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Financial Ratios in Project Finance Model Ver. 3.0

April 6th, 2016 Posted in financial ratios

Financial Ratios in Project Finance Model Ver. 3.0

Financial ratios are mathematical comparisons of financial statement (P&L or Income & Expense, Cash Flow, and Balance Sheet Statements) accounts or categories.

These relationships between income, expense, cash flow and balance sheet accounts help investors, creditors, and internal company management understand how well a business is performing and areas of needing improvement.

Financial ratios are the most common tools used in analyzing a business’ financial standing. Ratios are easy to understand and simple to compute.

They can also be used to compare different companies in different industries. Since a ratio is simply a mathematically comparison based on proportions, big and small companies can be use ratios to compare their financial information.

Ratios allow us to compare companies across industries, big and small, to identify their strengths and weaknesses. Financial ratios are often divided up into six main categories: liquidity, solvency, efficiency, profitability, market prospect, financial leverage, and coverage.

The following financial ratios have been implemented in this top-of-the-line project finance models; however, other minor financial ratios were not implemented as they are not of significant concern in power generation projects.

  1. Liquidity Ratios

Liquidity ratios analyze the ability of a company to pay off both its current liabilities as they become due as well as their long-term liabilities as they become current. It is also a measure of how easy it will be for the company to raise enough cash or convert assets into cash. Assets like accounts receivable, trading securities, and inventory are relatively easy for many companies to convert into cash in the short term. Thus, all of these assets go into the liquidity calculation of a company.

A.1 Quick Ratio

The quick ratio or acid test ratio is a liquidity ratio that measures the ability of a company to pay its current liabilities when they come due with only quick assets. Quick assets are current assets that can be converted to cash within 90 days or in the short-term. Cash, cash equivalents, short-term investments or marketable securities, and current accounts receivable are considered quick assets.

Formula

The quick ratio is calculated by dividing quick assets by current liabilities:

Quick Ratio = (Cash + Cash Equivalents + Short Term Investments + Current Receivables) /  (Current Liabilities)

Alternatively, the quick ratio may be computed in an indirect manner:

Quick Ratio = (Total Current Assets – Inventory – Prepaid Expenses) / (Current Liabilities)

A.2 Acid Test Ratio

(Same as Quick Ratio)

A.3 Current Ratio

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 (current 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 without the need to sell off long-term revenue generating assets.

Formula

The current ratio is calculated by dividing current assets by current liabilities:

Current Ratio = (Current Assets) / (Current Liabilities)

A.4 Working Capital Ratio

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.

  1. Solvency Ratios

Solvency ratios, also called leverage ratios, measure a company’s ability to sustain operations indefinitely by comparing debt levels with equity, assets, and earnings. It identify going concern issues and a firm’s ability to pay its bills in the long term, and focus more on the long-term sustainability of a company instead of the current liability payments.

Solvency ratios show a company’s ability to make payments and pay off its long-term obligations to creditors, bondholders, and banks. Better solvency ratios indicate a more creditworthy and financially sound company in the long-term.

B.1 Debt to Equity Ratio

The debt to equity ratio is a financial, liquidity ratio that compares a company’s total debt to total equity. The debt to equity ratio shows the percentage of company financing that comes from creditors and investors. A higher debt to equity ratio indicates that more creditor financing (bank loans) is used than investor financing (shareholders).

Formula

The debt to equity ratio is calculated by dividing total liabilities by total equity. The debt to equity ratio is considered a balance sheet ratio:

Debt to Equity Ratio = (Total Liabilities) / (Total Equity)

B.2 Equity Ratio

The equity ratio is a financial leverage or solvency ratio that measures the amount of assets that are financed by owners’ investments by comparing the total equity in the company to the total assets.

The equity ratio highlights two important financial concepts of a solvent and sustainable business. The first component shows how much of the total company assets are owned outright by the investors. After all of the liabilities are paid off, the investors will end up with the remaining assets.

Formula

The equity ratio is calculated by dividing total equity by total assets:

Equity Ratio = (Total Equity) / (Total Assets)

B.3 Debt Ratio

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. It 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.

Formula

The debt ratio is calculated by dividing total liabilities by total assets:

Debt Ratio = (Total Liabilities) / (Total Assets)

  1. Efficiency Ratios

Efficiency ratios, also called activity ratios, measure how well companies utilize their assets to generate income. Efficiency ratios often look at the time it takes companies to collect cash from customer or the time it takes companies to convert inventory into cash.

Efficiency ratios go hand in hand with profitability ratios. Most often when companies are efficient with their resources, they become also profitable.

C.1 Asset Turnover Ratio

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. 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.

