Financial Formula Reference

A Simple Collection of Information Cards and Real-Time Calculators

Doubling Time

Financial

The Doubling Time formula is used in finance and by financial institutions to calculate the length of time required to double an investment or money in an interest bearing account.

It is important to note that r variable in the doubling time formula is the rate per period. If one needs to calculate the amount of time to double their money in a money market account that is compounded monthly, then the r variable needs to express the monthly rate and not the annual rate. The monthly rate can be found by dividing the annual rate by 12. With this situation, the doubling time formula will give the number of months that it takes to double money and not years.

In addition to expressing r as the monthly rate if the account is compounded monthly, one could also use the effective annual rate, or annual percentage yield, as r in the doubling time formula. This particular calculator is used to calculate the monthly rate and not the annual rate.

Investment Turnover

Financial

The investment turnover measurement is used by investors to determine the ability of a company to convert its debt and equity into dollars of sales. A high ratio of sales to equity and debt indicates a high level of efficiency in creating sales while a low ratio of sales to equity and debt indicates a poor level of efficiency in creating sales.

The investment turnover measure should be tracked on a trend line to see if there are changes in the level of sales efficiency over time.

To find the investment turnover, divide total sales by the combination of stockholders’ equity and long-term liabilities. In cases where debt is coming due in the short term, and therefore is categorized as a short-term liability, it is also acceptable to include it in the denominator.

Break-Even Point

Financial

This measure should be in the core group of performance measures that any accountant uses in the financial and business worlds. It measures the sales level at which a company exactly breaks even.

This figure is useful for a number of operating decisions, such as determining how much extra productive capacity is available after break-even sales have been manufactured, which tells the management team how much profit can theoretically be generated at maximum capacity levels.

To find the break-even point, divide the average gross margin percentage into total operating costs. Be sure to include all operating costs outside of the cost of goods sold in this calculation; only extraordinary items that are in no way related to ongoing operations should be excluded.

Margin Of Safety

Financial

This is the amount by which sales can drop before a company’s break-even point is reached. It is particularly useful in situations where large portions of a company’s sales are at risk, such as when they are tied up in a single customer contract that can be cancelled.

The margin of safety indicates the probability that a company may find itself in difficult financial circumstances caused by sales fluctuations.

Subtract the break-even point from the current sales level, and then divide the result by the current sales level. To calculate the break-even point, divide the gross margin percentage into the total fixed costs. This formula can be broken down into individual product lines for a better view of risk levels within business units.

Dividend Payout Ratio

Financial

This ratio is used by investors to see if a company is generating a sufficient level of cash flow to assure a continued stream of dividends to them. A ratio of less than one indicates that existing dividends are at a level that cannot be sustained over the long term.

Divide total annual dividend payments by annual cash flow. If there is a long-standing tradition by the board of directors of continually increasing the amount of the dividend, then annualize the last (and presumably largest) dividend only and use the resulting figure in the numerator of the calculation.

Liquidity Index

Financial

The liquidity index measures the number of days it would take to convert accounts receivable and inventory into cash. This is useful in determining a company’s ability to generate sufficient cash to meet upcoming liabilities.

Multiply the accounts receivable balance by the average number of days required to liquidate it. Then multiply the inventory balance by the average number of days required to liquidate it (which includes both the number of days to sell the inventory and the number of days to collect the resulting accounts receivable). Then add these two items together and divide them by the sum of all accounts receivable and inventory.

If the accounts receivable or inventory balances tend to fluctuate significantly, an average figure can be used for both.

Net Worth

Financial

A company’s net worth is the amount of money that is left over after all its liabilities have been deducted from its assets. This is theoretically the amount of funds that would be left over for distribution to investors if a company were to be liquidated.

A negative net worth is a reasonable indicator of serious fiscal problems. This measure is sometimes used by lenders, who may require that a minimum net worth be maintained for a loan to be left outstanding.

In its simplest form, the net worth calculation is found by subtracting total liabilities from total assets.

Present Value Annuity

Financial

The present value of annuity formula determines the value of a series of future periodic payments at a given time.

The formula shown has assumptions, in that it must be an ordinary annuity. These assumptions are that:

  1. The periodic payment does not change
  2. The rate does not change
  3. The first payment is one period away

If the payment and/or rate changes, the calculation of the present value would need to be adjusted depending on the specifics. If the payment increases at a specific rate, the present value of a growing annuity formula would be used.

AdWords Budget Recommendation

Business

This formula can be used to determine the cost benefit of increasing AdWords campaign budgets based on the ratio of spending to results.

First find the current monthly budget. To do this, multiply the daily budget by 30.4 and then double the sum to account for markup.

Then find current results and produce a ratio of how many clicks it takes to produce 1 lead. Produce a ratio by simply dividing the users by the leads for that month.

Now find feasible suggestions by trying different increases. Remember that the Google suggestions provide the number of projected clicks by week, so you must multiply that number by 4 to remain in the monthly calculation.

Lastly, do simple division on the current and projected sets of numbers to see increases. Divide suggested budget by current budget. Then divide projected users by current users. And divide projected leads by current leads.

