Balance Sheet Ratio Analysis

Important Balance Sheet Ratios measure liquidity and solvency (a business's ability to pay its bills as they come due) and
leverage (the extent to which the business is dependent on creditors' funding). They include the following ratios:

Liquidity Ratios

These ratios indicate the ease of turning assets into cash. They include the Current Ratio, Quick Ratio, and Working
Capital.

Current Ratios. The Current Ratio is one of the best known measures of financial strength. It is figured as shown
below:

                        Total Current Assets

Current Ratio = ____________________
                        Total Current Liabilities

The main question this ratio addresses is: "Does your business have enough current assets to meet the payment schedule
of its current debts with a margin of safety for possible losses in current assets, such as inventory shrinkage or collectable
accounts?" A generally acceptable current ratio is 2 to 1. But whether or not a specific ratio is satisfactory depends on the
nature of the business and the characteristics of its current assets and liabilities. The minimum acceptable current ratio is
obviously 1:1, but that relationship is usually playing it too close for comfort.

If you decide your business's current ratio is too low, you may be able to raise it by:

 Paying some debts.

 Increasing your current assets from loans or other borrowings with a maturity of more than one year.
 Converting non-current assets into current assets.
 Increasing your current assets from new equity contributions.
 Putting profits back into the business.

Quick Ratios. The Quick Ratio is sometimes called the "acid-test" ratio and is one of the best measures of liquidity. It is
figured as shown below:

                        Cash + Government Securities + Receivables

Quick Ratio = _________________________________________
                                    Total Current Liabilities

The Quick Ratio is a much more exacting measure than the Current Ratio. By excluding inventories, it concentrates on
the really liquid assets, with value that is fairly certain. It helps answer the question: "If all sales revenues should
disappear, could my business meet its current obligations with the readily convertible `quick' funds on hand?"

An acid-test of 1:1 is considered satisfactory unless the majority of your "quick assets" are in accounts receivable, and
the pattern of accounts receivable collection lags behind the schedule for paying current liabilities.

Working Capital. Working Capital is more a measure of cash flow than a ratio. The result of this calculation must be a
positive number. It is calculated as shown below:

Working Capital = Total Current Assets - Total Current Liabilities

Bankers look at Net Working Capital over time to determine a company's ability to weather financial crises. Loans are
often tied to minimum working capital requirements.
A  general observation about these three Liquidity Ratios is that the higher they are the better, especially if you are
relying to any significant extent on creditor money to finance assets.

Leverage Ratio

This Debt/Worth or Leverage Ratio indicates the extent to which the business is reliant on debt financing (creditor
money versus owner's equity):

                               Total Liabilities

Debt/Worth Ratio = _______________
                                 Net Worth

Generally, the higher this ratio, the more risky a creditor will perceive its exposure in your business, making it
correspondingly harder to obtain credit.

Income Statement Ratio Analysis

The following important State of Income Ratios measure profitability:

Gross Margin Ratio

This ratio is the percentage of sales dollars left after subtracting the cost of goods sold from net sales. It measures the
percentage of sales dollars remaining (after obtaining or manufacturing the goods sold) available to pay the overhead
expenses of the company.

Comparison of your business ratios to those of similar businesses will reveal the relative strengths or weaknesses in your
business. The Gross Margin Ratio is calculated as follows:

                                    Gross Profit

Gross Margin Ratio = _______________
                                     Net Sales

(Gross Profit = Net Sales - Cost of Goods Sold)

Net Profit Margin Ratio

This ratio is the percentage of sales dollars left after subtracting the Cost of Goods sold and all expenses, except income
taxes. It provides a good opportunity to compare your company's "return on sales" with the performance of other
companies in your industry. It is calculated before income tax because tax rates and tax liabilities vary from company to
company for a wide variety of reasons, making comparisons after taxes much more difficult. The Net Profit Margin
Ratio is calculated as follows:

                                        Net Profit Before Tax

Net Profit Margin Ratio = _____________________
                                              Net Sales

Management Ratios

Other important ratios, often referred to as Management Ratios, are also derived from Balance Sheet and Statement of
Income information.

