DATED: December 13

PROJECT ON FINANCIAL RATIOS

TATA STEEL
INDUSTRY GUIDE: UTTAM KUMAR ROY, FINANCIAL CONTROLLER, TUBES DIVISION.

SUBMITTED BY: ANKITA BANERJEE

TATA STEELGLOBAL STEEL COMPANY PIONEERING IN STEEL MANUFACTURING

The Tata Group of Companies has always believed strongly in the concept of collaborative growth, and this vision has seen it emerge as one of India's and the world's most respected and successful business conglomerates. The Tata Group has traced a route of growth that spans through six continents and embraces diverse cultures. The total revenue of Tata companies, taken together, was $83.3 billion (around Rs3, 796.75 billion) in 2010-11, with 58 per cent of this coming from business outside India. In the face of trying economic challenges in recent times, the Tata Group has steered Indias ascent in the global map through its unwavering focus on sustainable development. Tata companies employ over 425,000 people worldwide. It is the largest employer in India in the Private Sector and continues to lead with the same commitment towards social and community responsibilities that it has shown in the past.

The Tata Group of Companies has business operations (114 companies and subsidiaries) in seven defined sectors Materials, Engineering, Information Technology and Communications, Energy, Services, Consumer Products and Chemicals. Tata Steel with its acquisition of Corus has secured a place among the top ten steel manufacturers in the world and it is the Tata Groups flagship Company. Other Group Companies in the different sectors are Tata Motors, Tata Consultancy Services (TCS), Tata Communications, Tata Power, Indian Hotels, Tata Global Beverages and Tata Chemicals.

TATA MOTORS is Indias largest automobile company by revenue and is among the top five commercial vehicle

manufacturers in the world. Jaguar and Land rover are now part of Tata Motors portfolio.

TATA CONSULTANCY SERVICES (TCS) is an integrated software solutions provider with delivery centres in more than 18 countries. It ranked fifth overall, and topped the list for IT services, in Bloomberg Business weeks 12 th annual 'Tech 100', a ranking of the world's best performing tech companies.

TATA POWER has pioneered hydro-power generation in India and is the largest power generator (production capacity of 2300 MW) in India in the private sector.

INDIAN HOTELS COMPANY (Taj Hotels, resorts and palaces) happens to be the leading chain of hotels in India and one of the largest hospitality groups in Asia. It has a presence in 12 countries in 5 continents.

TATA GLOBAL BEVERAGES (FORMERLY, TATA TEA), with its major acquisitions like Tetley and Good Earth is at present the second largest global branded tea operation.

Tata Steel Limited (formerly Tata Iron and Steel Company Limited, abbreviated as TISCO) is an Indian multinational steel-making company headquartered in Mumbai, Maharashtra, India, and a subsidiary of the Tata Group. It is the 12th-largest steel producing company in the world, with an annual crude steel capacity of 23.8 million tonnes, and the largest private-sector steel company in India measured by domestic production.

Tata Steel has manufacturing operations in countries including India, China, the United States and the United

Kingdom. Its largest plant is located in Jamshedpur, Jharkhand. In August 2007, Tata Steel acquired the UK-based steel maker Corus in what was, to date, the largest international acquisition by an Indian company. Tata Steel is listed on Bombay Stock Exchange and National Stock Exchange of India, and employs about 81,600 people.

Tata Steel is ranked 401st in the 2012 Fortune Global 500 ranking of the world's biggest corporations. It is the eighth most-valuable Indian brand according to an annual survey conducted by Brand Finance and The Economic Times in 2010. It has also been listed as World's most ethical companies by Forbes.

History TISCo was established by Dorabji Tata August 26, 1907, as part of his father Jamsetji's Tata Group. In year 1939, it had largest steel plant in the British Empire. A modernization and expansion program was launched in year 1951. Later, the program was upgraded to 2 MTPA project. In 1990, it started expansion plan and established its subsidiary Tata Inc. in New York. The company changed its name TISCO to Tata Steel in year 2005.

In August 2004, Tata Steel entered into definitive agreements with Singapore based NatSteel Ltd to acquire its steel business for Singapore $486.4 million (approximately Rs 1,313 crore) in an all cash transaction.

In 2005, Tata Steel acquired 40% Stake in Millennium Steel in Thailand for $130 million (approx. Rs 600 crore).

In 2007 Tata Steel through its wholly owned Singapore subsidiary, NatSteel Asia Pte Ltd acquired controlling stake in two rolling mills: SSE Steel Ltd, Vinausteel Ltd located in Vietnam.

Operations Tata Steel is headquartered in Mumbai, Maharashtra, India and has its marketing headquarters at Tata Centre in Kolkata, West Bengal. Tata Steel has a presence in around 50 countries with manufacturing operations in 26 countries including: India, Malaysia, Vietnam, Thailand, Dubai, Daggaron, Ivory Coast, Mozambique, South Africa, Australia, United Kingdom, The Netherlands, France and Canada.

Tata Steel primarily serves customers in the automotive, construction, consumer goods, engineering, packaging, lifting and excavation, energy and power, aerospace, shipbuilding, rail and defence and security sectors.

Major expansion projects Tata Steel has set a target of achieving an annual production capacity of 100 million tons by 2015; it is planning for capacity expansion to be balanced roughly 50:50 between greenfield developments and acquisitions. Overseas acquisitions have already added an additional 21.4 million tonnes of capacity, including Corus (18.2 million tonnes), Natsteel (2 million tonnes) and Millennium Steel (1.2 million tonnes). Tata is looking to add another 29 million tonnes through acquisitions. Major Greenfield expansion projects planned by Tata Steel include:

6 million tonne per annum capacity plant in Kalinganagar, Orissa, India 10 million tonne per annum capacity plant in Jharkhand, India: The capacity of Jamshedpur steel plant has already been increased to 6.8 MTPA. It is expected that its capacity will increase by 10 MPTA in near future. 5 million tonne per annum capacity plant in Chhattisgarh, India (Tata Steel signed a memorandum of understanding with the Chhattisgarh government in 2005; the plant is facing strong protest from tribal people) 3 million tonne per annum capacity plant in Iran 2.4 million tonne per annum capacity plant in Bangladesh 10.5 million tonne per annum capacity plant in Vietnam (feasibility studies are underway)

6 million tonne per annum capacity plant in Haveri, Karnataka. $5 billion steel plant in Vietnam (negotiations with the Vietnamese government are in process)

Major competitors Tata Steel's major competitors include ArcelorMittal, Essar Steel, JSW Steel, SAIL and VISA Steel.

When Jamsetji Tata gave shape to his vision of nation building by forming what was to become the Tata Group in 1868, he had envisaged India as an independent strength politically, economically and socially. In order to become a force that the world has to reckon with, the Tata Group has always ventured into path breaking territory and pioneered developments in industries of national importance.

