International Financial Management - Lecture 6

• The cash coverage ratio is = (EBIT + Depreciation) / interest
• Can also be written as EBITD / Interest
• the reason why is that the EBIT is not really a measure of cash available to pay interest
  • which is the case of the times interest earned ratio
• as an improvement, in the cash coverage, we include depreciation

Turnover (or asset management) measures describe how efficiently, or intensively, a firm uses its assets to generate sales

• You first need to consider the cost of goods sold, which is defined as the direct cost of earning the company's main revenue during this year
• the costs should include: materials used, labor costs, managerial salaries
• depreciation is included only if it is being charged on assets directly related to the main revenue stream 
• Inventory turnover = costs of goods sold / inventory
• normally, the higher this ratio is, the more efficient the company is at managing inventory

• If we know our inventory turnover, we can then figureout how long it took us to turn it over on average
• Days' sales in inventory = 365 days / inventory turnover
• this tells us how long inventory sits before being sold
• inventory is only appropriate in companies with real inventories

• inventory measures give us some indication of how fast products can be sold
• with these other measurements, we look at how fast we collect on those sales
• receivables turnover = sales / trade receivables
• this ratio makes more sense if converted to days, thus:
• days' sales in receivables = 365 days / receivables turnover
• this ratio is frequently called the average collection period (ACP)

• The result givcen my receivables turnover can be interpreted as the amount of times the money was collected and lent again
• once converted into days, it tells us how long the company takes to collect its credit sales
• "this company has 4.3 days' worth of sales currently uncollected"

• Total asset turnover = Sales / Total assets
• for every euro in assets, the company generates x times in sales
• if the result is 0.36, this means for every euro in assets, the company generates 0.35 times in sales

Profitability measures are intended to meausre how efficiently the firm uses its assets, and how efficiently the firm manages its operations, where the focus lines on net income

• Profit margin is an important profitability measure
• profit margin = net income / sales
• all other things equal, a relatively high profit margin is obviously desirable, because this corresponds to low expense ratios relative to sales

• It is a measure of profit per asset value
• Return on assets = net income / total assets
• Let's say the result of return on assets = 8%
• this means that the company, in an accounting sense, generates nearly 8 cents in profit for every euro in total assets 

• It is a profitability measure
• it is a measure of how the shareholders fared during the year
• it is the true bottom-line measure of performance
• return on equity = net income / total equity 
• ROA and ROE are both accounting rates of return
  • also called return on book assets and return on book equity
• ROE = (Net income / total equity) x (Assets / Assets) x (Sales / Sales)

• When you decompose the ROE formula into:
• profit margin x total asset turnover x equity multiplier

• Operating efficiency (measured by profit margin)
• Asset use efficiency (measured by total asset turnover)
• Financial leverage (measured by equity multiplier)

• This ratio is based on information, not necessarily contained in financial statements
• it is based on the share price
• these measures can only be calculated directly for publicly traded companies
• P/E Ratio = Price per share / Earnings per share
• The P/E Ratio measues how much investors are willing to pay per unit of current earnings

• Market to book ratio = market value per share / book value per share
• Book value per share is total equity divided by the total number of shares outstanding
• A value of less than 1 could mean that the firm has not been successful overall in creating value for its shareholders

The liabilities represent investments made by the company

They represent how investments are financed

Assets = Liabilities + Shareholders' Equity

• Liquidity
• Debt versus equity
• Value vs. cost

• Refers to the ease and rapidity with which assets can be converted into cash

• Current assets are the most liquid
• Trade receivables are amounts not yet collected from customers for goods or services sold to them
• Inventories are composed of raw materials 
• Non-current assets are the least liquid kind of assets
• Tangible non-current assets include property, plant, and equipment and do not convert to cash from normal business activity
• Intangible non-current assets have no physical existence but can be very valuable (ex: trademark, patent)

• Liabilities are debts (contractual obligations to be repaid)
• Shareholders' equity is the residual difference between assets and liabilities
• Assets - Liabilities = Shareholder's Equity 
• Shareholder's equity can then be understood also as shareholders' ownership

• The accounting value of a firm's assets is frequently referred to as the book value of the assets
• Market or fair value is the price at which willing buyers and sellers would trade the assets

• It measures performance over a specific period
• It is NOT the same as a balance sheet
• The accounting definition is: Reveue - Expenses = Income
• Metaphor: if the balance sheet is like a snapshot, the income statement is like a video recording of what the firm did between two snapshots

• Operations section: Reports the firm's revenues and expenses from principal operations
• Non-operating section: includes all financing costs, such as interest expense
• Then, a second section reports as a separate item the amount of taxes levied on income
• The bottom line: (net income) frequently expressed per share of equity or earnings per share

• they are expenses against revenues but do not affect cash flow 
• the most important is depreciation
• depreciation deflects the accountant's estimate of the cost of equipment used up in the production process
• another one is deferred taxes
• deferred taxes result from differences between accounting income and true taxable income 

Depreciation is a non-cash item that reflects the accountant's estimate of the cost of equipment used up in the production process

• Deferred taxes are a non-cash item that results from differences between accounting income and true taxable income
• If taxable income is less than accounting income in the current year, it will be more than accounting income later on
• Consequently, the taxes that are not paid today will have to be paid in the future (deferred tax liability)

• Often split into two: the short run and the long run
• the short run is the period in which certain equipment, resources and commitments of the firm are fixed, and is not a precise period that will be the same for all industries
  • Short run is long enough to vary its output by using more labor and raw materials
  • It entails fixed costs and variable costs
• in the long run, all costs are variable and the accounting costs fit into a classification that distinguishes product costs from period costs