MBF1223 Financial Management Prepared by Dr Khairul Anuar

MBF1223 Financial Management Prepared by Dr Khairul Anuar L5 - Financial Ratios and Firm Performance www.mba638.wordpress.com

Reference Reference for this topic is Financial Management By Raymond Brooks 2

Learning Objectives 1. Create, understand, and interpret common size financial statements. 2. Calculate and interpret financial ratios. 3. Compare different company performances using financial ratios, historical financial ratio trends, and industry ratios. 3

1. Financial Statements Just like a doctor takes a look at a patient s x rays or cat scan when diagnosing health problems, a manager or analyst can take a look at a firm s primary financial statements i. e. the income statement and the balance sheet, when trying to gauge the status or performance of a firm. Income statement: periodic recording of the sources of revenue and expenses of a firm, Balance sheet: provides a point in time snap shot of the firm s assets, liabilities and owner s equity. 4

2. Benchmarking The financial statements constitute fairly complex documents involving a whole bunch of numbers. Absolute values tell us something about the amount of assets, liabilities, equity, revenues, expenses, and taxes of a firm, difficult to really gauge what s going on, primarily because of size and maturity differences among firms. requires benchmarking against some standard. One common method of benchmarking a is to compare a firm s current performance against that of its own performance over a 3 5 year period (trend analysis), by looking at the growth rate in various key items such as sales, costs, and profits. 5

2. Benchmarking Table: Cogswell Cola s Abbreviated Income Statements ($ in thousands) 6

2. Benchmarking Another useful way to make some sense out of this mess of numbers, is to re cast the income statement and the balance sheet into common size statements, by expressing each income statement item as a percent of sales and each balance sheet item as a percent of total assets. 7

Figure Income Statement 2. Benchmarking 8

2. Benchmarking Figure Balance Sheet 9

2. Benchmarking Benchmarking is a good starting point to detect trends (if any) in a firm s performance and to make quick comparisons of key financial statement values with competitors on a relative basis. More in depth diagnosis requires individual item analyses and comparisons which are best done by conducting ratio analysis. 10

2. Benchmarking Financial ratios allow for comparisons between companies. between industries. between different time periods for one company. between a single company and its industry average. Thus, the ratios of firms in different industries, which face different risks, capital requirements, and competition are usually hard to compare. 11

3. Financial Ratios Financial ratios are relationships between different accounts from financial statements usually the income statement and the balance sheet that serve as performance indicators Being relative values, financial ratios allow for meaningful comparisons across time, between competitors, and with industry averages. 12

3. Financial Ratios 5 key areas of a firm s performance can be analyzed using financial ratios: 1. Liquidity ratios: Can the company meet its obligations over the short term? 2. Solvency ratios: (also known as financial leverage ratios): Can the company meet its obligations over the long term? 3. Asset management ratios: How efficiently is the company managing its assets to generate sales? 4. Profitability ratios: How well has the company performed overall? 5. Market value ratios: How does the market (investors) view the company s financial prospects? # Du Pont analysis involves a breakdown of the return on equity into its three components, i.e. profit margin, turnover, and leverage. 13

4. Short Term Solvency: Liquidity Ratios Measure a company s ability to cover its short term debt obligations in a timely manner: 3 key liquidity ratios include: The current ratio, quick ratio, and cash ratio. 14

4. Short Term Solvency: Liquidity Ratios Table: Liquidity Ratios 2011 for Cogswell Cola and Spacely Spritzers Cogswell has better liquidity and short term solvency than Spacely, but, higher investment in current assets also means that lower yields are being realized since current assets are typically low yielding. So, we need to look at the other areas and inter related effects of the firm s various accounting items. 15

5. Long Term Solvency: Solvency or Financial Leverage Ratios Measure a company s ability to meet its long term debt obligations based on its overall debt level and earnings capacity. Failure to meet its interest obligation could put a firm into bankruptcy. Equations 14.4, 14.5, and 14.6 can be used to calculate 3 key financial leverage ratios: the debt ratio, times interest earned ratio, and cash coverage ratio. 16