If you cannot produce a ratio of 2:3 (2x budget for 3x results), then reconsider increasing the budget and instead look to optimise the campaign.

Gross Pay

Business

The Gross Pay is the total amount of income through wages or salary made by a person from their employer before subtracting any deductions or taxes.

The Gross Pay can be calculated by multiplying the employee's hourly wage by the number hours they worked during the week. This is often based on a standard 40 hour work week.

Overtime Gross Pay

Business

The Overtime Gross Pay is the total amount of income through wages or salary made by a person from their employer before subtracting any deductions or taxes plus the income earned through overtime pay.

The Overtime Gross Pay can be calculated by carefully following the order of operations. First, multiply the product of the normal rate and the overtime compensation by the difference of the total hours worked and 40 standard hours. Then find the sum of the first product and the product of the normal rate and 40 standard hours.

Compensation is always given if an employee exceeds the standard 40 hours in a work week, and in many places, compensated pay is given if an employee works on a Sunday as well as holidays. Compensation is often time and a half (1.5), double overtime (2), or triple overtime (3).

Wage To Salary Ratio

Business

The wage to salary ratio is how one can determine the amount of money he or she will earn on a daily, weekly, monthly, and yearly basis. This formula is based on a 40 hour standard work week and an 8 hour work day.

To calculate the wage to salary ratio, start by calculating the smaller ratios and then use the product to find the larger ratios. To find the daily rate of pay, multiply the hours worked by the hourly rate. To find the weekly, multiply the wage by the total hours worked in a week. To find the monthly, multiply the previous product by the number of weeks in a month. To find the yearly, multiply the previous product by the number of months in a year.

Conversely, this formula can be used to determine an hourly wage if a salary is already known. Instead of multiplication, use division to divide the salary by the number of months, weeks, and hours worked respectively.

Operating Assets Ratio

Business

It is designed for use by managers to determine which assets can be safely eliminated from a company without impairing its operational capabilities.

This measurement is based solely on information in the balance sheet. Its intent is to focus management attention on assets that are not generating a return on investment so that they can be eliminated.

Divide the dollar value of all assets used in the revenue creation process by the total amount of assets. Both of these numbers should be recorded at their gross values, prior to any depreciation deduction. The calculation can also include accounts receivable and inventory

Sales To Income Ratio

Business

This ratio is useful for determining the results of operations before unrelated income or expense is added to or subtracted from a company’s financial results.

It is particularly noteworthy in cases where a company continually muddies the waters by adding a variety of items, such as asset sales and loss contingency reserves, that make it difficult to see how the underlying business is performing. The ratio is best used on a trend line, so that long-term changes in profitability can be readily seen and acted upon.

Divide operating income by net sales (reduced by investment income). Investment income, if listed as revenue, should be eliminated from the net sales figure, because it relates to a company’s financial activities rather than its operations.

Sales Margin

Business

This ratio clusters sales and distribution expenses with the cost of goods sold, thereby isolating all profits from a company’s revenue-generating activities. It can also be viewed as the contribution margin before administrative costs are considered.

It is particularly useful when calculated for individual product lines, since the cost of sales and distribution can vary significantly by product line, and thus shows the actual margins generated in these areas. It should be tracked on a trend line to see if distribution and sales costs are proportionally changing in relation to sales volume.

Subtract sales expenses from the gross margin, and divide the result by gross sales. Sales costs should include the sales department’s payroll, commissions, benefits, travel expenses, customer service, field maintenance, warranty, sales promotion, advertising, and distribution costs.

Gross Profit Percentage

Business

This measurement reveals the profit left over from operations after all variable costs have been subtracted from revenues. It reveals the efficiency of the production process in relation to the prices and unit volumes at which products are sold.

There are two ways to measure the gross margin. The most common approach is to add together the costs of overhead, direct materials, and direct labor; subtract the total from revenue; and then divide the result by revenue. This approach takes into account all costs that can be reasonably associated with the production process.

The trouble with this approach is that many of the production costs are not truly variable. Under a much more strictly defined view of variable costs, only direct materials should be included in the formula, since this is the only cost that truly changes in proportion with changes in revenue. All other production costs are then shifted into other operational and administrative costs, which typically yields a high gross margin percentage.

Gross Profit Index

Business

This ratio is used to detect significant changes in a company’s gross profit percentage from period to period, which can be a sign of fraudulent financial reporting.

If the ratio is substantially higher than one, then there is a high risk that fraudulent reporting was used to achieve an improvement in the gross profit percentage from period to period.

Divide the gross profit in period two by sales for the same period, and then divide this by the same calculation for period one.

Operating Profit Percentage

Business

The operating profit percentage calculates the return from standard operations, excluding the impact of extraordinary items and other comprehensive income separate from the operating income.

This percentage reveals the extent to which a company is earning a profit from standard operations, as opposed to resorting to asset sales or unique transactions to post a profit.

Subtract the cost of goods sold, as well as all sales, general, and administrative expenses, from sales. To obtain a percentage that is related strictly to operational results, be sure to exclude interest income and expense from the calculation, since these items are related to a company’s financing decisions rather than its operational characteristics. Expense totals used in the ratio should exclude all extraordinary transactions, as well as asset dispositions, since they do not relate to continuing operations.

