Activity Ratio

ACTIVITY RATIO : To measure efficiency of a company perform its daily main operations.

Examples of Activity Ratio

  1) INVENTORY TURNOVER

INVENTORY TURNOVER = COST OF GOODS SOLD / AVERAGE INVENTORY 

To measure how fast inventory being cleared compared to cost of goods sold.

   

  2) DAYS OF INVENTORY ON HAND

DAYS OF INVENTORY ON HAND = 365 / INVENTORY TURNOVER 

To measure how many days need to clear inventory.

  3)  RECEIVABLES TURNOVER

RECEIVABLES TURNOVER = REVENUE / AVERAGE RECEIVABLES 

To measure how fast to receive money from customers compared to revenue.

  4)  DAYS OF SALES OUTSTANDING

DAYS OF SALES OUTSTANDING = 365 / RECEIVABLES TURNOVER 

To measure how many days need to receive cash from customers.

  5) PAYABLE TURNOVER

PAYABLE TURNOVER = PURCHASES / AVERAGE TRADE PAYABLE 

To measure how fast company pays money to suppliers.

  6) NUMBER OF DAYS OF PAYABLE 

NUMBER OF DAYS OF PAYABLE = 365 / PAYABLE TURNOVER 

To measure how many days company pays money to supplier.

  7)  WORKING CAPITAL TURNOVER

WORKING CAPITAL TURNOVER = REVENUE / AVERAGE WORKING CAPITAL 

To measure how efficient company use working capital to generate revenue.

  8)  TOTAL ASSETS TURNOVER

TOTAL ASSETS TURNOVER = REVENUE / AVERAGE TOTAL ASSETS 

To measure how efficient company use total assets to generate revenue.

Further Info: 

"LIQUIDITY RATIO"

"SOLVENCY RATIO"

"PROFITABILITY RATIO"

"VALUATION RATIO" 

Liquidity Ratio

LIQUIDITY RATIO : To evaluate whether a company will be able to pay its short term debts and interests.

Examples of Liquidity Ratio: 
  1)  CURRENT RATIO

CURRENT RATIO = CURRENT ASSET / CURRENT LIABILITY
To determine there are enough current asset to pay off current liability.

  2) QUICK RATIO

QUICK RATIO = (CASH + SHORT TERM MARKETABLE SECURITY + RECEIVABLES) / CURRENT LIABILITY
More conservative compared to CURRENT RATIO because inventory and prepaid expense which hard to liquidate are neglected.

  3)  CASH RATIO

CASH RATIO = (CASH + SHORT TERM MARKETABLE SECURITY ) / CURRENT LIABILITY
The most conservative method since only CASH and SHORT TERM MARKETABLE SECURITY that can fully liquidate to its fair value in short time.

  4) DEFENSIVE INTERVAL RATIO

DEFENSIVE INTERVAL RATIO = (CASH + SHORT TERM MARKETABLE SECURITY ) / DAILY EXPENDITURE
To evaluate new or highly dangerous company how many days the company can survive only based on its cash.

  5)  CASH CONVERSION CYCLE

CASH CONVERSION CYCLE = DAYS OF INVENTORY ON HAND + DAYS OF SALES OUTSTANDING - NUMBER OF DAYS OF PAYABLE
To calculate number of days between cash paid to suppliers and cash received from customers.

Other Info: 

"ACTIVITY RATIO"

"SOLVENCY RATIO"

"PROFITABILITY RATIO"

"VALUATION RATIO" 

  
 

Solvency Ratio

SOLVENCY RATIO : To evaluate whether a company can pay its long term debts.

Examples of Solvency Ratio: 
  1)  DEBT-TO-ASSET-RATIO

DEBT-TO-ASSET-RATIO = TOTAL DEBT / TOTAL ASSET
To measure the percentages of asset financed by debt.

  2)  DEBT-TO-EQUITY-RATIO

DEBT-TO-EQUITY-RATIO = TOTAL DEBT / TOTAL SHAREHOLDERS' EQUITY
To measure proportions of capital that are financed by debt and equity.

  3) FINANCIAL LEVERAGE RATIO

FINANCIAL LEVERAGE RATIO = TOTAL ASSET / TOTAL EQUITY  
To measure the amount of assets that can be created by one unit of equity. Higher financial leverage ratio means company uses more financial leverage such as debt and borrowing to finance its assets.