Inventory Turnover Ratio

This ratio reveals how well inventory is being managed. It is important because the more times inventory can be turned
in a given operating cycle, the greater the profit. The Inventory Turnover Ratio is calculated as follows:

                                                        Net Sales

Inventory Turnover Ratio = ___________________________
                                          Average Inventory at Cost

Accounts Receivable Turnover Ratio

This ratio indicates how well accounts receivable are being collected. If receivables are not collected reasonably in
accordance with their terms, management should rethink its collection policy. If receivables are excessively slow in
being converted to cash, liquidity could be severely impaired. The Accounts Receivable Turnover Ratio is calculated as
follows:

Net Credit Sales/Year

__________________ = Daily Credit Sales
365 Days/Year

                                                                  Accounts Receivable

Accounts Receivable Turnover (in days) = _________________________
                                                                   Daily Credit Sales

Return on Assets Ratio

This measures how efficiently profits are being generated from the assets employed in the business when compared with
the ratios of firms in a similar business. A low ratio in comparison with industry averages indicates an inefficient use of
business assets. The Return on Assets Ratio is calculated as follows:

                                   Net Profit Before Tax

Return on Assets = ________________________
                                     Total Assets

Return on Investment (ROI) Ratio.

The ROI is perhaps the most important ratio of all. It is the percentage of return on funds invested in the business by its
owners. In short, this ratio tells the owner whether or not all the effort put into the business has been worthwhile. If the
ROI is less than the rate of return on an alternative, risk-free investment such as a bank savings account, the owner may
be wiser to sell the company, put the money in such a savings instrument, and avoid the daily struggles of small business
management. The ROI is calculated as follows:

                                      Net Profit before Tax

Return on Investment = ____________________
                                           Net Worth

These Liquidity, Leverage, Profitability, and Management Ratios allow the business owner to identify trends in a
business and to compare its progress with the performance of others through data published by various sources. The
owner may thus determine the business's relative strengths and weaknesses.

Qualification
Although there are no formal qualification criteria, analysts usually have graduate level training in finance such as MSF
or MBA degrees, or are qualified accountants. "Industry experience" is often a pre-requisite and so analysts often have
undergraduate degrees in related fields. Also, many analysts originally enter this domain through their practice as
consultants or accountants and so a very wide range of qualifications is common.

Increasingly, it is (additionally) required that analysts earn a professional certification such as the Chartered Financial
Analyst (CFA) designation , or the Certified International Investment Analyst (CIIA) designation, particularly if they
wish to advance beyond a certain level within a firm.

There are also often regulatory requirements relating to the profession. For example, in the United States, sell-side or
Wall Street research analysts must register with FINRA, the Financial Industry Regulatory Authority. In addition to
passing the General Securities Representative Exam, candidates must pass the Research Analyst Examination (series
86/series87) in order to publish research for the purpose of selling or promoting publicly traded securities.

Prognosys Custom Research solutions address unique research needs, tailor market intelligence to specific
customer requests, and help our customers to better understand their markets so they lead, rather than follow
market trends.
 
Prognosys Custom Research solutions can help you:
 
Understand the Market Size & Forecasts for new technologies

Learn more about what your competitors are doing

Gain insight on the dynamics in specific vertical industries, technologies, and

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Profile vendors, partners, and local channels

Learn more about targeted accounts and their dynamics like spending, vendors,

  and investments

Assess the potential of emerging markets and emerging technologies

 
Prognosys has been particularly successful securing and delivering projects with tight budgets and very
aggressive timelines that demand the highest levels of efficiency.

Skill

Most analysts will require basic analytical skills, and very good numerical skills. Importantly, communication skills are
necessary to explain complex concepts to management or clients.

Financial Ratios
 
PEB Ratio The PEG ratio is a powerful formula which compares earnings growth and the Price Earnings
Ratio: Divide the expected long-term growth rate (in earnings per share) by the current Price
Earnings Ratio. If dividends are significant, add the Dividend Yield to the growth rate (when
calculating the PEG ratio).

