Finance Quick Reference Guide

Basic Equations

This equation tells us two things, 1) Assets (the

things a business has to help it generate profit are
either owned by the business (equity) or owed by
The Accounting Equation Assets = Liabilities + Equity the business (liabilities). 2) Financial Accounting
is not concerned with revenues and profit. Its
purpose is to keep accurate records of all
financial transactions that have transpired.

The foundation of the Financial Equation is:

Income = Revenue - Cost. However, in order to
perform this equation, we must first calculate
Revenue (Price x Volume) and Cost (Fixed +
Variable). It is therefore the job of financial
Revenue = Price x Volume; Cost = managers (and all management) to concern
The Financial Equation(s) Fixed + Variable; Income = themselves with revenues, costs and profits.
Revenue - Cost Though emphasis from department to department
may vary, management must concern themselves
with all three. Generally speaking, both revenues
and profits must increase over the medium and
long terms while costs most often must be
maintained or decreased over the same period.
The Financial
Statements

A financial statement that summarizes a

company's assets, liabilities and shareholders'
Assets = Liabilities + Equity (a equity at a specific point in time. These three
Balance Sheet
“snapshot” moment in time) balance sheet segments give investors an idea as
to what the company owns and owes, as well as
the amount invested by the shareholders.

A financial statement that measures a company's

financial performance over a specific accounting
period. Financial performance is assessed by
Income = Revenues - Cost (over a giving a summary of how the business incurs its
Income Statement
period of time) revenues and expenses through both operating
and non-operating activities. It also shows the net
profit or loss incurred over a specific accounting
period, typically over a fiscal quarter or year.

Because public companies tend to use accrual

accounting, the income statements they release
each quarter may not necessarily reflect changes
Cash in and out (over a period of in their cash positions. This document provides
Cash Flow Statement time) and added to (or subtracted aggregate data regarding all cash inflows a
from) the opening cash value. company receives from both its ongoing
operations and external investment sources, as
well as all cash outflows that pay for business
activities and investments during a given quarter.
 Also known as "equity" and "net worth", the
Changes in equity due to such things
shareholders' equity refers to the shareholders'
as net income (or loss), sale (or
Statement of ownership interest in a company. It is comprises
repurchase) of stock and changes in
Shareholders’ Equity of Preferred stock, Additional contributed (paid-
asset values since the last reporting
in) capital, Common stock, Retained earnings,
period.
Other items (such as valuation allowances)

Liquidity Ratios

The working capital ratio (Current Assets/Current

Liabilities) indicates whether a company has
enough short term assets to cover its short term
debt. Anything below 1 indicates negative W/C
Working Capital Ratio Current Assets / Current Liabilities
(working capital). While anything over 2 means
that the company is not investing excess assets.
Most believe that a ratio between 1.2 and 2.0 is
sufficient.Also known as "net working capital".

Quick Ratio (Acid Test) (Current Assets - Inv) / Current An indicator of a company’s short-term liquidity.
Lliabilities The quick ratio measures a company’s ability to
meet its short-term obligations with its most
liquid assets. For this reason, the ratio excludes
inventories from current assets.The quick ratio
measures the dollar amount of liquid assets
available for each dollar of current liabilities.
Thus, a quick ratio of 1.5 means that a company
has $1.50 of liquid assets available to cover each
$1 of current liabilities. The higher the quick
ratio, the better the company's liquidity position.
Also known as the “acid-test ratio" or "quick
 assets ratio."

The debt ratio is the ratio of total debt to total

assets, expressed in percentage, and can be
interpreted as the proportion of a company’s
Debt Ratios Total Debt / Total Assets assets that are financed by debt.The higher this
ratio, the more leveraged the company and the
greater its financial risk. Debt ratios vary widely
across industries.

Total Liabilities / Shareholder's

Debt to Equity Ratio See Asset Management Ratios
Equity

Asset Turnover Ratios

Inventory Turnover Sales / Inventory or COGS / Ave Although the first calculation is more frequently
Inventory or (12 months Cost of used, COGS (cost of goods sold) may be
Revenue / (Inventories from current substituted because sales are recorded at market
year + Inventories from prior year) / value, while inventories are usually recorded at
2)) cost. Also, average inventory may be used
instead of the ending inventory level to minimize
seasonal factors. This ratio should be compared
against industry averages. A low turnover implies
poor sales and, therefore, excess inventory. A
high ratio implies either strong sales or
ineffective buying. High inventory levels are
unhealthy because they represent an investment
with a rate of return of zero. It also opens the
 company up to trouble should prices begin to fall.

