FMAccounting.com » Ratio Analysis

What is Price-to-cash flow ratio? How useful is this ratio?

slang — Mon, 12 Apr 2010 08:32:52 +0000

MARKET RATIO: Price-to-cash flows-ratio

One of the business ratio analysis which we often come across is the Price-to-cash flow ratio.

Append below in summary what is this market ratio is all about:-

Ratio	Purpose	Formula
Price-to-cash flow ratio	To measure whether a company’s share price is high or low in the context of its cash flow. Useful as it indicates the company’s market value plus enabling competitor analysis among companies. Important as this ratio can also indicate the future financial health of a company	Price-to-cash flow ratio =Share price/Cash flow per share{ Cash flow per share = (Operating cash flow-preferred dividend)/Number of common shares outstanding
Simple illustration:
ABC Ltd has share price as $20 per share and its cash flow per per share is $10.ABC Ltd’s price-to-cash flow ratio =20/10=2Its indicates how much an investor will paid for its $1 of cash flow generated by the company i.e. $2 in stock.
Interpretation: The lower the price-to-cash flow ratio means the more the company may be undervalued which poses good opportunity for investment.
Salient points to note: This business ratio is useful as it does not need to go through the process of using net income less depreciation and amortization charge The disadvantages is that cash flow is not static and different industries are associate with different price-to-cash flow level Note that to be comparable the price-to-cash flow ratio should be used in companies which sells similar products and services A related ratio is the price-to-free cash flow which is cash that is available to benefit the shareholders and after deducting capital expenditures from operating cash flow. This price-to-free cash flow ratio shows how much investors must pay for each $1 of free cash flow)

What is Price-to-sales ratio? How useful is this market ratio?

slang — Mon, 12 Apr 2010 03:25:09 +0000

Market ratio: Price-to-sales-ratio

One of the business ratio analysis which we often come across is the Price-to-sales ratio.

Append below in summary what is this market ratio is all about:-

Ratio	Purpose	Formula
Price-to-sales ratio	Measures the relationship between the value of stock and the level of company. PS: note that sales volume is an operating activity of a company	Price-to-sales =Current share price/ Revenue per shareOrPrice-to-sales =Market Capitalization/Annual revenue
Simple illustration:
ABC Ltd has:-Its current share price is $20 and the revenue per share is $10.ABC Ltd’s price-to-sales ratio =20/10=2-
Interpretation: Generally, a low Price-to-sales ratio indicates that a company has better value. In another word, if a company’s price-to-sales ratio is high, the investor is paying more for the company’s sale than if the business market ratio is low.
Salient points to note: This business ratio is ideal for computing the value of a company with no earnings history.In the past, this ratio being frequently used for internet based companies which has no or low earnings records as earning per share, etc cannot be used effectively. The underlying assumption of this price-to-sales ratio is that profits will be made once market share is established. A few considered this as a good business ratio as sales statistics are difficult to manipulate. Unfortunately, nowadays, we also see many public listed companies manipulating their sales figures as the sales figure also form one part of the key performance metric/KPA/KPI.

What is Price-to-book ratio? How Useful is this ratio?

slang — Sun, 11 Apr 2010 12:30:03 +0000

MARKET RATIO:Price-to-book ratio

One of the business ratio analysis which we often come across is the Price-to-book ratio.

Append below in summary what is this market ratio is all about:-

Ratio	Purpose	Formula
Price-to-book ratio (P/B ratio)	Measures the value that the stock market places on a company relative to its book value. Also known as price-equity ratio Frequently used by investors to find undervalued companies	Price-to-book =Current share price/ Book value per share{ Note:(a) Book value= total assets-( liabilities + intangible assets)(b) Book value per share=Book value/ No of common shares outstanding }
Simple illustration:
ABC Ltd has:-Total assets of $100,000: Liabilities & Intangible assets of $50,000. There are currently 10,000 ABC Ltd’s shares outstanding and the market price for one share is $2.00ABC Ltd’s book value per share=($100,000-$50,000)/10,000=$5P/B ratio of ABC Ltd =5.00/2.00=2.5
Interpretation: Generally, a high P/B indicate that a company is overvalued and a low P/B ratio an undervalued company.
Salient points to note: This business ratio is relatively simplistic High P/B might not mean overvalue as the public might view the company’s future are good and earning potential is high Also, in bull market, normally high P/B but during bear markets P/B be similar re: nearer to 1 Also be aware that some consumer and service orientated companies have negative P/B ratio because they have relatively more liabilities than assets This ratio cannot be used singly and should analyzed together with other financial measurements like return on equity, etc and also cash flow and volatility of earnings must be considered too.

