled Detailed Results which includes a comprehensive analysis about the investment returns, balance sheets, income statement, and productivity ratios. Also comment on each of these factors in addition to providing support for your statements with graphs and tables. 7. Evaluate results from various quarters in a section titled Analysis of Variance. 8. Prepare an appendix for Financial Revenues defining how that term was used for preparing the report. Tabulate the revenues over the analysis time period. 9. End the report with an appendix for Observations discussing any problems faced while performing analysis and thereafter explaining about how research method handled problems. Conclude the report with a statement projecting future performance on the basis of past years

Liquidity ratios: What is it?

Liquidity ratios are the ratios that measure the ability of a company to meet its short term debt obligations. These ratios measure the ability of a company to pay off its short-term liabilities when they fall due. The liquidity ratios are a result of dividing cash and other liquid assets by the short term borrowings and current liabilities. They show the number of times the short term debt obligations are covered by the cash and liquid assets. If the value is greater than 1, it means the short term obligations are fully covered. Generally, the higher the liquidity ratios are, the higher the margin of safety that the company posses to meet its current liabilities. Liquidity ratios greater than 1 indicate that the company is in good financial health and it is less likely fall into financial difficulties. Most common examples of liquidity ratios include current ratio, acid test ratio (also known as quick ratio), cash ratio and working capital ratio. Different assets are considered to be relevant by different analysts. Some analysts consider only the cash and cash equivalents as relevant assets because they are most likely to be used to meet short term liabilities in an emergency. Some analysts consider the debtors and trade receivables as relevant assets in addition to cash and cash equivalents. The value of inventory is also considered relevant asset for calculations of liquidity ratios by some analysts. The concept of cash cycle is also important for better understanding of liquidity ratios. The cash continuously cycles through the operations of a company. A companys cash is usually tied up in the finished goods, the raw materials, and trade debtors. It is not until the inventory is sold, sales invoices raised, and the debtors make payments that the company receives cash. The cash tied up in the cash cycle is known as working capital, and liquidity ratios try to measure the balance between current assets and current liabilities. A company must posses the ability to release cash from cash cycle to meet its financial obligations when the creditors seek payment. In other words, a company should posses the ability to translate its short term assets into cash. The liquidity ratios attempt to measure this ability of a company.