Operating Leverage Ratio

Business

This ratio reveals the extent to which fixed costs are required to create profits, by comparing the amount of fixed costs to operating income.

It is particularly useful when a company is considering the acquisition of more fixed assets to replace variable costs, such as manual labor in the production process, and wants to find out the extent to which this will add to its fixed cost structure. This ratio works well when combined with break-even analysis, which is heavily influenced by changes in fixed costs.

Subtract all variable expenses from sales and then divide this amount by operating income. Under the most strict definition of variable expenses, this will likely include only direct materials costs and commissions; all other expenses are fixed in the short run and can be included in the ratio as fixed costs.

Net Income Percentage

Business

This percentage is used to determine the proportion of income derived from all operating, financing, and other activities that an entity has engaged in during an accounting period.

This figure is the one most commonly used as a benchmark for determining a company’s performance, even though it can be significantly misrepresented by the accounting department.

Divide net income by revenue. If this percentage is being tracked on a trend line, it may be useful to eliminate from the calculation any extraordinary income items, such as losses from disasters, since they do not yield comparable period-to-period information.

Profit Per Person

Business

This measure is useful for those enterprises with a high proportion of personnel costs to other costs, such as consulting or other service businesses, where changes in the efficiency of the staff have a direct impact on the profitability of the overall corporation.

It is least useful in highly automated entities where the proportion of labor costs to total costs is quite small. This is a more comprehensive measure than sales per person since it accounts for not only the ability of the staff to bring in sales but also their ability to wring a profit from those sales.

Divide net profit by the total number of full-time equivalents. This measure is more reliable when net profit from operations is used instead of total net profit, since this concentrates attention on actual operating results, rather than other actions that may impact profits. A full-time equivalent (FTE) is the combination of staffing that equals a 40-hour week. For example, two half-time employees would be counted as one FTE.

Future Value Annuity

Realty

The future value of an annuity formula is used to calculate what the value at a future date would be for a series of periodic payments.

The future value of an annuity formula assumes that:

  1. The rate does not change
  2. The first payment is one period away
  3. The periodic payment does not change

If the rate or periodic payment does change, then the sum of the future value of each individual cash flow would need to be calculated to determine the future value of the annuity. If the first cash flow, or payment, is made immediately, the future value of annuity due formula would be used.

Future Value Annuity CC

Realty

The future value (FV) of an annuity with continuous compounding formula is used to calculate the ending balance on a series of periodic payments that are compounded continuously.

Understanding the future value of annuity with continuous compounding formula requires the understanding of two specific financial and mathematical concepts, which are future value of an annuity and continuous compounding.

The future value of an annuity is the sum of a series of periodic payments and typically involves compounding of interest as the balance increases. The formula for future value of annuity alone generally solves the question "How much will I have saved at X dollars per month after Y months."

Continuous compounding is compounding that is constant. One way some try to visualize the concept of continuous compounding is that is fluid, constantly compounding moment by moment, as opposed to daily, monthly, quarterly, or annually. The question a few sentences above regarding 'How much will I have saved' must also take into consideration how often interest is compounded in the interest bearing account.

Capitalization Rate

Realty

The Capitalization Rate (Cap Rate) is the rate of return on a real estate investment property based on the income that the property is expected to generate. The cap rate is used to estimate the potential return for the investor on his or her investment.

The Capitalization Rate of an investment may be calculated by dividing the investment’s net operating income (NOI) by the current market value of the property, where NOI is the annual return on the property minus all operating costs.

Loan To Value Ratio

Realty

The Loan-To-Value (LTV) ratio is a financial term used by lenders to express the ratio of a loan to the value of an asset purchased. The term is commonly used by banks and building societies to represent the ratio of the first mortgage lien as a percentage of the total appraised value of real property.

For instance, if someone borrows $130,000 to purchase a house worth $150,000, the LTV ratio is $130,000 to $150,000 or $130,000/$150,000, or 87%. The remaining 13% represent the lender's haircut, adding up to 100% and being covered from the borrower's equity. The higher the LTV ratio, the riskier the loan is for a lender.

The valuation of a property is typically determined by an appraiser, but a better measure is an arms-length transaction between a willing buyer and a willing seller. Typically, banks will utilize the lesser of the appraised value and purchase price if the purchase is "recent" with in 1–2 years.

Debt Service Coverage Ratio

Realty

The Debt Service Coverage Ratio (DSCR) is the ratio of cash available for debt servicing to interest, principal and lease payments. It is used in the measurement of an entity's ability to produce enough cash to cover its debt payments.

The higher this ratio is, the easier it is to obtain a loan. The phrase is also used in commercial banking and may be expressed as a minimum ratio that is acceptable to a lender; it may be a loan condition. Breaching a DSCR covenant can, in some circumstances, be an act of default.

In corporate finance, DSCR refers to the amount of cash flow available to meet annual interest and principal payments on debt, including sinking fund payments.

n personal finance, DSCR refers to a ratio used by bank loan officers in determining debt servicing ability.

