International Corporate Governance Lecture 2

Balance sheet =
Current assets (ie/ cash, account recievable, inventory, others)
Long-term assets (ie/ land, buildings, goodwill)

Liabilities =
Current liabilities (ie/ accounts payable, notes payable, short-term debt, current
maturities of long-term debt)
Long-term liabilities (ie/ long-term debt, deferred taxes)

Liquidity – It refers to the ease and quickness with which assets can be
converted to cash without significant loss in value.

Book value = Carrying value, AKA the accounting value of a firm’s asset
Market value = The price that buyers and sellers would trade the asset

Income statement/P&L:
 Lists the firm’s revenues and expenses over a period of time
 Measures the profitability of a firm during the specific period
 Income = Revenue – Expenses

Income classification:
- The unrealized appreciation from owing properties are not recognised as
income
- Income is reported when it is earned, accrued or credited without
considering the cash flow

Expense classification:
- Depreciation: accountant’s estimation of the cost of equipment used up in
the production process
- Deferred taxes: deferred tax liability on the balance sheet

Current ratio:
- Current ratio is a financial ratio that measures whether the firm has
enough resources to pay its debts over the next 12 months, AKA short-
term liquidity
- Current ratio = Current assets/Current liabilities
- A firm’s current ratio of 1.5 implies that the firm’s current liabilities are
covered 1.5 times by the current assets
- A current ratio less than one implies negative working capital

Quick ratio and cash ratio:

- Quick ratio = Quick asset/Quick liabilities
- Quick assets include cash, marketable securities, and accounts receivable
- Cash ratio = Cash (+market receivables)/Current liabilities
NWC – total asset ratio:
- NWC – total assets = NWC/Total assets
- It records the net liquid assets relative to total capitalization

Interval measure:
- Interval measure = Quick assets/Average daily operating expenses
- It provides the average number of days a firm can operate simply using
the quick assets to meet its expenses

Total debt ratio:

- Total debt ratio = (Total assets – Total equity)/Total assets
- It provides what percentage of total assets is provided by creditors
- Creditors may prefer a lower debt ratio, but financial managers may
prefer to lever operations, producing a higher ratio

Equity multiplier:
- It measures the firm’s total assets per dollar of stockholder’s equity
- Equity multiplier = Total assets/Total equity
- A higher equity multiplier implies that the firm is relying more on debt to
finance its assets

Debt-Equity ratio:
- Debt-Equity ratio = Total debt/Total equity
- Both book-value and market-value can be used, but the market debt-
equity ratio is more informative
- A higher debt-equity ratio implies that the firm is more aggressive in
financing its growth with debt, and therefore could induce more volatile
earnings since a larger amount of debt will cost higher interest expenses

Long-term debt to capitalization:

- LT debt to cap = Long-term debt/(Long-term debt + stock)
- Stock includes both the common and preferred
- It can be applied to analyse firms’ risk exposure

Times interest earned:

- This ratio measures how well a firm’s earnings can cover its interest
payments on its debt
- Times interest ratio = EBIT/Interest payments
- A higher TIE ratio may imply the fact that the firm has too few debt or is
paying down too much debt with earnings that can be invested for other
projects

Cash coverage ratio:

- Cash coverage ratio = EBITD/Interest payments
- It measures the ability of a firm to generate sufficient cash flow available
to meet financial obligations
- A firm is not generating enough cash from its operations to cover its
interest obligations when its CC ratio is less than 1
Asset/Capital utilization ratio:
- Fundamental to measure a firm’s efficiency of converting its assets to
sales
- Asset utilization = Sales revenue/Total assets = Sales revenue/Total
capital employed
- The value of net total assets is always equal to the value of total capital

Inventory turnover:
- It measures the number of times a firm’s inventory is sold and replaced
over a specific period
- Inventory turnover = Cost of good sold/Average inventory
- Average inventory is equal to the sum of beginning inventory and ending
inventory divided by 2, which can avoid seasonal volatilities.

Days’ sales in inventory:

- This provides the number of days a firm takes the inventory to turnover
- DSIN = Average inventory/Daily cost of goods sold = 365/Inventory
turnover
- Generally speaking, the shorter the DSIN, the better, but it varies from
industry to industry

Receivables turnover:
- This ratio indicates the number of times accounts receivable are paid by
clients and re-established over a specific period
- Receivable turnover = Credit sales/Average accounts receivable
- The higher the ratio, the faster the firm is collecting its receivables, which
implies that the more cash the client generally has on hand and the less
risky the business is

Days’ sales in receivables:

- It provides the number of days a firm needs to collect all accounts
receivable
- DSIR = Average accounts receivable/Daily credit sales

Payables turnover:
- It measures how many times a firm pays its average payable amount over
a specific period
- Payables turnover = Total purchases/Average accounts payable
- A low payable turnover may be a sign that the firm has chronic cash
shortages

NWC turnover:
- NWC turnover = Sales revenue/NWC
- A higher NWC turnover is usually positive as it indicates that the firm is
able to generate sales from its NWC more efficiently