Chapter 1

ROA = Net Income/Average total Asset

The Return on Assets ratio is an important profitability ratio because it measures the efficiency
with which the company is managing its investment in assets and using them to generate profit.
It measures the amount of profit earned relative to the firm's level of investment in total assets.
ROE = Net Income/Average Stockholder Equity
ROE is the amount of profit generated from each dollar of shareholders’ equity. A return value of 1
indicates that each dollar of shareholders’ equity generates a profit of one dollar.
ability to turn the invested money into profits. The higher the ROE, the better a company is at
generating profit with the equity it has. It also shows how effective the management is utilizing equity
financing to grow the business.

Chapter 2

Net working capital = Current asset – Current liabilities

EXP: Net working capital is the aggregate amount of all current assets and current liabilities. It
is used to measure the short-term liquidity of a business, and can also be used to obtain a
general impression of the ability of company management to utilize assets in an efficient
manner. To calculate net working capital, use the following formula:

+ Cash and cash equivalents

+ Marketable investments
+ Trade accounts receivable
+ Inventory
- Trade accounts payable

= Net working capital

If the net working capital figure is substantially positive, it indicates that the short-term funds
available from current assets are more than adequate to pay for current liabilities as they
come due for payment. If the figure is substantially negative, then the business may not have
sufficient funds available to pay for its current liabilities, and may be in danger of bankruptcy.

Chapter 4

Financial Leverage = Average total asset/ Average Stockholder Equity

This ratio measures the effectiveness of management in using debt to increase the amount of
assets the company employs to earn income for stockholders.

The higher the number, the more assets are financed through debt; the lower the number, the
more assets are financed through equity.
ROE = ROA* Financial Leverage
ROA = Profit Margin*Asset Turnover

Profit Margin = Net income/ Sales

Gross profit margin is generally important because it is the starting point toward achieving healthy
bottom line net profit. When you have a high gross profit margin, you are a in better position to have
a strong operating profit margin and strong net income. For a newer business, the higher your gross
profit margin, the faster you reach the break-even point and begin earning profits from basic
business activities.

Asset Turnover = Sales/Average Total asset

Your company's asset turnover ratio helps you understand how productive your small business has
been. In short, it reveals how much revenue the company is generating from each dollar's worth of
assets

There are two methods of measuring shareholders’ equity. One is the Return on Equity (ROE)
which is the measure of shareholders’ equity on a company’s common stocks. It shows how a
company skillfully manages its funds to produce maximum interest and growth.
To come up with a company’s ROE, all assets including long term (equipment and capital)
and current ones (receivables and cash) are added. Its long term (debts that do not have to be
paid within the year) and current (accounts payable and employees’ salaries) liabilities are
also added. The total liabilities are then subtracted from the total assets.
Return on Net Operating Assets (RNOA), on the other hand, is the measure of a company’s
capability to create profit from each piece of equity. It calculates the amount that a company
earns for each dollar that it invests. A company’s net income before tax (profit before tax) is
divided by its total assets to come up with its RNOA. It is also known as a profitability or
productivity ratio that gives owners an idea of how well their company is doing based on their
goals, competitors, and the industry as a whole.

Net operating assets are those assets of a business directly related to its operations, minus
all liabilities directly related to its operations. Stated differently, net operating assets are:
 + The total assets of a company
- All liabilities
- All financial assets
+ All financial liabilities
= Net operating assets

This second definition shows that all finance-related items are to be extracted from assets
and liabilities. A financial asset is one that generates interest income, while a financial
liability generates interest expense. Financial assets include cash and marketable
securities, while financial liabilities usually refer to debt and leases. Conversely, operating
assets include accounts receivable, inventory, and fixed assets; operating liabilities include
accounts payable and accrued liabilities.

Where,
NOPAT is an acronym that stands for Net Operating Profit After Tax. The measurement is a
good way to understand the underlying profitability of a business by stripping away the
effects of financing, since its primary focus is on earnings generated by operations.
For example, a business has revenues of $1,000,000, cost of goods sold of
$650,000, administrative expenses of $250,000, and interest expense (on a heavy debt
load) of $100,000. Its tax rate is 35%. The company's income statement reveals net income
of $0, which seems to imply that the organization is not capable of generating a profit.
However, when the interest expense is stripped away and the tax rate is applied to the
remaining profit, it is apparent that the company has an after-tax operating profit of
$65,000.

The current ratio is mainly used to give an idea of a company's ability to pay back
its liabilities (debt and accounts payable) with its assets (cash, marketable
securities, inventory, accounts receivable). As such, current ratio can be used to
make a rough estimate of a company’s financial health. The current ratio can
give a sense of the efficiency of a company's operating cycle or its ability to turn
its product into cash. Companies that have trouble getting paid on their
receivables or that have high inventory turnover can run into liquidity problems if
they are unable to alleviate their obligations.