As a policy, the Tata Group Companies promote and encourage economic, social and educational development in the community, returning wealth to the society they serve. Two-thirds of the equity of Tata Sons is held in philanthropic trusts that take care of endowments towards improvement programmes in these spheres.

Through the years, the Tata Group has been amongst the most prestigious corporate presences in the world governed by its principles of business ethics. Its foray into international business has been recognised by various bodies and institutions. Brand Finance, a UK based consultancy firm after a valuation of the Tata brand at $15.75 billion in 2011, ranked it 41st among the world's top 100 brands. BusinessWeek magazine ranked Tata 17th among the '50 Most Innovative Companies' list and the Reputation Institute, USA, in 2009 rated it 11th on its list of the world's most reputable companies. In the road ahead, the Tata Group is focusing on integration of new technologies in its operations and breaking

new grounds in product development. The Eka supercomputer had been ranked the worlds fourth fastest in 2008 and the launch of the Nano has been a benchmark for the auto industry specifically and the economy in general.

With a holistic approach in all its business operations, a loyal and dedicated workforce and its rooted belief in value creation and corporate citizenship, the Tata Group is always ready to realise its vision and objectives. The challenges of the future will only help to enhance the Groups performance and transform newer dreams to reality.

Established in 1907, Tata Steel is among the top ten global steel companies with an annual crude steel capacity of over 28 million tonnes per annum (mtpa). It is now one of the world's most geographically-diversified steel producers, with operations in 26 countries and a commercial presence in over 50 countries.

The Tata Steel Group, with a turnover of US$ 26.13 billion in FY 2011- 2012, has over 81,000 employees across five continents and is a Fortune 500 company.

Tata Steels vision is to be the worlds steel industry benchmark through the excellence of its people, its innovative approach and overall conduct. Underpinning this vision is a performance culture committed to aspiration targets, safety and social responsibility, continuous improvement, openness and transparency.

Tata Steels larger production facilities include those in India, the UK, the Netherlands, Thailand, Singapore, China and Australia. Operating companies within the Group include Tata Steel Limited (India), Tata Steel Europe Limited (formerly Corus), NatSteel, and Tata Steel Thailand (formerly Millennium Steel).

TATA TUBESLARGEST DOMESTIC MANUFACTURER OF STEEL TUBES AND PIPES

Pipes manufactured by the Companys strategic business unit Tata Tubes, is the most prominent brand in the industry today which is retailed through a wide distribution network. A deeply thought out branding exercise was undertaken in order to unleash the power of the Tata Pipes' brand in the welded steel category.

In 1985, the Indian Tube Company (a joint venture between Tata Steel and Stewarts & Lloyds of UK) merged with Tata Steel to form the Tata Steel-Tubes Division. The Tubes Strategic Business Unit (SBU) today is a leading manufacturer of welded pipes and tubes in the Country with an annual production capacity of around 4,00,000 tonnes, with expansion plans for the future. Its market share at present is 16%. The tubes Divisions main works is situated at Jamshedpur and the marketing Head Office is in Kolkata.

Its three main lines of business are

Commercial Tubes for the conveyance segments, sold under the brand name of "Tata Pipes" Structural Tubes for the construction segment, sold under the brand name of "Tata Structura" Precision Tubes for the Auto, Boiler and Engineering segment.

Product Range and Application The Commercial Tubes (Tata Pipes) cater to the plumbing, irrigation, cold storage, HVAC applications and other Industrial end usage. The structural tubes (Tata Structura) are used for a variety of architectural, industrial, scaffolding, infrastructural and general engineering applications. Landmark airport structures in India have been built using Tata Structura. The Precision Tubes cater to the auto, boiler and general engineering segments.

The Tubes Division entered the high-tech segment with the successful commissioning of its hydroforming line and commencement of supply of tubular hydroformed engine cradle for the Tata Nano cars. It has also developed telescopic front fork for motorcycles. The Division has substantially increased its share (40% YoY) of High Precision Cold Drawn tubes for Propeller Shaft, Drive Shaft and Front Fork tubes. It continues to hold a leading position in the Boiler Segment in spite of intensifying competition.

As the tubes are manufactured from high quality hot rolled coils from the advanced hot strip mill of Tata Steel, they come with a number of sure advantages. These steel tubes are manufactured in ISO certified manufacturing facilities, under strict quality control norms, and have high strength and durability.

The Tubes division recorded sales of 377k tonnes in Financial Year 2011-12. The year also marked the unveiling of the 'CHARKHA' at Oval Maidan, Mumbai a symbol of the innovative and futuristic applications of the Tata Structura hollow section.

Manufacturing Technology The Tata Group has been a pioneer in adopting the most modern, state-of-the-art technologies for its businesses. The Standard Tubes Plant for Tata Pipes and Tata Structura boasts of high-class facilities in tube making, with

technology from OTO Mills (Italy), Kusakabe (Japan) and MAIR Research (Italy). The Tubes Division has six inhouse mills and select external processing agents across India. Key facilities include pickling, tube making mills, galvanizing, heat treatment furnaces, cold draw facility and state-of-the art hydroforming facility.

The Tata Steel Tubes Division won the coveted JRD QV award in 2010. It is certified to ISO 9001, ISO 14001, ISO 19001 and TS 16949.

The Tubes division received the award of the 'Most Innovative Environment Project' at the CII Environmental Best Practices Competition held on 9-10 February, 2012 at Hyderabad.

FINANCIAL RATIOS
A financial ratio (or accounting ratio) is a relative magnitude of two selected numerical values taken from an enterprise's financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization. Financial ratios may be used by managers within a firm, by current and potential shareholders (owners) of a firm, and by a firm's creditors. Financial analysts use financial ratios to compare the strengths and weaknesses in various companies. If shares in a company are traded in a financial market, the market price of the shares is used in certain financial ratios.

Ratios can be expressed as a decimal value, such as 0.10, or given as an equivalent percent value, such as 10%. Some ratios are usually quoted as percentages, especially ratios that are usually or always less than 1, such as earnings yield, while others are usually quoted as decimal numbers, especially ratios that are usually more than 1, such as P/E ratio; these latter are also called multiples. Given any ratio, one can take its reciprocal; if the ratio was above 1, the reciprocal will be below 1, and conversely. The reciprocal expresses the same information, but may be more understandable: for instance, the earnings yield can be compared with bond yields, while the P/E ratio cannot be: for example, a P/E ratio of 20 corresponds to an earnings yield of 5%.

Sources of data for financial ratios Values used in calculating financial ratios are taken from the balance sheet, income statement, statement of cash flows or (sometimes) the statement of retained earnings. These comprise the firm's "accounting statements" or financial statements. The statements' data is based on the accounting method and accounting standards used by

the organization.