(also called days sales outstanding) measures the

average number of days that accounts receivable
are outstanding. Accounts receivable collection
period measures the average number of days
between sending invoices to customers and
collecting payments from them. To calculate this
ratio, the average accounts receivable are divided
Accounts Receivable Average Accounts Receivable
by the average daily sales in the period. The
Collection Period /Average Daily Sales
average accounts receivable can be determined
by adding beginning accounts receivable to
ending accounts receivable and dividing the
result by two. The average daily sales can be
determined by dividing the sales for the period
(e.g., a year) by the number of days in the period
(e.g., 365 days).

(12 Months Net Sales / (Total

Accounts Receivable from current Number of times per year that the A/R account
A/R Turnover
year + Total Accounts Receivable turns over.
from prior year) / 2))

(12 Months Cost of Revenue /

(Total Accounts Payable from Number of times per year that the A/P account
A/P Turnover
current year + Total Accounts turns over.
Payable from prior year) / 2))

Inventory to Cash Days Average accounts receivable days + Inventory to cash days calculates the total
 average inventory days where average days from receiving inventory to
accounts receivable days is 365 days receiving cash for its sale. Thus, this metric adds
divided by accounts receivable average days in inventory to average days of
turnover, and inventory days is 365 accounts receivable to arrive at a final number (of
divided by inventory turnover. days) that combines the two.

Profitability Ratios

The ROE is useful for comparing the profitability

Return on Equity (ROE) Net Profit / Total Equity of a company to that of other firms in the same
industry.

Return on Assets (ROA) Net Profit / Total Assets The assets of the company are comprised of both
debt and equity. Both of these types of financing
are used to fund the operations of the company.
The ROA figure gives investors an idea of how
effectively the company is converting the money
it has to invest into net income. The higher the
ROA number, the better, because the company is
earning more money on less investment. For
example, if one company has a net income of $1
million and total assets of $5 million, its ROA is
20%; however, if another company earns the
same amount but has total assets of $10 million,
it has an ROA of 10%. Based on this example,
the first company is better at converting its
investment into profit. When you really think
about it, management's most important job is to
make wise choices in allocating its resources.
Anybody can make a profit by throwing a ton of
 money at a problem, but very few managers excel
at making large profits with little investment.

A financial ratio that measures a company's

profitability and the efficiency with which its
capital is employed.Instead of using capital
ROCE = Earnings Before Interest
ROCE (Return on Capital employed at an arbitrary point in time, analysts
and Tax (EBIT) / Capital Employed
Employed) and investors often calculate ROCE based on
(Assets - Current Liabilities)
“Average Capital Employed,” which takes the
average of opening and closing capital employed
for the time period

Keep in mind that the calculation for return on

investment and, therefore the definition, can be
modified to suit the situation -it all depends on
what you include as returns and costs. The
definition of the term in the broadest sense just
attempts to measure the profitability of an
investment and, as such, there is no one "right"
calculation. For example, a marketer may
Return on Investment Gain from Investment - Cost of
compare two different products by dividing the
(ROI) Investment / Cost of Investment
gross profit that each product has generated by its
respective marketing expenses. A financial
analyst, however, may compare the same two
products using an entirely different ROI
calculation, perhaps by dividing the net income
of an investment by the total value of all
resources that have been employed to make and
sell the product.
 Profit margin is very useful when comparing
companies in similar industries. A higher profit
margin indicates a more profitable company that
Net Income / Revenues or Net has better control over its costs compared to its
Net Profit Margin
Profits / Sales competitors. Profit margin is displayed as a
percentage; a 20% profit margin, for example,
means the company has a net income of $0.20 for
each dollar of sales.

