Financial Ratio Analysis and Credit Risk Formulas

Credit Risk Ratios and Liquidity Metrics

Short-Term Liquidity — Stock

• Current Ratio = Current Assets / Current Liabilities (>1 is better)
• Quick Ratio = (Cash + Short-Term Investments + Receivables) / Current Liabilities
• Cash Ratio = (Cash + Short-Term Investments) / Current Liabilities

Short-Term Liquidity — Flow

• Cash Flow Ratio = Cash Flow from Operations / Current Liabilities
• Defensive Interval = (Cash + Short-Term Investments + Receivables) / Capital Expenditures × 365
• Cash Flow to Capital Expenditures = Unlevered Cash Flow from Operations / Capital Expenditures

Long-Term Solvency — Stock

• Debt to Assets = Total Debt / Total Assets
• Debt to Equity = Total Debt / Total Equity
• Long-Term Debt Ratio = Long-Term Debt / (Long-Term Debt + Equity)

Long-Term Solvency — Flow

• Times Interest Earned (TIE) = Operating Income / Net Interest Expense (<1.5 is a danger zone)
• Interest Coverage (Cash) = Unlevered Cash Flow from Operations / Net Cash Interest
• Fixed Charge Coverage = (Operating Income + Fixed Charges) / Fixed Charges
• Fixed Charge Coverage (Cash) = (Unlevered Cash Flow from Operations + Fixed Charges) / Fixed Charges
• CFO to Debt = Unlevered Cash Flow from Operations / Total Debt

Profitability Exercise and Investment Steps

Step 1: Current Ratios

• RNOA = Operating Income / Net Operating Assets
• NBC = Net Financial Expense / Net Financial Obligations
• FLEV = Net Financial Obligations / Common Shareholders' Equity
• ROCE = (Operating Income − Net Financial Expense) / Common Shareholders' Equity

Leverage creates value if: RNOA > NBC

Step 2: After Investment (50/50 Benchmark)

• New Operating Income = Operating Income + (ΔNet Operating Assets × RNOA)
• New Net Operating Assets = Net Operating Assets + ΔNet Operating Assets
• New Net Financial Obligations = Net Financial Obligations + 0.5 × ΔNet Operating Assets
• New Common Shareholders' Equity = Common Shareholders' Equity + 0.5 × ΔNet Operating Assets
• Net Financial Expense = Net Financial Obligations × NBC
• NBC = Borrowing Cost × (1 − Tax)
• Spread = RNOA − NBC
• FLEV = Net Financial Obligations / Common Shareholders' Equity
• ROCE = (Operating Income − Net Financial Expense) / Common Shareholders' Equity
• ROCE = RNOA + ((RNOA − NBC) × FLEV)

Step 3: Find Optimal Debt

• Let D = Debt financing of project (0 ≤ D ≤ ΔNet Operating Assets)
• Net Financial Obligations = Old Net Financial Obligations + D
• Common Shareholders' Equity = Old Common Shareholders' Equity + (ΔNet Operating Assets − D)
• Set NBC = RNOA and solve for D
• If D is outside the feasible range, use a corner solution (D = 0 or D = max)
• Compare ROCE across intervals and pick the highest value

Tiered Interest (After Tax)

• Net Financial Expense = [Bracket 1 × Rate 1 + (D − Threshold) × Rate 2] × (1 − Tax)

Comprehensive Ratio Analysis and Profitability

Balance Sheet Analysis

• Operating Asset Composition = Operating Asset / Total Operating Assets
• Operating Liability Composition = Operating Liability / Total Operating Liabilities
• Operating Liability Leverage (OLLEV) = Operating Liabilities / Net Operating Assets
• Financial Leverage (FLEV) = Net Financial Obligations / Common Shareholders' Equity
• Capitalization Ratio = Net Operating Assets / Common Shareholders' Equity
• (Note: Capitalization − FLEV always equals 1)

Income Statement Analysis

• Operating Profit Margin = Operating Income (After Tax) / Sales
• Sales Profit Margin = Operating Income from Sales (After Tax) / Sales
• Other Items Profit Margin = Operating Income from Other Items / Sales
• Net Comprehensive Profit Margin = Comprehensive Income / Sales
• Expense Ratio = Expense / Sales (1 − Sales Profit Margin = Σ Expense Ratios)

Shareholders' Equity Metrics

• ROCE = Comprehensive Earnings / ½(CSE_t + CSE_t-1)
• Comprehensive Earnings = CSE_end − CSE_beg + Net Dividends
• Dividend Payout = Dividends / Comprehensive Income
• Total Payout = (Dividends + Repurchases) / Comprehensive Income
• Dividends to Book Value = Dividends / (Book Value of CSE + Dividends)
• Total Payout to Book Value = (Dividends + Repurchases) / (Book Value of CSE + Dividends + Repurchases)
• Retention Ratio = (Comprehensive Income − Dividends) / Comprehensive Income = 1 − Payout
• Net Investment Rate = Transactions with Shareholders / Beginning CSE
• Growth Rate of CSE = (Comprehensive Income + Net Transactions) / Beginning CSE

Profitability Summary

• RNOA = Operating Income_t / ½(NOA_t + NOA_t-1)
• NBC = Net Financial Expense_t / ½(NFO_t + NFO_t-1)
• RNFA = Net Financial Income_t / ½(NFA_t + NFA_t-1)
• ROCE_t = Comprehensive Earnings / ½(CSE_t + CSE_t-1)
• ROCE_t = (Operating Income − Net Financial Expense) / (Net Operating Assets − Net Financial Obligations)