Purpose and types of ratios Financial ratios quantify many aspects of a business and are an integral part of the financial statement analysis. Financial ratios are categorized according to the financial aspect of the business which the ratio measures. Liquidity ratios measure the availability of cash to pay debt.

Activity ratios measure how quickly a firm converts non-cash assets to cash assets.

Debt ratios measure the firm's ability to repay long-term debt.

Profitability ratios measure the firm's use of its assets and control of its expenses to generate an acceptable rate of return.

Market ratios measure investor response to owning a company's stock and also the cost of issuing stock.

These are concerned with the return on investment for shareholders, and with the relationship between return and the value of an investment in companys shares.

Financial ratios allow for comparisons

between companies between industries between different time periods for one company between a single company and its industry average

Ratios generally are not useful unless they are benchmarked against something else, like past performance or another company. Thus, the ratios of firms in different industries, which face different risks, capital requirements, and competition, are usually hard to compare.

Accounting methods and principles Financial ratios may not be directly comparable between companies that use different accounting methods or follow various standard accounting practices. Most public companies are required by law to use generally accepted accounting principles for their home countries, but private companies, partnerships and sole proprietorships may not use accrual basis accounting. Large multi-national corporations may use International Financial Reporting Standards to produce their financial statements, or they may use the generally accepted accounting principles of their home country.

There is no international standard for calculating the summary data presented in all financial statements, and the terminology is not always consistent between companies, industries, countries and time periods.

When it comes to investing, analyzing financial statement information (also known as quantitative analysis), is one of, if not the most important element in the fundamental analysis process. At the same time, the massive

amount of numbers in a company's financial statements can be bewildering and intimidating to many investors. However, through financial ratio analysis, you will be able to work with these numbers in an organized fashion.

The objective of this tutorial is to provide you with a guide to sources of financial statement data, to highlight and define the most relevant ratios, to show you how to compute them and to explain their meaning as investment evaluators.

In this regard, we draw your attention to the complete set of financials for Zimmer Holdings, Inc. (ZMH), a publicly listed company on the NYSE that designs, manufactures and markets orthopedic and related surgical products, and fracture-management devices worldwide. We've provided these statements in order to be able to make specific reference to the account captions and numbers in Zimmer's financials in order to illustrate how to compute all the ratios.

Among the dozens of financial ratios available, we've chosen 11 measurements that are the most relevant to the investing process.

Earnings before Interest, Taxes, Depreciation and Amortization EBITDA

EBITDA is essentially net income with interest, taxes, depreciation, and amortization added back to it, and can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions.

It is an indicator of a company's financial performance which is calculated in the following EBITDA calculation:

This is a non-GAAP measure that allows a greater amount of discretion as to what is (and is not) included in the calculation. This also means that companies often change the items included in their EBITDA calculation from one reporting period to the next.

EBITDA first came into common use with leveraged buyouts in the 1980s, when it was used to indicate the ability of a company to service debt. As time passed, it became popular in industries with expensive assets that had to be written down over long periods of time. EBITDA is now commonly quoted by many companies, especially in the tech sector - even when it isn't warranted.

A common misconception is that EBITDA represents cash earnings. EBITDA is a good metric to evaluate profitability, but not cash flow. EBITDA also leaves out the cash required to fund working capital and the replacement of old equipment, which can be significant. Consequently, EBITDA is often used as an accounting gimmick to dress up a company's earnings. When using this metric, it's key that investors also focus on other performance measures to make sure the company is not trying to hide something with EBITDA.

The EBITDA of a company gives an indication on the operational profitability of the business, i.e. how much profit does it make with its present assets and its operations on the products it produces and sells, taking into account possible provisions that need to be carried out. A negative EBITDA indicates that a business has fundamental problems. A positive EBITDA, on the other hand, does not necessarily mean that the business generates cash. This is because EBITDA ignores changes in Working Capital (usually needed when growing a business), capital expenditures (needed to replace assets that have broken down), taxes, and interest.

While the omission of taxes, interest, and amortization for the sake of comparison of companies has some justification, some analysts do not support omission of capital expenditures when evaluating the profitability of a company: capital expenditures are needed to maintain the asset base which in turn allows for profit. Warren Buffett famously asked, "Does management think the tooth fairy pays for capital expenditures?" Depreciation is often a very good approximation of the capital expenditures required to maintain the asset base, so it has been argued that EBITA ("Earnings before Interest, Taxes and Amortization) would be a better indicator.

EBITDA margin refers to EBITDA divided by total revenue (or "total output", "output" differing "revenue" by the changes in inventory).

Use Apart from the use mentioned above, EBITDA is widely used in loan covenants, mostly in the following two metrics: 1. Leverage: Debt/EBITDA. This metric measures the amount of debt in relation to the EBITDA, i.e. how does the debt relate to the operational profit generating ability of the company. Whilst there is no absolute target and whilst leverage ratios differ widely, it can probably be argued that a leverage >3 is unhealthy for most businesses. 2. Interest Cover: (EBITDA/Interest Expense). This metric measures the ability of a company to generate profit out of its operations to cover interest payments. Again there is no absolute target for this value, as the ratio that is required obviously depends on taxes, working capital needs, capital expenditures and the repayment needs of the principal. However, it is clear that a ratio <1 is not sustainable for long.

Misuse EBITDA has increasingly become the key metric to show the "intrinsic operational performance" of the business, i.e. the performance when all costs that do not occur in the normal course of business (e.g. restructuring costs, ramp-up costs, consulting fees for special projects, special legal fees, ...) are ignored. Whilst this is helpful in general, it is often misused by declaring too many cost items as "one-offs" and thus boosting profitability. The resulting metric when such "non-normal" costs have been deducted should be called "adjusted EBITDA" or similar, but this "adjusted" nature is often times not shown sufficiently clearly.

Because EBITDA (and its variations) are not measures generally accepted under U.S. GAAP, the U.S. Securities and Exchange Commission requires that companies registering securities with it (and when filing its periodic reports) reconcile EBITDA to net income in order to avoid misleading investors.

In another attempt to boost EBITDA, some companies have reverted to activate development efforts in the profit and loss statement. This effectively increases total output and hence increases EBITDA. Such development costs are then recorded as capital expenditures. A view on EBITA as discussed above would hence eliminate such an artifact.

Difference between EBITDA and Revenue Revenue is the total money that a company generates through its business. EBITDA is the company's profit from that revenue after expenses but before taxes and such are subtracted.

Profit before Tax PBT

It is a profitability measure that looks at a company's profits before the company has to pay corporate income tax. This measure deducts all expenses from revenue including interest expenses and operating expenses, but it leaves out the payment of tax.

