Tag Archives | financial ratio

Sharpe Ratio

See Also:
Efficient Market Theory
Effective Rate of Interest Calculation
Coupon Rate Bond
Discount Rate
Federal Funds Rate Definition

Sharpe Ratio Definition

The sharpe ratio definition is the excess return or risk premium of a well diversified portfolio or investment per unit of risk. Measure sharpe ratio using standard deviation. You may also know this ratio as the reward to variability ratio or the reward to volatility ratio.

Sharpe Ratio Explained

The sharpe ratio is a good measure for investors because it allows them to distinguish the amount of reward needed per unit of risk. This allows for risk averse investors to stay away from low reward high risk situation that they are uncomfortable with. The higher the ratio the better for an investor. It is also useful in establishing the ratio efficient frontier in which an investor can build a model for several different investments and build a portfolio that is exactly equal to the desired ratio. These efficient frontier models can distinguish down to the specific weights what an investor needs to do to build the desired portfolio.

Sharpe Ratio Formula

Use the following sharpe ratio formula:

SR = E(R-Rf)
       σ

Where:

R = asset return
Rf = Risk free return
E(R-Rf) = Expected return of the risk premium
σ = standard deviation of the risk premium

Example

Tim is looking to invest in a stock that has an expected return of 12%. The risk free rate is 4%, and the standard deviation of the risk premium is 10%. Thus, the calculation is as follows:
Sharpe = (.12-.04)/.10 = .8

The .8 can be interpreted as meaning that for every unit of risk that you accept as an investor you will be taking on an additional one and a quarter amount of risk.

sharpe ratio, Sharpe Ratio Definition, Sharpe Ratio Formula

sharpe ratio, Sharpe Ratio Definition, Sharpe Ratio Formula

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Time Interest Earned Ratio Analysis

See Also:
EBITDA Definition
Debt Ratio
Financial Ratios
Fixed Charge Coverage Ratio
Debt to Equity Ratio
Long Term Debt to Total Asset Ratio Analysis
Current Ratio Definition

Time Interest Earned Ratio Analysis Definition

Time interest earned ratio (TIE), also known as interest coverage ratio, indicates how well a company can cover its interest payments on a pretax basis. The larger the time interest earned, the more capable the company is at paying the interest on its debt.

Time Interest Earned Ratio Formula

Use the following formula to calculate Time Interest Earned Ratio:

Times Interest Earned Ratio = EBIT / Total Interest

Time Interest Earned Ratio Calculation

EBIT: earnings before interest and taxes. For example, a company has $10,000 in EBIT, and $1,000 in interest payments. As a result, calculate times interest earned ratio as 10,000 / 1,000 = 10

This means that a company has earned ten times its interest charges.

Times Interest Earned Ratio Analysis

Times interest earned ratio measures a company’s ability to continue to service its debt. It is an indicator to tell if a company is running into financial trouble. A high ratio means that a company is able to meet its interest obligations because earnings are significantly greater than annual interest obligations. However, a high ratio can also mean that a company has an undesirably low level of leverage or pays down too much debt with earnings that could be used for other investment opportunities to get higher rate of return.

A lower times interest earned ratio means fewer earnings are available to meet interest payments. Failing to meet these obligations could force a company into bankruptcy. It is used by both lenders and borrowers in determining a company’s debt capacity.

Times Interest Earned Benchmarking Resources

For statistical information about industry financial ratios, please click the following website: www.bizstats.com and www.valueline.com.

time interest earned ratio analysis

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Return on Equity Analysis

See Also:
Financial Ratios
Return on Asset
Required Rate of Return
Return on Invested Capital (ROIC)
Debt to Equity Ratio
Return on Common Equity (ROCE)
What The CEO Wants You to Know How Your Company Really Works

Return on Equity Analysis

Defined also as return on net worth (RONW), return on equity reveals how much profit a company earned in comparison to the money a shareholder has invested.

Return on Equity Explanation

This term is explained as a measure of how well a company uses investment dollars to generate profits. Return on equity is more important to a shareholder than return on investment (ROI) because it tells investors how effectively their capital is being reinvested. Therefore, a company with high return on equity is more successful to generate cash internally. Investors are always looking for companies with high and growing returns on equity. However, not all high ROE companies make good investments. The better benchmark is to compare a company’s return on equity with its industry average. Generally, the higher the ratio, the better a company is.

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Return on Equity Formula

The following return on equity formula forms a simple example for solving ROE problems.

Return on Equity Ratio = Net income ÷ Average shareholders equity

When solving return on equity, equation solutions only form part of the problem. Thus, one must be able to apply the equation to a variety of different and changing scenarios.

Return on Equity Calculation

Average shareholders’ equity, or return on 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. Unfortunately, no simple return on equity calculator can complete the job that a solid understanding of ROE can.