PEB Ratio = Average EPS growth / PE

PEG <1 Poor

 1 <  PEG   Good
2 <  PEG   Strong Buy
 

 
Dividend per share DPS is dividend payout to stockholder per each share.
Dividend per
Share  (DPS) Dividend per share (DPS) = Dividend after Tax / Total Shares

 
Dividend Yield on The Dividend Yield on common stock is computed by divide the DPS per share by its market price.
Common Stock It shows the current return an investor can obtain in buying a share. To obtain an idea of the
attractiveness of a share, compare its Dividend Yield against current fixed deposit interest rates.

Dividend yield on common stock = Dividend per share / market price per share

 
Dividend Payout Dividend payout ratio is percentage of profit that is paid out as dividend.
Ratio
Dividend payout ratio = Dividends per share / Earnings per Share

This company is giving out dividends

Dividend Payout <= 0 though it incurred a loss.
1 <  Ratio This company is paying more dividends
   than it proportionately earned this period.
 

 
Strategic Cash Strategic cash flow is the cash left once internal growth has been financed. In other words, it is the
Flow cash left either to invest in strategic developments, or to distribute dividends, or to lower the debt
load.

Strategic cash flow = Cash flow + Cash need variation + Capital expenditure

Cash flow = Net income + depreciation, depletion and amortization.

Cash need = Inventories + Receivables - Payables, the variation of which from one period to the
other is computed.

Capital expenditure = Tangible and intangible investments, the variation of fixed assets from one
year to the other being an acceptable approximation.

Free Cash Flow Free cash flow provide Specialists in Leverage Buyouts (or takeovers) to look at this amount in
planning their strategy.

Free cash flow = Cash flow - capital expenditures - dividends

Cash flow = operating cash flow - interest expense - income tax expense
 Dividends = dividends per share * number of shares

The difference between the levels of fixed assets over two periods is an approximation for Capital
Expenditure.

 
Degree of The Degree of Operating Leverage is the volume of sales, above the breakeven point, needed to
Operating earn a profit. This ratio varies with the level of sales. In other words, it shows how a percent change
Leverage in sales volume will affect profit, at a specific level of sales. The higher the Degree of Operating
Leverage, the greater the impact of a change in sales volume on profit.

Degree of operating leverage = Contribution Margin / Net Income, with

Contribution Margin = Sales - Variable Costs

You need first to be familiar with the concept of Variable Costs to determine the Contribution
Margin. Then, you need to distinguish, in the Income Statement, among those costs that are
variable and those that are not.

 
Index of Index of sustainable growth developed by Robert L. Higgins, this index helps determine the level of
Sustainable Growth growth of sales beyond which external capital will be needed. In other words, when planning for a
specific growth in sales, one must be aware of whether external financing will be needed.
g = (X1 (1 - X2) (1 + X3)) / (X4 - (X1 (1 - X2) (1 + X3)))
X1 = Profit Margin = (Income before Taxes / Sales) * 100
X2 = Dividend Payout Ratio = Total Dividends / Net Income
X3 = Leverage = Liabilities / Equity
X4 = (Assets / Sales) * 100 
If Sales growth forecast are above g:
 -- External financing (equity or debt) should be sought after,
 -- or the profit margin should be improved,
 -- or the distribution of dividends should be lower,
 -- or the level of assets should be lower (lease instead of buy).

Balance Sheet Analysis

Introduction

In this section, we will look at some of the tools you can use in making an investment decision from balance sheet
information. If you are not familiar with balance sheets, you are advised to first read the section entitled, "Understanding
the Balance Sheet". It provides a good overview of the functions of a balance sheet and its components. We will cover
the following topics here:

 Why You Should Analyze a Balance Sheet

 Liquidity Ratios
 Leverage
 Bankruptcy
 Tying It All Together

A thorough analysis of a company's balance sheet is extremely important for both stock and bond investors.

Why You Should Analyze a Balance Sheet

The analysis of a balance sheet can identify potential liquidity problems. These may signify the company's inability to
meet financial obligations. An investor could also spot the degree to which a company is leveraged, or indebted. An
overly leveraged company may have difficulties raising future capital. Even more severe, they may be headed towards
bankruptcy. These are just a few of the danger signs that can be detected with careful analysis of a balance sheet.

