RelativeResourceManager

RelativeResourceManager - Exhibit 5—9 Kev Financial...

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Unformatted text preview: Exhibit 5—9 Kev Financial Ratios for Credit. Analysis CATEGORY <H~n~ccnn FINANCIAL RATIO 1. Current Ratio 2. Net Working Current Capital 3. Quiclt fiatio 4. Cash Flow to Total Debt 5. Cash Flori.r from Operations term) FORMULA INTERPRETATIQN _ Current Assets Current Liabilities Current Assets Liabilities Higher is better, indicating increased ability to cover payables. Higher is better, indicating increased ability to cover payabies. Current Assets — Inventor_y Current liabilities Measures the company's ability to pay current obligations with its most liquid assets. More conservative measure than #1 or #2; again higher is better. indicating increased ability to cover payables. Net income + Depreciation Expense Short—Term Debt + Long— Term Debt or Net Income + Depreciation Expense [Current Liabilities — t\lP_—— Accrued Expenses} + Long— Terrn Debt Netlncome -l Noncash Charges | Change in Operating Current Liabilities — Change in Current Assets (or just pull #- ft’om Statement ot‘Cash Flows} Higher is better. indicating ability to cover debt service (interest and principal repayments}. Larger amottnt is better. (lives flow concept of ability of company to generate cash from operations. Much better measure of additions to liquidity than earnings when company is capital—intensive or growing rapidly. WARNING SIGNS Watch ottt for values that are artificially inflated due to slow—moving. perishable. or obsolete inventory. Must evaluate in light of size of company; also watch out for values that are artificially inflated clue to slow—moving, perishable, or obsolete inventory. Flow concepts and receivablei’payable synchronization must also be evaluated. The quick ratio Still cloes not capture the tlnsyncht'onized nature of receipts and disbursements (e.g., situation where only CA are receivables. only CL are payables: it QR. = 1, you collect receivables in 60 days but pay payables in 30 clays and thus will be unable to meet payables). Low ratio often t'oresbadows bankruptcy. Company may be able to use large cash and securities position to offset temporary declines in cash flow. Negative [)FFO signals increasing inability to pay payables. Unhealthy firm must Fund negative (IFFO by selling off assets or issuing new liabilities; so, compare investing and financing cash flows from SCF to give depth to analysis. {continued} limitatioqu amnme Sittt‘tUJJV g .tatduuj [91 Exhibit 5—9 (continued) Key Financial Ratios for Credit. Analysis CATEGORY FINANCIAL RAT10 FORMULA INTERPRETATION WARNING SEGNS L 6. Cash Cycle CC = (Days Inventory Held Shorter is better. longer CC signals more of Any unexpected lengthening of CC is bothersome. I (CC; also called + Days Sales Outstanding — company’s cash being tied up in operations. Determine the source of deterioration (inventory Q Cash Conversion Days Payables Outstanding) For any given balance sheet liquidity position. conversion taking longer, collection experience U Period) or, equivalently, a longer CC indicates more of that iiquidity deteriorating) to evaluate seriousness. Creditor I CC 2 Inventory Conversion is encumbered by operational working may begin to stretch payables to compensate for D Period + Receivables capital needs. Further, the CC indicates the longer operating cycle (CC = DIII + USO). I Conversion Period — dependence on outside financing. Controlling for size, bankrupt firms are more T Payables Deferral Period likely to successfully emerge from bankruptcy Y with higher receivables—to—total debt and lower payables—to—lotal debt ratios (Tucker and Moore. 2000]. 7. Cash Turnover HZOL“. CT : 365lCC Higher is better. Measu res how many “turns” company gets on cash tied up in operations. Views cash as inventory. More cash tied up in operations means more nonearning assets. 8. Net Liquid Balance 9. Defensive Interval or “'l'ime to Ruin” NLB = (Cash + Short—Term investments} — (Notes Payable + Current Portion of Long—Term Debt) Larger amount is better. Shows ability of nonspontaneous current assets to cover nonspontaneons (arranged) debts. ls unaffected by collectibility of receivables or salability of inventories. In effect. assumes operating cycle (Accounts Receivable and inventories) is exactly matched by Accounts Payable, and prepaid expenses are exactly matched by accruals. Hypothetically, if CC = 0, how much residual liquidity does the organization have? Offers credit analyst incisive supplement to CC. (lives insight into financial flexibility. Watch for near-term principal repayments beyond one—year cutoff that separates Current Liabilities From Long Term Debts. This applies to revolving credit agreements, term loans, and bonds. Companies also may use leases in lieu of debt. Cash + Short—Term Investments Daily Operating Expenses ivltere Daily Operating Expenses = (COGS + Selling, General. 