Financial Statement Analysis / Ratio Analysis | Most Comprehensive Guide

This is the most comprehensive guide to Ratio Analysis / Financial Statement Analysis

This expert-written guide goes beyond the usual gibberish and explore practical Financial Statement Analysis as used by Investment Bankers and Equity Research Analysts.

Here I have taken Colgate case study and calculated Ratios in excel from scratch.

Please note that this Ratio Analysis guide is over 9000 words and took me 4 weeks to complete. Do save this page for future reference and don’t forget to share it :-)

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Ratio Analysis / Financial Statement Analysis

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What is Financial Statement Analysis / Ratio Analysis?

The purpose of Financial Statement Analysis is to evaluate management performance in Profitability, Efficiency and  Risk

Although financial statement information is historical, it is used to project future performance

Financial Statement Analysis can be done using Three Methods –

Financial Statement Analysis

  • Vertical Analysis (also called as Common Size Statements Analysis) – It compares the each item of to the base case of the financial statements. All income statement items are expressed as percentage of Sales. Balance Sheet Items are expressed as a percentage of Total Assets or Total Liabilities (please note Total Assets = Total Liabilities)
  • Horizontal Analysis – It compares the two financial statements (income statement, balance sheet) o determine the absolute change as well as percentage changes.

Ratio Analysis – Puts important business variables into perspective by comparing it with other numbers. It provides meaningful relationship between individual values in the financial statements.

So, which one is the best when it comes to Financial Statement Analysis? 

Ofcourse, you can’t pick and choose a single method as the best and ONLY method to do the financial statement analysis.

You need to do all THREE analysis in-order to get a complete picture of the Company.

Let us look at each one of them one by one.

Vertical Analysis or Common Size Statements

Vertical analysis is a technique used to identify where a company has applied its resources and in what proportions those resources are distributed among the various balance sheet and income statement accounts. The analysis determines the relative weight of each account and its share in asset resources or revenue generation

Vertical Analysis – Income Statement

  • On the income statement, vertical analysis is a universal tool for measuring the firm’s relative performance from year to year in terms of cost and profitability.
  • It should always be included as part of any financial analysis. Here, percentages are computed in relation to Sales which are considered to be 100%.
  • This vertical analysis effort in the income statement is often referred to as margin analysis, since it yields the different margins in relation to sales.
  • It also helps us do the time series analysis ( how the margins has increased/decreased over the years) and also helps in cross sectional analysis with other comparable companies in the industry.
Vertical Analysis of Income Statement: Colgate Case Study


  • For each year, Income Statement line items is divided by its respective year’s Top Line (Net Sales) number.
  • For example, for Gross Profit, it is Gross Profit / Net Sales. Likewise for other numbers

Vertical Analysis of Colgate Income Statement

What can we interpret with Vertical Analysis of Colgate Palmolive
  • Vertical Analysis helps us with analyzing the historical trends.
  • Please note that from vertical analysis we only get to the the point of asking the right questions (identification of problems). However, we do not get answers to the our questions here.
  • In Colgate, we note that gross profit margin (Gross Profit / Net Sales) has been in the range of 56%-59%.  Why Fluctuating?
  • We also note that the Selling General and administrative expenses (SG&A) has decreased from 36.1% in 2007 to 34.1% in the year ending 2015. Why?
  • Also note that the operating income has dropped significantly in 2015. Why?
  • Net income decreased substantially to less than 10%. Why?
  • Also, effective tax rates jumped to 44% in 2015 (from 2008 until 2014, it was in the range of 32-33%). Why?


Vertical Analysis – Balance Sheet (Common Size Ratio?)