Beyond liquidity and leverage, the following section will discuss other analysis such as working capital and bankruptcy.
As an investor, you will want to know if a company you are considering is in danger of not being able to make its
payments. After all, some of the company's obligations will be to you if you choose to invest in it.

We will start with Liquidity Ratios, an important topic for all investors.

Top

Liquidity Ratios

The following liquidity ratios are all designed to measure a company's ability to cover its short-term obligations.
Companies will generally pay their interest payments and other short-term debts with current assets. Therefore, it is
essential that a firm have an adequate surplus of current assets in order to meet their current liabilities. If a company has
only illiquid assets, it may not be able to make payments on their debts. To measure a firm's ability to meet such short-
term obligations, various ratios have been developed.

You will study the following balance sheet ratios:

 Current Ratio
 Acid Test (or Quick Ratio)
 Working Capital
 Leverage

These tools will be invaluable in making wise investment decisions.

Current Ratio

The Current Ratio measures a firm's ability to pay their current obligations. The greater extent to which current assets
exceed current liabilities, the easier a company can meet its short-term obligations.

Current Assets
Current Ratio = ---------------------------
Current Liabilities

After calculating the Current Ratio for a company, you should compare it with other companies in the same industry. A
ratio lower than that of the industry average suggests that the company may have liquidity problems. However, a
significantly higher ratio may suggest that the company is not efficiently using its funds. A satisfactory Current Ratio for
a company will be within close range of the industry average.

Acid Test or Quick Ratio

The Acid Test Ratio or Quick Ratio is very similar to the Current Ratio except for the fact that it excludes inventory. For
this reason, it's also a more conservative ratio.

Current Assets - Inventory

Acid test = ---------------------------
Current Liabilities

Inventory is excluded in this ratio because, in many industries, inventory cannot be quickly converted to cash. If this is
the case, inventory should not be included as an asset that can be used to pay off short-term obligations. Like the Current
Ratio, to have an Acid Test Ratio within close range to the industry average is desirable.

Working Capital

Working Capital is simply the amount that current assets exceed current liabilities. Here it is in the form of the equation:

Working Capital = Current Assets - Current Liabilities

This formula is very similar to the current ratio. The only difference is that it gives you a dollar amount rather than a
ratio. It too is calculated to determine a firm's ability to pay its short-term obligations. Working Capital can be viewed as
somewhat of a security blanket. The greater the amount of Working Capital, the more security an investor can have that
they will be able to meet their financial obligations.

You have just learned about liquidity and the ratios used to measure this. Many times a company does not have enough
liquidity. This is often the cause of being over leveraged.

Top

Leverage

Leverage is a ratio that measures a company's capital structure. In other words, it measures how a company finances their
assets. Do they rely strictly on equity? Or, do they use a combination of equity and debt? The answers to these questions
are of great importance to investors.

Long-term Debt
Leverage = ----------------------
Total Equity

A firm that finances its assets with a high percentage of debt is risking bankruptcy should it be unable to make its debt
payments. This may happen if the economy of the business does not perform as well as expected. A firm with a lower
percentage of debt has a bigger safety cushion should times turn bad.

A related side effect of being highly leveraged is the unwillingness of lenders to provide more debt financing. In this
case, a firm that finds itself in a jam may have to issue stock on unfavorable terms. All in all, being highly leveraged is
generally viewed as being disadvantageous due to the increased risk of bankruptcy, higher borrowing costs, and
decreased financial flexibility.

On the other hand, using debt financing has advantages. Stockholder's potential return on their investment is greater
when a firm borrows more. Borrowing also has some tax advantages.

The optimal capital structure for a company you invest in depends on which type of investor you are. A bondholder
would prefer a company with very little debt financing because of the lower risk inherent in this type of capital structure.
A stockholder would probably opt for a higher percentage of debt than the bondholder in a firm's capital structure. Yet, a
company that is highly leveraged is also very risky for a stockholder.
When a firm becomes over leveraged, bankruptcy can result. Read on to learn more about this dreaded occurrence.