5. Long Term Solvency: Long Term Solvency: Solvency or Financial Leverage Ratios 17

5. Long Term Solvency: Long Term Solvency: Solvency or Financial Leverage Ratios Table: Financial Leverage Ratios 2011 for Cogswell Cola and Spacely Spritzers Cogswell Cola has relatively less debt and a significantly greater ability to cover its interest obligations by using either its EBIT (times interest earned ratio) or its net cash flow (cash coverage ratio) than Spacely Spritzers. Leverage must be analyzed as a combination of debt level and coverage. If a firm is heavily leveraged but has good interest coverage, it is using the interest deductibility feature of taxes to its benefit. Having a high leverage with low coverage could put the firm into a risk of bankruptcy. 18

6. Asset Management Ratios Measure how efficiently a firm is using its assets to generate revenues or how much cash is being tied up in other assets such as receivables and inventory. Equations 14.7 14.11 can be used to calculate 5 key asset management ratios. 19

6. Asset Management Ratios Table: Asset Management Ratios 2011 for Cogswell Cola and Spacely Spritzers While Cogswell is more efficient at managing its inventory, Spacely seems to be doing a better job of collecting its receivables and utilizing its total assets in generating revenues 20

7. Profitability Ratios Profitability ratios such as net profit margin, returns on assets, and return on equity, measure a firm s effectiveness in turning sales or assets into profits. 21

7. Profitability Ratios Table: Profitability Ratios 2011 for Cogswell Cola and Spacely Spritzers As far as profitability is concerned, Cogswell is outperforming Spacely by about 3%. 22

8. Market Value Ratios Used to gauge how attractive or reasonable a firm s current price is relative to its earnings, growth rate, and book value. 23

8. Market Value Ratios Potential investors and analysts often use these ratios as part of their valuation analysis. Typically, if a firm has a high price to earnings and a high market to book value ratio, it is an indication that investors have a good perception about the firm s performance. However, if these ratios are very high it could also mean that a firm is over valued. With the price/earnings to growth ratio (PEG ratio), the lower it is, the more of a bargain it seems to be trading at, vis à vis its growth expectation. 24

8. Market Value Ratios Ratio Cogswell Cola Spacely Spritzers P/E 15.41 13.01 PEG 1.28 0.86 P/B 5.49 4.17 The ratios seem to indicate that investors in both firms seem to have good expectations about their performance and are therefore paying fairly high prices relative to their earnings book values. 25

9. DuPont analysis Involves breaking down ROE into three components of the firm: 1) operating efficiency, as measured by the profit margin (net income/sales); 2) asset management efficiency, as measured by asset turnover (sales/total assets); and 3) financial leverage, as measured by the equity multiplier (total assets/total equity). Equation below shows that if we multiply a firm s net profit margin by its total asset turnover ratio and its equity multiplier, we will get its return on equity. 26

10. DuPont analysis Cogswell has better operational efficiency, i.e. it is better able to move sales dollars into income, but Spritzer is more efficient at utilizing its assets, and since it uses more debt, it is able to get more of its earnings to its shareholders. Although these 14 ratios are not the only ones that can be used to assess a firm s performance, they are the most popular ones. It is important to look at the overall picture of the firm in all 5 areas and accordingly reach conclusions or make recommendations for changes. 27

10. External Uses of Financial Statements and Industry Averages Financial statements of publicly traded companies and industry averages of key items provide the raw material for analysts and investors to make investment recommendations and decisions 28

11. Cola Wars Table: Key Financial Ratios and Accounts for PepsiCo and Coca Cola (as of December 31, 2010) 29

11. Cola Wars Table: Some Key Ratios for PepsiCo and Coca Cola (Five Year Period) 30

11. Cola Wars One of the first things we notice in looking over the five years of data is how similar many of the ratios are from year to year, showing remarkable consistency for these two companies. We also can see that the gross margin of Coca Cola is consistently higher than that of PepsiCo. The debt to equity ratio of both firms is mostly falling over the five year period. We also can see that ROE has been very good for both companies, although slightly better for PepsiCo. Finally, PepsiCo has very strong and growing earnings per share over this period, outperforming Coca Cola s EPS, but PepsiCo is also more expensive (higher current price per share). 31

