Tag Archives | financial ratio

Price to Sales Ratio Analysis

See Also:
Price Earnings Ratio
Price to Book Value Ratio
Financial Ratios

Price to Sales Ratio Analysis Definition

Price to sales ratio (PSR ratio) indicates how much investor paid for a share compared to the sales a company generated per share. It measures the value placed on sales by the market. A higher ratio means that the market is willing to pay for each dollar of annual sales. In general, the lower the P/S, the better the value is. However, the value of the ratio varies across industries. A better benchmark is to compare with industry average.

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Price to Sales Ratio Formula

Price to sales ratio = Market price per share ÷ Sales per share

Or = Market Cap ÷ total sales

Price to Sales Ratio Calculation

Example: assume $20 in market price per share and $5 in sales per share.

Price to sales ratio = 20 / 5 = 4

This means that investors pay $4 for every dollar of sales that a company generates.

Applications

Price to sales ratio values a stock relative to its historical performance, market competitors or general market. In general, a low price to sales ratio means a good investment because investors are paying less for each unit of sales. However, price to sales sometimes provide very limited information because it does not take into account any expenses or debt and a company with high sales maybe unprofitable.

Resources

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

To learn how to price for profit, download our Pricing for Profit Inspection Guide.

Price to Sales Ratio Analysis

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Price to Sales Ratio Analysis

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Price Earnings Growth Ratio Analysis

See Also:
Financial Ratios
Price Earnings Ratio
Compound Annual Growth Rate (CAGR)

Price Earnings Growth Ratio Analysis Definition

Price earnings growth ratio (PEG ratio) expresses the relationship among current stock price, a company’s earning per share, and earnings expected future growth. Similar to the Price earnings ratio, the lower the PEG, the more undervalued the stock is.

Price Earnings Growth Ratio Formula

Use the following formula to calculate price earnings growth ratio:

Price to sales ratio = Price per earnings ÷ Annual EPS growth

Calculation

Calculate the annual growth rate of earning for a company by the average annual growth rate over the past 5 years excluding extraordinary items.

For example, a company has a P/E of 20 and is estimated its earnings will grow 20% annually.

PEG ratio = 20 / 20 = 1

Applications

PEG is an indicator of a stock’s potential market value. So, use it to discover stocks with high growth potential while trading at a premium. In general, the value of 1 is considered a sign of good value. However, different industries trade at different PEGs. Furthermore, it is always better to compare a company to its peers group to get more useful information. The weakness of PEG ratio is that it may provide limited information since it relies heavily on earnings estimates.

Price Earnings Growth Ratio Analysis

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Price Earnings Growth Ratio Analysis

Resources

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

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Overhead Rate

See Also:
Discount Rate
Overhead Expense Reduction
When is an interest rate not as important in selecting a loan?
Required Rate of Return
Predetermined Overhead Rate
Outstanding Debt

Overhead Rate Definition

Overhead rate, defined as an expression of overhead costs which are displayed across periods, is an essential function for a business which must manage cash carefully because of overhead costs. It compares cost to productivity to yield a final rate which can be used to compare efficiency to cost. The objective is to have an rate of overhead which decreases each period, ideally. This rate can be expressed as overhead rate per hour, overhead rate per unit, per month, per period, and more.

Overhead Rate Explanation

Overhead rate means, very specifically, overhead cost divided by the main factor of productivity in work. This factor can be labor hours, labor cost, machine hours, or another measure. All-in-all, overhead rate analysis evaluates whether a company is making value of the overhead costs it incurs or whether productivity must be increased to sustain firm value.

This rate of overhead, to indicate increased efficiency in the production of a company, should decrease. This shows that either overhead cost is decreasing or productivity, keeping a standard overhead, is increasing. Though a firm would prefer to have both at optimal levels it can experience increased value with a positive change in either.

Exceptions to the above paragraph exist. If the rate of overhead is increasing because of a plant expansion it may not be a negative indication. Additionally, if labor hours or cost are increasing while a company experiences a decrease in productivity then the overhead rate variance might appear favorable though it is not. Critical thinking skills are required to make sense of the any of the financial ratios in a company.

Overhead Rate Formula

The formula is quite simple. For a company to calculate overhead, the most difficult task is to keep pristine records of cost and production. From these, the overhead rate equation is a matter of simple division.

Overhead rate = Overhead cost / productivity (labor hours, labor cost, machine hours, etc.)