Formula

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

Asset Turnover Ratio = (Net Sales) / (Average Total Assets)

C.2 Inventory Turnover

The inventory turnover ratio is an efficiency ratio that shows how effectively inventory is managed by comparing cost of goods sold with average inventory for a period. This measures how many times average inventory is “turned” or sold during a period. It measures how many times a company sold its total average inventory dollar amount during the year.

Formula

The inventory turnover ratio is calculated by dividing the cost of goods sold for a period by the average inventory for that period:

Inventory Turnover Ratio = (Cost of Goods Sold) / (Average Inventory)

  1. Profitability Ratios

Profitability ratios compare income statement accounts and categories to show a company’s ability to generate profits from its operations. Profitability ratios focus on a company’s return on investment in inventory and other assets. These ratios show how well companies can achieve profits from their operations.

D.1 Gross Margin Ratio

Gross margin ratio is a profitability ratio that compares the gross margin of a business to the net sales. This ratio measures how profitable a company sells its inventory or merchandise. The gross profit ratio is essentially the percentage markup on merchandise from its cost. This is the pure profit from the sale of inventory that can go to paying operating expenses.

Formula

Gross margin ratio is calculated by dividing gross margin by net sales:

Gross Margin Ratio = (Gross Margin) / (Net Sales)

D.2 Operating Profit Margin Ratio

The operating margin ratio, also known as the operating profit margin ratio, is a profitability ratio that measures what percentage of total revenues is made up by operating income. The operating margin ratio demonstrates how much revenues are left over after all the variable or operating costs have been paid. Conversely, this ratio shows what proportion of revenues is available to cover non-operating costs like interest expense.

Formula

The operating margin formula is calculated by dividing the operating income by the net sales during a period:

Operating Margin Ratio = (Operating Income) / (Net Sales)

The Operating Income, also called income from operations, is the earnings before interest and taxes. It can be calculated by subtracting cost of goods sold (variable expenses) and fixed expenses (rent, wages, other O&M expenses) from net sales (net revenues).

D.3 Return on Assets Ratio

The return on assets ratio, often called the return on total assets, is a profitability ratio that measures the net income produced by total assets during a period by comparing net income to the average total assets. The return on assets ratio or ROA measures how efficiently a company can manage its assets to produce profits during a period. This ratio measures how profitable a company’s assets are.

Formula

The return on assets ratio formula is calculated by dividing net income by average total assets:

Return on Assets Ratio = (Net Income) / (Average Total Assets)

The Net Income generally refers to the net profit after tax, not the net profit before tax.

D.4 Return on Capital Employed

Return on capital employed or ROCE is a profitability ratio that measures how efficiently a company can generate profits from its capital employed by comparing net operating profit to capital employed. Return on capital employed shows investors how many dollars in profits each dollar of capital employed generates.

ROCE is a long-term profitability ratio because it shows how effectively assets are performing while taking into consideration long-term financing. This is why ROCE is a more useful ratio than return on equity to evaluate the longevity of a company.

This ratio is based on two important calculations: operating profit and capital employed.

Net operating profit is often called EBIT or earnings before interest and taxes.

Capital employed refers to the total assets of a company less all current liabilities.

Formula

Return on capital employed formula is calculated by dividing net operating profit or EBIT by the employed capital:

Return on Capital Employed = (Net Operating Profit or EBIT) / (Employed Capital)

                           = (Net Operating Profit or EBIT) / (Total Assets – Current Liabilities)

D.5 Return on Equity Ratio

The return on equity ratio or ROE is a profitability ratio that measures the ability of a firm to generate profits from its shareholders investments in the company. The return on equity ratio shows how much profit each dollar of common stockholders’ equity (total equity – preferred shares) generates.

ROE is also an indicator of how effective management is at using equity financing to fund operations and grow the company.

Formula

The return on equity ratio formula is calculated by dividing net income by shareholder’s equity:

Return on Equity Ratio (ROE) = (Net Income) / (Shareholder’s Equity)

  1. Market Prospect Ratios

Market Prospect ratios are used to compare publicly traded companies’ stock prices with other financial measures like earnings and dividend rates. Investors use market prospect ratios to analyze stock price trends and help figure out a stock’s current and future market value.

Market prospect ratios show investors what they should expect to receive from their investment. They might receive future dividends, earnings, or just an appreciated stock value. These ratios are helpful for investors to predict how much stock prices will be in the future based on current earnings and dividend measurements.

E.1 Earnings Per Share

Earnings per share, also called net income per share, is a market prospect ratio that measures the amount of net income earned per share of stock outstanding. This is the amount of money each share of stock would receive if all of the profits were distributed to the outstanding shares at the end of the year.

