TURNOVER(TO) - (to compute average, add beg and ending balance and divided b

indicates the rec'bles quality &

the success of the co. in
collecting o/s rec'bles. Faster
Remember TSA - turnover gives credibility to
Turnover =
the current & acid test ratios

Sales(numerator
) divided by Ave
(denominator)

Accts Rec'bles
Turnover

reducing A/R wud improve TO ratio

numerator is sales
except for AP &
Inventory (COGS)
denominator is
average of the
name of the
formula

this measures of how

quickly inventory is sold is
an indicator of co.
performance. The higher the
turnover in gen, the better
the performance

a high ratio indicates effecive

assets use to generate sales

Inventory
Turnover

Total Assets
Turnover

A/P Turnover

Compute COGS if not given

Net Cr Sales

COGS

Net Sales

COGS

Ave Net Receivables

Ave Inventory

Ave Total Assets

Ave Net A/P

AVERAGE TURNOVER IN DAYS -just reverse the turnover ratio and divide the deno
indicates the ave. no. of days
required to collect A/R; the
more he sales are o/s. the
longer the rec'bles are o/s

A/R Turnover in
days aka Days
Sales O/S
numerator is
average of the
name of the ratio
denominator of
turnover ratio
divided by 365
days

indicates the average no. of

days required to senn
inventory

indicates the no. of days bet.

Acq'n of inventory and
realization of cash fr selling of
inventory

Inventory
+ Turnover in days = Operating Cycle

Inventory
Conversion Period
same result as days
of COS in Inventory
= Ave Inventory
over (COGS/365)

Ave Net Receivables

Ave Inventory

365

Net Cr Sales/365

COGS/365

Inventory Turnover

Measures the time from cash outlay to cash collection in days. The CCC can be shortened in
increasing inv. turnover, collecting Rec'bles more quickly or deferring remitances on payables for a
longer period o time. Can be calculated by simply adding the results of 365/INV TO ; 365/A/R TO
and 365/ A/P TO. Use to evaluate co. liquidity - the ability of the co meet its obligation as they
become due.

Cash Conversion Cycle (CCC)

.

Annual Percentage Rate (APR) o

quick paymt discount
.

how long does it take for a co to buy inventory on credit fr a vendor, sell that inventory on credit, collect cash for the sale
and use the proceeds to pay the vendor for the purchase

Inventory Conversion
+
Period

Receivables
Collection Period

Payables Deferral
Period
.

365
Pay period less Discount
x
Period

RETURN - same formula as "TURNOVER" but instead of sales in the numerator, use
is the profitability ratio that

Remember RNA produces a % output making it

- Return = easy to campare companies
that differ in sizes

NI(numerator)
divided by
Average(denomi
nator)

Return of Total
Assets (ROA)

measures co.'s % return

relative to its capital
investment risk without
regard to the method of
financing (Income over
Invested Capital)

Return on
Investment
(ROI)

a critical measure for determining a co.'s effectiveness; measure of

the rate of return earned by a company on the equity component of
its capital structure. Shows how well a co. is using its funds to
generate earnings.

Return on Equity
(ROE)

Return on Common
Equity

evaluates profitability of a firm

Numerator is Net
Income

Net Income (NI)

NI + Int (1-Tax Rate)

Net Income

NI-Preferred Dividends

Denominator is
average of name of
the ratio

Ave Total Assets

Ave Invested Capital

(LT Liab + Equity)

Total Equity

Ave Common Equity

indicates profit rate & used

when used with the asset
turnover ratio, indicates rate
of return on assets

Profit Margin

OR
Profit Margin

x Investment Turnover

**Assets valuation can

impact ROI and ROA results

Net Income (NI)

Sales

invested capital capital can

also be computed as ave
working capital plus ave PPE
Ideal to invest in SBUs with
higher ROI or ROE

measures the effect on a firm's proftability caused by a change in

sales. Firms hat rely more heavily on fixed costs as opposed to
variable costs will have higher levarage. High leverage means
higher risk but greater possible returns

