Corporate Finance

120
Corporate Finance

2000 2001 Industry

B. Activity ratios
Asset turnover 8 11
Inventory turnover 6.86 6.60

C. Leverage ratios
Debt ratio (total debt/equity) 0.04 0.03
Times interest earned 126.88 243.61
Days’ payable 91 96

D. Liquidity ratios
Current ratio 1.02 1.04
Quick ratio 0.49 0.61

Note: HLL operates on a very thin margin of working capital which often turns negative. This
means that while it demands credit of anywhere between 60 and 90 days from its suppliers,
it does not extend any credit and insists on immediate payment by its stockists and dealers.
All the ratios for select companies are given in Appendix 1 at the end of this chapter.

Definitions of Ratios Used

ROA = [Net earnings + Interest (1 – Tax rate)]/Total assets (average)

ROE = Net earnings/Total stockholders’ equity (average)

Asset turnover = Net sales/Total assets (average)

Days’ receivable = Accounts receivable (average) × 365/Net sales

Inventory turns = COGS/Inventory (average)

Days’ payables = Accounts payable (average) × 365/[COGS + This year’s inventory

• Last year’s inventory]
  Current ratio = Current assets/Current liabilities
  Quick ratio = [Cash + Accounts receivable]/Current liabilities
  Debt-to-equity ratio = Total liabilities/Total shareholders equity
  Debt to capitalization = Non-current liabilities/(Non current liabilities + Shareholders’
  equity)
  Interest coverage = Income before interest and taxes/Interest expense

COMMON-SIZE FINANCIAL STATEMENTS

Common-sized balance sheet and income statements are prepared by dividing each entry with a common
denominator such as total assets and sales respectively. The objective of preparing common size balance
sheet and income statement is to ascertain the trends in proportions. For instance, if total currents have
grown from 10 percent of total assets to 15 percent between the last year and the current year, one can
investigate the reasons for changes in proportion. Exhibit 5.2 presents the common sheet financial statements
for HLL.

Table contd.