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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.

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.

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

Market To Book Ratio

slang — Sat, 24 Mar 2007 15:40:25 +0000

One of the essential ratio to investors and analysts is the market to book ratio.

This ratio expresses the relationship between a company’s value in the stock market and the net asset value as per the company’s balance sheet.

The formula is = market price per share/book value per share.

The purpose of this ratio is to indicate the value investors place on the company. To a certain extent, this ratio can reflects that the company’s assets are undervalued.

Simple illustration:

In 2006, Company A’s market price per share =$2.20

The book value of its share was $2.00

It’s market/book ratio

=$2.20/$2.00 =1.10

which means that the company’s value in the market place is 10% higher than its actual book value.

So what might this ratio reveals:

it might indicates that the company’s assets are understated/undervalued and

its prospects are good and investors believe that its earnings and value would grow

The market/book ratio summarizes investors’ views on the company’s performance and its future prospects. This is done when the investors decide the rate(price) for a business and they mark the share price at a premium or discount depending on whether the return is more or less.

Ratio Analysis Of A Company

slang — Wed, 21 Mar 2007 16:31:33 +0000

The following are the articles written in relation to Ratio Analysis of a Company:

Assessing the Liquidity Of A Company

Assessing the Profitability Of A Company

Assessing The Activity Of Assets Utilised

Assessing The Leverage Or Gearing Of A Company

Assessing The Market Value Of A Company

Using Altman-Z-System To Forecast Company’s bankruptcy

Innovative/ A better Way of Looking At Gross-Margin

Price Earnings Ratio – A Very Useful Ratio To Understand

Which Financial Ratios Have The Most Value

What Other Factors Beyond Ratios Need To Be Considered

Gearing-determinants-its-advantages-and-disadvantages

Ratio-Analysis-Existing and Potential Net Tangible Asset Basis-NTA

Common Size Financial Statements As An Analytical Tool.

slang — Wed, 21 Mar 2007 15:27:31 +0000

Using common size methodology to analyze the financial statements like the Income Statement and Balance Sheet are extremely useful as it removes bias particularly when the companies are of differing sizes. Common financial statements enable us to do easy analysis between companies or between time periods of a company.

It allows us to analyze the company over various time periods, revealing, for example, what percentage of sales is cost of goods sold and how that value has changed over time or what percentage of total assets is inventory/receivables and how that value has changed over time.

So what is really common size financial statements?

Common size methodology is simply displaying or formatting all items whether in the balance sheet or income statement as percentages of a common base figure.

In the case of an income statement, the common base is the revenue whilst in the balance sheet it can be the total assets/total liabilities.

Common size financial statement is one of the principal tools used in ratio analysis as most firms don’t report their statements in common size, it is beneficial to compute if we want to analyze two or more companies of differing size against each other.

Let’s look at a simple Income Statement – a normal one and then compared with a Common size :

A normal Income Statement

In Thousand(‘000)	Year 2006	Year 2005
Sales	15,000	11,000
COGS	10,000	8,000
Gross Profit	5,000	3,000
Operating Costs	1.000	1,100
Operating Profit	4,000	1,900
Other Incomes	100	50
Profit Before Tax	4,100	1,950

Translated into a Common Size Income Statement

Line		Year 2006	Year 2005	Year 2006	Year 2005
	Revenues	15,000	11,000	100.0%	100.0%
	COGS	10,000	8,000	66.7%	72.7%
1	Gross Profit	5,000	3,000	33.3%	27.3%
2	Operating Costs	1.000	1,100	6.6%	10.0%
	Operating Profit	4,000	1,900	26.7%	17.3%
3	Other Incomes	600	50	4.0%	0.5%
	Profit Before Tax	4,600	1,950	30.7%	17.8%

After the re-format / display into common size income statement, we can see how the various components of the income statement affecting the company’s profit.

Line (1) – gross profit have improved from 27.3% in 2005 to 33.3% – why?