Also referred to as "earnings before tax ".

This measure combines all of the company's profits before tax, including operating, non-operating, continuing operations and non-continuing operations. PBT exists because tax expense is constantly changing and taking it out helps to give an investor a good idea of changes in a company's profits or earnings from year to year.

Profit In accounting, profit is the difference between the purchase and the component costs of delivered goods and/or services and any operating or other expenses.

There are several important profit measures in common use.

Gross profit equals sales revenue minus cost of goods sold (COGS), thus removing only the part of expenses that can be traced directly to the production or purchase of the goods. Gross profit still includes general (overhead) expenses like R&D, S&M, G&A, also interest expense, taxes and extraordinary items.

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) equals sales revenue minus cost of goods sold and all expenses except for interest, amortization, depreciation and taxes. It measures the Cash earnings that can be used to pay interest and repay the principal. Since interest is paid before income tax is calculated, the debt holder can ignore taxes.

Earnings Before Interest and Taxes (EBIT) or Operating profit equals sales revenue minus cost of goods sold and all expenses except for interest and taxes. This is the surplus generated by operations. It is also known as Operating Profit Before Interest and Taxes (OPBIT) or simply Profit Before Interest and Taxes (PBIT).

Earnings Before Taxes (EBT) or Net Profit Before Tax equals sales revenue minus cost of goods sold and all expenses except for taxes. It is also known as pre-tax book income (PTBI), net operating income before taxes or simply pre-tax Income.

Earnings After Tax or Net Profit After Tax equals sales revenue after deducting all expenses, including taxes (unless some distinction about the treatment of extraordinary expenses is made). In the US, the term Net Income is commonly used. Income before extraordinary expenses represents the same but before adjusting for extraordinary items.

Earnings After Tax (or Net Profit After Tax) minus payable dividends becomes Retained Earnings.

To accountants, Economic Profit, or EP, is a single-period metric to determine the value created by a company in one periodusually a year. It is Earnings After Tax less the Equity Charge, a risk-weighted cost of capital. This is almost identical to the economists' definition of economic profit.

There are analysts who see benefit in making adjustments to economic profit such as eliminating the effect of amortized goodwill or capitalizing expenditure on brand advertising to show its value over multiple accounting periods. The underlying concept was first introduced by Schmalenbach, but the commercial application of the concept of adjusted economic profit was by Stern Stewart & Co. which has trade-marked their adjusted economic profit as Economic Value Added (EVA).

Economists define also the following types of profit:

Abnormal profit (or Supernormal profit) Subnormal profit Monopoly profit (or Super profit)

Optimum Profit is a theoretical measure and denotes the "right" level of profit a business can achieve. In business, this figure takes account of marketing strategy, market position, and other methods of increasing returns above the competitive rate.

Accounting profits should include economic profits, which are also called economic rents. For instance, a monopoly can have very high economic profits, and those profits might include a rent on some natural resource that firm owns, whereby that resource cannot be easily duplicated by other firms.

Return on Average Capital Employed ROACE

It is a financial ratio that shows profitability compared to investments made in new capital. "Return on average capital employed" is calculated as: EBIT Average Total Assets - Average Current Liabilities Total Assets - Current Liabilities = Capital Employed

It differs from the "return on capital employed" (ROCE) calculation, in that it takes the average of the opening and closing capital for a period of time, as opposed to only the capital figure at the end of the period.

Return on average capital employed is a useful ratio when analyzing businesses in capital-intensive industries, such as oil. Businesses that are able to squeeze higher profits from a smaller amount of capital assets will have a higher ROACE than businesses that are not as efficient in converting capital into profit.

Investors should be careful when using the ratio since capital assets, such as a refinery, can be depreciated over time. If the same amount of profit is made from an asset each period, the asset depreciating will make ROACE increase because it is less valuable. This makes it look as if the company is making good use of capital, though it is really not making any additional investments. The formula

(Expressed as a %) It is similar to Return on Assets (ROA), but takes into account sources of financing. Net Operating Profit After Tax (NOPAT) is equal to EBIT * (1 - tax) -- the return on the capital employed should be measured in after tax terms.

Operating income In the numerator we have Net Operating Profit After Tax, i.e. operating profit or EBIT (earnings after tax).

Capital employed In the denominator we have net assets or capital employed instead of total assets (which is the case of Return on Assets). Capital Employed has many definitions. In general it is the capital investment necessary for a business to function. It is commonly represented as total assets less current liabilities (or fixed assets plus working capital).

ROCE uses the reported (period end) capital numbers; if one instead uses the average of the opening and closing capital for the period, one obtains Return on Average Capital Employed (ROACE).

Application ROCE is used to prove the value the business gains from its assets and liabilities. A business which owns lots of land but has little profit will have a smaller ROCE to a business which owns little land but makes the same profit. It basically can be used to show how much a business is gaining for its assets, or how much it is losing for its liabilities.

Drawbacks of ROCE The main drawback of ROCE is that it measures return against the book value of assets in the business. As these are depreciated the ROCE will increase even though cash flow has remained the same. Thus, older businesses with depreciated assets will tend to have higher ROCE than newer, possibly better businesses. In addition, while cash flow is affected by inflation, the book value of assets is not. Consequently revenues increase with inflation while capital employed generally does not (as the book value of assets is not affected by inflation).

Return On Average Capital Employed (ROCE) Return on average capital employed is a performance measure ratio. From the perspective of the business segments, ROCE is annual business segment earnings divided by average business segment capital employed (average of beginning- and end-of-year amounts). These segment earnings include ExxonMobils share of segment earnings of equity companies, consistent with our capital employed definition, and exclude the cost of financing. The Corporations total ROCE is net income excluding the after-tax cost of financing, divided by total corporate average capital employed. The Corporation has consistently applied its ROCE definition for many years and views it as the best measure of historical capital productivity in our capital-intensive, long-term industry, both to evaluate managements performance and to demonstrate to shareholders that capital has been used wisely over the long term. Additional measures, which are more cash-flow based, are used to make investment decisions.

(millions of dollars) Return on Average Capital Employed Net income Financing costs (after tax) Gross third-party debt ExxonMobil share of equity companies All other financing costs net Total financing costs Earnings excluding financing costs Average capital employed Return on average capital employed corporate total

2008 45,220 (343) (325) 1,485 817 44,403 129,683 34.2%

2007 40,610 (339) (204) 268 (275) 40,885 128,760 31.8%

2006 39,500 (264) (156) 499 79 39,421 122,573 32.2%

2005 36,130 (261) (144) (35) (440) 36,570 116,961 31.3%

2004 25,330 (461) (185) 378 (268) 25,598 107,339 23.8%

Return on Net Worth- RONW

The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. RONW is expressed as a percentage and calculated as: Return on Net Worth= Net Income/Shareholder's Equity

Net income is for the full fiscal year (before dividends paid to common stock holders but after dividends to preferred stock.) Shareholder's equity does not include preferred shares. Also known as return on equity (ROE). The ROE is useful for comparing the profitability of a company to that of other firms in the same industry. There are several variations on the formula that investors may use:

1. Investors wishing to see the return on common equity may modify the formula above by subtracting preferred dividends from net income and subtracting preferred equity from shareholders' equity, giving the following: return on common equity (ROCE) = net income - preferred dividends / common equity.

