Basic Equations

Assets = Liabilities + Equity

This equation tells us two things, 1) Assets (the things a business h

help it generate profit are either owned by the business (equity) or
by the business (liabilities). 2) Financial Accounting is not concern
with revenues and profit. Its purpose is to keep accurate records of
financial transactions that have transpired.

Revenue = Price x Volume; Cost = Fixed +

Variable; Income = Revenue - Cost

The foundation of the Financial Equation is: Income = Revenue However, in order to perform this equation, we must first calculate
Revenue (Price x Volume) and Cost (Fixed + Variable). It is theref
the job of financial managers (and all management) to concern
themselves with revenues, costs and profits. Though emphasis from
department to department may vary, management must concern
themselves with all three. Generally speaking, both revenues and p
must increase over the medium and long terms while costs most o
must be maintained or decreased over the same period.

Assets = Liabilities + Equity (a snapshot

moment in time)

A financial statement that summarizes a company's assets, liabiliti

and shareholders' equity at a specific point in time. These three ba
sheet segments give investors an idea as to what the company own
owes, as well as the amount invested by the shareholders.

Income Statement

Income = Revenues - Cost (over a period of

time)

A financial statement that measures a company's financial perform

over a specific accounting period. Financial performance is assess
giving a summary of how the business incurs its revenues and exp
through both operating and non-operating activities. It also shows
net profit or loss incurred over a specific accounting period, typica
over a fiscal quarter or year.

Cash Flow Statement

Because public companies tend to use accrual accounting, the inco

statements they release each quarter may not necessarily reflect ch
Cash in and out (over a period of time) and
in their cash positions. This document provides aggregate data
added to (or subtracted from) the opening cash
regarding all cash inflows a company receives from both its ongoi
value.
operations and external investment sources, as well as all cash out
that pay for business activities and investments during a given qua

Statement of Shareholders
Equity

Changes in equity due to such things as net

income (or loss), sale (or repurchase) of stock
and changes in asset values since the last
reporting period.

Also known as "equity" and "net worth", the shareholders' equity r

to the shareholders' ownership interest in a company. It is compris
Preferred stock, Additional contributed (paid-in) capital, Common
stock, Retained earnings, Other items (such as valuation allowance

Current Assets / Current Liabilities

The working capital ratio (Current Assets/Current Liabilities) indi

The Accounting Equation

The Financial Equation(s)

The Financial Statements

Balance Sheet

Liquidity Ratios

Working Capital Ratio

whether a company has enough short term assets to cover its short
debt. Anything below 1 indicates negative W/C (working capital).
While anything over 2 means that the company is not investing ex
assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.A
known as "net working capital".

(Current Assets - Inv) / Current Lliabilities

An indicator of a companys short-term liquidity. The quick ratio

measures a companys ability to meet its short-term obligations wi
most liquid assets. For this reason, the ratio excludes inventories f
current assets.The quick ratio measures the dollar amount of liquid
assets available for each dollar of current liabilities. Thus, a quick
of 1.5 means that a company has $1.50 of liquid assets available to
cover each $1 of current liabilities. The higher the quick ratio, the
the company's liquidity position. Also known as the acid-test ratio
"quick assets ratio."

Debt Ratios

Total Debt / Total Assets

The debt ratio is the ratio of total debt to total assets, expressed in
percentage, and can be interpreted as the proportion of a company
assets that are financed by debt.The higher this ratio, the more
leveraged the company and the greater its financial risk. Debt ratio
vary widely across industries.ash for its sale. Thus, this metric add
average days in inventory to average days of accounts receivable t
arrive at a final number (of days) that combines the two.

Debt to Equity Ratio

Total Liabilities / Shareholder's Equity

See Asset Management Ratios

Sales / Inventory or COGS / Ave Inventory or

(12 months Cost of Revenue / (Inventories
from current year + Inventories from prior
year) / 2))

Although the first calculation is more frequently used, COGS (cos

goods sold) may be substituted because sales are recorded at mark
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, therefor
excess inventory. A high ratio implies either strong sales or ineffec
buying. High inventory levels are unhealthy because they represen
investment with a rate of return of zero. It also opens the company
trouble should prices begin to fall.