Top

Bankruptcy

Bankruptcy is a legal mechanism that allows creditors to assume control of a firm when it can no longer meet its
financial obligations. Bankruptcy is a result feared by both stock and bond investors. Generally, the firm's assets are
liquidated (sold) in order to pay off creditors to the extent that is possible. When bankruptcy occurs, stockholders of a
corporation can only lose the amount they have invested in the bankrupt company. This is called Limited Liability. The
stockholders' liability to creditors is limited to the amount invested. Therefore, if a firm's liabilities exceed the liquidation
value of their assets, creditors also stand to lose money on their investments.

When bankruptcy occurs, a federal court official steps in and handles the payments of assets to creditors. The remaining
funds are always distributed to creditors in a certain pecking order:

1. Unpaid taxes to the IRS and bankruptcy court fees

2. Unpaid wages
3. Secured bondholders
4. General creditors and unsecured bonds
5. Subordinated debentures
6. Preferred Stockholders
7. Common Stockholders

Obviously, to hold secured bonds rather than unsecured bonds is more advantageous in the event of a bankruptcy. This is
where you must examine your risk/reward requirements. As you move down this hierarchy, your risk of losing your
investment increases. However, you are "rewarded" for taking more risk with potentially higher investment returns.

How do you predict bankruptcy? Well, no one can do it perfectly. However, one popular method called a Z-score
(developed by Edward Altman) has a good track record. To learn more about "Z-scores" go to your local library. We will
recap a few of the most important points about learning to analyze a company's balance sheet.

Top

Tying It All Together

Analyzing a balance sheet is fundamental knowledge for anyone who wishes to carefully select solid and profitable
investments. The balance sheet is the basic report of a firm's possessions, debts and capital. The composition of these
three items will vary dramatically from firm to firm. As an investor, you need to know how to examine and compare
balance sheets of different companies in order to select the investment that meets your needs.

After reading this section, you should have an understanding of liquidity, leverage and bankruptcy and know how to
apply basic ratios to measure each. These ratios should be compared to other firms in the same industry in order for them
to have relevance. Be careful, however, that the firms are not fundamentally different even if they are in the same
industry.

Balance Sheet
A company's financial statement that reports the assets, liabilities and net worth at a specific time.
Notes:
You will notice that assets = liabilities + shareholders' equity. This equation is true for all balance sheets.

If the balance sheet is "consolidated" it just means that the company is a corporate group rather than a single
company.
Asset
 1. A resource having economic value that an individual, corporation or country owns or controls with the
expectation that it will provide future benefit.

2. A balance sheet item representing what a firm owns.

Notes:
1. Assets are bought to increase the value of a firm or benefit the firm's operations. You can think of an asset as
something that can generate cash flow, regardless of whether it's a company's manufacturing equipment or an
individual's rental apartment.

2. In the context of accounting, assets are either current or fixed (non-current). Current means that the asset will
be consumed within one year. Generally this includes things like cash, accounts receivable and inventory. Fixed
assets are those that are expected to keep on providing benefit for more than one year, such as equipment,
buildings, real estate, etc.
Liability
A legal debt or obligation estimated via accrual accounting.
Notes:
Recorded on the balance sheet, liabilities include loans, accounts payable, mortgages, deferred revenues, and
accrued expenses. For example, the unpaid value of a mortgage or outstanding money owed to suppliers would be
considered a liability. Current liabilities are debts payable within one year, while long-term liabilities are debts
payable over a longer period.

Inventory
Inventory can be either raw materials, finished items already available for sale, or goods in the process of being
manufactured. Inventory is recorded as an asset on a company's balance sheet.
Notes:
High inventory isn't a good sign because there is a cost associated with storing the extra inventory.

Inventory Turnover
A ratio that shows how many times the inventory of a firm is sold and replaced over a specific period.

Notes:
Although the first calculation is more frequently used, COGS may be substituted because sales are recorded at
market value while inventories are usually recorded at 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 in the case of falling prices.
 MARKET RESEARCH
eMpulse India conducts high quality market research at value price.

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 Market Research in multiple markets on different continents

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 Client Projects at Fortune 500 Companies
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We are able to deliver extraordinary results, using extensive market research domain experience within the Indian market. eMpulse brings the
latest in MR tools and techniques and we are on the cutting edge of applied Market Research methods.

eMpulse India benefits from the insight of the team in USA, which helps the India operations keep in touch with the latest trends in the global
market and advanced research techniques.