2. Return on equity may also be calculated by dividing net income by average shareholders' equity. Average shareholders' equity is calculated by adding the shareholders' equity at the beginning of a period to the shareholders' equity at period's end and dividing the result by two.

3. Investors may also calculate the change in ROE for a period by first using the shareholders' equity figure from the beginning of a period as a denominator to determine the beginning ROE. Then, the end-of-period shareholders' equity can be used as the denominator to determine the ending ROE. Calculating both beginning and ending ROEs allows an investor to determine the change in profitability over the period.

Return on equity (ROE) measures how much a company earns within a specific period in relation to the amount that's invested in its common stock.It is calculated by dividing the company's net income before common stock dividends are paid by the company's net worth, which is the stockholders' equity.If the ROE is higher than the company's return on assets, it may be a sign that management is using leverage to increase profits and profit margins.In general, it's considered a sign of good management when a company's performance over time is at least as good as the average return on equity for other companies in the same industry.

It is publicly-traded company's earnings divided by the amount of money invested in stock, expressed as a percentage. This is a measure of how well the company is investing the money invested in it. A high return on equity indicates that the company is spending wisely and is likely profitable; a low return on equity indicates the opposite. As a result, high returns on equity lead to higher stock prices. Some analysts believe that return on equity is the single most important indicator of publicly-traded companies' health.

Asset Turnover
It is the amount of sales generated for every dollar's worth of assets. It is calculated by dividing sales in dollars by assets in dollars. Formula:

Also known as the Asset Turnover Ratio. Asset turnover measures a firm's efficiency at using its assets in generating sales or revenue - the higher the number the better. It also indicates pricing strategy: companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover. Asset turnover is a financial ratio that measures the efficiency of a company's use of its assets in generating sales revenue or sales income to the company. Companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover. Companies in the retail industry tend to have a very high turnover ratio due mainly to cut throat and competitive pricing.

"Sales" is the value of "Net Sales" or "Sales" from the company's income statement

"Average Total Assets" is the average of the values of "Total assets" from the company's balance sheet in the beginning and the end of the fiscal period. It is calculated by adding up the assets at the beginning of the period and the assets at the end of the period, then dividing that number by two. Asset turnover This ratio considers the relationship between revenues and the total assets employed in a business. A business invests in assets (machinery, inventories etc) in order to make profitable sales, and a good way to think about the asset turnover ratio is imagining the business trying to make those assets work hard (or sweat) to generate sales.

In terms of where to get the numbers:

Revenue obviously comes from the income statement Net assets = total assets less total liabilities The resulting figure is expressed as a number of times per year

Particular care needs to be taken with the asset turnover ratio. For example:

The number will vary enormously from industry to industry. A capital-intensive business may have a much lower asset turnover than a business with low net assets but which generates high revenues. The asset turnover figure for a specific business can also vary significantly from year to year. For example, a business may invest heavily in new production capacity in one year (which would increase net assets) but the revenues from the extra capacity might not arise fully until the following year The asset turnover ratio takes no direct account of the profitability of the revenues generated

Inventory Turnover
It is a ratio showing how many times a company's inventory is sold and replaced over a period. the

The days in the period can then be divided by the inventory turnover formula to calculate the days it takes to sell the inventory on hand or "inventory turnover days." Although the first calculation is more frequently used, COGS (cost of goods sold) may be substituted because sales are recorded at market value, while inventories are usually recorded at cost. Also, average inventory may be used instead of the ending inventory level to minimize seasonal factors. This ratio should be compared against industry averages. A low turnover implies poor sales and, therefore, excess inventory. A high ratio implies either strong sales or ineffective buying. High inventory levels are unhealthy because they represent an investment with a rate of return of zero. It also opens the company up to trouble should prices begin to fall.

In accounting, the Inventory turnover is a measure of the number of times inventory is sold or used in a time period such as a year. The equation for inventory turnover equals the cost of goods sold divided by the average inventory. Inventory turnover is also known as inventory turns, stock turn, stock turns, turns, and stock turnover.

The formula for average inventory:

The average days to sell the inventory is calculated as follows:

Application in Business

A low turnover rate may point to overstocking, obsolescence, or deficiencies in the product line or marketing effort. However, in some instances a low rate may be appropriate, such as where higher inventory levels occur in anticipation of rapidly rising prices or expected market shortages. Conversely a high turnover rate may indicate inadequate inventory levels, which may lead to a loss in business as the inventory is too low. This often can result in stock shortages.

Some compilers of industry data (e.g., Dun & Bradstreet) use sales as the numerator instead of cost of sales. Cost of sales yields a more realistic turnover ratio, but it is often necessary to use sales for purposes of comparative analysis. Cost of sales is considered to be more realistic because of the difference in which sales and the cost of sales are recorded. Sales are generally recorded at market value, i.e. the value at which the marketplace paid for the good or service provided by the firm. In the event that the firm had an exceptional year and the market paid a premium for the firm's goods and services then the numerator may be an inaccurate measure. However, cost of sales is recorded by the firm at what the firm actually paid for the materials available for sale. Additionally, firms may reduce prices to generate sales in an effort to cycle inventory. In this article, the terms "cost of sales" and "cost of goods sold" are synonymous.

An item whose inventory is sold (turns over) once a year has higher holding cost than one that turns over twice, or three times, or more in that time. Stock turnover also indicates the briskness of the business. The purpose of increasing inventory turns is to reduce inventory for three reasons.

Increasing inventory turns reduces holding cost. The organization spends less money on rent, utilities, insurance, theft and other costs of maintaining a stock of good to be sold. Reducing holding cost increases net income and profitability as long as the revenue from selling the item remains constant. Items that turn over more quickly increase responsiveness to changes in customer requirements while allowing the replacement of obsolete items. This is a major concern in fashion industries. When making comparison between firms, it's important to take note of the industry, or the comparison will be distorted. Making comparison between a supermarket and a car dealer, will not be appropriate, as supermarket sells fast moving goods such as sweets, chocolates, soft drinks so the stock turnover will be

higher. However, a car dealer will have a low turnover due to the item being a slow moving item. As such only intra-industry comparison will be appropriate.