  • Vertical Analysis on the Balance Sheet normalizes the Balance Sheet and expresses each item in percentage of total assets/liabilities.
  • It helps us to understand how each item of the balance sheet has moved over the years. For eg. Debt has increased or decreased?
  • It also helps in cross sectional analysis (comparing the balance sheet strength with other comparable companies)
Vertical Analysis of Balance Sheet: Colgate Case Study


  • For each year, Balance Sheet line items is divided by its respective year’s Top Assets (or Total Liabilities) number.
  • For example, for Accounts Receivables, we calculate as Receivables / Total Assets. Likewise for other balance sheet items

Vertical Analysis - Colgate Balance Sheet Asset

Interpretation of Colgate’s Vertical Analysis
  • Cash and Cash equivalents has increased from 4.2% in 2007 and is currently standing at 8.1% of the total assets. Why a built-up of cash?
  • Receivables has decreased from 16.6% in 2007 to 11.9% in 2015. Does this mean a stricter credit policy terms?
  • Inventories has decreased too from 11.6% to 9.9% overall. Why?
  • What is included in “other current assets”? It shows a stead increase from 3.3% to 6.7% of the total assets over the last 9 years.
  • What is included in other assets? Why shows a fluctuating trend?

Vertical Analysis - Colgate Balance Sheet Liabilities

  • On the liabilities side, there can be many observations we can highlight. Accounts payable decreased continuously over the past 9 years and currently stands at 9.3% of the total assets.
  • Why there has been a significant jump in the Long Term Debt to 52,4% in 2015. For this we need to investigate this in the 10K?
  • Non controlling interests has also increased over the period of 9 years and is now at 2.1%


Horizontal Analysis

Horizontal analysis is a technique used to evaluate trends over time by computing percentage increases or decreases relative to a base year.It provides an analytical link between accounts calculated at different dates using currency with different purchasing powers. In effect, this analysis indexes the accounts and compares the evolution of these over time.
As with the vertical analysis methodology, issues will surface that need to be investigated and complemented with other financial analysis techniques. The focus is to look for symptoms of problems that can be diagnosed using additional techniques. Let’s look at an example.


Horizontal Analysis of Colgate’s Income Statement


We calculate the growth rate of each of the line items with respect to the previous year.
For example, to find growth rate of Net Sales of 2015, the formula is (Net Sales 2015 – Net Sales 2014) / Net Sales 2014
Horizontal Analysis - Income Statement Colgate

What can we interpret with Horizontal Analysis of Colgate Palmolive
  • The last two years Colgate has seen a dip in Net Sales figures. In 2015, Colgate saw a de-growth of -7.2% in 2015. Why?
  • Cost of Sales, however, has decreased (positive from company’s point of view). Why is this so?
  • Net Income decreased in the last three years, with as much as 36.5% delcine in 2015.


Trend Analysis

Trend Analysis compare the overall growth of key financial statement line item over the years from the base case.

For example, in case of Colgate, we assume that 2007 is the base case and  analyze the performance in Sales and Net profit over the years.

  • We note that Sales has increased by only 16.3% over a period of 8 years (2008-2015).
  • We also note that the overall net profit has decreased by 20.3% over the 8 year period.

Trend Analysis - Colgate

Ratio Analysis

Ratio analysis is another tool that helps identify changes in a company’s financial situation. A single ratio is not sufficient to adequately judge the financial situation of the company. Several ratios must be analyzed together and compared with prior-year ratios, or even with other companies in the same industry. This comparative aspect of ratio analysis is extremely important in financial analysis. It is important to note that ratios are parameters and not precise or absolute measurements. Thus, ratios must be interpreted cautiously to avoid erroneous conclusions. An analyst should attempt to get behind the numbers, place them in their proper perspective and, if necessary, ask the right questions for further clarification.

Ratio Analysis Framework 2

Solvency Ratios

Solvency Ratios are primarily sub-categorized into two parts – Liquidity Ratios and Turnover Ratios. They are further sub-divided into 10 ratios as seen in the diagram below.

We will discuss each sub category one by one.

Solvency Ratios 2

Liquidity Ratios

Liquidity ratios measure how liquid the company’s assets are (how easily can the assets be converted into cash) as compared to its current liabilities. There are three common liquidity ratios

  1. Current ratio
  2. Acid test (or quick asset) ratio
  3. Cash Ratios

#1 – Current Ratio

What is Current Ratio?