12. Industry ratios: Table: Financial Ratios: Industry Averages Industry ratios are often used as benchmarks for financial ratio analysis of individual firms. There can be significant differences in various key areas across industries, which is why comparing company ratios with industry averages can be very useful and more informative. 32

Additional Problems with Answers Problem 1 Constructing an Income Statement. Using the income and expense account information for Tri Mark Products Inc. listed below, construct an income statement for the year ended 31st December, 2009. Shares outstanding: 1,575,000 Tax rate: 35% Interest expense: $3,540,000 Revenue: $950,500,000 Depreciation: $50,000,000 Selling, general, and administrative expense: $85,000,000 Other income: $1,350,000 Research and development: $5,200,000 Cost of goods sold: $730,000,000 33

Additional Problems with Answers Problem 1 (Answer) Tri-mark Products Incorporated Income Statement for the year ended 31st Dec. 2009 ('000s) Revenue $ 950,500 Cost of goods sold $ 730,000 Gross Profit $ 220,500 Operating expenses Selling, general and administrative expenses $ 85,000 R&D $ 5,200 Depreciation $ 50,000 Operating Income $ 80,300 Other Income $ 1,350 EBIT $ 81,650 Interest Expense $ 3,540 Taxable Income $ 78,110 Taxes $ 27,339 Net Income $ 50,772 Shares Outstanding $ 16,740 EPS $ 3.03 34

Additional Problems with Answers Problem 2 Constructing a Balance Sheet. Construct Tri Mark Incorporated s 2009 year end Balance Sheet using the asset, liability, and equity accounts listed below: Retained Earnings $60,500,000 Accounts Payable $57,000,000 Accounts Receivable $43,000,000 Common Stock $89,676,000 Cash $6,336,000 Short Term Debt $1,500,000 Inventory $42,000,000 Goodwill $30,000,000 Long Term Debt $74,000,000 Other Non Current Liabilities $15,000,000 PP&E $225,000,000 Other Non Current Assets $14,000,000 Long Term Investments $25,340,000 Other Current Assets $12,000,000 35

Additional Problems with Answers Problem 2 (Answer) Tri-mark Products Inc. Balance Sheet as at year ended 31st December 2009 ( 000s) Liabilities: Current Assets Current Liabilities Cash $6,336 Accounts Payable $57,000 Accts. Rec. $43,000 Short Term Debt $1,500 Inventory $42,000 TOTAL Current Liabilities. $58,500 Other Current $12,000 Long Term Debt $74,000 Total Current $103,336 Other Liabilities $15,000 L- T Inv. $25,340 Total Liabilities $147,500 PP&E $225,000 Owner s Equity Goodwill $30,000 Common Stock $189,676 Other Assets $14,000 Total Assets $397,676 Retained Earnings $60,500 Total OE $250,176 Total Liab. And OE $397,676 36

Additional Problems with Answers Problem 3 Common size statements: Re state Tri Mark Incorporated s 2009 financial statements as common size statements and comment on them 37

Assets: Current Assets Additional Problems with Answers Problem 3 (Answer) % of Total Assets Cash $6,336 0.02 Accts. Rec. $43,000 0.11 Inventory $42,000 0.11 Other Current $12,000 0.03 Total Current $103,336 0.26 L- T Inv. $25,340 0.06 PP&E $225,000 0.57 % of Total Assets Liabilities: Current Liabilities Accounts Payable $57,000 0.14 Short Term Debt $1,500 0.00 TOTAL Current Liab. $58,500 0.15 Long Term Debt $74,000 0.19 Other Liabilities $15,000 0.04 Total Liabilities $147,500 0.37 Owner s Equity Common Stock $189,676 0.48 Retained Earnings $60,500 0.15 Goodwill $30,000 0.08 Other Assets $14,000 0.04 Total Assets $397,676 1.00 Total OE $250,176 0.63 Total Liab. And OE $397,676 1.00 38

