This is “Worked Problem: CABS Inc.”, section 4.7 from the book Finance for Managers (v. 0.1).
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CABS Inc. is a fictional company that makes custom invitations and cards. Below are their financials.
Figure 4.6 CABS, Inc. Balance Sheet
Figure 4.7 CABS, Inc. Income Statement
Figure 4.8 CABS, Inc. Statement of Cash Flows
Figure 4.9 CABS, Inc. Other Data
In this section we pick some key ratios to calculate for CABS. Then we will analyze using data over time and versus competitors.
The two liquidity ratios are the Current Ratio and the Quick Ratio. Both are important to calculate.
To calculate the current ratio we take the current assets number from the balance sheet and divide it by the current liabilities number, also from the balance sheet. For CABS the calculation is:
$$\text{CurrentRatio}=\text{}\frac{\text{TotalCurrentAssets}}{\text{TotalCurrentLiabilities}}=\text{}\frac{315.7}{169.5}=1.86$$To calculate the quick ratio we take three numbers from the balance sheet: current assets, inventories and current liabilities.
$$\text{QuickRatio}=\text{}\frac{\text{TotalCurrentAssets}-\text{Inventories}}{\text{TotalCurrentLiabilities}}=\text{}\frac{315.7-33.6}{169.5}=1.66$$Asset management ratios calculate how efficiently the firm uses its assets. Here we calculate average sales per day, total asset turnover and fixed asset turnover.
Average sales per day takes the sales number from the income statement and divides it by 365.
$$\text{averagesales}=\text{}\frac{\text{annualsales}}{365}=\text{}\frac{1680.0}{365}$$Total asset turnover is computed by dividing the sales number from the income statement by the total asset number from the balance sheet.
$$\text{TotalAssetTurnover}=\text{}\frac{\text{Sales}}{\text{TotalAssets}}=\text{}\frac{1680.0}{458.2}=3.66$$Fixed asset turnover focuses just on the fixed assets (for example a factory). It divides the sales number from the income statement by the net fixed assets (note: net!) from the balance sheet.
$$\text{FixedAssetTurnover}=\text{}\frac{\text{Sales}}{\text{NetFixedAssets}}=\text{}\frac{1680.0}{142.5}$$Debt management ratios measure the indebtness of the firm. The key ratios we analyze here are the debt ratio, debt-equity and TIE.
The debt ratio simply divides two numbers from the balance sheet: total liabilities divided by total assets.
$$\text{DebtRatio}=\text{}\frac{\text{TotalLiabilities}}{\text{TotalAssets}}=\text{}\frac{242.1}{458.2}=\text{}0.52$$The debt-equity ratio changes the denominator by subtracting total liabilities. Debt-equity also uses total assets and total liabilities from the balance sheet.
$$\text{Debt-EquityRatio}=\text{}\frac{\text{TotalLiabilities}}{(\text{TotalAssets}-\text{TotalLiabilities})}=\text{}\frac{242.1}{458.20-242.1}=1.12$$TIE measures the ability of a firm to pay back its debt. It uses EBIT and interest expense from the income statement.
$$\text{Times-Interest-Earned}=\text{}\frac{\text{EBIT}}{\text{InterestExpense}}=\text{}\frac{222.6}{25}$$Debt management ratios measure the indebtness of the firm. The key ratios we analyze here are the debt ratio, debt-equity and TIE.
The amount of money left over after all expenses are paid. It uses sales and cost of goods sold from the income statement.
$$\text{ProfitMargin}=\text{}\frac{\text{Sales}-\text{CostofGoodsSold}}{\text{Sales}}=\text{}\frac{1680.0-910.4}{1680.0}=0.46$$Operating profit margin is a better measure of the actual profit from operations because it ignores items such as depreciation. It is operating profits (EBIT) divided by sales. Both numbers come from the income statement.
$$\text{OperatingProfitMargin}=\text{}\frac{\text{OperatingProfits}\left(\text{EBIT}\right)}{\text{Sales}}=\text{}\frac{222.6}{1680.0}=\text{}0.13$$Net profit margin is the percentage of each sales dollar that remains after all expenses have been deducted. It is calculated by dividing earnings (net income) by sales. Both numbers come from the income statement.
$$\text{NetProfitMargin}=\text{}\frac{\text{EarningsAvailableforCommonStockholders}}{\text{Sales}}=\text{}\frac{118.6}{1680.0}=\text{}0.07$$Is the amount of earnings generated by each share of stock. It is calculated by dividing earnings by the number of shares of stock.
$$\text{EarningsPerShare}=\text{}\frac{\text{EarningsAvailableforCommonStockholders}}{\text{NumberofSharesofCommonStockOutstanding}}=\text{}\frac{118.6}{6}=19.77$$Basic Earning Power is earning power of the firm before taxes and leverage. It is calculated by dividing EBIT from the income statement by total assets from the balance sheet.
$$\text{BasicEarningPower}=\text{}\frac{\text{EBIT}}{\text{TotalAssets}}=\text{}\frac{222.6}{458.2}=\text{}0.49$$Return on Equity is the ratio of net income to total equity. It is calculated by dividing net income from the income statement by equity, from the balance sheet.
$$\text{ReturnonEquity}=\text{}\frac{\text{NetIncome}}{\text{CommonStockEquity}}=\text{}\frac{118.6}{216.1}=\text{}0.55$$Return on Assets is the ratio of net income to total assets. This is calculated by diving net income from the income statement by total assets from the balance sheet.
$$\text{ReturnonAssets}=\text{}\frac{\text{NetIncome}}{\text{TotalAssets}}=\text{}\frac{118.6}{458.2}=0.26$$Market Value Ratios are a way to measure the value of a company’s stock relative to another company’s stock. Here we focus on P/E ratio and market book ratio.
Price / Earnings ratio is used to show how much investors are willing to pay per dollar of profits. It is calculated by dividing the price per share of stock (in the other information section) by the earnings per share (calculated earlier).
$$\text{Price/EarningsRatio}=\text{}\frac{\text{Pricepershareofstock}}{\text{Earningspershareofstock}}=\text{}\frac{149}{19.77}=7.54$$Market book ratio is a measure of investor’s evaluation of firm performance. First the book value per share of stock is calculated using the common equity number from the balance sheet and dividing it by the number of shares outstanding from the other information.
$$\text{BookValuePerShareofStock}=\text{}\frac{\text{CommonStockEquity}}{\text{NumberofSharesofStockOutstanding}}=\text{}\frac{216.1}{6}=\text{}36.01$$This is then substituted in to calculate the Market/Book ratio. This equation uses the market price (selling price) per share of stock from the other information section and the book value calculated above.
$$\text{MarketBookRatio}=\text{}\frac{\text{MarketValuepershareofcommonstock}}{\text{BookValuepershareofcommonstock}}=\frac{149}{36.01}=4.13$$Below is a table summarizing the numbers we just calculated in the CABS 2011 column. The table also includes CABS data from last year and also the industry average for 2011.
Figure 4.10 CABS, Inc. Averages
How do you think CABS is doing financially? How are they doing versus other players in their industry?
Calculate the following ratios from the data for CABS (these were not calculated above):