Current ratio is the most frequently used ratio to measure company’s liquidity as it is quick, intuitive and easy measure to understand the relationship between the current assets and current liabilities. It basically answers this question “How many dollars in current assets does the company have to cover each $ of current liabilities”

Current Ratio Formula = Current Assets / Current Liabilities

Let us take a simple Current Ratio Calculation example,

Current Assets = $200 Current Liabilities = $100
Current Ratio = $200 / $100 = 2.0x
This implies that the company has two dollar of current assets for every one dollar of current liabilities.


Analyst Interpretation of Current Ratio

  • Current ratio provides us with a rough estimate that whether the company would be able to “survive” for one year or not. If Current Assets is greater than Current Liabilities, we interpret that the company can liquidate its current assets and pay off its current liabilities and survive atleast for one operating cycle.
  • Current Ratio in itself does not provide us with full details of the quality of current assets and whether they are fully realizable.
  • If the current assets consists primarily of receivables, we should investigate the collectability of such receivables.
  • If current assets consists of large Inventories, then we should be mindful of the fact that inventories will take longer to convert into cash as they cannot be readily sold. Inventories are much less liquid assets than receivables.
  • Average maturities of current assets and current liabilities should also be looked into. If current liabilities mature in the next one month, then current assets providing liquidity in 180 days may not be of much use.

Current Ratio – Colgate Case Study Example

Let us now calculate the Current Ratios for Colgate.

Current Ratio - Colgate

  • Colgate has maintained a healthy current ratio of greater than 1 in the past 10 years.
  • Current ratio of Colgate for 2015 was at 1.24x. This implies that current assets of Colgate are more than current liabilities of Colgate.
  • However, we still need to investigate on the quality and liquidity of Current Assets. We note that around 45% of current assets in 2015 consists of Inventories and Other Current Assets. This may affect the liquidity position of Colgate.
  • When investigating Colgate’s inventory, we note that majority of the Inventory consists of Finished Goods (which is better in liquidity than raw materials supplies and work-in-progress).

Colgate Inventory Breakup

source: Colgate 2015 10K  Report, Pg – 100

Below is a quick comparison of Current Ratio of Colgate’s vs P&G vs Unilever

Current Ratio - Colgate vs PG vs Unilver

source: ycharts

  • Colgate’s current Ratio as compared to its peer group (P&G and Unilever) appears to be much better.
  • Unilever current ratio seems to be declining over the past 5 years. However, P&G Current ratio has remained less than 1 in the past 10 years or so.


#2 – Quick Ratio

What is Quick Ratio?

  • Sometimes current assets may contain huge amounts of inventory, prepaid expenses etc. This may skew the current ratio interpretations as these are not very liquid.
  • To address this issue, if we consider the only most liquid assets like Cash and Cash equivalents and Receivables, then it should provide us with a better picture on the coverage of short term obligations.
  • This ratio is know as Quick Ratio or the Acid Test.
  • The rule of thumb for a healthy acid test index is 1.0.
Quick Ratio Formula = (Cash and Cash Equivalents + Accounts Receivables)/Current Liabilities

Let us take a simple Quick Ratio Calculation example,

Cash and Cash Equivalents = $100
Accounts Receivables = $500
Current Liabilities = $1000
Then Quick Ratio = ($100 + $500) / $1000 = 0.6x


Analyst Interpretation

  • Accounts Receivables are more liquid than the inventories.
  • This is because Receivables directly convert into cash after the credit period, however, Inventories are first converted to Receivables which in turn take further time to convert into cash.
  • In addition, there can be uncertainty related to the true value of the inventory realized as some of it may become obsolete, prices may change or it may become damaged.
  • It should be noted that a low quick ratio may not always mean liquidity issues for the company. You may find low quick ratios in businesses that sell on cash basis (for example, restaurants, supermarkets etc). In these businesses there are no receivables, however, there maybe a huge pile of inventory.

Quick Ratio – Colgate Case Study Example

Let us now look at the Quick Ratio calculations in Colgate.