For example, a company has $6,000 in net income, and $20,000 in average shareholders’ equity.

Return on equity: $6,000 / $20,000 =30%

In conclusion, a company that has $0.3 of net income for every dollar that has been invested by shareholder.

Return on Equity Example

Melanie, after seeing success in her corporate career, has left the comfortable life to become an angel investor. She has worked diligently to select companies and their managers, hold these managers accountable to their promises, provide advice and mentoring, and lead her partners to capitalization while minimizing risk. At this stage, Melanie is ready to receive her pay-out. Melanie wants to know her Return on Equity analysis ratio for one of her client companies.

Melanie begins by finding the net income and average shareholder’s equity for the venture. Looking back to her records, Melanie has invested $20,000 in the business. Her net income from it is $6,000 per year. Performing her return on equity analysis yields the following results:

Return on equity: $6,000 / $20,000 =30%

Melanie is happy with her results. Because she was purposeful and started small, she built the experience and confidence to be successful. She can now move on to bigger and better deals.

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return on equity analysis

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return on equity analysis

Resources

For statistical information about industry financial ratios, please go to the following websites: www.bizstats.com and www.valueline.com.

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Raise Inventory Turnover Ratio

Raise or Increase Inventory Turnover Ratio

In order to increase inventory turnover ratio for a company, it is important to understand the calculations that go into calculating the turnover ratio. Once this is achieved, a company can go about the necessary efforts to raise this ratio, increasing the overall inventory sold.

Inventory Ratio Calculation

Inventory turnover ratio calculations may appear intimidating at first but are fairly easy once a person understands the key concepts of inventory turnover.

For example, assume annual credit sales are $10,000, and inventory is $5,000. The inventory turnover is: 10,000 / 5,000 = 2 times

For example, assume cost of goods sold during the period is $10,000 and average inventory is $5,000. Inventory turnover ratio: 10,000 / 5,000 = 2 times

This means that there would be 2 inventory turns per year. That is a company would take 6 months to sell and replace all inventories.

Inventory Turnover Ratio: Example

For example, Derek owns a retail clothing store which sells the best designer attire. Derek, an avid fan of fashion, has worked in the apparel industry for quite a while and is well suited for the operations of his company.

Still, Derek has a little to learn about the business of retail clothing. He has been studying the subject with passion and wants to grow his business. From his study he has realized that inventory turnover is the key to his business.

Derek first talks to his accountant for inventory turnover ratio analysis. This requires somewhat of an expert because the matter is more complicated than the abilities simple, web-based inventory turnover ratio calculator. His accountant comes up with a figure which Derek would like to increase.

Annual credit sales are $10,000 and inventory is $5,000

The inventory turnover is: 10,000 / 5,000 = 2 times

Derek decides, from this, that he needs to make some changes. He aligns a few strategies to move his products. First, he considers marking-down styles from the previous season as each season approaches. Similarly, he considers product give-aways with minimum transaction amounts. Derek considers the option of spreading contests and deals on social networking websites. He finishes his evaluation by finding ways to turn his extra inventory into a tax write-off.

Derek is pleased because he is applying his newly found skills and knowledge to better his business. Derek looks forward to the future.

increase inventory turnover ratio

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increase inventory turnover ratio

See Also:
Inventory Turnover Ratio Analysis

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Quick Ratio Analysis

Quick Ratio Analysis Definition

The quick ratio, defined also as the acid test ratio, reveals a company’s ability to meet short-term operating needs by using its liquid assets. It is similar to the current ratio, but is considered a more reliable indicator of a company’s short-term financial strength. The difference between these two is that the quick ratio subtracts inventory from current assets and compares the quick asset to the current liabilities. Similar to the current ratio, value for the quick ratio analysis varies widely by company and industry. In theory, the higher the ratio is, then the better the position of the company is; however, a better benchmark is to compare the ratio with the industry average.

Quick Ratio Explanation

Quick ratios are often explained as measures of a company’s ability to pay their current debt liabilities without relying on the sale of inventory. Compared with the current ratio, the quick ratio is more conservative because it does not include inventories which can sometimes be difficult to liquidate. For lenders, the quick ratio is very helpful because it reveals a company’s ability to pay off under the worst possible condition.

Although the quick ratio gives investors a better picture of a company’s ability to meet current obligations the current ratio, investors should be aware that the quick ratio does not apply to the handful of companies where inventory is almost immediately convertible into cash (such as retail stores and fast food restaurants).

Quick Ratio Formula

The current ratio formula is as follows:

Current ratio = (Current assets – Inventories) / Current liabilities

Or = Quick assets / Current liabilities

Or = (Cash + Accounts Receivable + Cash equivalents) / Current liabilities


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quick ratio analysis

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quick ratio analysis

Resources

For statistical information about industry financial ratios, please go to the following websites: www.bizstats.com and www.valueline.com.