((Total Revenue for the current

Sales Growth % period / Total Revenue for the last Yields period to period sales growth
period) - 1) x 100

((Gross Profit for the current

Gross Profit Growth % period / Gross Profit for the last Yields period to period gross profit growth
period) - 1) x 100

((Operating Income for the current

Operating Income Growth period / Operating Income for the Yields period to period operating income growth
last period) - 1) x 100

Break Even Analysis

Break Even Analysis in Fixed Cost / Contribution per Unit Break-even analysis is used to determine the
Units Break Even (i.e. Price -Variable Cost) Fixed point at which revenue received equals the costs
Analysis in Sales $ Cost/ (Contribution/Price) associated with receiving the revenue. Break-
even analysis calculates what is known as a
margin of safety, the amount that revenues
 exceed the break-even point. This is the amount
that revenues can fall while still staying above
the break-even point. Break-even analysis is a
supply-side analysis; it only analyzes the costs of
the sales. It does not analyze how demand may
be affected at different price levels.

Asset Management
Ratios

A financial ratio that measures the extent of a

company’s or consumer’s leverage. The debt
ratio is defined as the ratio of total debt to total
assets, expressed in percentage, and can be
interpreted as the proportion of a company’s
assets that are financed by debt.The higher this
ratio, the more leveraged the company and the
Debt Ratio Total Debt / Total Assets greater its financial risk. Debt ratios vary widely
across industries, with capital-intensive
businesses such as utilities and pipelines having
much higher debt ratios than other industries like
technology. In the consumer lending and
mortgage businesses, debt ratio is defined as the
ratio of total debt service obligations to gross
annual income.

Debt to Equity Ratio Total Liabilities / Shareholder's The debt-equity ratio is another leverage ratio
Equity that compares a company's total liabilities to its
total shareholders' equity. This is a measurement
of how much suppliers, lenders, creditors and
 obligors have committed to the company versus
what the shareholders have committed. To a large
degree, the debt-equity ratio provides another
vantage point on a company's leverage position,
in this case, comparing total liabilities to
shareholders' equity, as opposed to total assets in
the debt ratio. Similar to the debt ratio, a lower
the percentage means that a company is using
less leverage and has a stronger equity position.

Gross Margin to Net Sales Expresses Gross Margin as a percentage of Net

(Gross Profit / Net Sales) x 100
% Sales

This ratio can be performed for total expenses or

Expenses to Revenues (Expenses / Revenues) x 100
for a specific expense account

This ratio can be performed for total expenses or

Expenses to Net Sales % (Expenses / Net Sales) x 100
for a specific expense account

The DuPont Pyramid

DuPont analysis tells us that ROE is affected by

three things: 1) Operating efficiency, which is
Profit Margin = Profit/Sales Total
measured by profit margin 2) Asset use
DuPont Pyramid Asset Turnover = Sales/Assets
efficiency, which is measured by total asset
Equity Multiplier = Assets/Equity
turnover 3) Financial leverage, which is
measured by the equity multiplier
 Profit margin is very useful when comparing
companies in similar industries. A higher profit
margin indicates a more profitable company that
has better control over its costs compared to its
Profit Margin = Profit / Sales
competitors. Profit margin is displayed as a
percentage; a 20% profit margin, for example,
means the company has a net income of $0.20 for
each dollar of sales.

The amount of sales or revenues generated per

dollar of assets. The Asset Turnover ratio is an
indicator of the efficiency with which a company
is deploying its assets.Generally speaking, the
Total Asset Turnover = Sales higher the ratio, the better it is, since it implies
/Assets the company is generating more revenues per
dollar of assets. But since this ratio varies widely
from one industry to the next, comparisons are
only meaningful when they are made for different
companies in the same sector.

Equity Multiplier = Assets / Equity The ratio of a company’s total assets to its
stockholder’s equity. The equity multiplier is a
measurement of a company’s financial leverage.
Companies finance the purchase of assets either
through equity or debt, so a high equity multiplier
indicates that a larger portion of asset financing is
being done through debt. The multiplier is a
variation of the debt ratio. The ratio is calculated
fairly simply. For example, a company has assets
valued at $3 billion and stockholder equity of $1
billion. The equity multiplier value would be 3.0
($3 billion / $1 billion), meaning that one third of
 a company’s assets are financed by equity.

