Financial Analysis

Quick Ratio excludes inventory and other current assets (such as prepaid expenses); because they are generally more difficult to turn into cash.

The Current Ratio considers inventory and prepaid expenses assets.

Inventory takes time to liquidate, although a few rare companies can turn their inventory fast enough to consider it a quick asset.

Prepaid expenses, though an asset, cannot be used to pay for current liabilities.

Amphi 1

Cash / Total Current Liabilities

The most stringent liquidity ratio. Under 1, means poor liquidity.

Amphi 1

Enterprise value / EBITDA

(Earnings Before Interest, Taxes,  Depreciation, and Amortization = Net Income + Taxes + Interest Expense + Depreciation and Amortization)

Valuation metric to compare the relative value of different businesses. A lower value is better than a higher value. As an acquirer, you will want to buy a company with a low ratio. A firm's higher profit leads to a lower Enterprise Value.

Comment: The enterprise multiple for Company A is # and that for Company B is #. According to the above results, we may conclude that Company A's valuation is on the lower side, while Company B has a higher valuation. As a result, Company A becomes an easier target for acquisition.

Long-term Debt / Equity

Measure of how much of a company's operations are funded using debt versus the funding received from shareholders as equity. Excessive gearing may present a significant risk of bankruptcy.

Long term financing:

• Internal: Equity
• External: Long-term Debt

1. No standard method but the most commonly used approach is when "gearing" is a percentage of long-term debt relative to equity. Long-term Debt / Equity.
    
2. Another approach is when "gearing" is a percentage of long-term debt relative to capital employed. Long-term Debt / Capital Employed. Capital Employed = Long-term Financing = Equity + Long-term Debt. Also computed as "TALCL" = Total Assets - Current Liabilities.

Often considered that anything over 50% is a high level of gearing. May be true in some cases, but not always. Example: High levels of gearing BUT enough profit to service that debt without adversely affecting the returns of shareholders. If 0% -> "all-equity company" or "ungeared company". If higher than 0% -> "geared company".

Because of different approaches, always state how gearing has been calculated when quoting the ratio for a company.

Refers to the total amount of debt a business can incur and repay. Incurring too much debt or taking on the wrong type can result in damaging consequences.

• EBITDA
  Companies with higher levels can generate more earnings to repay their debt. The higher the EBITDA, the higher the debt capacity. Companies with stable levels are preferred because unlikely to default. Factors that contribute to stability: cyclicality and barriers to entry.
  • Cyclical businesses inherently have less debt capacity than non-cyclical businesses. From a lender's point of view, volatile EBITDA has a much higher default risk.
  • Industries with low barriers to entry also have less debt capacity compared to industries with high barriers to entry. Indeed, companies that have low barriers to entry can easily be disrupted as competition enters.
     
• Debt / Equity
  No standard method. Long-term Debt / Equity. Financial Gearing.
   
• Total Debt / EBITDA
  Most common cash flow metric to evaluate debt capacity. Demonstrates a company's ability to pay off its incurred debt.  Provides investment bankers with information on the amount of time required to clear all debt, ignoring interest, taxes, depreciation, and amortization.
   
• Interest Cover: EBIT / Interest Payable
  Measures the ability of a company to meet interest payments. An "interest cover" of 2 or less is seen as a problem. Indicates that more than half of the profits earned would be going to interest payments.

The ability of a company to meet its long-term financial obligations. Reflects the ability of a company to honor its commitments in the event of liquidation. Refers to a company's ability to meet long-term debts and continue operating into the future.

Example: Total amount of debts EUR 200'000. Total net value of assets EUR 300'000. If the company has to close, we can sell the assets to repay the debts.

The higher the "Total Net Value of Assets" in comparison with "Total Debts", the better the solvency.

Measuring Solvency:

1. Financial Gearing Ratios = Long-term Debts / Equity or Long-term Debt / Capital Employed
    
2. Interest Cover = EBIT / Interest Payable
    
3. Book Value of Equity = Total Assets - Total Liabilities

Refers to both an enterprise's ability to pay short-term bills and debts and a company's capability to sell assets quickly to raise cash.

• Current Ratio
• Quick Ratio
• Cash Ratio
• Working Capital