© The McGraw-Hill Companies, Inc., 2001 Irwin/McGraw-Hill Commonly Used Ratios The 1999 and 1998 balance sheets for Home Depot are presented next. We will be referring to these financial statements throughout the ratio analyses. Home Depot
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Commonly Used Ratios
The 1999 and 1998 balance sheets for Home Depot are presented next.
We will be referring to these financial statements throughout the ratio
analyses.
The 1999 and 1998 balance sheets for Home Depot are presented next.
We will be referring to these financial statements throughout the ratio
analyses.
Home Depot
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Comparative StatementsHOME DEPOT
Comparative Balance Sheets (Condensed)Amounts in Millions
1999 1998Assets
Cash and Cash Equivalents 62$ 172$ Receivables, net 469 556 Merchandise inventories 4,293 3,602 Other Current Assets 109 130 Total Current Assets 4,933 4,460 Property and Equipment, at cost 9,422 7,487 Less Accumulated Depreciation 1,262 978 Net Property and Equipment 8,160 6,509 Other Assets 372 260 Total Assets 13,465$ 11,229$
Continued
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Comparative StatementsHOME DEPOT
Comparative Balance Sheets (Condensed)Amounts in Millions
1999 1998Liabilities
Current Liabilities 2,857$ 2,456$ Noncurrent Liabilities 1,868 1,675 Total Liabilities 4,725 4,131
Stockholders' Equity Common Stock, $.05 par 74 73 Paid-in Capital 2,854 2,626 Retained Earnings 5,876 4,430 Accumulated Other Comprehensive Income (61) (28) Total 8,743 7,101 Less: Treasury Stock 3 3 Total Stockholders' Equity 8,740 7,098
Total Liabilities & Stockholders' Equity 13,465$ 11,229$
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Tests of Profitability
Profitability is a primary measure of the overall success of a company.
Now, let’s look at the profitability ratiosfor Home Depot for 1999.
Profitability is a primary measure of the overall success of a company.
Now, let’s look at the profitability ratiosfor Home Depot for 1999.
Home Depot
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Return on Equity
Return on Equity$1,614
($8,740 + $7,098) ÷ 2= = 20.4%
Income Average Owners’ EquityReturn on Equity =
This measure indicates how muchincome was earned for every dollar
invested by the owners.
This measure indicates how muchincome was earned for every dollar
invested by the owners.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Return on Assets
Return on AssetsIncome + Interest Expense (net of tax)
Average Total Assets=
Return on Assets$1,614 + ($37 ×(1 - .34)) ($13,465 + $11,229) ÷ 2
= = 13.3%
This ratio is generally consideredthe best overall measure of a
company’s profitability.
This ratio is generally consideredthe best overall measure of a
company’s profitability.
Corporate tax rateis 34 percent.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Financial Leverage
Financial Leverage Return on Equity – Return on Assets=
7.1% = 20.4% – 13.3%
Financial leverage is the advantage or disadvantage that occurs as the result of earning a return on equity that is different
from the return on assets.
Financial leverage is the advantage or disadvantage that occurs as the result of earning a return on equity that is different
from the return on assets.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Earnings per Share (EPS)
IncomeAverage Number of Shares ofCommon Stock Outstanding
EPS =
EPS$1,614
(1,471 + 1,459) ÷ 2= = $1.10
Earnings per share is probably the single most widely watched
financial ratio.
Earnings per share is probably the single most widely watched
financial ratio.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Quality of Income
Qualityof Income
Cash Flow from Operating Activities Net Income
=
Cash Flow from Operating Activities
Net Income 1,614$ Add: Depreciation 373
Deferred Income Tax Expense 7 Decrease in Receivables, net 85 Increase in Current Liabilities 536
Deduct: Increase in Merchandise Inventories (698) Cash Flow from Operating Activities 1,917$
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Quality of Income
Qualityof Income
Cash Flow from Operating Activities Net Income
=
Qualityof Income
$1,917 $1,614
= = 1.19
A ratio higher than 1 indicates higher-quality earnings.
A ratio higher than 1 indicates higher-quality earnings.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Profit Margin
= 5.3%ProfitMargin
$1,614$30,219
=
This ratio describes a company’s ability to earn
income from sales.
This ratio describes a company’s ability to earn
income from sales.
ProfitMargin
Income (before Extraordinary Items) Net Sales
=
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Fixed Asset Turnover Ratio
FixedAsset
Turnover
$30,219($8,160 + $6,509) ÷ 2
= = 4.12
FixedAsset
Turnover
Net Sales RevenueAverage Net Fixed Assets
=
This ratio measures a company’s ability to generate sales given an
investment in fixed assets.
This ratio measures a company’s ability to generate sales given an
investment in fixed assets.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Tests of Liquidity
Tests of liquidity focus on the relationship between current assets
and current liabilities. Now, let’s look at the liquidity ratios
for Home Depot for 1999.
Tests of liquidity focus on the relationship between current assets
and current liabilities. Now, let’s look at the liquidity ratios
for Home Depot for 1999.
Home Depot
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Cash Ratio
CashRatio
Cash + Cash EquivalentsCurrent Liabilities
=
= 0.022 : 1CashRatio
$62$2,857
=
This ratio measures theadequacy of available cash.
This ratio measures theadequacy of available cash.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Current Ratio
CurrentRatio
Current Assets Current Liabilities
=
CurrentRatio
$4,933 $2,857
= = 1.73 : 1
This ratio measures the abilityof the company to pay current
debts as they become due.