Additional Problems with Answers Problem 4 Compute and analyze financial ratios. Using the 2009 income statement and balance sheet of Trimark Products Inc., as constructed in problems 1 and 2 above, compute its financial ratios. How is the firm doing relative to its industry in the areas of liquidity, asset management, leverage, and profitability? 39

Additional Problems with Answers Problem 4 (continued) Industry Ratio Average Current Ratio 2.200 Quick Ratio (or Acid Test Ratio) 1.500 Cash Ratio 0.135 Debt Ratio 0.430 Cash Coverage 10.600 Day s Sales in Receivables 29.000 Total Asset Turnover 2.800 Inventory Turnover 20.100 Day s Sales in Inventory 11.500 Receivables Turnover 32.000 Profit Margin 0.045 Return on Assets 0.126 Return on Equity 0.221 40

Additional Problems with Answers Problem 4 (Answer) Industry Trimark Average Current Ratio 1.766 2.200 Quick Ratio (or Acid Ratio Test) 1.048 1.500 Cash Ratio 0.108 0.135 Debt Ratio 0.371 0.430 Cash Coverage 37.189 10.600 Day s Sales in Receivables 16.512 12.000 Total Asset Turnover 2.390 2.800 Inventory Turnover 28.808 30.100 Day s Sales in Inventory 12.670 11.500 Receivables Turnover 22.105 30.000 Profit Margin 0.053 0.045 Return on Assets 0.128 0.126 Return on Equity 0.203 0.221 41

Additional Problems with Answers Problem 4 (Answer) (continued) Analysis: Liquidity: Trimark s liquidity ratios are below the industry average indicating that they might need to look into their management of current assets and liabilities. Leverage: Trimark s debt ratio is much lower than the industry average and its cash coverage is more than 3 time the average, indicating that if it needs to borrow longterm debt it should not have much of a problem. Asset management: Trimark s asset turnover ratios are all below the average. It needs to tighten up collections, and manage its inventory more efficiently. Profitability: Trimark has a good control on cost of goods sold. Its net profit margin is better than the industry and so is its ROA. The industry, however, is returning a higher rate to the shareholders on average, primarily due to the higher debt levels. 42

Additional Problems with Answers Problem 5 DuPont Analysis. Based on the ratios calculated in problem 4 above, and in conjunction with the industry averages given, conduct a DuPont analysis on Trimark s key profitability ratios. 43

Additional Problems with Answers Problem 5 (Answer) According to the Du Pont breakdown, we have ROE = Net Profit Margin * Total Asset Turnover * Equity Multiplier ROE = NI/S * S/TA * TA/Equity Note: since we don t have the accounting information for the average, we have to figure out the industry s equity multiplier by some algebraic manipulation. Equity Multiplier = Total Assets/Equity Now, debt ratio = Total Debt/Total Assets Total Assets = Total Debt + Equity (Total Debt/Total Assets) +( Equity/Total assets) = 1 Equity/Total Assets = 1 (Total Debt/Total Assets) TA/E = 1/(1 TD/TA) 44

Additional Problems with Answers Problem 5 (Answer) (continued) Trimark Industry Debt Ratio 0.371 0.430 Total Asset Turnover 2.390 2.800 Profit Margin 0.053 0.045 Return on Assets 0.128 0.126 Return on Equity 0.203 0.221 Equity multiplier = 1/(1-debt ratio) 1.59 1.75 Despite a lower Total Asset Turnover ratio, Trimark s ROA (12.8%) is better than that of the industry (12.6%), primarily due to its higher net profit margin. The industry, however, has a higher ROE (22.1%) due to its higher debt ratio and correspondingly higher equity multiplier. 45

Figure 14.1 Cogswell Cola Balance Sheet 46

Figure 14.2 Cogswell Cola Income Statement 47

Potential problems and limitations of financial ratio analysis Comparison with industry averages is difficult for a conglomerate firm that operates in many different divisions. Average performance is not necessarily good, perhaps the firm should aim higher. Seasonal factors can distort ratios. Window dressing techniques can make statements and ratios look better.