Overhead Rate Calculation

Once the proper data is available overhead rate calculations are quite simple.

If:
Overhead Cost = $5,000
Labor Cost = 100

Rate of Overhead = $5,000 / 100 = 50

Overhead Rate Example

For example, John is the chief operating officer of a plant which produces chemicals for pharmaceutical companies. John runs a “tight ship” in his plant: he knows what factors are important and sets achievable goals to increase productivity. To balance this, he is a caring manager who motivates the best of those who he works with.

John spends 1 day each month looking over the important measurements and research which tell him the productivity of his plant. This gives John a solid understanding of his plant from a perspective which he may not have seen.

Overhead Rate Direct Labor Cost Calculation

John decides to calculate overhead rate direct labor cost to evaluate the plant. He performs this calculation:

If:
Overhead Cost = $5,000
Labor Cost = 100

Rate of Overhead = $5,000 / 100 = 50

John compares this to the overhead rate of 52 from last month. He then digs deeper to find that labor productivity has decreased, showing a false decrease in overhead rate per direct labor cost.

John talks with the employees and finds that many are distressed by a recent injury at the plant. A young lady, new to the plant, has slipped on a spilled liquid and injured herself. This liquid was accidentally spilled by a coworker. John believes this may have caused a decrease in morale which has caused labor efficiency to decline.

Create a Plan

John creates a plan to revamp safety procedures at the plant. He sends the plan off to the CFO of the plant and finds that this will not be excessively expensive to implement. He then gets confirmation from the board of directors to try his plan.

John is not sure if this will increase employee morale. Despite this, John moves forward with the plan. In 2 months time, if labor efficiency has not returned to original levels, then he will attempt to fix the problem another way. With a foundation of research and proper management John, unsure of this plan, is sure that he can achieve his goal.

If you want to find out more about how you could utilize your unit economics to add more value to your organization, then click here to download the Know Your Economics Worksheet.

Overhead Rate

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Overhead Rate

 

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Operating Profit Margin Example

See Also:
Operating Profit Margin Ratio Analysis

Operating Profit Margin Example

In an operating profit margin example, Bill is the founder and CEO of a retail store called Shopco. Shopco recently took a loan. Shopco has experienced a dip in sales, because of the recession, and wants to make sure they can keep net operating profit margin ratio above the limit in their loan agreement. If not, Shopco may have their loan revoked. Shopco decides to prepare for this scenario by looking at their books and finding all relevant numbers. Bill then performs the calculation below.

Revenue $ 1,000,000 Cost of Goods Sold $ 500,000 Gross Margin $ 500,000 Operating Cost $ 250,000 Interest Expense $ 25,000 Operating Profit $ 225,000 Operating Profit Percentage 22.5%

Shopco was required by the bank to maintain an operating profit margin about 10%. After performing the calculation Bill now knows that his operating profit margin ratio calculation is above this. Bill feels very relieved. He also now has the confidence to survive through his time of difficulty.

Operating Profit Margin Meaning

The meaning of operating profit margin varies slightly, although the basics stay the same across all industries. This makes it a common and important metric. Operating profit margin ratio analysis measures a company’s operating efficiency and pricing efficiency with its successful cost controlling. The higher the ratio, the better a company is. A higher operating profit margin means that a company has lower fixed cost and a better gross margin or increasing sales faster than costs, which gives management more flexibility in determining prices. It also provides useful information for investors to determine the quality of a company when looking at the trend in operating margin over time and to compare with industry peers.

There are many ways for a company to artificially enhance this ratio by excluding certain expenses or improperly recording inventory. Revenues may also be falsified by recording unshipped products, recording sales into a different period than they actually occurred, or more. Usually, it serves more as a general measurement than a concrete value.

To learn how to price for profit, download our Pricing for Profit Inspection Guide.

Operating Profit Margin Example

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Operating Profit Margin Example

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Operating Profit Margin Ratio

See Also:
Operating Profit Margin Ratio Example
Net Profit Margin
Operating Income (EBIT)
Financial Ratios
Gross Profit Margin Ratio Analysis
Interest Expense

Operating Profit Margin Ratio

The operating profit margin ratio indicates how much profit a company makes after paying for variable costs of production such as wages, raw materials, etc. It is also expressed as a percentage of sales and then shows the efficiency of a company controlling the costs and expenses associated with business operations. Furthermore, it is the return achieved from standard operations and does not include unique or one time transactions. Terms used to describe operating profit margin ratios this include the following:

Operating Profit Margin Formula

In order to calculate the operating profit margin ratio formula, simply use the following formula:

Operating profit margin = Operating income ÷ Total revenue

Or = EBIT ÷ Total revenue

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

Operating Profit Margin Calculation

The operating profit margin calculations are easily performed, including the following example.

