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3)
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Profitability Ratio
Profitability ratios allow us to measure the ability of the firm to earn an
adequate return on sales, assets and invested capital.
Under this type, ratios are used to measure the speed at which the firm is
turning over accounts receivable, inventory and long term assets to generate
sales and revenue.
a)
The higher ROA & ROE, the better, or more effectively, the company is using its
assets and capital.
Inventory Turnover
It Indicates how quickly inventory is sold during the year.
d)
Assets Turnover
The Asset Turnover Ratio measures the amount of sales revenue the
company is generating from the use of all of its assets. It provides a
means to measure the overall efficiency of the companys use of all
of its investments, as represented by both short-term assets and
long-term assets.
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a)
Current Ratio
A measure of short term debt paying ability. The norm is 2:1. A
lower ratio indicates a possible liquidity problem.
b)
Working Capital
Indicates the cash generated by operations after allowing for cash
payment of expenses and operating liabilities.
a)
Debt Ratio
Percentage of assets financed by creditors, and also indicates relative size of the equity position.
b)
The Debt to Equity ratio can serve as a screening device for the analyst when looking at capital
structure ratios. If this ratio is extremely low (for instance, 0.1:1), then there is no need to
calculate other capital structure ratios because there is no real concern with this part of the
companys financial situation. The analysts time could be better spent looking at other aspects
of the companys operations.
However, if the Debt to Equity ratio is in the neighbourhood of 2:1 or higher, it would be
important to do some extended analysis that focuses on other ratios such as profitability, as well
as the companys future prospects.
The Interest Coverage ratio compares the funds available to pay interest. This ratio
gives an indication of how much the company has available for the payment of its
fixed interest expense.
A high ratio is desirable. An interest coverage ratio of greater than 3.0 is excellent.
When the interest coverage ratio gets down to 1.5, a company has a heightened risk
of default, which becomes higher the further the ratio declines below 1.5.
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EPS is essentially the measure of the amount of income that each share of common stock would have
earned if the profit of the company had been paid (distributed) to all of the common shares
outstanding.
The dividend payout ratio measures the proportion of earnings paid out as dividends to common
stockholders.
b)
Generally, a new company or a company that is growing will have a low or no dividend payout,
because it is retaining earnings in the company to finance its growth.
The P/E ratio gives an indication of what shareholders are paying for continuing Earnings Per Share.
Investors view it as an indication of what the market considers to be the firms future earning power.
The P/E ratio is greatly influenced by where a company is in its cycle. A company in a growth stage
will usually have a high P/E ratio because of the markets expectations of future profits (which
makes the market price higher) despite the fact that at the current time, profits may be low.
Companies with low growth generally have lower P/E ratios.
This ratio is meaningless when a company is experiencing losses (the P/E would be negative
because earnings are negative)
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