More issues regarding ratios Different operating and accounting practices can distort comparisons. Sometimes it is hard to tell if a ratio is good or bad. Difficult to tell whether a company is, on balance, in strong or weak position.

Qualitative factors to be considered when evaluating a company s future financial performance Are the firm s revenues tied to one key customer, product, or supplier? What percentage of the firm s business is generated overseas? Competition Future prospects Legal and regulatory environment

Industry Specific Ratios Industry specific ratios are ratios that are useful only in a specific industry and hence calculated for analysing entities in that industry only. These ratios are meaningless for entities in other industries.

Occupancy Ratio for Hotel Industry The occupancy rate of hotels is the share of an establishment's available rooms that are occupied at a given time. The occupancy rate is usually used alongside two other statistical units, the average daily rate (ADR) and revenue per available room (RevPAR), to measure a hotel's performance.

Occupancy Ratio for Hotel Industry Average Daily Rate Average Daily Rate commonly referred to as ADR is a statistical unit that is often used in the lodging industry. The number represents the average rental income per paid occupied room in a given time period. ADR along with the property's occupancy are the foundations for the property's financial performance. Calculation: ADR = Room Revenue / Rooms Sold House use and complimentary rooms are excluded from the denominators. 'House Use' rooms or those occupied by hotel employees or management are excluded as they are not available for sale and not generating income.

Occupancy Ratio for Hotel Industry Revenue per available room (RevPAR) RevPAR it is a performance metric in the hotel industry that is calculated by dividing a hotel's total guestroom revenue by the room count and the number of days in the period being measured. Calculation: RevPAR = Rooms Revenue/Rooms Available RevPAR is rooms revenue per available room (Total rooms inventory), Rooms Revenue is the revenue generated by room sales Rooms Available as used in calculating

Ratio for Banking Industry Capital adequacy ratio It is also known as Capital to Risk (Weighted) Assets Ratio (CRAR). It is the ratio of a bank's capital to its risk. It is a measure of a bank's capital. It is expressed as a percentage of a bank's risk weighted credit exposures. This ratio is used to protect depositors and promote stability and efficiency of financial systems around the world. Capital adequacy ratio is the ratio which determines the bank's capacity to meet the time liabilities and other risks such as credit risk, operational risk etc.

Two types of capital are measured in CAR: Tier one capital : which can absorb losses without a bank being required to cease trading. Tier two capital: which can absorb losses in the event of a windingup and so provides a lesser degree of protection to depositors. Capital adequacy ratio is defined as: Ratio for Banking Industry Capital adequacy Ratio for banking Industry TIER 1 CAPITAL = (paid up capital + statutory reserves + disclosed free reserves) (equity investments in subsidiary + intangible assets + current & b/f losses) TIER 2 CAPITAL = A) Undisclosed Reserves + B) General Loss reserves + C) hybrid debt capital instruments and subordinated debts

Ratio for Banking Industry Loan to Deposit Ratio in Banks The loan to deposit ratio (LTD) is a commonly used statistic for assessing a bank's liquidity by dividing the bank's total loans by its total deposits. This number is expressed as a percentage. If the ratio is too high, it means that the bank may not have enough liquidity to cover any unforeseen fund requirements, and conversely, if the ratio is too low, the bank may not be earning as much as it could be. Formula:

Ratio for Construction Industry Construction Industry Ratios Modified traditional ratios such as Liquidity, Leverage, Activity and Profitability ratios are adapted from Construction Financial Management Association (CFMA) to support different purposes of analysis. When evaluating ratios, the results are compared with other firms in the same sector of industry. Two types of comparisons can be made when using ratio analysis: 1. A company can track improvements over time by comparing its current performance with prior years performance. 2. A company can compare itself to the industry as a way of measuring whether or not it is performing as efficiently and effectively as its peers.