8: Administrative Expenses — Depreciation Expenselt'365 Higher is better. showing how long company can pay bills if it has a strike or other disruption of revenue stream, assuming it has lengthy DST and D80 and has no short—term borrowing capacity. When company has significant un— tapped short—term borrowing capacity. this measure is overly conservative. Also, the greater the proportion of short— term debt as a percent of total financing, the less protection the cash value represents (interest and principal flows are not included in the tneasure’s formula}. Watch for deterioration in this number as :1 relative liquidity indicator. When labeled as “time to ruin," it provides an indicator of efficacy of hedging strategies used by the company. If the company‘s hedges do not significantly increase the“lime to ruin,“ its hedging strategy is flawed. The latter consideration applies to creditors having significant commodity price exposure, foreign exchange transaction exposure, or interest rate exposure. ZQI {ending} Suppom fa mamafiouuw a toad CATEGORY FlNANCIAL RATlO FORM ULA INTERPRETATION WARNING SlGNS Habit! ozmammmzsg (3t mmbmmaoq 1 . Times Interest Elf-[T Higher is better. How many times over could Provides an inaccurate indicator of ability to Earned Intmgtm we pay the interest expense From the pool of service debt. It overstates that ability to a degree. in m. Funds available to pay it? if we lake 1 — that accrual basis for EBlT recognizes revenue Operating profit (ltTlE), we get the % reduction in operating before cash is received and recognizes expenses — profits that company could experience while alter cash expenditures for labor and materials are Interest Expense yet allowing it to cover its interest payments. made. Furthermore, lease payments, principal For example, ifTIE is 4, company‘s operating repayments, and preferred dividends are also profit could drop 75% l= l —(ll’=l)] before ils financing—related cash outflows that must be ability to pay interest is impaired. Smaller covered, and these are not included in the formula. values indicate reduced financial flexibility, On the other hand, capital—intensive companies increasing risk to other creditors (including would see this ratio as underslating cash generated trade creditors). and might add back depreciation and amortization to get a better picture of cash generated (yielding EBITDA). May wish to supplement with Cash from Operating Activities (From Statement of Cash Flows) divided by Interest Expense or use a “fixed charges coverage ratio" to include sinking fund payments, lease payments, and preferred stock dividends in the denominator. Also, consider plans for new debt issues. 2. long-Term Long—Term Debt Lower is better. We are measuring the percent This ratio does not account for ability of large Debt to Capital jugg_—l—crm Deb“. oflong—term financing that is borrowed. operating cash flows to service debt. it is really Where More debt reduces financial flexibility and measuring the relative use of debt and financial Long_Term Debt includeS increases risk to other creditors including flexibility remaining (untapped borrowingI l0ng_tc].m notes and bonds, trade creditors. capacity) more than the drain on cash flow related tum Imus’ and capital [cage to debt service. Short—term debt, operating leases, Obligalions newlplanned borrowing, and preterred stock dividends should be evaluated for more complete analysis. 3. Total Liabilities Total Liabilities Lower is better, for the same reasons Other than the fact that this ratio includes short~ to Total Assets m indicated for #2. High values show term debt, same concerns as for #2. Further proportionately greater use ofborrowed comment is necessary because ofthe linkage to money (less equity], which must be paid back ROE: ii: the company’s "operating return—on—assels” with interest. This ratio is related to the (EBlTMssets) exceeds the interest rate on debt, it “equity multiplier” that many companies use can effectively “lever up" ROE by using more debt. as a “ROE profit driver" in DuPont modeling: The increased profits and cash flows are offset, TUTA =( EM — 1} EM) from the trade creditors’ vantage, by increased financial risk. (continued) nowafimiuw aiqmiaJs-H saunas-Jig; g .mde 991 Exhibit 5—9 (continued) Key Financial Ratios: for Credit Analysis CATEGORY FINANCIAL RATIO FORMULA INTERPRETATION WARNING SIGNS P 1. Return on Earnings Available to Higher is better. assuming it does not come Market value added. economic value added. and E Equity (ROFL) Shareholders with too much risk. This is a profit and realized shareholder returns are better R Conunon qui'i'l'), performance scorecard For stockholders. lt performance metrics. Net income is not the same F with”? shows The ability to generate profits, from the as cash flow. Risk may be high. Prospects For 0 Earnings Manama 7 (Net stockholders’ perspective. continued profits and cash flows more important R income __ preferred Stock from trade creditors’ perspective. M Dividends — Sinking Fund ’1: Payments — Amortization] C 2. Profit Margin Net income Higher is better. Measures ability to generate Same concerns as in #1. E on Sales for Net Revemles ' profits from each $1 of sales. Profit Margin} 3. Return on Net income Higher is better. Measures ability to generate Same concerns as in #1 and #2. Total Assets Tomi Assels profits from each $1 of assets. Deeornpose (RDA) into: NU'l'A = Nlt'SaJcs X SaleslTA This shows us the two drivers for ROA: 1. Profit Margin 011 Sales [#2 above) 2. "I‘otal Asset Turnover, which shows us asset use efficiency. Turnover is diminished by overitwestmenl in fixed assets as well as working capital such receivables and inventory. »———__—_——_ Source: Fair lsaac [kn-poration, http:waw.fairisaaccomifairisaac. ’791 Iottdnj Suptmmllb Ittatuafi'nunw fitted ...
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This note was uploaded on 01/24/2012 for the course FIN 4260 taught by Professor Victorwakeling during the Spring '12 term at Kennesaw.

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RelativeResourceManager - Exhibit 5—9 Kev Financial...

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