Quick Ratio - Colgate
Quick Ratio of Colgate is relatively healthy (between 0.56x – 0.73x). This acid test shows us the company’s ability to pay off short term liabilities using Receivables and Cash & Cash Equivalents.
Below is a quick comparison of Quick Ratio of Colgate’s vs P&G vs Unilever
Colgate Quick Ratio vs PG vs Unilver v1
source: ycharts
As compared to its Peers, Colgate has a very healthy quick ratio.
While, Unilever’s Quick Ratio has been declining for the past 5-6 years, we also note that P&G Quick ratio is much lower than that of Colgate.


#3 – Cash Ratio

What is Current Ratio?

Cash ratio considers only the Cash and Cash Equivalents (there are the most liquid assets within the Current Assets). If the company has a higher cash ratio, it is more likely to be able to pay its short term liabilities.

Cash Ratio Formula = Cash & Cash equivalents / Current Liabilities

Let us take a simple Cash Ratio Calculation example,

Cash and Cash Equivalents = $500
Current Liabilities = $1000
Then Quick Ratio = $500 / $1000 = 0.5x


Analyst Interpretation

  • All three ratios – Current Ratios, Quick Ratios and Cash Ratios should be looked at for understanding the complete picture on Company’s liquidity position.
  • Cash Ratio is the ultimate liquidity test. If this number is large, we can obviously assume that the company has enough cash in its bank to pay off its short term liabilities.

Cash Ratio – Colgate Case Study Example

Let us calculate Cash Ratios in Colgate.

Cash Ratio - Colgate
Colgate has been maintaining a healthy cash ratio of 0.1x to 0.28x in the past 10 years. With this higher cash ratio, the company is in a better position to payoff its current liabilities.
Below is a quick comparison of Cash Ratio of Colgate’s vs P&G vs Unilever
Cash Ratio - Colgate vs PG vs Unilver
source: ycharts
Colgate’s Cash ratio as compared to its peers seems to be much superior.
Unilever’s Cash Ratio has been declining in the past 5-6 years.
P&G cash ratio has steadily improved over the past 3-4 years period.


Turnover Ratios

We saw from the above three liquidity ratios (Current, Quick and Cash Ratios) that it answer the question “Whether the company has enough liquid assets to square off its current liabilities”. So this ratio is all about the $ amounts.

However, when we look at Turnover ratios, we try to analyze the liquidity from “how long it will take for the firm to convert inventory and receivables into cash or time taken to pay its suppliers”.

Turnover Ratios - Financial Statement Analysis 1

The commonly used turnover ratios include:

  • 4) Receivables turnover
  • 5) Accounts receivables days
  • 6) Inventory turnover
  • 7) Inventory days
  • 8) Payables turnover
  • 9) Payable days
  • 10) Cash Conversion Cycle

#4 – Receivables Turnover Ratio

What is Receivables Turnover Ratio?

  • Accounts Receivables Turnover Ratio can be calculated by dividing Credit Sales by Accounts Receivables.
  • Intuitively. it provides us the number of times Accounts Receivables (Credit Sales) is converted into Cash Sales
  • Accounts Receivables can be calculated for the full year or for a specific quarter.
  • For calculating accounts receivables for a quarter, one should take annualized sales in the numerator.
Receivables Turnover Formula = Credit Sales / Accounts Receivables

Let us take a simple Receivables Turnover Calculation example,

Sales = $1000
Credit given is 80%
Accounts Receivables = $200
Credit Sales = 80% of $1000 = $800
Accounts Receivables Turnover = $800 / $200 = 4.0x

Analyst Interpretation


  • Please note that the Total Sales include Cash Sales + Credit Sales. Only Credit Sales convert to Accounts Receivables, hence, we should only take Credit Sales.
  • If a company sells most of its items on Cash Basis, then there will be No Credit Sales.
  • Credit Sales figures may not be directly available in the annual report. You may have to dig into the Management discussions to understand this number.
  • If it is still hard to find the percentage of credit sales, then do have a look at conference calls where analysts question the management on relevant business variables.  Sometimes it is not available at all.


