Financial Parameters - Part 2

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  • Profit Margin

Profit Margin broadly indicates both a company’s competitive position in an industry, and the industry’s characteristics in terms of the strength of competition, pricing flexibility, demand-supply scenario and regulation. A company’s profit performance is a good indicator of its fundamental health and competitive position. The net profit percentage is the ratio of after-tax profits to net sales. It reveals the remaining profit after all costs of production, administration, and financing have been deducted from sales, and income taxes recognized. As such, it is one of the best measures of the overall results of a firm, especially when combined with an evaluation of how well it is using its working capital.

PAT: PAT/Net Sales

  • Return on Capital Employed

Return on Capital Employed indicates the returns generated by a company on the total capital employed in the business. The ratio comprehensively tells us how well the company is run by its managers and how unaffected it is by the extent of its leveraging or by the nature of its industry. A consistently low ROCE reflects the company’s poor viability over the long term.

ROCE: EBIT/ [Total debt+ Tangible net worth+ deferred tax liability]

  • Total Debt to Net cash accruals

This ratio reflects the number of years a company will take to repay all its debt obligations at the present cash generation levels.

Total debt/ [PAT + Depreciation]

  • Current 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. The reason this ratio is called the working capital ratio is because it comes from the working capital calculation. When current assets exceed current liabilities, the firm has enough capital to run its day-to-day operations. In other words, it has enough capital to work. The working capital ratio transforms the working capital calculation into a comparison between current assets and current liabilities. A ratio less than 1 is considered risky by creditors and investors because it shows the company isn't running efficiently and can't cover its current debt properly. A ratio less than 1 is always a bad thing and is often referred to as negative working capital.

On the other hand, a ratio above 1 shows outsiders that the company can pay all of its current liabilities and still have current assets left over or a positive working capital.

Current Ratio: Current Assets/ Current Liabilities

  • Net Sales

Net sales are the total revenue, less the cost of sales returns, allowances, and discounts. This is the primary sales figure reviewed by analysts when they examine the income statement of a business. If a company's income statement only has a single line item for revenues that is labelled "sales," it is usually assumed that the figure refers to net sales. A growth in Net Sales signifies a growth in the business. If the Net sales are decreasing, find out the reasons for the same if possible.

  • EBITDA

EBITDA is calculated by taking net income and adding interest, taxes, depreciation and amortization expenses back to it. EBITDA is used to analyze a company's operating profitability before non-operating expenses (such as interest and "other" non-core expenses) and non-cash charges (depreciation and amortization). While EBITDA may be a widely accepted indicator of performance, using it as a single measure of earnings or cash flow can be very misleading. An analyst needs to check for the EBITDA margin trend while analyzing the income statement

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