Debtors Turnover Ratio / Accounts Receivable Turnover Ratio

A concern may sell goods on cash as well as on credit. Credit is one of the important elements of sales promotion. The volume of sales can be increased by following a liberal credit policy.

The effect of a liberal credit policy may result in tying up substantial funds of a firm in the form of trade debtors (or receivables). Trade debtors are expected to be converted into cash within a short period of time and are included in current assets. Hence, the liquidity position of concern to pay its short term obligations in time depends upon the quality of its trade debtors. Debtors turnover ratio or accounts receivable turnover ratio indicates the velocity of debt collection of a firm. In simple words it indicates the number of times average debtors (receivable) are turned over during a year. Formula of Debtors Turnover Ratio: Debtors Turnover Ratio = Net Credit Sales / Average Trade Debtors The two basic components of accounts receivable turnover ratio are net credit annual sales and average trade debtors. The trade debtors for the purpose of this ratio include the amount of Trade Debtors & Bills Receivables. The average receivables are found by adding the opening receivables and closing balance of receivables and

dividing the total by two. It should be noted that provision for bad and doubtful debts should not be deducted since this may give an impression that some amount of receivables has been collected. But when the information

about opening and closing balances of trade debtors and credit sales is not available, then the debtors turnover ratio can be calculated by dividing the total sales by the balance of debtors (inclusive of bills receivables) given and formula can be written as follows. Debtors Turnover Ratio = Total Sales / Debtors

Significance of the Ratio: Accounts receivable turnover ratio or debtors turnover ratio indicates the number of times the debtors are turned over a year. The higher the value of debtors turnover the more efficient is the management of debtors or more liquid the debtors are. Similarly, low debtors turnover ratio implies inefficient management of debtors or less liquid debtors. It is the reliable measure of the time of cash flow from credit sales. There is no rule of thumb which may be used as a norm to interpret the ratio as it may be different from firm to firm.

An accounting measure used to quantify a firm's effectiveness in extending credit as well as collecting debts. The receivables turnover ratio is an activity ratio, measuring how efficiently a firm uses its assets. Formula:

Some companies' reports will only show sales - this can affect the ratio depending on the size of cash sales.

By maintaining accounts receivable, firms are indirectly extending interest-free loans to their clients. A high ratio implies either that a company operates on a cash basis or that its extension of credit and collection of accounts

receivable is efficient. A low ratio implies the company should re-assess its credit policies in order to ensure the timely collection of imparted credit that is not earning interest for the firm. The Accounts Receivable Turnover measures the number of times Accounts Receivable were collected during a period. This period can be any length of time, such as monthly, quarterly, or yearly. The Accounts Receivable Turnover ratio is also a measure of how well the company can collect sales on credit from its customers. The Average Collection Period is a similar measurement, and estimates the average number of days it takes for a company to collect on its credit sales. Accounts Receivable Turnover is found by adding the starting and ending values of accounts receivable, then dividing by two. The Net Sales is then divided by this average Accounts Receivable value. Another way to write this equation is: Net Sales [ (Starting Accounts Receivable + Ending Accounts Receivable) / 2] A high, or increasing Accounts Receivable Turnover is usually a positive sign - showing the company is successfully executing its credit policies and quickly turning its Accounts Receivable into cash. Being able to efficiently collect on its credit sales is important for any company, and each company has to find a balance between extending credit to other companies to encourage more sales, yet not be too forthcoming with credit, as the sheer number of credit accounts can become a problem when trying to manage all of them. A possible negative aspect to an increasing Accounts Receivable Turnover is the company may be too strict in its credit policies and missing out on potential sales. Although companies may play it safe and restrict credit sales to

prevent abuse, a better approach would be to evaluate potential companies wishing to receive sales on credit and start with smaller credit values. Once companies have gained a reputation of keeping their promise, the company extending credit can increase the amount of credit.

Dividend Payout Ratio

It is the percentage of earnings paid to shareholders in dividends. Calculated as:

The payout ratio provides an idea of how well earnings support the dividend payments. More mature companies tend to have a higher payout ratio. In the U.K. there is a similar ratio, which is known as dividend cover. It is calculated as earnings per share divided by dividends per share.

Dividend payout ratio is the fraction of net income a firm pays to its stockholders in dividends:

The part of the earnings not paid to investors is left for investment to provide for future earnings growth. Investors seeking high current income and limited capital growth prefer companies with high Dividend payout ratio. However investors seeking capital growth may prefer lower payout ratio because capital gains are taxed at a lower rate. High growth firms in early life generally have low or zero payout ratios. As they mature, they tend to return more of the earnings back to investors. Note that dividend payout ratio is calculated as DPS/EPS. According to Financial Accounting by Walter T. Harrison, the calculation for the payout ratio is as follows: Payout Ratio = (Dividends - Preferred Stock Dividends)/Net Income The dividend yield is given by earnings yield times DPR:

Impact of buybacks Some companies chose stock buybacks as an alternative to dividends, in such cases this ratio becomes less meaningful. One way to adapt it using an augmented payout ratio: Augmented Payout Ratio = (Dividends + Buybacks)/ Net Income for the same period

Earnings per Share EPS

It is the portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serve as an indicator of a company's profitability. Calculated as:

When calculating, it is more accurate to use a weighted average number of shares outstanding over the reporting term, because the number of shares outstanding can change over time. However, data sources sometimes simplify the calculation by using the number of shares outstanding at the end of the period. Diluted EPS expands on basic EPS by including the shares of convertibles or warrants outstanding in the outstanding shares number. Earnings per share are generally considered to be the single most important variable in determining a share's price. It is also a major component used to calculate the price-to-earnings valuation ratio. For example, assume that a company has a net income of $25 million. If the company pays out $1 million in preferred dividends and has 10 million shares for half of the year and 15 million shares for the other half, the EPS

would be $1.92 (24/12.5). First, the $1 million is deducted from the net income to get $24 million, and then a weighted average is taken to find the number of shares outstanding (0.5 x 10M+ 0.5 x 15M = 12.5M).