In commercial real estate finance, DSCR is the primary measure to determine if a property will be able to sustain its debt based on cash flow.

Gross Rent Multiplier

Realty

Gross Rent Multiplier is the ratio of the price of a real estate investment to its monthly rental income before expenses such as property taxes, insurance, and even utilities for vacation rental properties.

The Gross Rent Multiplier (GRM) is the number of months the property would take to pay for itself in gross received rent. For the investor, a higher GRM (perhaps over 120) is a poorer opportunity, whereas a lower one (perhaps under 80) is better.

The GRM is useful for comparing and selecting investment properties where depreciation effects, periodic costs (such as property taxes and insurance) and costs to the investor incurred by a potential renter (such as utilities and repairs) can be expected to be uniform across the properties (either as uniform values or uniform fractions of the gross rental income) or insignificant in comparison to gross rental income. As these costs are also often more difficult to predict than market rental return, the GRM serves as an alternative to a measure of net investment return where such a measure would be difficult to determine.

Operating Expense Ratio

Realty

The Operating Expense Ratio (OER) is the total of all expenses needed to operate a property divided by the potential rental income for a property.

The Operating Expense Ratio formula measures how much of a property’s potential rental income is consumed by expenses needed to operate the property. When building a multi-year proforma, it can often be helpful to calculate an operating expense ratio for each year in the holding period in order to spot trends in total operating expenses, relative to potential rental income.

Average Collection Period

Accounting

The average collection period formula is the number of days in a period divided by the receivables turnover ratio. The typical collection period is 365 calendar days.

The numerator of the average collection period formula shown at the top of the page is 365 days. For many situations, an annual review of the average collection period is considered. However, if the receivables turnover is evaluated for a different time period, then the numerator should reflect this same time period.

For example, if the receivables turnover for one year is 8, then the average collection period would be 45.63 days. If the period considered is instead for 180 days with a receivables turnover of 4.29, then the average collection period would be 41.96 days. By the nature of the formula, a company will have a lower receivables turnover when a shorter time period is considered due to having a larger portion of its revenues awaiting receipt in the short run.

Sales To Assets Ratio

Accounting

In some industries, a key barrier to entry is the large amount of asset required to produce revenues. By using the sales to fixed assets ratio, one can see if a company is investing a great deal of money in assets in order to generate sales.

This is a particularly effective measure when compared to the same ratio for other companies in the same industry; that is, if another company has found a way to generate profitable sales with a smaller asset investment, then it will be rewarded with a higher valuation. This measure is also useful when tracked on a trend line, so that one can see if there are any sudden jumps in asset investments that the company has made to incrementally bring in more sales.

Divide net sales for a full year by the total amount of fixed assets. There are several variations on this formula. One is to calculate annualized net sales on a rolling basis, so that the last 12 months of revenue are always used. This can be a better approach than attempting to extrapolate revenues forward for several months, especially if future revenues are uncertain. The denominator in the calculation, which is the amount of total fixed assets, may be used net of depreciation or before depreciation; the most common usage is after depreciation, since this is more indicative of the actual value of the assets.

Sales To Expenses Ratio

Accounting

A key issue is how much overhead expense is needed to maintain a certain level of sales volume. It is important to ensure that the administrative expense is carefully controlled, so that it does not have an excessively large impact on profits.

Divide annualized net sales by the total of all general and administrative expenses. It is better to use the last twelve months of net sales for the annualized net sales figure, rather than an estimate of sales for future months, since the look-forward estimate may be substantially incorrect. Also, the expense figure in the denominator should include the cost of the sales department, especially if its cost is largely fixed (as is the case when the sales staff has a high proportion of salaries to commissions).

Sales To Equity Ratio

Accounting

This ratio is used to determine the amount of equity that should be retained within a business as sales volumes fluctuate.

The ratio can also be used to determine if too much equity has accumulated in a business, so that some may be extracted through extra dividends, a stock buyback, or some other form of distribution.

Divide annual net sales by total equity. It is important to include retained earnings in the denominator; many companies that have high margins or have been generating profits for many years have accumulated a great deal of retained earnings, which may make up the largest component of equity.

Sales Backlog Ratio

Accounting

The sales backlog ratio cannot be determined strictly from any standard financial statements, since the backlog is normally included only in internal management reports. If the backlog information is available, this ratio should be used as an extremely useful tool for determining a company’s ability to maintain its current level of production.

If the ratio is dropping rapidly over several consecutive months, then it is likely that the company will soon experience a reduction in sales volume as well as over-capacity in its production and related overhead areas, resulting in imminent losses. Conversely, a rapid jump in the ratio indicates that a company cannot keep up with demand, and it may soon have customer relations problems from delayed orders and need additional capital expenditures and staff hirings to increase its productive capacity.

Divide the most current total backlog of sales orders by sales. It is generally best not to use annualized sales in the denominator, since sales may vary considerably over that period, due to the influence of seasonality. A better denominator is sales over just the preceding quarter.