Operating leverage

A co. with high operating leverage must produce sufficient sales

sales revenue to over its high fixed operating costs but will be highly
profitable once those fixed costs are met.. Capital intensive
industries often have high operating leverage. Labor-inensive
industries generaaly have low opearating leverage.
measures the extent to w/c co uses debt in its capital structure
(must be w/in risk appetitie

Financial
Leverage
Ave Total Assets

Equity

Extended Dupont Retu

Tax burden

reflects how much in pretax inc a

co retains after paying interest to
debt holders

extent to w/c a co. retains

profit after paying taxes

Net Income (NI)

Pretax income

Interest burden

Pretax Income
x

EBIT

x
after crossing out,result

RATIOS

involves managing CA (esp cash) & CL so that a co. can meet its current obligations in an efficient manner. The current and quick r

Working Capital (WC) Managementwealth. Adequate Working capital (WC) reserves mitigates risk, potemtially reduce returns and thereby increase profitability
Aggressive WC mgt
increae the ratio of CL to nonCL (more CA financed with CL : WC down; current ratio; down risk up
Conservative WC mgt
increase the ratio of CA to non CA (nore CA financed by non CL : WC up; current ratio up ; risk down
WC risks

less WC inreases risks by exposing a co to the likelihood of a possible failure to meet current obligations and increases risks bec. It

Quick (Acid Test) Ratio

used in working capital analysis to evaluate firm's short-term liquidity; ability to meet current obligation
w/o liquidating its inventory

Current ratio or WC ratio

measures the no, of times CA exceed CL and way of measuring short-term solvency and also shows
ability of the firn to generate cash to meets its short-term obligations; higher current ratio is better;
decline in of ratio implies a reduced ability to generate cash, increase in short-term debt, dec in CA or
combination of both; improving ratio an inc ability to pay off CL, and attributable to using LT borrowing to
repay shot-term debt

cost of credit discount aka cost of not taking discount aka memorize
Annual Percentage Rate (APR) of quick paymt discount

Average collection period in days

Motives for holding cash
Transaction motive
Speculative motive
Precautionary motive

=
=

if only terms of discount is given, the % of customers avaling disc & rest do not avail disc

to meet payments arising fr ordinary vourse of buisiness

cash maybe needed to take advatange of temporary opportunities
to maintain safety cushion to meet unexpected needs, concern of treasurer - liquidity and safet

Dsiadvantage of high cash levels = ROA down

Either speeding up cash inflows or slowing down cash outflows increases cash balances
Method to speed collection

Customer screening and credit policy ; prompt billing and payment discount

Expedite deposits

Electronic Fund Transfer & Lockbox systems

Methods to delay disbursements

defer payment, drafts (increases payable float) , line of credit & zero balance account

Tools for Cash Management

Float
- is the difference bet the balance of checks o/s which have not cleared in the bank and deposits made b
- use of draft delays a cash disbursement and increases payable float
Overdraft protection - OD loans is activated when an OD occurs and maybe automatically paid with next deposits
compensating balances - are bank requirement related to a loan - bank requires a certain balance to be maintain
Interest paid
to compute effective int rate with a compensating balance
ex loan of $200k @ 12% w/ 20 % compensating balance
Net proceeds

A/R Management
balancing credit and collection policies to optimize ave colletion period and numbre of days' sales in receivables
factor (sell) its receivables to get more quicly but its costly therefore this shld be the last resort sale of A/R to a fac
lockbox system - is used to accelerate the inflow of funds
Trade credit is the primary source of short-term credit for small firms
Debt-to-Equity ratio

indicates the degree of protection to creditors in case of solvency. The lower this ration the better the
co. position.

Debt ratio aka Debt-to-Assets

ratio

the ratio indicates how much of the total assets are financed by the creditors

Debt-to-total-capital ratio

measure of financial leverage; the ratio provides indication related to org's LT debt-paying ability, the
lower the ratio , the > the level of solvency and the greater the presumed ability to pay debts

Operating Cash flow to total debt

Time Interest earned

=
the ratio reflects the ability of a company to cover interest charges. It uses income bef interest and
taxes to reflect the amt of income available to cover interest expense

cost of factoring

Cost of equity capital

Using DCF,estimate the cost of equity capital of a firm with the stock of $85. The next annual dividend is expected
to be $4.25 and is expected to grow at a rate of 7%. The corporate tax rate is 30%.