Accounts Receivables – Colgate Example


  • To calculate the receivables turnover, we have considered average receivables. We consider the “average” figures as these are balance sheet items.
  • For eg. as shown in the image below, we took the average receivables of 2014 and 2015.
  • Also, please note that I have taken the assumption that 100% of Colgate’s Sales were “Credit Sales”.

Colgate Receivables Turnover

  • We note that the Receivables Turnover was less than 10x in 2008-2010.  However, it improved significantly in the past 8 years and is was closer to 11x in 2015.
  • Higher Receivables Turnover implies higher frequency of converting receivables into cash (this is good!)

Receivable Turnover - Ratio Analysis Colgate 1

Below is a quick comparison of Receivables turnover of Colgate vs P&G vs Unilever

  • We note that P&G Receivable turnover ratio is slightly higher than Colgate.
  • Unilever’s Receivables turnover is closer to that of Colgate.

Colgate Receivable Turnover vs PG vs Unilver

source: ycharts

#5 – Days Receivables

What is Days Receivables?

Days receivables is directly linked with the Accounts Receivables Turnover. Days receivables expresses the same information but in terms of number of days in a year. This provides with a intuitive measure of Receivables Collection Days
You may calculate Account Receivable days based on the year end balance sheet numbers.
Many analysts, however, prefer to use the average balance sheet receivables number to calculate the average collection period. (right way is to use the average balance sheet)

Accounts Receivables Days Formula = Number of Days in Year / Accounts Receivables Turnover

Let us take the previous example and find out the Days Receivables

Let us take a simple Days Receivables Calculation example,

Accounts Receivables Turnover = 4.0x
Number of days in a year = 365
Days Receivables = 365 / 4.0x = 91.25 days ~ 91 days
This implies that it takes 91 days for the company to convert Receivables into Cash.


Analyst Interpretation


  • Number of days taken by most analysts is 365, however, some analyst also use 360 as the number of days in the year. This is normally done to simplify the calculations.
  • Accounts receivable days should be compared with the average credit period offered by the company. For example in the above case, if the Credit Period offered by the company is 120 days and they are receiving cash in just 91 days, this implies that the company is doing well to collect its receivables.
  • However, if the credit period offered is say 60 days, then you may find significant amount of previous accounts receivables on the balance sheet, which obviously is not good from company’s point of view.


Days Receivables – Colgate Case Study Example


  • Let’s calculate Days Receivables for Colgate. To calculate Days Receivables, we have taken 365 days assumption.
  • Since, we had already calculated receivables turnover above, we can easily calculate the days receivables now.Receivable DaysDays receivables or Average Receivables collection days has decreased from around 40 days in 2008 to 34 days in 2015.
  • This means that Colgate is doing a better job in collecting its receivables. They may have started implementing a stricter credit policy.

Recievalble Days - Ratio Analysis - Colgate


#6 – Inventory Turnover Ratio

What is Inventory Turnover Ratio?

Inventory Ratio means how many times the inventories are restored during the year. It can be calculated by taking Cost of Goods Sold and dividing by Inventory.Inventory Turnover Formula = Cost of Goods Sold / Inventory

Let us take a simple Inventory Turnover Ratio Calculation example.

Cost of Goods Sold = $500
Inventory = $100
Inventory Turnover Ratio = $500 / $100 = 5.0x
This implies that during the year, inventory is used up 5 times and is restored to its original levels.


Analyst Interpretation

You may note that when we calculate receivables turnover, we took Sales (Credit Sales), however, in inventory turnover ratio, we took Cost of Goods Sold. Why?

The reason is that when we think about receivables, it directly comes from Sales made on the credit basis. However, Cost of Goods sold is directly related to inventory and is carried on the balance sheet at cost.

To get an intuitive understanding of this, you may see the BASE equation.