See Also:
Balance Sheet
Working Capital
Current Ratio Analysis
Financial Ratios
Quck Ratio Analysis Benchmark Example

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Quick Ratio Analysis Benchmark Example

Quick Ratio Analysis Benchmark Example

Quick ratio calculation is a useful skill for any business that may face cash flow issues. Furthermore, quick assets include those current assets that presumably can be quickly converted to cash at close to their book values. It normally includes cash, marketable securities, and some accounts receivables.

Current liabilities represent financial obligations that come due within one year. It normally included accounts payable, notes payable, short-term loans, current portion of term debt, accrued expenses and taxes.

For example, a business has $5,000 in current assets, $1,000 in inventories and $2,500 in current liabilities.

Quick ratio = (5,000 – 1,000) / 2,500 = 1.6

Since we subtracted current inventory, it means that for every dollar of current liabilities there are $1.6 of easily convertible assets.

Quick Ratio Example

The following is a quick ratio analysis benchmark example. Suzy has started a boutique-style bakery which is mainly servicing customers who desire wedding cakes. Suzy, who works in a trade which she is truly passionate about, is by no means an expert in financial statements. She is, however, an expert in the operations of her business. She knows that if she wants to scale, something that her customers are driving her to as much as her own desires for financial success, she needs a partner who can provide the business expertise. About the time she realizes this Suzy meets Monica, an experienced restauranteur. The two women quickly develop a rapport. Suzy learns that Monica is looking for a new deal and communicates her needs over lunch. They resolve, after a testing period, to support each other by applying their expertise to Suzy’s business. The two women become partners.

Calculation

Monica knows that lack of cash is one of the main reasons that causes any business, especially in food-service, to close doors. As Monica takes her initial look at the financial statements of the business she keeps this in mind.

Monica wants to know if the company can pay its debts. Due to the fact that the business desperately needs all inventory to continue scaling, she resolves to use quick ratio vs current ratio calculation. Since there is no quick ratio accounting calculator, she performs this calculation:

If:

Current Assets = $5,000 Inventory = $1,000 Current Liabilities = $2,500

Quick ratio = (5,000 – 1,000) / 2,500 = 1.6

This means that for every dollar of current liabilities there are $1.6 of easily convertible assets.

This is a major relief to Monica. Finishing her analysis of the company statements Monica feels very confident. As long as employee turnover remains the same the two women have avoided two of the most important issues a business could face.

quick ratio analysis benchmark example

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quick ratio analysis benchmark example

See Also:

Quick Ratio Analysis

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Retail Markup Example

See Also:
Margin vs Markup

Retail Markup Example

Max owns a retail store called Retailco. Retailco sells clothing as well as other items common to department stores. Max’s company has just opened their doors and is still finding a place in the market. As a result, some of the essential financial ratios have not been calculated yet. Max would like to calculate his retail markup for his various selling items so that his new business can determine the retail actual retail price of the products that they are selling. These markups will serve as benchmarks for the rest of the business team in an effort to show the company’s likelihood of success. Achieve these efforts by estimating the total amount of profits by comparing the retail price of the products with the overall spending and costs of the company.

(NOTE: Want the Pricing for Profit Inspection Guide? It walks you through a step-by-step process to maximizing your profits on each sale. Get it here!)

Recently, the amount of profit made on the average pair of women’s jeans has come into question. Max, from working in the industry for years, has an intuition that he is making a profit on these products. Still, he needs to prove this to the rest of his company. Personally, he also wonders what is standard retail markup for a department store just like his.

Calculating Retail Markup

Max initially searches Yahoo for the term “retail markup calculator”. Though he does not find a function to provide his calculation, he does find a formula which will serve the purpose. Max will utilize the formula known as the retail markup formula. Because this formula takes the retail price of the cost to produce a unit of product and subtracts that price from the retail price of the product, what is left is a retail markup price.

Max sells the average pair of jeans for $15. His cost of goods sold on each unit is $10. Max uses the retail markup formula to calculate the retail markup average on his pair of jeans:

$15 – $10 = $5

Knowing his retail markups will help him to build confidence and courage in his team. He resolves to find retail markups for all of his products. As a result, he finds that this amount is standard with industry expectations.

Additionally, the retail markup percentage is calculated by taking the retail markup and dividing the value by the unit cost of the product. The fraction that remains after the calculation is known as the retail markup percentage. To learn how to price for profit, download our Pricing for Profit Inspection Guide. Easily discover if your company has a pricing problem and fix it!

Retail Markup Example

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Retail Markup Example

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