Asset base

Hurdle Income

Total target income

Inventory management-

inventory depends on sales forecasts; lack of inventory can result in lost of sales and excessive inventory can result in burdensome
invenotry investments and lost invenotry due to obsolescence or spoilage

balancing the cost of carrying inventory against the cost of "stocking out"
inventory turnover & no. of days' sales in inventory used to control inventory quanti
Optimal level of inventory is affected by:
usage rate of inventory per period of time
the time required to receive the inventory
the cost per unit of inventory, which will have a direct impact on inventory cost
the cost of placing an order impacts order frquency, which affects order sizw and optimal inventory levels

Tools or Inventory models and systems used in determination of the optimal level of inventory or Method of invnetory c
Inventory turnover
COGS / Ave Inventory
Safety stock
Reorder point

co maintains safety stock to ensure mftg or customer supply requirements are met; if lead time becomes more variable, the amt of
stock needed to reduce the risk of stock outs will increase
inventory level at w/c a co should order or manufacture additional inventory to meet demand and to
avert incurring stockout costs

=
=

Economic Order Quantity (EOQ) it anticipates orders at the point where carrying costs are nearest to restocking costs in order to minimize total inventory costs. WH

MANAGING INVENToRY, THERE IS TRADE-OFF BT CARRYING COSTS (THE COSTS OF HOLDING INVENOTRY) AND ORDERING COSTS (C
OR ORDERING ADDITIONAL INV). For ex. If inv. Levels are low, then carrying costs are low, but inventory must be rrdered more
frequently, w/c increases ordering costs. . EOQ sttempts to minimize both ordering and carrying costs. The model can be applied to
mgt of any exchangeable goods. The method assumes the periodic demand is known and annual sales volume isc a crucial variabl
EOQ formula.

materials req't planning (MR extends the idea of computreized inventory control to manufacturing operations. MRP systems are generally computer-based and a

determines the inventory req't when a given no. of units is needed. The method is used to create a precise schedules of which item

just-in-time (JIT) model

was developed to reduce the lag time bet inventory arrival and inventory use. JIT ties delivery of components to the speed of assem
requires a considerable degree of coordination bet manufacturer and supplier. It maintains a smaller level of inventorym hence it in

Kanban Inventory Control

gives visual signals that a component required in production must be replenished. It prevents oversupply or interruption of the enti

OTHER FORMULA
Capital Budgeting process

after-tax cash flows over life of the rproject, both DIRECT (the effect when co. pays out cash, received cash, or makes a cas
(indirect cash flow effects included transactions that are indirectly asso. with a capital project or represent a noncash activity that p

Stages of cash flows ina capital

investment project

include inception of the project (at time period zero), the on-going periodic cash flows generated by the project and
project

Steps in Calculating a Capital Budgeting project's annual cash Flows:

1) Estimate net cash inflows
2) Subtract non cash tax deductible expenses to arrive at pretax income (ex depreciation and amorization
3) Compute income tax expense based on the tax rate
4) Subtract tax expense from net cash inflows to derive after-tax cash flows
Example:

Cash inflow
Less: Cash outflow

Sales
Cost

1000000
900000

Pre-tax Income (Net Inflow)

(1-tax rate)
After-tax Cash Flow
Add: depreciation tax shield (21000 x 40%)
After-tax cash flow

40% tax rate

100000
60%
60000
8400
68400

* depreciation of $21,000 not deducted since there is no cash involved in depreciation but depreciation
Depreciation tax shield
DDCF valuation method

determine the present value of all expected future cash flows using a predetermine discount

After-tax cash flows

After-tax cost of debt (kdx)

Cost of preferred stock

Cost of preferred stock (kps)

=
Where:

Present value of 1 or a lump sum

Dps = Preferred stock cash dividiends

n = number of years

Present value of an annuity

Net Present Value (NPV)

Positive NPV - investment should be made (IRR > NPV required rate of return)
Negative NPV - investment should not be made (IRR > NPV required rate of return)