Accounts Receivable
Collection Period

Average Accounts Receivable /Average Daily

Sales

(also called days sales outstanding) measures the average number

days that accounts receivable are outstanding. Accounts receivable
collection period measures the average number of days between
sending invoices to customers and collecting payments from them
calculate this ratio, the average accounts receivable are divided by
average daily sales in the period. The average accounts receivable
be determined by adding beginning accounts receivable to ending
accounts receivable and dividing the result by two. The average da
sales can be determined by dividing the sales for the period (e.g., a
year) by the number of days in the period (e.g., 365 days).

A/R Turnover

(12 Months Net Sales / (Total Accounts

Receivable from current year + Total Accounts Number of times per year that the A/R account turns over.
Receivable from prior year) / 2))

Quick Ratio (Acid Test)

Asset Turnover Ratios

Inventory Turnover

A/P Turnover

(12 Months Cost of Revenue / (Total Accounts

Payable from current year + Total Accounts
Number of times per year that the A/P account turns over.
Payable from prior year) / 2))

Inventory to Cash Days

Average accounts receivable days + average

inventory days where accounts receivable days
is 365 days divided by accounts receivable
turnover, and inventory days is 365 divided by
inventory turnover.

Inventory to cash days calculates the total average days from recei
inventory to receiving cash for its sale. Thus, this metric adds aver
days in inventory to average days of accounts receivable to arrive
final number (of days) that combines the two.

Net Profit / Total Equity

The ROE is useful for comparing the profitability of a company to

of other firms in the same industry.

Return on Assets (ROA)

Net Profit / Total Assets

The assets of the company are comprised of both debt and equity.
of these types of financing are used to fund the operations of the
company. The ROA figure gives investors an idea of how effective
the company is converting the money it has to invest into net incom
The higher the ROA number, the better, because the company is ea
more money on less investment. For example, if one company has
income of $1 million and total assets of $5 million, its ROA is 20%
however, if another company earns the same amount but has total
of $10 million, it has an ROA of 10%. Based on this example, the
company is better at converting its investment into profit. When yo
really think about it, management's most important job is to make
choices in allocating its resources. Anybody can make a profit by
throwing a ton of money at a problem, but very few managers exc
making large profits with little investment.

ROCE (Return on Capital

Employed)

ROCE = Earnings Before Interest and Tax

(EBIT) / Capital Employed (Assets - Current
Liabilities)

A financial ratio that measures a company's profitability and the

efficiency with which its capital is employed.Instead of using capi
employed at an arbitrary point in time, analysts and investors often
calculate ROCE based on Average Capital Employed, which tak
the average of opening and closing capital employed for the time p

Gain from Investment - Cost of Investment /

Cost of Investment

Keep in mind that the calculation for return on investment and,

therefore the definition, can be modified to suit the situation -it all
depends on what you include as returns and costs. The definition o
term in the broadest sense just attempts to measure the profitability
an investment and, as such, there is no one "right" calculation. For
example, a marketer may compare two different products by divid
the gross profit that each product has generated by its respective
marketing expenses. A financial analyst, however, may compare th
same two products using an entirely different ROI calculation, per
by dividing the net income of an investment by the total value of a
resources that have been employed to make and sell the product.

Net Income / Revenues or Net Profits / Sales

Profit margin is very useful when comparing companies in similar

industries. A higher profit margin indicates a more profitable comp
that has better control over its costs compared to its competitors. P
margin is displayed as a percentage; a 20% profit margin, for exam
means the company has a net income of $0.20 for each dollar of sa

Profitability Ratios

Return on Equity (ROE)

Return on Investment
(ROI)

Net Profit Margin

Sales Growth %

((Total Revenue for the current period / Total

Revenue for the last period) - 1) x 100

Yields period to period sales growth

Gross Profit Growth %

((Gross Profit for the current period / Gross

Profit for the last period) - 1) x 100

Yields period to period gross profit growth

Operating Income Growth

((Operating Income for the current period /

Yields period to period operating income growth
Operating Income for the last period) - 1) x 100

Break Even Analysis

Fixed Cost / Contribution per Unit (i.e. Price

-Variable Cost) Fixed Cost/
(Contribution/Price)

Break-even analysis is used to determine the point at which revenu

received equals the costs associated with receiving the revenue. Br
even analysis calculates what is known as a margin of safety, the
amount that revenues exceed the break-even point. This is the amo
that revenues can fall while still staying above the break-even poin
Break-even analysis is a supply-side analysis; it only analyzes the
of the sales. It does not analyze how demand may be affected at
different price levels.