Formula

Earnings per share or basic earnings per share is calculated by subtracting preferred dividends from net income and dividing by the weighted average common shares outstanding:

Earnings per Share = (Net Income – Preferred Dividends) / (Weighted Average Common Shares Outstanding)

Since companies often issue new stock and buy back treasury stock throughout the year, the weighted average common shares are used in the calculation.

E.2 Price Earnings Ratio or P/E Ratio

The price earnings ratio, often called the P/E ratio or price to earnings ratio, is a market prospect ratio that calculates the market value of a stock relative to its earnings by comparing the market price per share by the earnings per share. The price earnings ratio shows what the market is willing to pay for a stock based on its current earnings.

Formula

The price earnings ratio formula is calculated by dividing the market value price per share by the earnings per share:

Price Earnings Ratio = (Market Value Price per Share) / (Earnings per Share)

E.3 Dividend Payout Ratio

The dividend payout ratio measures the percentage of net income that is distributed to shareholders in the form of dividends during the year. This ratio shows the portion of profits the company decides to keep to fund operations and the portion of profits that is given to its shareholders.

Investors are particularly interested in the dividend payout ratio because they want to know if companies are paying out a reasonable portion of net income to investors.

Formula

The dividend payout formula is calculated by dividing total dividend by the net income of the company:

Dividend Payout Ratio = (Total Dividends) / (Net Income)

E.4 Dividend Yield Ratio

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.

Formula

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

Dividend Yield = (Cash Dividends per Share) / (Market Value per Share)

  1. Financial Leverage Ratios

Financial leverage ratios, sometimes called equity or debt ratios, measure the value of equity in a company by analyzing its overall debt picture. These ratios either compare debt or equity to assets as well as shares outstanding to measure the true value of the equity in a business.

The financial leverage ratios measure the overall debt load of a company and compare it with the assets or equity. This shows how much of the company assets belong to the shareholders rather than creditors.

When shareholders own a majority of the assets, the company is said to be less leveraged. When creditors own a majority of the assets, the company is considered highly leveraged.

F.1 Debt to Equity Ratio (see B.1)

F.2 Equity Ratio (see B.2)

F.3 Debt Ratio (see B.3)

  1. Coverage Ratios

G.1 Times Interest Earned Ratio (not implemented)

G.2 Fixed Charge Coverage Ratio (not implemented)

G.3 Debt Service Coverage Ratio (DSCR)

The debt service coverage ratio is a financial ratio that measures a company’s ability to service its current debts by comparing its net operating income with its total debt service obligations. This ratio compares a company’s available cash with its current interest, principle, and sinking fund obligations.

The debt service coverage ratio is important to both creditors and investors, but creditors most often analyze it. Since this ratio measures a firm’s ability to make its current debt obligations, current and future creditors are particularly interested in it.

Unlike the debt ratio, the debt service coverage ratio takes into consideration all expenses related to debt including interest expense and other obligations like pension and sinking fund obligation. In this way, the DSCR is more telling of a company’s ability to pay its debt than the debt ratio.

Formula

The debt service coverage ratio formula is calculated by dividing net operating income by total debt service (principal + interest payments):

Debt Service Coverage Ratio = (Operating Income) / (Total Debt Service)

For more details (e.g. analysis and sample calculations) and other financial ratios, please follow the link

http://www.myaccountingcourse.com/financial-ratios/

The above financial ratios are include in the top-of-the-line project finance models (deterministic or stochastic Monte Carlo Simulation).

For more details and to order above models, email me:

