Long term debt to total capital ratio: This ratio indicates the proportion of Total capital derived from long term debt capital. The formular is
The long term capital ratio is inclusive of long term debt, and any preference stock and common equity with retained earnings.
Earnings and cash flow coverage ratio
Interest coverage ratio:
This ratio indicates by how many times interest charges are covered. It shows how far earnings must delcline before it would be impossible to pay interest charges from current earnings. To calculate the percentage earnings must decline before it is impossible to pay, we say: (1- reciprocal of the interest coverage)
In the case where lease payments exist, we calculate the interest coverage by saying
The interest coverage is very useful in analyzing debts, because in a situation where a company replaces a debt with a new one but is now paying higher interests, the debt to equity ratio would be unchanged. In the case of a fixed interest coverage ratio, there would be a decline indicating that the interest payment has been increased, and there is a slightly higher chance of default in settling financial obligations.
Cash flow to outstanding debt ratio:
This is used to measure how many times long term debts are covered from the cash flows. It is used to gauge by how many percent cash flow derived from operating activities need to fall to be unable to settle its long term debt obligations. This ratio can be used to predict bankruptcy and it is also useful in bond rating.
Growth ratios
Price/earnings ratio: This ratio shows the current market’s evaluation of a stock, based on its earnings; shows how much the investor is willing to pay for each dollar of earnings. The formula is:
Dividend Payout ratio: This indicates the percentage of profit that is paid out as dividends. The formula is:
Dividend yield on common stock: This indicates the dividend rate of return to common shareholders at the current market price.
Retention rate: This is used to determine the percentage of profits that were ploughed back into the business for investments. The formula is:
Tips for Analyzing Financial Statements
Steps to take in analyzing financial statements include:
a) Review historical income statements and balance sheets
b) Compare historical statements over time
c) Calculate changes that occur in individual categories from year to year .
d) Determine the changes as a percentage
e) Adjust for Inflation
Recommended Reading
Frank Fabozzi., Financial management and analysis.
Leave a Reply