Asset Quality –Earnings Coverage

slang — Thu, 26 Apr 2007 07:25:02 +0000

To assess the Asset Quality of Banks/Financial Institutions, the following ratios need to be analyzed:

Loans Loss
Non-performing loans to total loans
Loan Recoveries ratio
Loan Loss Reserves
EARNINGS COVERAGE
Capital Adequacy
1. Capital Formation Ratio
2. Capital to Assets Growth
3. Gross Capital to Average Assets plus Reserves

Ratio

Purpose

Formula

Earnings Coverage Ratio

Measures the level of earnings and the charge to income against the actual net charge offs and

Provides a measurement of the bank’s earnings cover to actual loan losses.

Total Net Operating Income+ Provision for loan losses ———————— Net Write Offs

Illustration: Details of ABC Bank:

Net Operating Income for Year 2006	$8,000 m
Provision for Loan losses	$1,000m
Net Loans Write Off	$ 2,000m
Earning Coverage Ratio	= 8,000/2,000= 4.0 times

Interpretation: For ABC Bank, its earning is adequate to cover the amounts written off.
The earnings coverage ratio is very important.Normally, when the earnings coverage is equal to or below 3 times, it’s high time to examine and determine the reason(s).

Asset Quality – Adequacy Of Loan Loss Reserves

slang — Thu, 26 Apr 2007 07:17:54 +0000

To assess the Asset Quality, the following ratios need to be analyzed:

Loans Loss
Non-performing loans to total loans
Loan Recoveries ratio
LOAN LOSS RESERVES
Earnings coverage
Capital Adequacy
1. Capital Formation Ratio
2. Capital to Assets Growth
3. Gross Capital to Average Assets plus Reserves

ADEQUACY OF LOAN LOSS RESERVE

Ratio

Purpose

Formula

Loan Loss Reserve Ratio

To check whether the bank, in comparison with other banks, is making adequate provision for losses.

Reserves For Loan Losses —————————-

Total Loans

Illustration: Simple Illustration: Details of ABC Bank:

Total Loans	$200 m
Loan Losses Reserve for 2006	$ 8m
Loan Loss Reserve Adequacy Ratio	= 50/300= 4%

Interpretation:If reserves deteriorate as a result of large write offs, perhaps in excess of the provision for loan losses made in the year, then the quality of the assets will be impacted.It is not always possible to state whether this is adequate, since it depends on the quality of the assets, industry concentration of loans and the write off history of the bank.

Defensive Interval

slang — Thu, 26 Apr 2007 06:49:50 +0000

One interesting liquidity ratio is the defensive interval which reflects theoretically how long the company can survive or defend itself in terms of its available cash plus cash equivalent ( most liquid cash) versus its daily cash operating requirement.

Ratio	Purpose	Formula
Defensive ratio	Used to indicate the number of days a company could theoretically remain in business without additional sales or new loans ( financing)	Average daily cash expenditure for operating expenses ————————– Company’s most liquid assets
Note: Most liquid assets =cash + cash equivalents
Illustration: ABC Ltd:Annual operating expenses = $365,000 per annum Current cash & cash equivalents as follows: Cash 60,000 Fixed deposits less than three months 140.000 Marketable securities 100,000 300,000 Defensive ratio =Average daily cash operating expenses/ Most liquid assets =$365,000/365 =$1,000 Daily operating expenses = Annual operating expenses/365 days =$365,000/365=$1,000,00 Defensive Interval = Average =$300,000/$1,000=300 days
Interpretation: What it means is that ABC Ltd can continue to be in business without any trade-related activity (additional sales) or new funding (new loans) for 300 days.

