Financial Ratios Used in GLO-BUS
Profitability Ratios (as reported on pages 2 and5 of the Camera & Drone Journal)
Earnings Per Share (EPS) isdefined as net income divided by the number of shares of stockissued to stockholders. Higher EPS values indicate the company isearning more net income per share of stock outstanding. Because EPSis one of the five performance measures on which your company isgraded (see p. 2 of the CDJ) and because your company has a higherEPS target each year, you should monitor EPS regularly and takeactions to boost EPS. One way to boost EPS is to pursue actionsthat will raise net income (the numerator in the formula forcalculating EPS). A second means of boosting EPS is to repurchaseshares of stock, which has the effect of reducing the number ofshares in the possession of shareholders.
Return On Equity (ROE) is definedas net income (or net profit) divided by total shareholders’ equityinvestment in the business. Higher ratios indicate the company isearning more profit per dollar of equity capital provided byshareholders. Because ROE is one of the five performance measureson which your company is graded (see p. 2 of the CDJ), and becauseyour company’s target ROE is 15%, you should monitor ROE regularlyand take actions to boost ROE. One way to boost ROE is to pursueactions that will raise net profits (the numerator in the formulafor calculating ROE). A second means of boosting ROE is torepurchase shares of stock, which has the effect of reducingshareholders’ equity investment in the company (the denominator inthe ROE calculation).
Operating Profit Margin isdefined as operating profits divided by net revenues (where netrevenues represent the dollars received from camera sales, afterexchange rate adjustments and any promotional discounts). A higheroperating profit margin (shown on p. 5 of the CDJ) is a sign ofcompetitive strength and cost competitiveness. The bigger thepercentage of operating profit to net revenues, the bigger themargin for covering interest payments and taxes and moving dollarsto the bottom-line.
Net Profit Margin is defined asnet income (or net profit, which means the same thing) divided bynet revenues (where net revenues represent the dollars receivedfrom camera sales, after exchange rate adjustments and anypromotional discounts). The bigger a company’s net profit margin(its ratio of net income to net revenues), the better the company’sprofitability in the sense that a bigger percentage of the dollarsit collects from camera sales flow to the bottom-line. The netprofit margin represents the percentage of revenues that end up onthe bottom line.
Operating Ratios (as reported on the ComparativeFinancial Performances page of the Camera & Drone Journal)
The ratios relating to costs and profit as a percentage of netrevenues that are at the bottom of page 5 of the CDJ are ofparticular interest because they indicate which companies are mostcost efficient:
The percentage of total production coststo net sales revenues. This ratio is calculated by dividingtotal production costs of cameras by net revenues (where netrevenues represent the dollars received from camera sales, afterexchange rate adjustments and any promotional discounts). Lowpercentages are generally preferable to higher percentages becausethey signal that a bigger percentage of the sales price for eachcamera is available to cover delivery, marketing, administrative,and interest costs, with any remainder representing pre-tax profit.Companies having the highest ratios of production costs to netrevenues are likely to be caught in a profit squeeze, with marginstoo small to cover delivery, marketing, and administrative costsand interest costs and still have a comfortable margin for profit.Production costs at such companies are usually too high relative tothe price they are charging (their strategic options for boostingprofitability are to cut costs, raise prices, or try to make up forthin margins by somehow selling additional units).
The percentage of delivery costs forcameras to net sales revenues. This ratio is calculated bydividing total delivery costs by net revenues (where net revenuesrepresent the dollars received from camera sales, after exchangerate adjustments and any promotional discounts). A low percentageof delivery costs to net revenues is preferable to a higherpercentage, indicating that a smaller proportion of revenues isrequired to cover delivery costs (which leaves more room forcovering other costs and earning a bigger profit on each unitsold).
The percentage of total marketing costsfor cameras to net sales revenues. This ratio is calculatedby dividing total marketing costs by net revenues (where netrevenues represent the dollars received from camera sales, afterexchange rate adjustments and any promotional discounts). A lowpercentage of marketing costs to net revenues relative to othercompanies signals good efficiency of marketing expenditures (morebang for the buck), provided unit sales volumes areattractively high. However, a low percentage of marketingcosts, if coupled with low unit sales volumes, generally signalsthat a company is spending too little on marketing.The optimal condition, therefore, is a low marketing costpercentage coupled with high sales, high revenues, andabove-average market share (all sure signs that a company has acost-effective marketing strategy and is getting a nice bang forthe marketing dollars it is spending).
The percentage of total administrativecosts for cameras to net sales revenues. This ratio iscalculated by dividing administrative costs by net revenues (wherenet revenues represent the dollars received from camera sales,after exchange rate adjustments and any promotional discounts). Alow ratio of administrative costs to net revenues signals that acompany is spreading its fixed administrative costs out over abigger volume of sales. Companies with a high percentage ofadministrative costs to net revenues generally need to pursueadditional sales or market share or risk squeezing profit marginsand being at a cost disadvantage to bigger-volume rivals (althougha higher administrative cost ratio can sometimes be offset withlower costs/ratios elsewhere).
Liquidity Ratio (as reported on the ComparativeFinancial Performances page of the Camera & Drone Journal)
The current ratio is defined ascurrent assets divided by current liabilities. It measures thecompany’s ability to generate sufficient cash to pay its currentliabilities as they become due. At the least, your company’scurrent ratio should be greater than 1.0; a current ratio in the1.5 to 2.5 range provides a much healthier cushion for meetingcurrent liabilities. Ratios in the 5.0 to 10.0 range are far betteryet. A bolded number in the current ratio column designates thecompany with the best/highest current ratio; companies with shadedcurrent ratios need to work on improving their liquidity if thenumber is below 1.5.