Quick assets are current assets that can be converted to cash within 90 days or
in the short-term. The quick ratio is a liquidity ratio that measures a company's
ability, using its quick assets, to pay off its current debt as they come due. The
ratio derives its name presumably from the fact that assets such as cash
and marketable securities are quick sources of cash. Therefore, only assets that
can be liquidated quickly are factored into the equation. Inventory, even though it
is a current asset, is not considered a quick asset since it cannot be converted to
cash within a very short time frame. Furthermore, if inventories have to be sold
quickly, the company may have to accept a lower price than the book value. This
is the difference between the quick ratio and the current ratio, which includes all
current assets in its calculation including inventory.
Debt/Equity (D/E) Ratio, calculated by dividing a company's total liabilities by its
stockholders' equity, is a debt ratio used to measure a company's financial leverage. The
D/E ratio indicates how much debt a company is using to finance its assets relative to the value
of shareholders' equity.

is another debt ratio that measures the long-term solvency of a business. It measures the
proportionate amount of income that can be used to meet interest and debt service expenses—
For example, if a company owes interest on its long-term loans or mortgages, the TIE can
measure how easily the company can come up with the money to pay the interest on that debt.

Chapter 5

Accounts receivable turnover is the number of times per year that a business collects its
average accounts receivable. The ratio is intended to evaluate the ability of a company to
efficiently issue credit to its customers and collect funds from them in a timely manner. A
high turnover ratio indicates a combination of a conservative credit policy and an
aggressive collections department, as well as a number of high-quality customers. A low
turnover ratio represents an opportunity to collect excessively old accounts receivable
that are unnecessarily tying up working capital. Low receivable turnover may be caused by
a loose or nonexistent credit policy, an inadequate collections function, and/or a large
proportion of customers having financial difficulties. It is also quite likely that a low
turnover level indicates an excessive amount of bad debt.

Due to the high importance of cash in running a business, it is in a company's

best interest to collect on its outstanding account receivables as quickly as
possible. While companies can most often expect with relative certainty that they
will in fact receive outstanding receivables, because of the time value of
money principle, money that a company spends time waiting to receive is money
lost. By quickly turning sales into cash, a company has a chance to put the cash
to use again more quickly.

A high DSO number shows that a company is selling its product to customers on
credit and taking longer to collect money. This may lead to cash flow problems
because of the long duration between the time of a sale and the time the
company receives payment. A low DSO value means that it takes a company
fewer days to collect its accounts receivable. In effect, the ability to determine the
average length of time that a company’s outstanding balances are carried in
receivables can in some cases tell a great deal about the nature of the
company’s cash flow.
Inventory turnover = Average Inventory/ COGS

inventory turnover measures how fast a company is selling inventory and is

generally compared against industry averages. A low turnover implies weak
sales and, therefore, excess inventory. A high ratio implies either strong sales
and/or large discounts.

The speed with which a company can sell inventory is a critical measure of
business performance. It is also one component of the calculation for return on
assets (ROA); the other component is profitability. The return a company makes
on its assets is a function of how fast it sells inventory at a profit. As such, high
turnover means nothing unless the company is making a profit on each sale.

Days payable outstanding (DPO) evaluates how long it takes a company to pay its bills to its
creditors, suppliers and vendors by relating the accounts payable to the number of days bills
remain unpaid and the cost of goods sold (COGS). The ratio depicts how well a company is
managing its cash flows given the number of days during an accounting period that it pays off its
account payables.
Companies must strike a delicate balance with DPO. The longer they take to pay their creditors,
the more money the company has on hand, which is good for working capital and free cash
flow. In this case, a high DPO is advantageous. A high days payable outstanding also comes
with its disadvantages. If the company takes too long to pay its creditors, the creditors will be
unhappy, and may refuse to extend credit in the future, or they may offer less favorable terms.
Also, because some creditors give companies a discount for timely payments, the company
may be paying more than it needs to for its supplies.

The fixed-asset turnover ratio is commonly used as a metric in manufacturing

industries that make substantial purchases for PP&E in order to drive up output.
When a company makes such significant purchases, wise investors closely
monitor this ratio in subsequent years, to observe the effectiveness of such an
investment in fixed assets.
While a higher ratio is indicative of greater efficiency in managing fixed-asset
investments, there is not an exact number or range that dictates whether a
company has been efficient at generating revenue from such investments. For
this reason, it is important for analysts and investors to compare a company’s
most recent ratio to both the historic ratios of the company and to ratio values
from peer companies and/or industry averages.