Total Debt / Total Assets

A financial ratio that measures the extent of a companys or consu

leverage. The debt ratio is defined as the ratio of total debt to total
assets, expressed in percentage, and can be interpreted as the prop
of a companys assets that are financed by debt.The higher this rat
the more leveraged the company and the greater its financial risk.
ratios vary widely across industries, with capital-intensive busines
such as utilities and pipelines having much higher debt ratios than
industries like technology. In the consumer lending and mortgage
businesses, debt ratio is defined as the ratio of total debt service
obligations to gross annual income.

Debt to Equity Ratio

Total Liabilities / Shareholder's Equity

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 obligo
have committed to the company versus what the shareholders have
committed. To a large degree, the debt-equity ratio provides anoth
vantage point on a company's leverage position, in this case, comp
total liabilities to shareholders' equity, as opposed to total assets in
debt ratio. Similar to the debt ratio, a lower the percentage means
company is using less leverage and has a stronger equity position.

Gross Margin to Net Sales

%

(Gross Profit / Net Sales) x 100

Expresses Gross Margin as a percentage of Net Sales

Expenses to Revenues

(Expenses / Revenues) x 100

This ratio can be performed for total expenses or for a specific exp
account

Expenses to Net Sales %

(Expenses / Net Sales) x 100

This ratio can be performed for total expenses or for a specific exp

Break Even Analysis in

Units Break Even Analysis
in Sales $

Asset Management
Ratios

Debt Ratio

account

The DuPont Pyramid

DuPont Pyramid

Profit Margin = Profit/Sales Total Asset

Turnover = Sales/Assets Equity Multiplier =
Assets/Equity

DuPont analysis tells us that ROE is affected by three things: 1)

Operating efficiency, which is measured by profit margin 2) Asset
efficiency, which is measured by total asset turnover 3) Financial
leverage, which is measured by the equity multiplier

Profit Margin = Profit / Sales

Profit margin is very useful when comparing companies in similar

industries. A higher profit margin indicates a more profitable comp
that has better control over its costs compared to its competitors. P
margin is displayed as a percentage; a 20% profit margin, for exam
means the company has a net income of $0.20 for each dollar of sa

Total Asset Turnover = Sales /Assets

The amount of sales or revenues generated per dollar of assets. Th

Asset Turnover ratio is an indicator of the efficiency with which a
company is deploying its assets.Generally speaking, the higher the
ratio, the better it is, since it implies the company is generating mo
revenues per dollar of assets. But since this ratio varies widely fro
industry to the next, comparisons are only meaningful when they a
made for different companies in the same sector.

Equity Multiplier = Assets / Equity

The ratio of a companys total assets to its stockholders equity. Th

equity multiplier is a measurement of a companys financial levera
Companies finance the purchase of assets either through equity or
so a high equity multiplier indicates that a larger portion of asset
financing is being done through debt. The multiplier is a variation
the debt ratio. The ratio is calculated fairly simply. For example, a
company has assets valued at $3 billion and stockholder equity of
billion. The equity multiplier value would be 3.0 ($3 billion / $1
billion), meaning that one third of a companys assets are financed
equity.

Net Income - Dividends on Preferred Stock /

Average Outstanding Shares

The portion of a company's profit allocated to each outstanding sh

common stock. Earnings per share serves as an indicator of a
company's profitability. Earnings per share is generally considered
the single most important variable in determining a share's price. I
also a major component used to calculate the price-to-earnings
valuation ratio. For example, assume that a company has a net inc
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 mil
shares for the other half, the EPS would be $1.92 (24/12.5). First,
$1 million is deducted from the net income to get $24 million, the
weighted average is taken to find the number of shares outstanding
x 10M+ 0.5 x 15M = 12.5M).