B + A = S + E

B = Beginning Inventory

A = Addition to Inventory (purchases during the year)

S = Cost of Goods sold

E = Ending Inventory

S  = B + A – E

As we note from the above equation, Inventory is directly related to Cost of Goods Sold.

Inventory Turnover Ratio – Colgate Case Study Example


  • Let us calculate Inventory Turnover Ratio of Colgate. Like in receivables turnover, we take the average inventory for calculating Inventory Turnovers.
  • Colgate’s inventory consists of Raw material and supplies, work in progress and finished goods.

Colgate Inventory Turnover Ratio

  • Colgate’s inventory turnover has been in the range of 5x-6x.
  • In the last 3 years, Colgate has seen a lower inventory turnover ratio. This means that Colgate is taking longer to process its inventory to finished goods.

Inventory Turnover Ratio Analysis - Colgate


#7 – Days Inventory

What is Days Inventory?

We calculated Inventory Turnover Ratio earlier. However, most analyst prefer calculating inventory days. This is obviously the same information but more intuitive. Think of Inventory Days as the approximate number of days it takes for inventory to convert into finished product.

Inventory Days Formula = Number of days in a year / Inventory Turnover.

Let us take a simple Days Inventory Calculation example. We will use the previous example of Inventory Turnover Ratio and calculate Inventory Days.

Cost of Goods Sold = $500
Inventory = $100
Inventory Turnover Ratio = $500 / $100 = 5.0x
Inventory Days = 365/5 = 73 days.
This implies that Inventory is used up every 73 days on an average and is restored to its original levels.


Analyst Interpretation

  • You may also think of inventory days as the number of days a company can continue with production without replenishing its inventory.
  • One should also look at the seasonality patter in how inventory is consumed depending on the demand. It is rare that inventory is consumed constantly throughout the year.

Inventory Days – Colgate Case Study Example


Let us calculate the Inventory turnover days for Colgate. Inventory Days for Colgate = 365 / Inventory Turnover.Colgate - Inventory Days

  • We see that inventory processing period has increased from 64.5 days in 2008 to around 70.5 days in 2015.
  • This implies that Colgate is processing its inventory a bit slowly as compared to 2008.

Inventory Days - Ratio Analysis - Colgate


#8 – Accounts Payable Turnover

What is Accounts Payable Turnover?

Payables turnover indicates the number of times that payables are rotated during the period. It is best measured against purchases, since purchases generate accounts payable.

Payables Turnover Formula = Purchases / Accounts Payables

Let us take a simple Accounts Payable Turnover calculation example. From the Balance Sheet, you are provided with the following –

Ending Inventory = $500
Beginning Inventory = $200
Cost of Goods Sold = $500
Accounts Payable = $200
In this example, we need to first find out Purchases during the year. If you remember the BASE equation that we used earlier, we can easily find purchases.
B + A = S + E
B = Beginning Inventory
A = Additions or Purchases during the year
E = Ending Inventory
we get, A = S + E – B
Purchases or A = $500 + $500 – $200 = $800
Payables Turnover = $800 / $200 = 4.0x


Analyst Interpretation

  • Some analysts make a mistake of taking Cost of Goods Sold in the numerator of this accounts payable turnover formula.
  • It is important to note here that Purchase is the one that leads to Payables.
  • We earlier saw Sales can be Cash Sales and Credit sales. Likewise, Purchases can be Cash Purchases as well Credit Purchases. Cash Purchases does not results in payables, it is only the Credit Purchases that leads to Accounts payables.
  • Ideally, we should seek for Credit Purchases information from the annual report.

Accounts Payable Turnover – Colgate Case Study Example


In Colgate’s case study, we first find the Purchases. Purchases 2015 = COGS 2015 + Inventory 2015 – Inventory 2014
Purchases Formula
Once we have the purchases, we can now find the payables turnover. Please note that we use the average accounts payable to calculate the ratio.
Colgate Payables Turnover
We note that Payable turnover has decreased to 5.50x in 2015. This implies that Colgate is taking a bit longer to make payment to its suppliers.
Payables Turnover Ratio Analysis - Colgate


#9 – Days Payable

What is Days Payable Ratio?