Asset Quality-Non Performing Loans To Total Loans

slang — Thu, 26 Apr 2007 05:27:31 +0000

To assess the Asset Quality of Banks/Financial Institutions, the following ratios need to be analyzed:

Loans Loss
NON-PERFORMING LOANS TO TOTAL LOANS
Loans Recoveries Rate
Loans Loss Reserve
Earnings coverage
Capital Adequacy
1. Capital Formation Ratio
2. Capital to Assets Growth
3. Gross Capital to Average Assets plus Reserves

NON-PERFORMING LOANS TO TOTAL LOANS

Ratio	Measure	Formula
Non Performing Loans To Total Loans	· helps determine the quantum of non-performing loans in the total loans portfolio.· It also gives an idea of the quality of the loan portfolio and an indication of possible loan losses in the future	Non Performing Loans ———————————-Total Loans

Simple Illustration:

Details of ABC Bank:

Total Loans	$600 m
Non Performing Loans	$ 30m
Non Performing Loans to Total Loan Ratio	= 30/600= 5%

The ratio is normally below 3%. It is important to use inter-bank/financial institutions comparison before proper conclusion is drawn.

More importantly, if we find this ratio is high next is that we should examine the reasons for such a large number of non-performing loans.

Asset Quality-Loans Loss

slang — Thu, 26 Apr 2007 05:07:59 +0000

To assess the Asset Quality of Banks/Financial Institutions, the following ratios need to be analyzed:

LOANS LOSS
Non-performing loans to Total Loans
Loans Recoveries Ratio
Loans Loss Reserves
Earnings coverage
Capital Adequacy

Capital Formation Ratio
Capital to Assets Growth
Gross Capital to Average Assets plus Reserves

LOANS LOSS:

Poor asset quality is reflected in the loans written off or loans loss ratio, the greater the losses, the poorer the quality of the assets.

Ratio	Measure	Formula
Loans Loss	· To give an analyst an idea of the quality of the assets of the bank.· If this ratio is low, it suggests that a bank has a reasonably sound portfolio and is able to recover its losses.	Net write offs ——————– Average loans

Simple Illustration:

Details of ABC Bank:

Bank has an average loan	$900 m
During the year loans written off	$ 25m
During the year loans recovery	($ 1m)
Loans Loss Ratio	= (25-1)/900= 2.7%

On average most banks should have a loan loss ratio lesser than 0.5 %. The loss ratio of ABC Bank is very high and reflects badly on asset quality

Asset Quality Of Banks And Financial Institutions- Introduction

slang — Thu, 26 Apr 2007 03:59:05 +0000

One of the fundamental reasons for a bank/financial institution to collapse is its poor asset quality namely giving out bad or poor credit standard loans Not even foreign exchange exposure, deposits, maturity mismatches and open positions can hit it so hard to cause a bank/financial institution to collapse ! When a bank/financial institution get too aggressive with its lending policy, it might get saddled with questionable loans. So can we name those questionable loans? This includes the following:

Bad loans can accumulate when loans are given to owners or insiders far in excess of their entitlement or ability to repay or on the basis of misrepresentations made.
Loans that the financiers are not prudent to see that they are lending to companies that have bad management and understated liabilities
Loans to companies that experience certain industry downturns
Loans given to politicians and high powered figures

So how do we examine poor asset quality/bad loans: the following are suggested:-

· Reviewing critically the number of loans given to directors or others connected with the bank or to companies or business in which the directors or the management have an interest.

· Determining whether loans have been given to politicians, bureaucrats or politically motivated reasons.

· Breaking down loans to industries or to geographical areas. In times of recession, a concentration of loans to an industry undergoing a difficult period would be potentially dangerous

In the forthcoming articles, we shall look at some Financial Ratios to assess the Asset Quality of Banks and or Financial Institutions

Market Value Added (MVA)

slang — Sat, 24 Mar 2007 15:57:03 +0000

Earlier, the market/book ratio has been mentioned now we look at another useful market based ratio which is known as the Market value added ( MVA).

MVA is the difference between the market value of the company and the total capital invested in the company.

The formula of MVA is =

market capitalization ( number of equity shares issued x market price per share )

less:

net worth ( share capital + reserves – accumulated losses)

The main purpose of this MVA ratio gives an indication of how the market perceives the company’s future EVA (economic value added). Naturally, the higher the value added, the more in demand the company’s shares.

Simple illustration:

On 30 th April 2006,Company A Ltd has the following details:

(a) 500,000 shares @ $10 each issued;

(b) market price per share =$22

To compute the MVA of Company A Ltd

firstly need to compute:

(a)Market capitalization=500,000 shares x$22 =$11.0m

(b) Net worth ( share capital($5m)+reserves($3.5m)+losses(-$2m) =$6.5m

MVA=

Market capitalization – net worth = $11.0 -$6.5m =$4.5m