Factor of Internal Rate of Return

(IRR)

require multiple trial & error computations; produces, rate of return that producesan NPV of 0; it is
evaluated in relation to mgt's req'd hurdle rate after the computation; the higher the PV factor, the
lower the computed rate (IRR), aka Time-adjusted Rate of Return

=
or
=

Payback Period-even cash flows(CF)

time required to recover cost of an investment, ofen used in risky investmentm focuses on liquidity
and risks; neglects total project profitability,

Discounted Payback Period

same formula with payback period, just multiply the figures by the PV factor

Present Value Factor

The higher the PV factor, the lower the computed rate (IRR). Increases to the invetment or decreases
to the cash flows serve to increase the PV factor

IRR -= discount rate at which NPV of the investment is equal to zero (0) IRR = discount rate at which
NPV of the investment = zero (0)
IRR > Hurdle rate (accept ; IRR < hurdle rate = reject

Profitability Index

=
is also referred to as the "excess present value index" or simply PV index. Company hope that this ratioi
will be over 1.0 which means that the PV of the inflows is > PV of the outflows

Residual Income

income in excess of desired minimum return historical weighted ave. cost of capital is usually used as the
target or hurdle rate. if the anount of the income fr investment exceeds the computed required return,
performance objectives have been met

Required return for Residual Income hurdle rate = target rate or discount rate in computing NPV

Economic Value added (EVA)

is a residual income technique used for capital budgeting & perofrmance evaluation. It represents the
residual (excess) income of project earnings in excess of cost of capital (incld. Cost of equity associated
with invested capital. It measures actual dolars that an invetment earns hence high return invetment will
not be rejected by hig-return divisions.

or

+ EVA = perforamce meeting stds Stock up : - EVA = not meeting stock down

Required Return for EVA

Profit before interest but after tax

Increase stock value/firm value

Weighted Average
Cost of Capital (WACC)

is the average cost of debt and equity financing associated with the firm's existing assets and
operations.

where :

=
% in capital structure =
If P/S is given in the problem, breakup equity as to PS and CS, hence, % in capital

Cost of Retained Earnings (kre) Method 1: Capital Assets Pricing

Model (CAPM)
Cost of Retained Earnings (Kre)Method 2 : Discounted Cash Flow
(DCF)

Cost of Retained Earnings (kre)Method 3: Bond Yield Plus risk

premium (BYRP)
Market rate of interest

=
=
=

Risk-free rate +
Risk-free rate +
Risk-free rate +
D=1 current
+ g
Mrket

value or price of the

P0
outstanding common
P
Where: 0 stock

D1 = the dividend pe share expected at the e

g = the constant rate of growth in dividends

= Pretax cost of long-term debt + market risk

= risk-free rate of interet + inflation premium

Lockbox systems

expedites cash inflows (minimize collection float)

Concentration banking

is the method by w/c a single bank is designated as a central bank as a means of controllng

zero balance account banking

represents an account that maintains a zero bal and accompanied by a master or parent account the
the availability of of idle cash

Opportunity cost

is the potential benefit lost by selecting a particular course of action ex revenue that will not

Relevant cost

those costs that will change in reponse to the selection of different courses of action

Incremental Cost

represent the change on cost associated with different alternatives

Differential Cost

represent the change in costs associated with 2 separate courses of action

Avoidable costs

represents the costs that can be averted by selecting different courses of action

operating leverage

the degree to which a firm used fixed operating costs as opposed to variable operating costs
high operating leverage = high fixed operating costs & low variable operating costs

financial leverage

as the degree to which a firm uses debt to to finance the company

combined (total) leverage

results from use of both fixed operating costs and fixed financing costs tomagnify retuns to t

Capital Budgeting techniques (use WACC as the hurdle rate)

IRR
utilize PV concepts to value both investments & the related cash flows. It is also referred to as time-adjusted rate o
NPV
as discounted based upon a predetermined rate (discount or hurdle rate) & compared to investment on t
Payback measures return of capital in years on either a discounted or undiscounted basus
Acctg Rate of Return - used GAAP basis of income