Returns Sales Ratio

Accounting

This ratio reveals the extent returns on its sales. An excessive level of returns can be indicative of product flaws requiring replacement, or an overly generous returns policy, or the sudden appearance of a competing product on the market that distributors would rather keep in stock.

Divide total sales returns by gross sales. This ratio can be unusually high or low from month to month, because sales returns are usually related to shipments made in previous months; consequently, a high sales month may have very low associated sales returns, which instead will appear in the ratio for the following month. To avoid this problem, the ratio should be aggregated on a rolling quarterly basis, so that returns will be more likely to be matched against related sales.

Depreciation To Assets Ratio

Accounting

Comparing the amount of accumulated depreciation to the gross amount of fixed assets recorded on a company’s balance sheet can indicate the extent to which a company has continued to replace its existing assets with new ones on an ongoing basis.

If the proportion of accumulated depreciation to fixed assets is quite high, it is evidence that not too many assets have been added by a company in recent years, which may in turn lead one to suspect that there is little cash available for such investments.

Divide the total accumulated depreciation by the total amount of fixed assets. A variation on this approach is to run the same calculation for different classes of assets, in order to see if there are certain types of assets in which a company does not appear to be making a sufficient level of investment in new assets.

Benefits To Wages Ratio

Accounting

Apparently small changes in a company’s benefit policies can have a profound impact on the total benefits expense for a company. The best way to see the total impact of these changes is to calculate a ratio of fringe benefit costs to total wages and salaries.

This is also a useful measure when comparing the overall fringe benefit costs of two companies that are considering merging, so that the surviving entity can calculate the potential savings to be made by shifting the other company’s benefit plan to that of the acquirer.

This can also be a tool for comparing the benefit costs of union shops to non-union shops, since there can be significant differences in the benefits granted to union members.

Add together the cost of all discretionary benefit costs, minus the cost of any related deductions from employee pay, and divide this amount by the total of all wages, salaries, and payroll taxes.

Discretionary Costs Ratio

Accounting

This ratio is extremely important when reviewing companies that are locked into tight cash flow situations, because an analyst can use it to determine what costs can be dispensed within the short term to bring a company back to a neutral or positive cash flow situation.

A high ratio of discretionary costs to sales means that there are considerable opportunities for expense reductions.

Divide all discretionary costs by sales. Discretionary costs can include marketing, research and development, training, and repairs and maintenance costs, as well as any other costs that do not directly contribute to ongoing sales or production activities.

Interest Expense To Debt Ratio

Accounting

This ratio is useful for determining the approximate interest rate that a company is paying on its debt. An analyst can use this information to see if a company is paying unusually high interest, which can be indicative of financial difficulties that are leading lenders to charge inordinately high rates of interest.

Divide the interest expense by the sum of all short- and long-term debt. The total amount of debt can also include all leases, if an interest expense can be calculated from them and is included in the interest expense account.

Overhead Rate

Accounting

The overhead rate is used to determine the amount of overhead cost that should be applied to a unit of production, which may be a completed product or some amount of services rendered to a customer.

Divide total overhead expenses by an activity measure. The following expenses should be included in overhead:

  1. Maintenance
  2. Quality control and inspection
  3. Repair expenses
  4. Rent
  5. Utilities

Quick Ratio

Accounting

Because of the presence of inventory in the current ratio that was covered in the last section, the current ratio may not be the best measure of a company’s liquidity.

One alternative is to use the quick ratio, which excludes inventory from the current assets portion of the current ratio. By doing so, one can gain a better understanding of a company’s very short-term ability to generate cash from more liquid assets, such as accounts receivable and marketable securities.

Add together cash, marketable securities, and accounts receivable, and then divide the result by current liabilities. Be sure to include only those marketable securities that can be liquidated in the short term and those receivables that are not significantly overdue.

Current Ratio

Accounting

The current ratio is a liquidity and efficiency ratio that measures a firm's ability to pay off its short-term liabilities with its current assets. The current ratio is an important measure of liquidity because short-term liabilities are due within the next year.

This means that a company has a limited amount of time in order to raise the funds to pay for these liabilities. Current assets like cash, cash equivalents, and marketable securities can easily be converted into cash in the short term. This means that companies with larger amounts of current assets will more easily be able to pay off current liabilities when they become due without having to sell off long-term, revenue generating assets.

The current ratio is calculated by dividing current assets by current liabilities. This ratio is stated in numeric format rather than in decimal format.

Working Capital Ratio

Accounting

The working capital ratio, also called the current ratio, is a liquidity ratio that measures a firm's ability to pay off its current liabilities with current assets. The working capital ratio is important to creditors because it shows the liquidity of the company.

Current liabilities are best paid with current assets like cash, cash equivalents, and marketable securities because these assets can be converted into cash much quicker than fixed assets. The faster the assets can be converted into cash, the more likely the company will have the cash in time to pay its debts.

The reason this ratio is called the working capital ratio comes from the working capital calculation. When current assets exceed current liabilities, the firm has enough capital to run its day-to-day operations. In other words, it has enough capital to work. The working capital ratio transforms the working capital calculation into a comparison between current assets and current liabilities.

The working capital ratio is calculated by dividing current assets by current liabilities.