An important aspect of EPS that's often ignored is the capital that is required to generate the earnings (net income) in the calculation. Two companies could generate the same EPS number, but one could do so with less equity (investment) - that company would be more efficient at using its capital to generate income and, all other things being equal would be a "better" company. Investors also need to be aware of earnings manipulation that will affect the quality of the earnings number. It is important not to rely on any one financial measure, but to use it in conjunction with statement analysis and other measures. Earnings per share (EPS) is the amount of earnings per each outstanding share of a company's stock. In the United States, the Financial Accounting Standards Board (FASB) requires companies' income statements to report EPS for each of the major categories of the income statement: continuing operations, discontinued operations, extraordinary items, and net income. Calculating EPS The EPS formula does not include preferred dividends for categories outside of continued operations and net income. Earnings per share for continuing operations and net income are more complicated in that any preferred dividends are removed from net income before calculating EPS. This is because preferred stock rights have precedence over common stock. If preferred dividends total $100,000, then that is money not available to distribute to each share of common stock. Earnings per Share (Basic Formula)

Earnings per Share (Net Income Formula)

Earnings per Share (Continuing Operations Formula)

Only preferred dividends actually declared in the current year are subtracted. The exception is when preferred shares are cumulative, in which case annual dividends are deducted regardless of whether they have been declared or not. Dividends in arrears are not relevant when calculating EPS. Earnings per share (EPS) are the profit attributable to shareholders (after interest, tax, minority interests and everything else) divided by the number of shares in issue. It is the amount of a company's profits that belong to a single ordinary share. Companies are required to publish the statutory (also called basic) EPS but there are a number of adjusted EPS numbers that are more useful to investors. The most common alternative EPS numbers used are adjusted or headline EPS and diluted EPS. Uses of EPS The most common use of EPS is to calculate the PE ratio, which puts EPS into context by comparing it to the share price. There are a number of variants of the PE ratio, using past earnings, forecast earnings, or the average over many years. Trends in EPS are also an important measure of growth EPS growth is combined with PE in the PEG ratio. It is also used to screen for growth companies. EPS growth is a key measure of management performance as shows how much money the company is making for shareholders, not only because of changes in profits, but also after all the effects of new share issues (this is particularly important when growth is acquisitive).

Price-Earnings Ratio - P/E Ratio

It is a valuation ratio of a company's current share price compared to its per-share earnings. Calculated as: Market Value per Share Earnings per Share (EPS) For example, if a company is currently trading at $43 a share and earnings over the last 12 months were $1.95 per share, the P/E ratio for the stock would be 22.05 ($43/$1.95). EPS is usually from the last four quarters (trailing P/E), but sometimes it can be taken from the estimates of earnings expected in the next four quarters (projected or forward P/E). A third variation uses the sum of the last two actual quarters and the estimates of the next two quarters. Also sometimes known as "price multiple" or "earnings multiple". In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the whole story by itself. It's usually more useful to compare the P/E ratios of one company to other companies in the same industry, to the market in general or against the company's own historical P/E. It would not be useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a technology company (high P/E) to a utility company (low P/E) as each industry has much different growth prospects. The P/E is sometimes referred to as the "multiple", because it shows how much investors are willing to pay per

dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings.

It is important that investors note an important problem that arises with the P/E measure, and to avoid basing a decision on this measure alone. The denominator (earnings) is based on an accounting measure of earnings that is susceptible to forms of manipulation, making the quality of the P/E only as good as the quality of the underlying earnings number.

Versions There are multiple versions of the P/E ratio, depending on whether earnings are projected or realized, and the type of earnings.

"Trailing P/E" uses per-share net income for the most recent 12 month period, divided by the weighted average number of common shares in issue during the period. This is the most common meaning of "P/E" if no other qualifier is specified. Monthly earnings data for individual companies are not available, and in any case usually fluctuate seasonally, so the previous four quarterly earnings reports are used and earnings per share are updated quarterly. Note, each company chooses its own financial year so the timing of updates will vary from one to another. "Trailing P/E from continued operations" uses operating earnings, which exclude earnings from discontinued operations, extraordinary items (e.g. one-off windfalls and write-downs), and accounting changes. "Forward P/E": Instead of net income, this uses estimated net earnings over next 12 months. Estimates are typically derived as the mean of those published by a select group of analysts (selection criteria are rarely cited).

Interpretation

By comparing price and earnings per share for a company, one can analyze the market's stock valuation of a company and its shares relative to the income the company is actually generating. Stocks with higher (or more

certain) forecast earnings growth will usually have a higher P/E, and those expected to have lower (or riskier) earnings growth will usually have a lower P/E. Investors can use the P/E ratio to compare the value of stocks: if one stock has a P/E twice that of another stock, all things being equal (especially the earnings growth rate), it is a less attractive investment. Companies are rarely equal, however, and comparisons between industries, companies, and time periods may be misleading. P/E ratio in general is useful for comparing valuation of peer companies in similar sector or group. It is usually not enough to look at the P/E ratio of one company and determine its status. Usually, an analyst will look at a company's P/E ratio compared to the industry the company is in, the sector the company is in, as well as the overall market.

Effect of leverage

P/E ratios are highly dependent on capital structure. Leverage (i.e. debt taken on by the company) affects both earnings and share price in a variety of ways, including the leveraging of earnings growth rates, tax effects and impacts on the risk of bankruptcy, and can sometimes dramatically affect the company's results. For example, for two companies with identical operations and taxation regime, and trading at typical P/E ratios, the company with a moderate amount of debt will commonly have a lower P/E than the one with no debt, despite having a slightly higher risk profile, slightly more volatile earnings and (if earnings are increasing) a slightly higher earnings growth rate. At higher levels of leverage (where the risk of bankruptcy forces up debt costs) or if profits decline substantially (driving up the P/E ratio) the indebted firm will have a higher P/E ratio than an unleveraged firm. To try to eliminate these leverage effects and better compare the values of the underlying operating assets, it is often preferable to use multiples based on the enterprise value of a company, such as EV/EBITDA, EV/EBIT or EV/NOPAT.

The P/E ratio in business culture The P/E ratio of a company is a major focus for many managers. They are usually paid in company stock or options on their company's stock (a form of payment that is supposed to align the interests of management with the interests of other stock holders). The stock price can increase in one of two ways: either through improved earnings or through an improved multiple that the market assigns to those earnings. In turn, the primary driver for multiples such as the P/E ratio is through higher and more sustained earnings growth rates. Consequently, managers have strong incentives to boost earnings per share, even in the short term, and/or which improve long term growth rates. This can influence business decisions in several ways:

If a company is looking to acquire companies with a company with a higher P/E ratio than its own it will usually prefer paying in cash or debt rather than in stock. Although in theory the method of payment makes no difference to value, doing it this way will offset or avoid earnings dilution (see accretion/dilution analysis). Conversely, companies with higher P/E ratios than their targets will be more tempted to use their stock as a means of payment for acquisitions. Companies with high P/E ratios but volatile earnings may be tempted to find ways to smooth earnings and diversify risk - this is the theory behind building conglomerates Conversely, companies with low P/E ratios may be tempted to acquire small high growth businesses in an effort to "rebrand" their portfolio of activities and burnish their image as growth stocks and thus obtain a higher PE rating. Companies will try to smooth earnings, for example by "slush fund accounting" (hiding excess earnings in good years to cover for losses in lean years). Such measures are designed to create the image that the company always slowly but steadily increases profits, with the goal to increase the P/E ratio. Companies with low P/E ratios will usually be more open to leveraging their balance sheet. As seen above, this mechanically lowers the PE ratio, which means the company looks cheaper than it did before leverage, and also improves earnings growth rates. Both of these factors will help drive up the share price.