Ratio for Construction Industry The Liquidity Ratios Banks and sureties rely on working capital calculations to determine credit. These ratios demonstrate the ability to finance new contracts and meet current obligations. Sureties rely heavily on these calculations to determine the amount of construction activity a contractor can handle.1. Current Ratio, 2. Quick Ratio, 3. Days of Cash, 4. Working Capital Turnover Profitability Ratios The construction industry is capital intensive industry. It relies heavily on equipment and assets to build projects. Profitability ratios are a measure of management s effectiveness in utilizing both the assets and the equity of the company. These ratios are a valuable tool in determining the most opportune allocation of an owner s capital based on his risk assessment 1. Return on Assets, 2. Return on Equity, 3. Times Interest Earned.

Ratio for Construction Industry Leverage Ratios Debt is often the silent killer of construction companies. These ratios indicate total debt, including debt to purchased equipment, accounts payable and accrued expenses. They reveal the relationship between the stockholders and creditors and whether or not there is a proper investment in fixed assets. 1. Debt To Equity, 2. Revenue To Equity, 3. Asset Turnover, 4. Fixed Asset Ratio, 5. Equity to General and Administrative Expenses, 6. Under Billings To Equity, 7. Backlog to Equity. Efficiency Ratios Efficiency ratios are a measure of certain selected metrics that indicate management s effectiveness in operating the company. Stockholders can glean important details about the company from these Measurements 1. Backlog to Working Capital, 2. Months in Backlog, 3. Days in Accounts Receivable, 4. Days in Inventory, 5. Days in Accounts Payable, 6. Operating Cycle.

Ratio for Hospitality Industry Key Financial Ratios to Analyse the Hospitality Industry The hospitality industry is a large field within the service industry that includes smaller fields such as hotels and lodging, event planning, theme parks, transportation, cruise lines and other fields within the tourism industry. The hospitality industry is heavy in fixed and tangible assets, and therefore requires a very specific set of financial ratios to accurately analyse the industry and come to conclusions based on performance of individual companies.

Ratio for Hospitality Industry 1. Liquidity Ratios Current ratio = (current assets / current liabilities) For the hospitality industry, companies have a lot of current liabilities in the form of salaries and wages, short term equipment leasing and other short term liabilities. Additionally, it is a cyclical industry, making it imperative that companies have enough current assets to cover current liabilities, even in an economic downturn. 2. Financial Leverage Ratios Debt ratio = (total debt / total assets) The debt ratio measures a company's ability to meet its long term debt obligations. For companies within the hospitality industry, it is important to have low debt ratios, meaning long term assets greatly outweigh the debt used to purchase them. 3. Profitability Ratios Gross profit margin = (sales cost of goods sold) / (sales) The net profit margin is similar to the gross profit margin except it measures the amount of net profit earned on the revenue a company generates. For the companies in the hospitality industry, profits are actually not very high, as there are high associated operating costs to run a company in this industry.

Ratio for Retail Business Sales per Square foot for companies in Retail Business Sales per square foot is a popular sales metric used in the retailing industry. Sales per square foot is simply the average revenue a retail business creates for every square foot of sales space. Sales per square foot is used by businesses and analysts alike to measure the efficiency of a store's management in creating revenues with the amount of sales space available to them. The higher the sales per square foot, the better job management is doing of marketing and displaying the store's products.

The formula for it is: Sales Per Square Foot = Sales / Square Feet of Selling Space For example, let's say Company XYZ sold $15 million worth of clothes last year in its 10 stores. Each store is about 3,000 square feet, for a total of 30,000 square feet. Using this data and the formula above, we can calculate Company XYZ's sales per square foot: $15,000,000 / 30,000 = $500 WHY IT MATTERS: Sales per square foot is an indicator of how efficiently a company uses its assets to make sales. For this reason, the higher the sales per square foot, the better.

Revenue per Employee Ratio Revenue per employee is a ratio that is calculated as company's revenue divided by the current number of employees. This ratio is most useful when comparing it against other companies in the same industry. Ideally, a company wants the highest revenue per employee possible, because it indicates higher productivity and effective use of the firm s resources. To evaluate revenue per employee, a business compares its results to other companies in the same industry. Some industries, such as banking, require a large number of employees to staff physical locations and answer customer questions. The banker should compare his company's results to competitors in the same industry. Revenue per employee is affected by a company s employee turnover rate, and turnover is defined as the percentage of the total workforce that leaves voluntarily each year and must be replaced.