Times Interest Earned Ratio

Accounting

The times interest earned ratio, sometimes called the interest coverage ratio, is a coverage ratio that measures the proportionate amount of income that can be used to cover interest expenses in the future.

In some respects the times interest ratio is considered a solvency ratio because it measures a firm's ability to make interest and debt service payments. Since these interest payments are usually made on a long-term basis, they are often treated as an ongoing, fixed expense. As with most fixed expenses, if the company can't make the payments, it could go bankrupt and cease to exist. Thus, this ratio could be considered a solvency ratio.

The times interest earned ratio is calculated by dividing income before interest and income taxes by the interest expense.

Receivables Turnover Ratio

Accounting

Accounts receivable turnover is an efficiency ratio or activity ratio that measures how many times a business can turn its accounts receivable into cash during a period. In other words, the accounts receivable turnover ratio measures how many times a business can collect its average accounts receivable during the year.

A turn refers to each time a company collects its average receivables. If a company had $20,000 of average receivables during the year and collected $40,000 of receivables during the year, the company would have turned its accounts receivable twice because it collected twice the amount of average receivables.

This ratio shows how efficient a company is at collecting its credit sales from customers. Some companies collect their receivables from customers in 90 days while other take up to 6 months to collect from customers.

Accounts receivable turnover is calculated by dividing net credit sales by the average accounts receivable for that period.

Asset Turnover Ratio

Accounting

The asset turnover ratio is an efficiency ratio that measures a company's ability to generate sales from its assets by comparing net sales with average total assets. In other words, this ratio shows how efficiently a company can use its assets to generate sales.

The total asset turnover ratio calculates net sales as a percentage of assets to show how many sales are generated from each dollar of company assets. For instance, a ratio of .5 means that each dollar of assets generates 50 cents of sales.

The asset turnover ratio is calculated by dividing net sales by average total assets.

Cash Conversion Cycle

Accounting

The cash conversion cycle is a cash flow calculation that attempts to measure the time it takes a company to convert its investment in inventory and other resource inputs into cash. In other words, the cash conversion cycle calculation measures how long cash is tied up in inventory before the inventory is sold and cash is collected from customers.

The cash cycle has three distinct parts. The first part of the cycle represents the current inventory level and how long it will take the company to sell this inventory. This stage is calculated by using the days inventory outstanding calculation.

The second stage of the cash cycle represents the current sales and the amount of time it takes to collect the cash from these sales. This is calculated by using the days sales outstanding calculation.

The third stage represents the current outstanding payables. In other words, this represents how much a company owes its current vendors for inventory and goods purchases and when the company will have to pay off its vendors. This is calculated by using the days payables outstanding calculation.

The cash conversion cycle is calculated by adding the days inventory outstanding to the days sales outstanding and subtracting the days payable outstanding.

Cash Ratio

Accounting

The cash ratio or cash coverage ratio is a liquidity ratio that measures a firm's ability to pay off its current liabilities with only cash and cash equivalents. The cash ratio is much more restrictive than the current ratio or quick ratio because no other current assets can be used to pay off current debt--only cash.

This is why many creditors look at the cash ratio. They want to see if a company maintains adequate cash balances to pay off all of their current debts as they come due. Creditors also like the fact that inventory and accounts receivable are left out of the equation because both of these accounts are not guaranteed to be available for debt servicing. Inventory could take months or years to sell and receivables could take weeks to collect. Cash is guaranteed to be available for creditors.

The cash coverage ratio is calculated by adding cash and cash equivalents and dividing by the total current liabilities of a company.

Compound Annual Growth Rate

Accounting

Compound annual growth rate or CAGR is a financial investment calculation that measures the percentage an investment increases or decreases year over year. You can think of this as the annual average rate of return for an investment over a period of time.

Since most investments’ annual returns vary from year to year, the CAGR calculation averages the good years’ and bad years’ returns into one return percentage that investors and management can use to make future financial decisions.

CAGR formula is calculated by first dividing the ending value of the investment by the beginning value to find the total growth rate. This is then taken to the Nth root where the N is the number of years money has been invested. Finally, one is subtracted from product to arrive at the compound annual growth rate percentage.

Contribution Margin

Accounting

The contribution margin, sometimes used as a ratio, is the difference between a company's total sales revenue and variable costs. In other words, the contribution margin equals the amount that sales exceed variable costs. This is the sales amount that can be used to, or contributed to, pay off fixed costs.

The concept of this equation relies on the difference between fixed and variable costs. Fixed costs are production costs that remain the same as production efforts increase. Variable costs, on the other hand, increase with production levels.

The contribution margin measures how efficiently a company can produce products and maintain low levels of variable costs. It is considered a managerial ratio because companies rarely report margins to the public. Instead, management uses this calculation to help improve internal procedures in the production process.

The contribution margin is calculated by subtracting total variable costs from total sales revenue.

Cost Of Goods Sold

Accounting

Cost of goods sold, often abbreviated COGS, is a managerial calculation that measures the direct costs incurred in producing products that were sold during a period. In other words, this is the amount of money the company spent on labour, materials, and overhead to manufacture or purchase products that were sold to customers during the year.