Current Ratio
It is a liquidity ratio that measures a company's ability to pay short-term obligations. The Current Ratio formula is:

Also known as "liquidity ratio", "cash asset ratio" and "cash ratio". The ratio is mainly used to give an idea of the company's ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health, it does not necessarily mean that it will go bankrupt - as there are many ways to access financing - but it is definitely not a good sign. 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 have long inventory turnover can run into liquidity problems because they are unable to alleviate their obligations. Because business operations differ in each industry, it is always more useful to compare companies within the same industry. This ratio is similar to the acid-test ratio except that the acid-test ratio does not include inventory and prepaids as assets that can be liquidated. The components of current ratio (current assets and current liabilities) can be

used to derive working capital (difference between current assets and current liabilities). Working capital is frequently used to derive the working capital ratio, which is working capital as a ratio of sales.

The current ratio is a financial ratio that measures whether or not a firm has enough resources to pay its debts over the next 12 months. It compares a firm's current assets to its current liabilities. The current ratio is an indication of a firm's market liquidity and ability to meet creditor's demands. Acceptable current ratios vary from industry to industry and are generally between 1.5 and 3 for healthy businesses. If a company's current ratio is in this range, then it generally indicates good short-term financial strength. If current liabilities exceed current assets (the current ratio is below 1), then the company may have problems meeting its short-term obligations. If the current ratio is too high, then the company may not be efficiently using its current assets or its short-term financing facilities. This may also indicate problems in working capital management. Low values for the current or quick ratios (values less than 1) indicate that a firm may have difficulty meeting current obligations. Low values, however, do not indicate a critical problem. If an organization has good longterm prospects, it may be able to borrow against those prospects to meet current obligations. Some types of businesses usually operate with a current ratio less than one. For example, if inventory turns over much more rapidly than the accounts payable become due, then the current ratio will be less than one. This can allow a firm to operate with a low current ratio. If all other things were equal, a creditor, who is expecting to be paid in the next 12 months, would consider a high current ratio to be better than a low current ratio, because a high current ratio means that the company is more likely to meet its liabilities which fall due in the next 12 months. You should view the relation between the operation cycle period and the current ratio.

Analysis Current ratio matches current assets with current liabilities and tells us whether the current assets are enough to settle current liabilities. Current ratio below 1 shows critical liquidity problems because it means that total current liabilities exceed total current assets. General rule is that higher the current ratio better it is but there is a limit to this. A current ratio higher than 2.5 might indicate existence of idle or underutilized resources in the company.

Examples Example 1: On December 31, 2009 Company A had current assets of $100,000 and current liabilities of $50,000. Calculate its current ratio. Solution Current ratio = $100,000 / $50,000 = 2.00

Example 2: On December 31, 2010 Company B had total asset of $150,000, equity of $75,000 and non-current assets and non-current liabilities of $50,000 each. Calculate the current ratio. Solution To calculate current ratio, we need to calculate current assets and current liabilities first: Current Assets = Total Asset Non-Current Assets = $150,000 $50,000 = $100,000 Total Liabilities = Total Assets Total Equity = $150,000 $75,000 = $75,000 Current Liabilities = $75,000 $50,000 = $25,000 Current Ratio = $100,000/$25,000 = 4.00

Debt/Equity Ratio
It is a measure of a company's financial leverage calculated by dividing its total liabilities by stockholders' equity. It indicates what proportion of equity and debt the company is using to finance its assets.

Note: Sometimes only interest-bearing, long-term debt is used instead of total liabilities in the calculation. Also known as the Personal Debt/Equity Ratio, this ratio can be applied to personal financial statements as well as corporate ones. A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense. If a lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing. If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders benefit as more earnings are being spread among the same amount of shareholders. However, the cost of this debt financing may outweigh the return that the company generates on the debt through investment and business activities and become too much for the company to handle. This can lead to bankruptcy, which would leave shareholders with nothing. The debt/equity ratio also depends on the industry in which the company operates. For example, capitalintensive industries such as auto manufacturing tend to have a debt/equity ratio above 2, while personal computer companies have a debt/equity of under 0.5.

The debt-equity ratio is another leverage ratio that compares a company's total liabilities to its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligors have committed to the company versus what the shareholders have committed. To a large degree, the debt-equity ratio provides another vantage point on a company's leverage position, in this case, comparing total liabilities to shareholders' equity, as opposed to total assets in the debt ratio. Similar to the debt ratio, a lower the percentage means that a company is using less leverage and has a stronger equity position.

Variations

A conservative variation of this ratio, which is seldom seen, involves reducing a company's equity position by its intangible assets to arrive at a tangible equity, or tangible net worth, figure. Companies with a large amount of purchased goodwill form heavy acquisition activity can end up with a negative equity position. Commentary

The debt-equity ratio appears frequently in investment literature. However, like the debt ratio, this ratio is not a pure measurement of a company's debt because it includes operational liabilities in total liabilities. Nevertheless, this easy-to-calculate ratio provides a general indication of a company's equity-liability relationship and is helpful to investors looking for a quick take on a company's leverage. Generally, large, well-established companies can push the liability component of their balance sheet structure to higher percentages without getting into trouble.

The debt-equity ratio percentage provides a much more dramatic perspective on a company's leverage position than the debt ratio percentage. For example, IBM's debt ratio of 69% seems less onerous than its debt-equity ratio of 220%, which means that creditors have more than twice as much money in the company than equity holders (both ratios are for FY 2005).

Usage Preferred shares can be considered part of debt or equity. Attributing preferred shares to one or the other is partially a subjective decision but will also take into account the specific features of the preferred shares. When used to calculate a company's financial leverage, the debt usually includes only the Long Term Debt (LTD). Quoted ratios can even exclude the current portion of the LTD. The composition of equity and debt and its influence on the value of the firm is much debated and also described in the Modigliani-Miller theorem. Financial analysts and stock market quotes will generally not include other types of liabilities, such as accounts payable, although some will make adjustments to include or exclude certain items from the formal financial statements. Adjustments are sometimes also made to, for example, exclude intangible assets, and this will affect the formal equity; debt to equity (dequity) will therefore also be affected. Financial economists and academic papers will usually refer to all liabilities as debt, and the statement that equity plus liabilities equals assets is therefore an accounting identity (it is, by definition, true). Other definitions of debt to equity may not respect this accounting identity, and should be carefully compared.