Company/Investment
Valuation

The portion of a company's profit allocated to

each outstanding share of common stock.
Earnings per share serves as an indicator of a
company's profitability. Earnings per share is
generally considered to be the single most
important variable in determining a share's price.
It is also a major component used to calculate the
Net Income - Dividends on price-to-earnings valuation ratio. For example,
Earnings Per Share (EPS) Preferred Stock / Average assume that a company has a net income of $25
Outstanding Shares million. If the company pays out $1 million in
preferred dividends and has 10 million shares for
half of the year and 15 million shares for the
other half, the EPS would be $1.92 (24/12.5).
First, the $1 million is deducted from the net
income to get $24 million, then a weighted
average is taken to find the number of shares
outstanding (0.5 x 10M+ 0.5 x 15M = 12.5M).

Dividend Per Share (DPS) Dividend (- Special Dividends) / The the sum of declared dividends for every
Number of Shares Outstanding ordinary share issued. Dividend per share (DPS)
is the total dividends paid out over an entire year
(including interim dividends but not including
special dividends) divided by the number of
outstanding ordinary shares issued. Dividends per
share are usually easily found on quote pages as
 the dividend paid in the most recent quarter
which is then used to calculate the dividend yield.
Dividends over the entire year (not including any
special dividends) must be added together for a
proper calculation of DPS, including interim
dividends. Special dividends are dividends which
are only expected to be issued once so are not
included. The total number of ordinary shares
outstanding is sometimes calculated using the
weighted average over the reporting period. For
example: ABC company paid a total of $237,000
in dividends over the last year of which there was
a special one time dividend totalling $59,250.
ABC has 2 million shares outstanding so its DPS
would be ($237,000-$59,250)/2,000,000 =
$0.0889 per share.

Price Earning Ratio (P/E Market Value Per Share / Earnings A valuation ratio of a company's current share
Ratio) Per Share price compared to its per-share earnings. For
example, if a company is currently trading at $43
a share and earnings over the last 12 months were
$1.95 per share, the P/E ratio for the stock would
be 22.05 ($43/$1.95). EPS is usually from the last
four quarters (trailing P/E), but sometimes it can
be taken from the estimates of earnings expected
in the next four quarters (projected or forward
P/E). A third variation uses the sum of the last
two actual quarters and the estimates of the next
two quarters.The P/E is sometimes referred to as
the "multiple", because it shows how much
investors are willing to pay per dollar of earnings.
If a company were currently trading at a multiple
(P/E) of 20, the interpretation is that an investor
 is willing to pay $20 for $1 of current
earnings.The average market P/E ratio is 20-25
times earnings.

The difference between the present value of cash

inflows and the present value of cash outflows.
NPV is used in capital budgeting to analyze the
profitability of an investment or project.
Determining the value of a project is challenging
because there are different ways to measure the
value of future cash flows. Because of the time
Net Present Value (NPV) (Excel Function) value of money, a dollar earned in the future
won’t be worth as much as one earned today. The
discount rate in the NPV formula is a way to
account for this. Companies have different ways
of identifying the discount rate, although a
common method is using the expected return of
other investment choices with a similar level of
risk.

Internal Rate of Return (Excel Function) The discount rate often used in capital budgeting
(IRR) that makes the net present value of all cash flows
from a particular project equal to zero. Generally
speaking, the higher a project's internal rate of
return, the more desirable it is to undertake the
project. As such, IRR can be used to rank several
prospective projects a firm is considering.
Assuming all other factors are equal among the
various projects, the project with the highest IRR
would probably be considered the best and
undertaken first.You can think of IRR as the rate
of growth a project is expected to generate. While
 the actual rate of return that a given project ends
up generating will often differ from its estimated
IRR rate, a project with a substantially higher
IRR value than other available options would still
provide a much better chance of strong growth.
IRRs can also be compared against prevailing
rates of return in the securities market. If a firm
can't find any projects with IRRs greater than the
returns that can be generated in the financial
markets, it may simply choose to invest its
retained earnings into the market.

Weighted Average Cost

of Capital (WACC)

A calculation of a firm's cost of capital in which

each category of capital is proportionately
weighted. All capital sources - common stock,
preferred stock, bonds and any other long-term
Weighted Average Cost
debt - are included in a WACC calculation. All
of Capital (WACC)
else equal, the WACC of a firm increases as the
beta and rate of return on equity increases, as an
increase in WACC notes a decrease in valuation
and a higher risk.

Where:

Re = cost of equity Rd = cost of debt E = market value of firm's equity

D = market value of firm's
V=E+D E/V = percentage of financing that is equity
debt

D/V = percentage of
Tc = corporate tax rate
financing that is debt