  4) INTEREST COVERAGE

INTEREST COVERAGE = EARNING BEFORE INTEREST & TAX / INTEREST PAYMENT
To determine whether the profit earned by company enough or not to pay off interest from borrowing.

Other Info:  

"ACTIVITY RATIO"

"LIQUIDITY RATIO"

"PROFITABILITY RATIO"

"VALUATION RATIO" 

Profitability Ratio

PROFITABILITY RATIO : To measure how much profit that a company can generate from its resources.

Examples of Profitability Ratio : 
  1)  NET PROFIT MARGIN

NET PROFIT MARGIN = NET PROFIT / REVENUE
To evaluate from 1 unit revenue, company can earn how much profit. Higher profit margin than peer companies shows that company very efficient in manage cost and maintain the lowest waste.

  2) PRETAX MARGIN

PRETAX MARGIN = EARNING BEFORE TAX / REVENUE
Since tax rebate will affect the true net profit , pretax margin employs earning before tax instead of net profit.

  3)  OPERATING PROFIT MARGIN

OPERATING PROFIT MARGIN = OPERATING PROFIT / REVENUE
To eradicate the effect of one-time profit earned through selling financial securities, operating profit is used.

  4)  GROSS PROFIT MARGIN

GROSS PROFIT MARGIN = GROSS PROFIT / REVENUE
To investigate minimum percentage of profit that can be earned because gross profit only involve the crucial expenses that need to produce revenue. 

  5)  RETURN ON ASSET

RETURN ON ASSET = NET PROFIT / TOTAL ASSET
To evaluate efficiency of a company using their assets to generate income.

  6)  RETURN ON EQUITY

RETURN ON EQUITY = NET PROFIT / TOTAL EQUITY
To evaluate the rate of return that provided to shareholders who invest capital into the company.

Other Info: 

"ACTIVITY RATIO"

"LIQUIDITY RATIO"

"SOLVENCY RATIO"

"VALUATION RATIO" 

Valuation Ratio

VALUATION RATIO : To measure stock price of a company whether undervalues/overvalues relative to its value.

Examples of Valuation Ratio:

  1)  P/E

P/E = PRICE PER SHARE / EARNING PER SHARE 

Link the stock price and earning of company together . Higher PE means the stock is expansive if compared to its earning.

  2)  P/CF

P/CF = PRICE PER SHARE / CASH FLOW PER SHARE 

Cash flow is used instead of earning because earning without cash received is not ascertained yet. 

  3)  P/S

P/S = PRICE PER SHARE / SALES PER SHARE 

Used by the company without positive income yet.

  4)  P/BV

P/BV = PRICE PER SHARE / BOOK VALUE PER SHARE 

Price is compared with the net asset of company. It is the most conservative calculation when the company is liquidated, how much cash can received from the company.

  5)  EPS

EPS = NET PROFIT / TOTAL COMMON SHARES 

To indicate how much earning can be imaginary earned by possess one share of company.

  6)  DIVIDEND PAYOUT RATIO

DIVIDEND PAYOUT RATIO = TOTAL DIVIDEND PAID / NET PROFIT 

To indicate the percentage of net profit that paid out as dividend to shareholders.

Other Info: 

"ACTIVITY RATIO"

"LIQUIDITY RATIO"

"SOLVENCY RATIO"

"PROFITABILITY RATIO"

A Story About Financial Reports

                             http://storiestastegood.com/2013/05/23/stories-stories-everywhere-and-not-a-drop-to-drink/

Firstly,  imagine you as a company.

You now have a house and a car.

These are your ASSET.

The car's value will decrease every year,

this is called DEPRECIATION.

However, you do not buy this house and car by cash.

You borrows the money from bank.

This borrowing is your LIABILITY.

Before you can work to earn money,

You need to survive,

So you need to find someone that can support your livings.

Your parents are your shareholders.

The money they support you is SHARE CAPITAL which  is recorded under EQUITY.

ASSET, LIABILITY & EQUITY are recorded in BALANCE SHEET.

Now you are working,

the income you earned is REVENUE.

Every day you need to spend some money for living so that you can continue working,

These are called EXPENSE.

Sometimes you go out to eat but you forget to bring money,

So you tell the tauke that you will pay next time,

this is called PAYABLE.