The COGS formula is particularly important for management because it helps them analyse how well purchasing and payroll costs are being controlled. Creditors and investors also use cost of goods sold to calculate the gross margin of the business and analyse what percentage of revenues is available to cover operating expenses.

Both manufacturers and retailers list cost of good sold on the income statement as an expense directly after the total revenues for the period. COGS is then subtracted from the total revenue to arrive at the gross margin.

The cost of goods sold formula is calculated by adding purchases for the period to the beginning inventory and subtracting the ending inventory for the period.

Debt Ratio

Accounting

Debt ratio is a solvency ratio that measures a firm's total liabilities as a percentage of its total assets. In a sense, the debt ratio shows a company's ability to pay off its liabilities with its assets. In other words, this shows how many assets the company must sell in order to pay off all of its liabilities.

This ratio measures the financial leverage of a company. Companies with higher levels of liabilities compared with assets are considered highly leveraged and more risky for lenders. This helps investors and creditors analysis the overall debt burden on the company as well as the firm's ability to pay off the debt in future, uncertain economic times.

The debt ratio is calculated by dividing total liabilities by total assets. Both of these numbers can easily be found the balance sheet.

Dividend Yield Ratio

Accounting

The dividend yield is a financial ratio that measures the amount of cash dividends distributed to common shareholders relative to the market value per share. The dividend yield is used by investors to show how their investment in stock is generating either cash flows in the form of dividends or increases in asset value by stock appreciation.

Investors invest their money in stocks to earn a return either by dividends or stock appreciation. Some companies choose to pay dividends on a regular basis to spur investors' interest. These shares are often called income stocks. Other companies choose not to issue dividends and instead reinvest this money in the business. These shares are often called growth stocks.

Investors can use the dividend yield formula to help analyse their return on investment in stocks.

The dividend yield formula is calculated by dividing the cash dividends per share by the market value per share.

DuPont Analysis

Accounting

The Dupont analysis also called the Dupont model is a financial ratio based on the return on equity ratio that is used to analyse a company's ability to increase its return on equity. In other words, this model breaks down the return on equity ratio to explain how companies can increase their return for investors.

The Dupont analysis looks at three main components of the ROE ratio: Profit Margin, Total Asset Turnover, and Financial Leverage.

Based on these three performances measures the model concludes that a company can raise its ROE by maintaining a high profit margin, increasing asset turnover, or leveraging assets more effectively.

The Dupont Model equates ROE to profit margin, asset turnover, and financial leverage.

Production Schedule Accuracy

Logistics

Without a production schedule that is carefully followed, the production department will find itself in a state of bedlam, with material shortages, irate customers, and projects being rushed through the production facility.

To avoid this, the logistics staff must ensure that the jobs listed on the production schedule are completed in an orderly manner and in the scheduled sequence and quantities. The production schedule accuracy measurement is a useful tool for tracking this.

Divide the number of scheduled jobs completed during the measurement period by the total number of jobs scheduled for completion. However, if there are large jobs that cross over multiple periods, they will fall outside of this measurement, which only tracks completed jobs. In such cases, it may be more accurate to divide the number of completed production tasks within each scheduled job by the total number of scheduled tasks for all jobs.

Economic Order Quantity

Logistics

If a company does not use a material requirements planning system or just-in-time system to control its inflow of raw materials, then a reasonable alternative is the economic order quantity.

Under this calculation, the point at which the carrying cost of inventory equals its ordering cost can be derived. Theoretically, this is the ideal quantity that should be ordered.

Multiply the total usage of a component by two, and then multiply the result by the cost per order. Then divide this result by the carrying cost per unit, and calculate the root of the result. Of particular importance is the variety of costs that can be included in the carrying cost per unit, which includes incremental materials handling costs, the cost of extra warehouse space and storage racks to contain it, damage caused by storage, insurance fees, and property taxes.

Period Order Placement

Logistics

The purchasing manager needs to have a general idea of the number of orders that the purchasing staff will be placing within a given time period, so that the departmental headcount can be adjusted to match purchasing needs.

Divide the total usage in units for a selected time period by the economic order quantity, as shown in the preceding section.

This measurement assumes that the effort required to place any order is the same. In reality, the cost of order placement varies widely, depending on the number of purchasing steps required for items of different costs (more steps for high-dollar orders), the uniqueness of the items ordered, and the need for documentation for international orders. Consequently, it is better to run this calculation for different types of orders, to gain a more accurate understanding of the total projected amount of time required to place them.

Production Run Size

Logistics

The economic production run size is similar to the economic order quantity except that it applies to the scheduling of production run quantities rather than purchasing quantities.

This is a useful tool for the production scheduling staff, which needs to know the most cost-effective size for which production runs should be scheduled.

Multiply the total unit demand of a product by two, and then multiply the result by the run setup cost. Then divide the result by the carrying cost per unit, and calculate the root of the result. Of particular importance is the variety of costs that can be included in the carrying cost per unit, which includes incremental materials handling costs, the cost of extra warehouse space and storage racks to contain it, damage caused by storage, insurance fees, and property taxes.