Company/Investment
Valuation

Earnings Per Share (EPS)

Dividend Per Share (DPS)

Dividend (- Special Dividends) / Number of

Shares Outstanding

The the sum of declared dividends for every ordinary share issued
Dividend per share (DPS) is the total dividends paid out over an en
year (including interim dividends but not including special dividen
divided by the number of outstanding ordinary shares issued. Divi

per share are usually easily found on quote pages as the dividend p
in the most recent quarter which is then used to calculate the divid
yield. Dividends over the entire year (not including any special
dividends) must be added together for a proper calculation of DPS
including interim dividends. Special dividends are dividends whic
only expected to be issued once so are not included. The total num
of ordinary shares outstanding is sometimes calculated using the
weighted average over the reporting period. For example: ABC
company paid a total of $237,000 in dividends over the last year o
which there was a special one time dividend totalling $59,250. AB
2 million shares outstanding so its DPS would be ($237,000$59,250)/2,000,000 = $0.0889 per share.

Price Earning Ratio (P/E

Ratio)

Net Present Value (NPV)

Internal Rate of Return

(IRR)

Weighted Average Cost

of Capital (WACC)

Market Value Per Share / Earnings Per Share

A valuation ratio of a company's current share price compared to i

per-share earnings. For example, if a company is currently trading
$43 a share and earnings over the last 12 months were $1.95 per sh
the P/E ratio for the stock would be 22.05 ($43/$1.95). EPS is usu
from the last four quarters (trailing P/E), but sometimes it can be t
from the estimates of earnings expected in the next four quarters
(projected or forward P/E). A third variation uses the sum of the la
two actual quarters and the estimates of the next two quarters.The
is sometimes referred to as the "multiple", because it shows how m
investors are willing to pay per dollar of earnings. If a company w
currently trading at a multiple (P/E) of 20, the interpretation is tha
investor is willing to pay $20 for $1 of current earnings.The avera
market P/E ratio is 20-25 times earnings.

(Excel Function)

The difference between the present value of cash inflows and the
present value of cash outflows. NPV is used in capital budgeting t
analyze the profitability of an investment or project. Determining
value of a project is challenging because there are different ways t
measure the value of future cash flows. Because of the time value
money, a dollar earned in the future wont be worth as much as on
earned today. The discount rate in the NPV formula is a way to acc
for this. Companies have different ways of identifying the discoun
although a common method is using the expected return of other
investment choices with a similar level of risk.

(Excel Function)

The discount rate often used in capital budgeting that makes the ne
present value of all cash flows from a particular project equal to ze
Generally speaking, the higher a project's internal rate of return, th
more desirable it is to undertake the project. As such, IRR can be u
to rank several prospective projects a firm is considering. Assumin
other factors are equal among the various projects, the project with
highest IRR would probably be considered the best and undertake
first.You can think of IRR as the rate of growth a project is expect
generate. While the actual rate of return that a given project ends u
generating will often differ from its estimated IRR rate, a project w
substantially higher IRR value than other available options would
provide a much better chance of strong growth. IRRs can also be
compared against prevailing rates of return in the securities marke
firm can't find any projects with IRRs greater than the returns that
be generated in the financial markets, it may simply choose to inve
retained earnings into the market.

A calculation of a firm's cost of capital in which each category of

capital is proportionately weighted. All capital sources - common
preferred stock, bonds and any other long-term debt - are included
WACC calculation. All else equal, the WACC of a firm increases a
beta and rate of return on equity increases, as an increase in WACC
notes a decrease in valuation and a higher risk.

Weighted Average Cost of

Capital (WACC)

Where:

Re = cost of equity

Rd = cost of debt

E = market value of firm's equity

D = market value of firm's

debt

V=E+D

E/V = percentage of financing that is equity

D/V = percentage of

Tc = corporate tax rate

financing that is debt