Dividend Ratios (as reported on the ComparativeFinancial Performances page of the Camera & Drone Journal)
The dividend yield is defined asthe dividend per share divided by the company’s current stockprice. It shows what return (in the form of a dividend) ashareholder will receive on their investment in the company if theypurchase shares at the current stock price. A dividend yield below2% is considered “low” unless a company is rewarding shareholderswith nice gains in the company’s stock price. A dividend yieldgreater than 5% is considered “high” by real world standards and isattractive to investors looking for a stock that will generatesizable dividend income. In GLO-BUS, you should consider the meritsof keeping your company’s dividend payments high enough to producean attractive yield compared to other companies. A rising dividendhas a positive impact on your company’s stock price (especially ifthe dividend is increased regularly, rather than sporadically), butthe increases need to be at least $0.05 per share to have muchimpact on the stock price. However, as explained below, you do notwant to boost your dividend so high (just for the sake ofmaintaining a record of dependable dividend increases) that yourdividend payout ratio becomes excessive. Dividend increases shouldbe justified by increases in earnings per share and by thecompany’s ability to afford paying a higher dividend.
The dividend payout ratio isdefined as the dividend per share divided by earnings per share (ortotal dividend payments divided by net profits—both calculationsyield the same result). The dividend payout ratio thus representsthe percentage of earnings after taxes paid out to shareholders inthe form of dividends. Generally speaking, a company’s dividendpayout ratio should be less than 75% of EPS, unless the company haspaid off most of its loans outstanding and has a comfortable amountof cash on hand to fund growth and contingencies. If your company’sdividend payout exceeds 100% for several quarters and certainly formore than a year or two, then you should consider a dividend cutuntil earnings improve. Dividends in excess of EPS areunsustainable and thus are viewed with considerable skepticism byinvestors—as a consequence, dividend payouts in excess of 100% havea negative impact on the company’s stock price.
Credit Rating Ratios (as reported on theComparative Financial Performances page of the Camera & DroneJournal)
Below are descriptions of each of the four factors determiningyour company’s credit rating:
The debt-equity ratio (defined aslong-term debt divided by total shareholders’ equity) indicates theextent to which the company’s long-term capital has been suppliedby creditors or by shareholders. A debt-equity ratio of .33 isconsidered “good”. As a rule of thumb, it will take a 4-quarteraverage debt-equity ratio close to 0.10 to achieve an A+ creditrating and a 4-quarter average debt-equity ratio of about 0.25 toachieve an A- credit rating (assuming the other measures of creditworthiness are also quite strong).
The times-interest-earned ratio(defined here as operating profit for the last four quartersdivided by net interest for the last 4 quarters) is a measure ofthe safety margin that creditors have in assuring that companyprofits from operations are sufficiently high to cover annualinterest payments. A times-interest-earned ratio of 2.0 isconsidered “rock-bottom minimum” by credit analysts. Atimes-interest-earned ratio of 5.0 to 10.0 is considered much moresatisfactory for companies in the digital camera industry becauseof quarter-to-quarter earnings volatility over each year, intensecompetitive pressures which can produce sudden downturns in acompany’s profitability, and the relatively unproven managementexpertise at each company.
The debt payback capability is ameasure of the number of years it will take to pay off thecompany’s outstanding loans based on the most recent year’sfree cash flow (where free cash flowis defined as net income plus depreciation minus total dividendpayments). Net income is reported on a company’s Income Statement,companywide depreciation costs are reported on the Production CostReport, and annual dividend payments are shown on the Cash FlowStatement portion of a company’s Finance Report. The number ofyears to pay off the debt equals the amount of long-term debt shownon the Balance Sheet divided by free cash flow. A short debtpayback period (less than 3 years) is a much stronger sign ofcreditworthiness and cash flow strength than a long payback period(8 to 10 years or more). If your company’s number for debt paybackis bolded, then your company has the shortest payback period in theindustry; if your company’s number has a shaded background, thenyour debt-payback period is high relative to rivals and you need towork on improving profitability and free cash flows in order toreduce the debt payback period.
A company is considered more creditworthy when its line of credit usage is small (say 5% to 15% ofthe total credit available) because it has less debt outstandingand greater access to additional credit should the need arise. Acompany’s creditworthiness is called into serious question when ithas used 80% or more of its credit line, especially if it also hasa long debt payback period, a relatively high debt-equity ratio,and/or a relatively low times-interest earned ratio. Generallyspeaking, credit analysts like to see companies using only arelatively small portion of their credit lines over the course of ayear (there’s no problem of borrowing more heavily to finance thetypically double production levels of the third quarter so long asmost of these borrowings are repaid in the fourth quarter when thecash from high third-quarter sales is received). What troublescredit analysts most is a company that calls upon 50% or more ofits credit line quarter-after-quarter, year-after-year and seemsconstantly on the verge of struggling to pay its debt outstanding.Companies that utilize only a small percentage of their creditlines are viewed as good credit risks, able to pay off their debtin a timely manner without financially straining theirbusiness.
The four credit rating measures are of roughly equal importancein determining a company’s credit rating. However, weakness on justone of the four can be sufficient to knock a company’s creditrating down a notch. Weakness on two (or more) can reduce therating by several notches. If any of the credit rating measures foryour company have a shaded or highlighted background, then you andyou co-managers need to take calculated action to get those ratiosup as rapidly as possible. Bolded numbers on the credit ratingmeasures indicate credit rating strength relative to rivalcompanies.
Companies placed oncredit watch need to pay special attention to improving theircreditworthiness and financial performance. This nearly alwaysmeans considering strategy changes and boosting your company’scompetitiveness in the marketplace so as to greatly improve yourcompany’s overall profitability and ROI.