Material Inventory Turns

Logistics

One of the key performance measures of a logistics manager is the ability to keep a company’s investment in raw materials to a minimum, which requires excellent inventory tracking systems, carefully maintained production planning systems, and good relations with high-quality suppliers.

Divide the dollar volume of raw materials consumed during the measurement period by the total dollar value of inventory on hand at the end of the period, and multiply the result by 12. The inventory value at the end of the period can be arbitrarily high in relation to average inventory levels throughout the measurement period, so an average value can be used instead.

Raw Material Content

Logistics

It is useful to determine the proportion of raw material costs included in a typical sale so that management can determine if the company is adding a sufficient amount of value to the product to yield a required level of profit.

Also, the measurement can be tracked on a trend line to see if the proportion of raw material to sales is rising, which indicates that raw material costs are increasing without a corresponding increase in sales.

Summarize the total amount of raw material dollars sold, and divide it by sales. The amount of raw materials can be collected from the bills of material associated with each product sold, though this only summarizes the standard amount of raw materials used (which may not reflect actual scrap levels or the most current raw material costs).

Finished Goods Turns

Logistics

A company may have an excellent overall inventory turnover rate but a poor finished goods turnover rate. This may be caused by the continuation of production into a slow part of the sales cycle, which will use up the remaining raw materials and convert them over to finished goods, which, in turn, will then sit until the sales cycle picks up again.

This manufacturing strategy is used by companies that level-load their work forces year-round and by companies that are attempting to increase their loan borrowing bases by pumping up the value of their inventories by converting them to higher-value finished goods. Given the latter reason, a lender may be interested in reviewing this measurement on a trend line to see if it increases in concert with the company’s borrowing base.

Divide the amount of finished goods dollars sold during the measurement period by the finished goods dollar amount on hand, and multiply the result by 12. In cases where there are highly seasonal sales, it is better to use an average annualized sales figure than the annualized sales for the month in which the measurement is made.

Obsolete Inventory Percentage

Logistics

A large amount of obsolete inventory does not reflect well on the logistics manager, who is responsible for maintaining a high level of inventory turnover. A company needs to know the proportion of its inventory that is obsolete for several reasons.

First, external auditors will require that an obsolescence reserve be set up against these items, which will lower the inventory value and create a charge against current earnings. Second, constantly monitoring the level of obsolescence allows a company to work on eliminating the inventory through such means as returns to suppliers, taxable donations, and reduced-price sales to customers. Finally, obsolete inventory takes up valuable warehouse space that could otherwise be put to other uses; monitoring it with the obsolete inventory percentage allows management to eliminate these items to reduce space requirements.

Summarize the cost of all inventory items having no recent use, and divide by the total inventory valuation. The amount used in the numerator is subject to some interpretation, since there may be an occasional use that will eventually use up the amount left in stock, despite the fact that it has not been used for some time. An alternative summarization method for the numerator that avoids this problem is to include only those inventory items that do not appear on any bill of material for a currently produced item.

Inventory Age Threshold

Logistics

A company may not have any obsolete inventory, but it may have enough older inventory that raise concern about obsolescence at some point in the future.

By determining the amount of inventory that is older than a certain fixed date, the logistics staff can determine which items should be returned to suppliers (see the next measurement) or which items should be sold off at a reduced price.

Settle on a number of days after which inventory is considered to be old enough to require liquidation action. Then determine the dollar value of all items whose age exceeds this number of days. Divide that total by the total dollar value of inventory. The measurement should be accompanied by a report that lists the detailed amounts and locations of each inventory item in the numerator so that the logistics staff can review them in detail.

Returnable Inventory Percentage

Logistics

Over time, a company will tend to accumulate either more inventory than it can use or inventory that is no longer used at all. These overaccumulations may be caused by an excessively large purchase, scaling back of production needs below original expectations, or perhaps a change in a product design that leaves some components completely unnecessary.

Whatever the reason, it is useful to review the inventory occasionally to determine what proportion of it can be returned to suppliers for cash or credit.

Summarize all inventory items for which suppliers have indicated that they will accept a return in exchange for cash or credit. For these items, use in the numerator either the listed book value of returnable items or the net amount of cash that can be realized by returning them (which will usually include a restocking fee charged by suppliers). The first variation is used when a company is more interested in the amount of total inventory that it can eliminate from its accounting records, whereas the second approach is used when a company is more interested in the amount of cash that can be realized through the transaction. The denominator is the book value of the entire inventory.

Component Defect Rate

Logistics

The purchasing staff should be interested in the proportion of components purchased from outside suppliers that are defective. Any defect requires expensive time to document and return and may even interfere with the timely completion of the production schedule.

Consequently, this is one of the most important measures of supplier performance. It should be measured both by supplier and by each component provided by each supplier, in case there are problems with only some portion of a supplier’s total deliveries to a company. Also, it should be measured on a trend line, so that gradual increases can be easily spotted and dealt with.

Summarize all rejected components and divide them by the total number of components received. As just noted, this measurement should at least be summarized by supplier, if not by specific component types delivered by individual suppliers.

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