Sometimes you go out with your friends,

you help your friend to pay first because your friend does not bring enough money,

this is called RECEIVABLE,

If your friend do not pay you later,

this is called  BAD DEBT WRITTEN OFF.

If you already know your friend will not pay you,

This is called PROVISION FOR BAD DEBT.

Your income after deduction for all the expenses is called PROFIT.

All of the things above which happen every year are recorded in INCOME STATEMENT.

Finally you have some money left after daily expenses,

You think you want to repay your parents.

So you give some allowances to your parents,

This is called DIVIDEND.

After working for many years,

You have accumulated some money,

this is called RETAINED EARNINGS.

 You want to buy a house for your parents ,

This is called BONUS ISSUE.

All of these above are recorded in CHANGE OF EQUITY STATEMENT.

However, although you earn a lot,

But you find that your money disappear  without reason,

So you decide to find out what is happening.

 You record every money that you get and expense.

This is called CASH FLOW STATEMENT.

  

Reading until here, you find that a company is just like a person. It is easier to learn FINANCIAL REPORTS by good imagination. So have a enjoyable learning journey.

Further Info:  

"An Introduction to Financial Reports"

Revenue Recognition

Revenue is one of the key data when we analyze one company. Big company with higher revenue usually produce higher profit than small company (not necessary). A company can only increase its profit  by two means, which are increase revenue or  increase profit margin. It is similar if a person want to increase its saving, either by increase his income or decrease his expense.
 

Since revenue is such an important data in financial statement, then the way company quantifies its revenue is also very important. Many scandals of company arise from boosting the revenue.

There is a few criteria for revenue recognition according to IFRS:
For company that selling products

1. Risk and Rewards of the product have been transferred to customers. In simple word, if the product break down now, company does not have the responsibility to compensate the customers.(warranty is another issue)
2. Company does not have continuing managerial involvement or control on the product. In simple word,  customer has totally freedom and power on how to use the product.
3. The amount of revenue can be quantify reliably. Since the revenue is recorded as number in financial statement, the value of revenue should be measurable.
4. The money from selling the product can probably received by company from customers.(not necessary immediately)
5. The cost incurred can be measured reliably.

For company that providing services

1. The amount of revenue can be quantify reliably. Since the revenue is recorded as number in financial statement, the value of revenue should be measurable.
2. The stage of completion can be measured reliably.
3. The money from selling the product can probably received by company from customers.(not necessary immediately)
4. The cost incurred can be measured reliably.

Below are several special cases
Special Case One:  Long Term Contract
Long Term Contract is contract which is more than one year . There are basically 2 methods to recognise revenue for long term contract.
a) Percentage of Completion Method
Revenue will be recognised on how much percentage of the project that have been completed in current year. For example, the total revenue for whole project is RM10m. This year complete 20% which means revenue for this year is RM2m
b)  Completed Contract Method
Revenue will be recognised only when the whole contract is completed. No revenue will be recognised in previous year for that contract.

Special Case Two: Installment Sales
Installment Sales means customer will not pay full money when buy the product. Instead, customer will pay the money separately each month after the buying with or without charging of interest. Under IFRS, revenue for selling the product according to the product price will be recognised at the date when selling the product whereas interest will be recognised  each month when installment is paid.
 

Special Case Three: Barter
Barter means exchange of goods. If company sell a product to a customer and at the same time receives goods and services with same value from the customer, no cash will be involved in system barter, should  this transaction be included as revenue?
Under IFRS, barter transaction can be measured based on fair value of similar non-barter transaction with other party. For example, company exchanges an apple with an orange with customer A, company sells an apple for RM1 for customer B, so the apple exchange with customer A  will be included in revenue with value of RM1.

Special Case Four: Agent Selling
If a company buys  a product from supplier and directly sell it to the customers , how should the revenue of the company be recognised?  There are two different methods to recognise the revenue.
a) Gross Reporting
Gross Reporting means company report the total of selling price of the product as revenue.
There is a few criteria for revenue to recognise based on gross reporting.

1. Company bear the inventory risk and credit risk. In simple word, if the product break down during the storing process or customer do not pay the money, company itself have to pay the bill.
2. Company can choose supplier.
3. Company can fix the product price.

If the above 3 criteria are not met, revenue will be recorded based on net reporting.
b) Net Reporting
Revenue is reported as the difference between product selling price and cost that incurred (profit).