Annual Savings needed to make the invetment realize a 12% yield where PV of cash savings inflows = PV of he net cash
Given:
Cost
$
50,000.00
Residual value at the end of 5 years
$
10,000.00
PV of annuity of $1 @ 12% for 5 yearas
3.60
PV of $1 in 5 years at 12%
0.57
Answer:
PV cash savings/inflows
annual savings x 3.60
annual savings
Annual savings need to make the I nvestment realize 12%

=
PV net cash outflows
=
50000 - (10000 x .57)
=
(50000 - 5700) 3.60
= $
12,306.00

TO prove:
12305.555 x 3.60
= 50000 - 5700
$
44,300.00 = $
44,300.00
PRE-TAX and AFTER-TAX CASH FLOWS :
Cash Inflow
Less:Cash Outflow
Net Cash Inflow

40% Tax rate

(Sales)
(Cost)

Pre-tax Cash Flows

1,000,000.00
900,000.00
100,000.00 x

(1-40%) =

Less: Non-cash tax deductibe

Depreciation
Amortizatiomn
Pre-tax income
Taxable Income
Tax rate
40%
Net Income

5,000.00
5,000.00
90,000.00
36,000.00
54,000.00

(10,000 x 40%)

x
Hurdle rate - is the discount % used in NPV calculation
Rate of return of the project > hurdle rate
= Positive NPV ( > 0 ) = make investment
Rate of return of the project , hurdle rate
= Negative NPV ( , 0 ) = do not make investment
Internal Rate of Return
= NPV = 0

Discounted Cash Flow models

NPV
use time value concepts
IRR
use time value concepts
PI
required detailed LT forecasts of projects cash flows for longer term projects; cash flow projection migh b

e and divided by 2)

indicates how effectively working

capital is used

Investment
Turnover

Working Capital
(WC)Turnover

Net Sales

Net Sales

Ave Invested
Capital (LT Liab +
Equity)

Ave Working
Capital

divide the denominator by 365

A/R Collection
Period

Accounts Payable
Deferral Period

365

365

A/R Turnover

A/P Turnover

ratio indicates how effectively

working capital is used

entage Rate (APR) of

scount
.

Working Capital

Discount

Current Assets less

Current Liabilities
.

100 less Discount

%

numerator, use net income

this ratio allows for increased analysis of changes in the percentages. The net profit margin
inidcates the percent return on each sale while the asset turnover indicates the effective use of
assets in generating that sale

Dupont Return on Assets

Profit Margin
measure operating
efficiency

Total Assets Turnover

measure of the degree of
effciency w/ w/c a co. is using its
assets

is defined as the degree to w/c a firm's use of debt to finance the firm magnifies th effects of a
given % change in EBIT on the % change in EPS

Dupont Return on Equity

Profit Margin

Asset Turnover

x Financial Leverage

or

Return on
Assets (ROA)
Net Income (NI)
Sales

x
or
x

Financial Leverage
Net Sales
Ave Total Assets

Ave Total Assets

Equity

Extended Dupont Return on Equity

Operating Income
margin

Asset Turnover

x Financial Leverage

is a measure of firm profits

earned on sales after
paying operating costs

EBIT

Sales

Sales
x
Ave total assets
er crossing out,results to NI / Equity

Ave total assets

x

Equity

t manner. The current and quick ratios are used in working capital analysis. TH goal is maximize the shareholder
ereby increase profitability

own risk up

up ; risk down

ations and increases risks bec. It may reduce a firms ability to obtain addional shor-term financing

(Cash + Marketable Securities + Net Rec'bles) / Current Liab

Current Assets / Current Liabilities

360 or 365
(Total pay period
- Discount period)

Discount %
x (100% - Discount%)

Ex. 2/10 = 70% customers avail & n/30 = 30% customers avail
10 x 70% = 7

30 x 30% = 9

7 + 9 = 16 ave collec

surer - liquidity and safety

ment discount

alance account

k and deposits made but which have not yet cleared in the bank

aid with next deposits

alance to be maintained in cash & cannoat be used as WC
200000 x 12%
24,000
15%
160,000 = Effective interest rate
200000x (100%-20%)