Operating Income = gross profit – operating expenses

For example, a company has $1,000,000 in sales; $500,000 in cost of goods sold; and $225,000 in operating costs. In conclusion, operating profit margin = (1,000,000 – 500,000 – 225,000)= $275,000 / 1,000,000 = 27.5%

In conclusion, this company makes $0.275 before interest and taxes for every dollar of sales.

If you want to learn how to price profitably, then download the free Pricing for Profit Inspection Guide.

Operating Profit Margin Ratio

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Operating Profit Margin Ratio

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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Operating Income Example

See Also:
Operating Income (EBIT)

Operating Income Example

For example, Marilyn is the CEO of a company which creates educational children’s toys. Marilyn loves her work and truly knows her business. With the support of her family and local bank Marilyn has taken her idea from startup to success in only 3 years. Pleased with her achievement, she wants to maintain what she has created.

Marilyn has come upon the bank period for the loan she has taken to start her business. She is almost finished with paying her liability and wants to make sure she exits the deal on good terms. Marilyn needs to make sure all of the financial ratios in her loan agreement are satisfactory in the view of her bank. This mainly revolves around her company operating margin.

Marilyn contacts her accountant. She needs to access her financials in order to find her EBIT to assure it is complaint with the loan covenant. Her company results are listed below:

$1,000,000 in revenues; $250,000 in cost of goods sold; and $100,000 in operating expenses.

EBIT = $1,000,000 – ($250,000 + $100,000) = $650,000

Marilyn then reviews her paperwork with the bank. She finds that she is complaint with their requirements and will soon be able to complete both interest and principal payments. She is extremely relieved because she is lifting a huge weight off of her shoulders. Additionally, she is in good standing with the bank and could use them as a source for capital to grow her business further. She is excited about what the future holds for her experience as an entrepreneur.

Operating Income Calculation

Operating income calculations simply involve addition and subtraction. When performed properly they serve great value with a relatively little amount of effort.

Example: A company has $1,000,000 in revenues; $250,000 in cost of goods sold; and $100,000 in operating expenses.

EBIT = $1,000,000 – ($250,000 + $100,000) = $650,000

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Operating Income
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Operating Income

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Operating Income (EBIT)

See Also:
Operating Income Example
EBITDA Definition
Net Income
Free Cash Flow
Operating Profit Margin Ratio
Time Value of Money (TVM)

Operating Income (EBIT) Definition

What is operating income? Earnings before interest and tax, also know as operating income (EBIT), is defined as a measure of a company’s profit from ordinary operations, excluding interest and tax. EBIT is also called net operating income, operating profit, or net operating profit. Calculate it using the following equation: revenues minus cost of goods sold (COGS) and other operating expenses.


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What is Operating Income? Operating Income Explanation

Operating income is a measure of company operations. It is also one of the most common financial ratios used for valuing a company as a whole. Therefore, it is very valuable, as well, as a measure of the success of a company from period to period. Additionally, it is the measure of the ability of a company to cover costs and make profit. Operating income ratios leaves out interest and taxes, so it does not serve as a net value of the wealth created from a business. More, it is a general tool used to evaluate the operating process and efficiency which ultimately lead to company profits.

One of the overall advantages of using operating income (EBIT) over other financial ratios is in the simplicity and standardization of calculation. Though interest and taxes play an important role in the financial health of a company they do not, generally, make or break the model for success. When evaluating operating income vs net income, ask whether you need a measurement of company operations as a whole or company operations as they lead to profit.

Operating Income Formula

The operating income formula provides a simple calculation for evaluating common business models. Calculating this equation is fairly simple when one has the three following values: revenues, cost of goods sold, and operating expenses.

Operating Profit = Revenues – (COGS + Operating Expenses)

Now, you know your operating income which is an important factor of valuing a company. If you’re looking to sell your company, then download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your value.

Operating income (EBIT), What is Operating Income

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Operating Income (EBIT), What is Operating Income

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