Formula Revenue per Employee Ratio

Ratio for Manufacturing Industry Manufacturing Industry Ratio To gauge the appropriateness of operations and to determine how well the manufacturing process is going, a company uses the following financial ratios to evaluate its business. These financial ratios are equally useful to an investor wishing to gain a deeper understanding of a manufacturing company. Inventory Turnover The inventory turnover ratio measures the effectiveness of a company s manufacturing process. It is measured by dividing the cost of goods sold by the average balance in inventory.

Ratio for Manufacturing Industry Maintenance Costs to Total Expenses A manufacturing company may utilize equipment or machinery during the production process of its goods. A critical measurement of the sustainability of long term operations is comparing repair and maintenance costs in relation to total expenses. Total Manufacturing Costs Per Unit Minus Materials this financial metric divides the total manufacturing costs, not including direct materials, by the number of units produced. An investor can utilize this figure by determining how much overhead is required to produce a good and how efficient a company s process is compared to other entities.

Ratio for Manufacturing Industry Manufacturing Costs to Total Expenses A manufacturing company incurs expenses while producing a product as well as indirect costs needed to operate the business. From an investor s standpoint, it is more desirable to see a majority of costs directly tied to the product being made as opposed to other expenses, including supervisor salaries or building rent. Unit Contribution Margin The ratio measures what percentage of revenue is attributed to covering fixed costs. An investor can use this ratio to determine the security of a manufacturing company. A manufacturing company with a high contribution margin ratio has an easier time covering fixed costs and is a less risky company in which to invest.

Logistics Industry Ratios Ratio for Logistics Industry The logistics industry or Trucking Industry, frequently operates on relatively thin margins. Given the high cost of equipment and fuel coupled with the competitive nature of the industry, many of the financial ratios for Logistics companies are relatively tight. Cost controls both on the micro level, such as cost per mile, as well as on the macro level can help a Logistics provider maintain profitability. Fixed Mileage Cost Ratios At the level of an individual vehicle, companies in the trucking industry essentially trade miles for money. Revenue per mile comes from dividing the amount of money that a truck makes on a trip by the number of miles driven. Cost per mile is calculated by adding up all of a truck's operating costs and dividing it by the number of miles that it drives during that period of time.

Ratio for Logistics Industry Variable Profit Ratio On the most basic level, a trucker makes his money based on the difference between costs and revenues. Dead Head Costs Dead head miles happen when a trucker has to drive to get paying cargo. For instance, if a trucker drives a load from Los Angeles to San Francisco, but has to drive unloaded to Reno to pick up his next load, that second leg would be a dead head. Subtracting the cost of a dead head from a trip, which is based on dead head miles multiplied by a truck's cost per mile, gives the true profitability.

Ratio for Logistics Industry Big Picture Financial Ratios Trucking companies also can be judged using the same basic financial analysis ratios as any other company. According to business credit rating firm DBRS, a strong trucking company maintains a debt to capital ratio of 20 percent or less, while a weak one has 60 percent or more. Strong companies still have 60 percent or more of their cashflow left after paying debt, while weak truckers have less than 10 percent. While a weak trucker returns 5 percent or less on its equity, a strong one provides a return of at least 14 percent.

Ratio for Airlines Industry There are a number of specific airline industry performance metrics that investors may examine. These points of performance analysis include available seat miles, cost per available seat mile, break even load factor and revenue per available seat mile. Available Seat Miles ASM A measure of an airplane's carrying capacity available to generate revenue. Available seat miles refers to how many seat miles are actually available for purchase on an airline. Seat miles are calculated by multiplying the available seats for a given plane by the number of miles that plane will be flying for a given flight. ASM is simply a measure of a flight's revenue generating abilities based upon traffic. For investors analyzing airlines, ASM is a very important metric in deciding which airlines are best at generating revenue from the availability of seats to customers. If all of the seats on the plane are not sold, then the ASM of the airline is operating at below capacity. Long instances of unavailable seats on an airline can cost an airline millions of dollars. 73

Ratio for Airlines Industry 74