Line (2) - operating costs also improved from 10% to 6.6% – why?

As a result now we know what caused the improvement in operating profit

But what is this “ other incomes” under Line 3 from a meager 0.5% have rose to 4.% of total revenues?

Is it common for this type of company to have such high other income – is it exceptional re: one time affair which might distort the profit before tax.

If we want to delve further, we should go into details into the operating cost (line2) or we can put up a detailed financial statement for inter-companies comparies.

Next what about the common size Balance sheet :

With a common-size balance sheet that displays all items as percentages of a common base figure like total assets, it assist us to perform analysis between companies or between time periods of a company.

Simple Illustration:

A normal Balance Sheet

In Thousand(‘000)	Year 2006	Year 2005
Cash	2,000	1,200
Inventory	3,300	2,000
Receivables	4,,500	2,000
Investments	2,000	1,500
Total Assets	11,800	6,700

Translated into a Common Size Balance Sheet

Line	In Thousand(‘000)	Year 2006	Year 2005	Year 2006	Year 2005
1	Cash	1,000	3,200	8%	48%
2	Inventory	4,300	1,000	36%	15%
3	Receivables	4,500	1,000	39%	15%
4	Investments	2,000	1,500	17%	22%
5	Total Assets	11,800	6,700	100%	100%

The above illustrates the difference between a regular balance sheet and a common size balance sheet.

Salient points:

o In the normal balance sheet, account values are expressed in dollar terms, while

o in the common size one, each value is listed as a percentage of total assets.

o This is also done for liabilities, where each liability account is a percentage of total liabilities

Reviewing the common sized balance sheet, line 1-3 showed a drastic decline of holding cash and more investments into inventory and receivables.

Principal Tools Of Analysis Of Financial Statements

slang — Wed, 21 Mar 2007 15:21:43 +0000

This article deals with the following principal tools that we can used to analyze the financial statement:

Comparative Financial Statements – Year to year changes
Index Number Trend Series
Specialized Analysis
Common – Size Financial Statements
Ratio Analysis

1. Comparative financial statements -Year to year changes

This analysis is very commonly used however there are certain basic rules we need to understand/avoid:

Rule No.1:-

when a negative amount appears in the base year and a positive amount in the following year or vice versa no percentage change can be meaningfully computed.

Rule No.2:-

When an item has a value in a base year and none in the following period, the decrease is 100 percent.

Rule No. 3:-

Where there is no figure for the base year, no percentage change can be computed.

Simple Illustration:

Year 1 Year 2 $ %

Net income/(loss) (4,500) 1,500 6,000 -

Tax expense 2,000 (1,000) (3,000) -

Notes payable - 8,000 8,000 -

Notes receivable 10,000 - (10,000) (100)

Next, we move to the second method which is the

Index-Number Trend Series

When a comparison of financial statements covers more than 3 years method no 1- Year to year method of comparison may become too cumbersome.

The best way to effect such longer-term trend comparison is by means of index numbers.

The computation of a series of index numbers requires the choice of a base year that will, for all items, have an index amount of 100. since such a base year represents a frame of reference for all comparisons, it is best to choose a year that, in a business condition sense, is as typical or normal as possible. If the earliest year in the series compared cannot fulfils this function , another year is chosen.

As is the case with the computation of year-to-year percentages changes, certain changes, such as those from negative to positive amounts, cannot be expressed by means of index numbers. All index numbers are computed by reference to the base year.

In planning an index-number trend comparison, only include the most significant item.

Care should be exercised in the use of index-number trend comparisons because such comparisons have weaknesses as well as strength.

For the specialized analysis method, this includes like:-

Cash forecasts
Analysis of changes in financial position
Statement of variation in gross margin
Breakeven analysis

The forthcoming articles deal with in details the Common-Size Financial Statements and Ratio Analysis ( Companies And Banks & Financial Institution)