energydataexpert@gmail.com

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FINANCIAL RATIOS Yr 1 Yr 2
LIQUIDITY RATIOS
a. CURRENT RATIO (WORKING CAPITAL RATIO): (preferably > 2.00)
   Current Assets          674,814          674,814
   Current Liabilities average            22,984            22,984
   Current Ratio = Current Assets / Current Liabilities 27.84 29.36 29.36
               2.00
b. QUICK RATIO: (preferably > 1.00)
   Cash + Receivables (Cash Equivalents, Short term investments)          589,101          590,573
   Current Liabilities average            22,984            22,984
   Current Ratio = (Cash + Receivables) / Current Liabilities 10.47 25.63 25.69
SOLVENCY RATIOS (FINANCIAL LEVERAGE RATIOS)                1.00
c. DEBT TO EQUITY RATIO: (preferably < 1.00)
   Total Liabilities        6,214,554        5,595,397
   Total Owners’ Equity average        3,124,688        3,376,264
   Debt to Equity Ratio = Total Liabilities / Total Owners’ Equity 0.48 1.99 1.66
               1.00
d. EQUITY RATIO: (preferably > 0.50)
   Total Owners’ Equity        3,124,688        3,376,264
   Total Assets average        9,339,242        8,971,662
   Equity Ratio = Total Owners’ / Total Assets 0.78 0.33 0.38
               0.50
e. DEBT RATIO: (preferably < 0.50)
   Total Liabilities        6,214,554        5,595,397
   Total Assets average        9,339,242        8,971,662
   Equity Ratio = Total Liabilities / Total Assets 0.22 0.67 0.62
               0.50
EFFICIENCY RATIOS
f. ASSET TURNOVER RATIO: (preferably > 0.33)
   Net Sales (Revenues)        2,384,791        2,380,022
   Average Total Assets average        9,092,171        9,155,452
   Asset Turnover Ratio = Net Sales / Average Total Assets 0.61 0.26 0.26
               0.33
g. INVENTORY TURNOVER RATIO: (preferably > 4.00)
   Cost of Goods Sold          838,291          837,174
   Average Inventory average            98,005          195,814
   Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory 4.92 8.55 4.28
               4.00
PROFITABILITY RATIOS
h. GROSS MARGIN RATIO: (preferably > interest rate)
   Gross Margin (Revenues – Cost of Goods Sold)        1,546,500        1,542,848
   Net Sales (Revenues) average        2,384,791        2,380,022
   Gross Margin Ratio = Gross Margin / Net Sales 63.06% 0.65 0.65
9.18% 64.85% 64.82%
i. EBITDA MARGIN RATIO: (preferably > interest rate)
   EBITDA (Earnings before interest, taxes, depreciation, amortization)        1,432,233        1,409,210
   Net Sales (Revenues)        2,384,791        2,380,022
   EBITDA Margin Ratio = EBITDA / Net Sales average 0.60 0.59
59.06% 60.06% 59.21%
j. PROFIT MARGIN RATIO: (preferably > interest rate)
   Net Income (Net Profit After Tax)          471,158          448,134
   Net Sales (Revenues) average        2,384,791        2,380,022
   Gross Margin Ratio = Gross Margin / Net Sales 32.49% 0.20 0.19
9.18% 19.76% 18.83%
k. RETURN ON ASSETS RATIO: (preferably > interest rate)
   Net Profit Before Tax          471,158          448,134
   Average Total Assets        9,092,171        9,155,452
   Return on Assets = Net Profit Before Tax / Average Total Assets average 0.05 0.05
24.31% 5.18% 4.89%
9.18%
l. NET PROFIT TO ASSETS RATIO: (preferably > interest rate)
   Net Income (Net Profit After Tax)          471,158          448,134
   Average Total Assets        9,092,171        9,155,452
   Net Profit to Assets = Net Income / Average Total Assets average 0.05 0.05
22.13% 5.18% 4.89%
9.18%
m. RETURN ON OWNERS’ EQUITY (ROI): (preferably > interest rate)
   Net Income (Net Profit After Tax)          471,158          448,134
   Total Owners’ Equity        3,124,688        3,376,264
   Return on Owners’ Equity = Net Income / Total Owners’ Equity average 0.15 0.13
34.03% 15.08% 13.27%
9.18%
n. RETURN ON CAPITAL EMPLOYED (ROCE): (preferably > interest rate)
   Net Operating Profit (EBIT)        1,063,756        1,040,733
   Employed Capital (Total Assets – Current Liabilities)        9,316,258        8,948,677
   Return on Owners’ Equity = Net Profit After Tax / Total Owners’ Equity average 0.11 0.12
36.41% 11.42% 11.63%
9.18%
MARKET PROSPECT RATIOS
o. EARNINGS PER SHARE
   Net Income (Net Profit After Tax)          471,158          448,134
   Preferred Shares (10% of shares with 12% p.a. interest) 10% ###          106,140          106,140
   Weighted Average Common Shares Outstanding average              8,845              8,845
   Earnings per share = (Net Income – Preferred Shares) / Common Shares 39.84              41.27              38.67
p. PRICE EARNINGS RATIO (P/E RATIO)
   Market Value Price per Share        100.00            100.00            100.00
   Earnings per Share average              41.27              38.67
   P/E Ratio = Market Value Price per Share / Earnings per Share 0.87                2.42                2.59
q. DIVIDEND PAYOUT RATIO
   Total Dividends                    –          196,557
   Net Income (Net Profit After Tax) average          471,158          448,134
   Dividend Payout Ratio = Total Dividends / Net Income 0.50                    –                0.44
r. DIVIDEND YIELD RATIO
   Cash Dividends per Share                    –              22.22
   Market Value per Share average            100.00            100.00
   Dividend Yield = Cash Dividends per Share / Market Value per Share 0.46                    –                0.22

 

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