This ratio measures the abilityof the company to pay current
debts as they become due.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Quick Ratio (Acid Test)
Quick Assets Current Liabilities
=QuickRatio
$531 $2,857
= .19 : 1=QuickRatio
Quick assets are Cash, Accounts Receivable, and Notes Receivable, and Short-term Investments.
This ratio is like the currentratio but measures the company’s
immediate ability to pay debts.
This ratio is like the currentratio but measures the company’s
immediate ability to pay debts.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Receivable Turnover
Net Credit Sales Average Net Trade Receivables
Receivable Turnover
=
Receivable Turnover
$30,219($469 + $556) ÷ 2
= 59 times=
This ratio measures how quickly a company collects its
accounts receivable.
This ratio measures how quickly a company collects its
accounts receivable.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Average Age of Receivables
Days in Year Receivable Turnover
Average Age of Receivables =
= 6.2 days36559
Average Age of Receivables
=
This ratio measures the average number of days it takes to collect
receivables.
This ratio measures the average number of days it takes to collect
receivables.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Inventory Turnover
Cost of Goods SoldAverage Inventory
Inventory Turnover =
Inventory Turnover
$21,614($4,293 + $3,602) ÷ 2 = 5.5 times=
This ratio measures how quickly the company sells its inventory.
This ratio measures how quickly the company sells its inventory.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Average Days’ Supply in Inventory
Days in YearInventory Turnover
Average Days’ Supply in Inventory
=
= 66 days3655.5=
Average Days’ Supply in Inventory
This ratio measures the average number of days it takes to sell
the inventory.
This ratio measures the average number of days it takes to sell
the inventory.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Tests of Solvency and Equity Position
Tests of solvency measure a company’s ability to meet its obligations.
Now, let’s look at the solvency ratios for Home Depot for 1999.
Tests of solvency measure a company’s ability to meet its obligations.
Now, let’s look at the solvency ratios for Home Depot for 1999.
Home Depot
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
This ratio indicates a margin of protection for creditors.
This ratio indicates a margin of protection for creditors.
Times Interest Earned
Net Interest Income Tax Income Expense Expense
Interest Expense
Times Interest Earned
=+ +
$1,614 + $37 + $1,040$37
Times Interest Earned
= = 72.7
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Cash Coverage
Cash Flow from Operating Activities
Net Income 1,614$ Add: Depreciation 373
Deferred Income Tax Expense 7 Decrease in Receivables, net 85 Increase in Current Liabilities 536
Deduct Increase in Merchandise Inventories (698) Cash Flow from Operating Activities 1,917$
CashCoverage
Cash Flow from Operating ActivitiesBefore Interest and Taxes
Interest Paid=
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Cash Coverage
CashCoverage
= $1,917 + $37 + $1,040$37
= 80.9
CashCoverage
Cash Flow from Operating ActivitiesBefore Interest and Taxes
Interest Paid=
This ratio compares the cash generated with the cash obligations
of the period.
This ratio compares the cash generated with the cash obligations
of the period.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Debt/Equity Ratio
Total LiabilitiesOwners’ Equity
Debt/Equity Ratio
=
$4,725$8,740
= 0.54Debt/Equity Ratio
=
This ratio measures the amount of liabilities that exists for each $1
invested by the owners.
This ratio measures the amount of liabilities that exists for each $1
invested by the owners.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Market Tests
Market tests relate the current market price of a share of stock to an indicator of the return that might accrue to the investor.
Now, let’s look at the market tests forHome Depot for 1999.
Market tests relate the current market price of a share of stock to an indicator of the return that might accrue to the investor.
Now, let’s look at the market tests forHome Depot for 1999.
Home Depot
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Price/Earnings (P/E) Ratio
P/E Ratio =Current Market Price Per Share
Earnings Per Share
P/E Ratio =$62
$1.10= 56.4
This ratio measures the relationship between the current market price of the
stock and its earnings per share.
This ratio measures the relationship between the current market price of the
stock and its earnings per share.
A recent price for Home Depotstock was $62 per share.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Dividend Yield Ratio
DividendYield
Dividends Per Share Market Price Per Share
=
DividendYield
$0.23$62
= = 0.37%
This ratio is often used to compare the dividend-paying performance of different
investment alternatives.
This ratio is often used to compare the dividend-paying performance of different
investment alternatives.
Home Depot paid dividends of $.23 per share when the market price was $62 per share.
Home Depot paid dividends of $.23 per share when the market price was $62 per share.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Miscellaneous Ratios
Financial analysts may calculate many other financial ratios to help evaluate
and compare investment opportunities.
Now, let’s look at book value per share as an example of such a ratio for Home
Depot for 1999.
Financial analysts may calculate many other financial ratios to help evaluate
and compare investment opportunities.
Now, let’s look at book value per share as an example of such a ratio for Home
Depot for 1999.
Home Depot
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
Book Valueper Share
$8,7401,471
= = $5.94
Book Value per Share
Book Valueper Share
Common Stock EquityNumber of Shares of
Common Stock Outstanding
=
Book value per share measures the owners’ equity in terms of common stock outstanding. Book value per share has
no relationship to market value.
Book value per share measures the owners’ equity in terms of common stock outstanding. Book value per share has
no relationship to market value.
© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill
End of Chapter 14
Ratios
Ratios
Ratios RatiosRatios