Liquidity ratios – measure of a company’s ability to meet short-term debt obligations.

Liquidity ratios can change drastically, on a quarterly basis, in the oil and gas industry due to the capital-
intensive nature of operations. Firm-specific liquidity risks include the management of credit accounts
such as accounts receivables and accounts payables.

Current ratio: 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠⁄𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

The current ratio measures the firm's ability to payoff its current liabilities with their current assets.
A current ratio greater than one (1) indicates a company has more current assets than current
liabilities. A higher ratio is indicative of higher liquidity.

Quick ratio: (𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦)⁄𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

The quick ratio (acid-test ratio) measures the firm's ability payback its short-term debt without
relying on the sale of inventory - which can be illiquid. A higher ratio implies greater liquidity.

Cash ratio: (𝐶𝑎𝑠ℎ + 𝐶𝑎𝑠ℎ 𝐸𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡𝑠)⁄𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

The cash ratio measures the firm's ability to payback its short-term debt solely using cash and
cash equivalents. A higher ratio implies greater liquidity.

Leverage ratios – measure of a company’s ability to meet long-term debt obligations.

Leverage ratios are indicators of a company’s financial and operating leverage. The debt structure of
companies in the oil and gas industry are relatively stable, on a quarterly basis, because projects and
operations tend to be funded with long-term debt contracts.

Debt ratio: 𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡 ⁄𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

The debt-to-asset ratio measures the percentage of total assets financing by debt. A greater ratio
means the company finances its assets with more debt.

Debt-to-equity ratio: 𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡⁄𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦

The debt-to-equity ratio measures how much debt is used to finance the firm's total assets in
relation to equity. A higher ratio implies the firm is becoming more aggressive with debt financing.

Interest coverage ratio: 𝐸𝐵𝐼𝑇 ⁄𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑃𝑎𝑦𝑚𝑒𝑛𝑡

The interest coverage ratio measures the firm's ability to payoff its interest expense on
outstanding debts. A greater ratio means the firm is better able to payoff its interest expense.

Cash coverage ratio: (𝐸𝐵𝐼𝑇 + 𝐿𝑒𝑎𝑠𝑒 𝑃𝑎𝑦𝑚𝑒𝑛𝑡)⁄(𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 + 𝐿𝑒𝑎𝑠𝑒 𝑃𝑎𝑦𝑚𝑒𝑛𝑡)

The cash coverage ratio measures the firm's ability to payback its' short-term liabilities with cash
only.

Efficiency ratios – measure of a company’s operating efficiency.

Efficiency ratios reflect the management of working capital and noncurrent assets. Oil and gas companies
make strategic investments in long-term projects which naturally exposes shareholders to uncertainties of
future returns.

Total asset turnover: 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 ⁄𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

The total asset turnover measures the firm's ability to generate revenue from its assets. A greater
ratio implies that the total assets are generating greater revenue.

Fixed asset turnover: 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 ⁄𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠

The fixed asset turnover measures the firm's ability to generate revenue using only its fixed
assets (Plant, Property & Equipment and Land). A greater ratio implies that the firm's fixed assets
are generating greater revenue.
 Inventory turnover: 𝐶𝑂𝐺𝑆⁄𝐴𝑣𝑒𝑟𝑒𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
The inventory turnover indicates how many times the firm has sold and replaced its inventory. A
greater ratio implies that the firm sells its inventory quicker.

Days Inventory Held: 𝐷𝑎𝑦𝑠 ⁄𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟

The days inventory held measures the average time, in days, that the firm holds the inventory
before it is sold. A greater ratio implies that the firm is less efficient at managing its supply chain.

Days Sales Outstanding: 𝐷𝑎𝑦𝑠 ⁄𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟

The days sales outstanding measures the average time, in days, it takes the firm to collect
payment on its sales. The lower it takes to collect payments; the more efficient the firm's account
managers are.

Days Payable Outstanding: 𝐷𝑎𝑦𝑠 ⁄𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟

The days payable outstanding measures the average time, in days, it takes for the firm to
payback its suppliers. A greater ratio is better because it gives the firm more time to payback its
debts.

Cash conversion cycle: 𝐷𝐼𝐻 + 𝐷𝑆𝑂 + 𝐷𝑃𝑂

The cash conversion cycle measures the average time, in days, it takes the firm to convert its
resource inputs into cash inflows. The shorter the cash conversion cycle, the more efficient the
firm is at collecting cash from its operational efforts

Operating cycle: 𝐷𝐼𝐻 + 𝐷𝑆𝑂 − 𝐷𝑃𝑂

The operating cycle is the sum of the days inventory held and days sales outstanding.

Profitability ratios – measure a company’s ability to generate profit on capital invested.

Profitability ratios indicate how well a firm can absorb revenues and reduce expenses to make positive
returns for the firm. The oil and gas industry is susceptive to volatile price swings which makes revenues
and ultimately returns uncertain.

Gross profit margin: 𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 ⁄𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

The gross profit margin measures the percentage of operating revenue after accounting for cost
of goods sold. A greater ratio means the company is retaining more revenue from its net sales.

Operating profit margin: 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡 ⁄𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

The operating profit margin (earnings before interest) measures the percentage of profit after
accounting for cost of goods sold and operating expenses. A greater ratio implies greater
earnings before interest.

Net profit margin: 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 ⁄𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

The net profit margin measures the percentage of profit after deducting cost of goods sold,
operating expenses, interest expenses, and taxes. A higher ratio implies greater residual income
for ordinary shareholders.

Return on assets: 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 ⁄𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

The return on assets ratio measures the percentage of net income in relation total assets. A
greater ratio is better because it means the firm's earnings are increasing in relation to their
assets.

Return on equity: 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 ⁄𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦

The return on equity ratio measures the percentage of net income in relation to shareholders'
equity. A greater ratio implies the firm is more efficient at using its capital.
DuPont Analysis – decomposition of ROE

NI/EBT: This represents the tax burden on the ROE.

EBT/EBIT: This represents the interest burden on the ROE.

EBIT/Sales: This represents the operating profit margin component of the ROE.

Asset turnover: This represents the efficiency component on the ROE.

Equity multiplier: This represents the solvency component on the ROE