' sales in receivables

sale of A/R to a factor usuallt a bank

Total Liabilities / Common stockholders equity

Total Liabilities /Total Assets

Total debt / Total Capital (Debt + Equity)

Operating Cash Flow / Total Debt

Earnings befor interest and taxed (EBIT) / Interest expense

Net cost/average amount invested
(Expected dividend / Current share price) + Growth rate
($4.25 / $85) + 0.07

0.12

working capital + PPE

Asset base x Imputed interest rate
Hurdle income + Residual income target (given)

ventory can result in burdensome carrying costs, incldng storage costs, insurance cost, opportunity costs of

ocking out"
ntrol inventory quantities

ventory levels

Method of invnetory control

ecomes more variable, the amt of safety

safety stock
+ (Lead time x Sales during lead time)
Safety stock + (Lead time x Safe during lead time)

minimize total inventory costs. WHEN

NOTRY) AND ORDERING COSTS (COSTS
entory must be rrdered more
osts. The model can be applied to the
sales volume isc a crucial variable n the

e generally computer-based and are designed to control the use of raw materials in the production process. It
a precise schedules of which items will be needed and what times they will be needed.

components to the speed of assembly line. It reduces the need of manufacutrers to carry large inventories, but
ler level of inventorym hence it increases Inventory turnover and decreases invenotry as a % of total assets.

rsupply or interruption of the entire manufacturing process as the result of lacking a componemt

sh, received cash, or makes a cash commnitment that is directly related to capital investment) and INDIRECT
epresent a noncash activity that produces cash benefits or obligations ex. depreciation tax shield) are analyzed

generated by the project and the terminal value associated with the disposal or winding down of a

amorization

ion but depreciation tax shield was added since it is a tax savings..
depreciation x tax rate

a predetermine discount rate (ex. WACC, required rate of return)

Pretax cash flow

pretax cost of debt x

(1-tax rate)
(1-tax rate)

Preferred stock dividends / net proceeds of Preferred stock

Dps / Nps
Nps = Net proceeds of preferred stock
Future value / (1 + interest rate)n
[
1
Payment x

1 _

(1 + interest rate)n ]
Interest Rate

PV of future flows cash inflows - PV cash outflows = 0

PV of cash inflows - original cost of the asset or investment
Net Incrememtal investment (investment required
Net Annual Cash Flow

Net Initial Investment / Increase in annual net after-tax cash flow

PV Initial Investment / PV of Increase in annual net after-tax CF

Investment / Cash Flows

Net incremental investment (investment required) / Annual CF

PV of net future cash inflow / PV of net initial investment
Annual after-tax cash flows / PV of net initial investment

Net Income - Required return or

Actual income earned by an investment - required return
Net Book Value x Hurdle Rate

Net operating profit after taxes (NOPAT) - Required Return

Investment (Debt and Equity) x $WACC
Cost of equity x %
equity in capital
structure

Weighted ave after-tax

cost of debt x % debt in
x capital structure

Debt has tax savings

when debt is used in
financing a project

debt / (debt + equity (Preferred stock and Common Stock)

equity / (debt + equity (Preferred stock and Common Stock)
CS, hence, % in capital structure for DEBT, P/S & C/S would be computed

Risk premium
(Beta x Market Risk premium)
Beta ( Market return - Risk-free rate)

share expected at the end of one year

te of growth in dividends

-term debt + market risk premium

eret + inflation premium

as a means of controllng receipts

ster or parent account the serves to fund any negative bal and is designed to maximize

ex revenue that will not occur

courses of action

ses of action

variable operating costs

operating costs

sts tomagnify retuns to the firm owners

o as time-adjusted rate of return (PV of Cash Inflow = PV of Cash Outflow

red to investment on the project to arrive at + or - NPV

ws = PV of he net cash outflows

After-tax Cash Flows

60,000.00

Net Cash Inflow after tax of 40%

4,000.00

64,000.00
3.79
242,560.00
240,000.00
2,560.00

Tax shield (dep or amort x tax rate)

After-tax cash flow

PV value of an annuity (series of inflow amt
pv OF Future cash flow
Initial Cash outflow or Investment
NET PRESENT VALUE

flow projection migh be either unavailable or unrealizable-limitation