 Acquiring market data (click here)

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These services are provided for the entire marketing life cycle :

Project Examples
 Baseline Usage & Attitude studies for segmentation and market sizing
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 Employee satisfaction to curtail attrition
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Target Market

How old are they?

What gender are they?

Where do they live?

What is their family structure (number of children, extended family, etc.)?

What is their income?

What do they do for a living?

What is their lifestyle like?

How do they like to spend their spare time?

What motivates them?

What is the size of your target market?

But don't stop here. To define your target market, you need to ask the specific questions that are directly related to your products or
services. For instance, if you plan to sell computer-related services, you need to know things such as how many computers your
prospective customer owns. If you plan on selling garden furniture and accessories, you need to know what kinds of garden
furniture or accessories your potential customers have bought in the past, and how often.

Projections About The Target Market

What proportion of your target market has used a product similar to yours before?

How much of your product or service might your target market buy? (Estimate this in gross sales and/or in units of product/service
sold.)

What proportion of your target market might be repeat customers?

How might your target market be affected by demographic shifts?

How might your target market be affected by economic events (e.g. a local mill closing or a big-box retailer opening locally)?

How might your target market be affected by larger socioeconomic trends?

How might your target market be affected by government policies (e.g. new bylaws or changes in taxes)?

Writing The Market Analysis Section Of The Business Plan

Once you have all this information, you'll write the Market Analysis in the form of several short paragraphs. Use appropriate
headings for each paragraph. If you have several target markets, you may want to number each. (See the sidebar for a sample of
this section of the business plan, from the Royal Bank.)

Remember to properly cite your sources of information within the body of your Market Analysis as you write it. You and other
readers of your business plan will need to know the sources of the statistics or opinions that you've gathered from others.

On the next page are tips and suggestions for researching the market analysis section of the business plan, including sources for
Canadian information.

Definition Of Market Research:

Market research is the collection and analysis of information about consumers, competitors and the effectiveness of marketing
programs.

Small business owners use market research to determine the feasibility of a new business, test interest in new products or services,
improve aspects of their businesses, such as customer service or distribution channels, and develop competitive strategies.

In other words, market research allows businesses to make decisions that make them more responsive to customers' needs and
increase profits.

While market research is crucial for business start up, it's also essential for established businesses. It's accurate information about
customers and competitors that allows the development of a successful marketing plan.

While it's common for businesses to hire market research companies to conduct market research for them, it is possible for small
business owners to do their own. For an explanation of the basics of market research and tips on designing your own market
research surveys and questionnaires, see Do-It-Yourself Market Research.

MAPIN is the name for the Market Participants and Investors' Integrated Database, which is being created by SEBI to enhance
investor protection. The MAPIN Database will allot Unique Identification Number (UIN) which would be required to be quoted by all
corporate investors while carrying out securities transactions in lieu of the Unique Client Code (UCC). A MAPIN card will be lika a
PAN card which is mandatory now to invest in stocks!!
Documents to Gather Before Applying for a Business Loan

Waiting for a loan approval can feel like an eternity. The good news is that there are things you can do to expedite the
process. Preparing all the documents you will need is one way to move the process along. Here are some documents to
collect for your application:

 Business profile. This document describes your business, including annual sales, number of employees, length
of time in business, and ownership.
 Business plan. A business plan is particularly important for new businesses, as they lack a track record for
lenders to go by. Your plan should convey all important facts about your business in a concise manner. Your business
plan may range anywhere from 5 to 20 pages, plus financial projections. Learn to Write a Winning Business Plan.
 Loan request. This should detail the amount of money requested, how the loan funds will be used, the type of
loan, and the amount of working capital you have on hand.
 Collateral. Describe what will be used to secure the loan, including equity in the business, borrowed funds, and
available cash. Review the information in Should You Personally Guarantee a Loan to Your Small Business?
 Personal and business financial statements. You will likely need to provide financial information for anyone
who owns 20 percent or more of the business, including owners, partners, officers, and stockholders. Lenders will want
to see a complete schedule of current debts with balances, payment schedules, maturity, and collateral used to secure
other loans.