Like with all the other turnover ratios, most analyst prefer to calculate much intuitive Days payable. Payable days represent the average number of days a company takes to make the payment to its suppliers.

Payables Days Formula = Number of Days in a year / Payables Turnover

Let’s take a simple Payable Days calculation example. We will use the previous example of Accounts Payable Turnover to find the Payable days

We earlier calculated Accounts Payable Turnover as 4.0x
Payable Days = 365 / 4 = 91.25 ~ 91 days
This implies that the company pays its clients every 91 days.


Analyst Interpretation


  • Higher the accounts payable days, better it is for the company from liquidity point of view.
  • Payable days can be affected by seasonality in the business. Sometimes business may stock inventories due to upcoming business cycle. This may distort the interpretations that we make on payable days if we are not aware of seasonality.


Accounts Payable – Colgate Case Study Example


Let us calculate Accounts Payable for Colgate. Since, we have already calculated the Payables Turnover, we can calculate Payable days = 365/Payables Turnover.
Colgate - Payable Days
Payable days have been constant at around 66 days for the past 3 years. This means that Colgate takes around 66 days for paying its suppliers.
Payment Period - Ratio Analysis - colgate


#10 – Cash Conversion Cycle

What is Cash Conversion Cycle?

Cash conversion cycle is the total time taken by the firm to convert its cash outflows into cash inflows (returns). Think of Cash Conversion Cycle as time taken by a company to purchase the raw materials, then convert inventory into finished product and sell the product and receive cash and then make the necessary payout for the purchases.
Cash Conversion cycle Ratio Analysis 1
Cash Conversion cycle depends primarily on three variables – Receivable Days, Inventory Days and Payable Days.

Cash Conversion Cycle Formula = Receivable Days + Inventory Days – Payable Days

Let us take a simple Cash Conversion Cycle calculation example,

Receivable Days = 100 days
Inventory Days = 60 days
Payable Days = 30 days
Cash conversion cycle = 100 + 60 – 30 = 130 days.


Analyst Interpretation of Cash Conversion


  • It signifies the number of days firm’s cash is stuck in the operations of the business.
  • Higher cash conversion cycle means that it takes longer time for the firm to generate cash returns.
  • However, a lower cash conversion cycle may be viewed as a healthy company.
  • Also, one should compare the cash conversion cycle with the industry averages so that we are in a better position to comment on higher/lower side of cash conversion cycle.

Cash Conversion Cycle – Colgate Case Study Example

  • Cash Conversion Cycle of colgate = Receivable Days + Inventory Days – Payable Days
  • Overall, we note that the cash collection cycle has decreased from around 46 days in 2008 to 38 days in 2015.
  • This implies that overall Colgate is improving its cash conversion cycle with each year.
  • We note that the receivables collection period has decreased overall that has contributed to the decrease in cash conversion cycle.
  • Additionally, we also note that the average payable days has increased, which again positively contributed to the cash conversion cycle.
  • However, the increase in inventory processing days in the recent years has negatively affected its cash conversion cycle.

Colgate Cash Conversion Cycle

Cash Conversion cycle Ratio Analysis - Colgate

Ratio Analysis – Operating Performance 

Operating performance ratios try and measure how the business is performing at the ground level and is sufficiency generating returns relative to the assets deployed.

Operating Performance Ratios are two sub-divided as per the diagram below

Operating Performance 1

Operating Efficiency Ratios

#11 – Asset Turnover Ratio

What is Asset Turnover Ratio?

The asset turnover ratio is a comparison of sales to total assets. This ratio provides with an indication on how efficiently the assets are being utilized to generate sales.

Asset Turnover Formula = Total Sales / Assets

Let us take a simple Cash Conversion Cycle calculation example. 

Sales of Company A = $900 million
Total Assets = $1.8 billion
Asset Turnover = $900/$1800 = 0.5x
This implies that for every $1 of assets, the company is generating $0.5


Analyst Interpretation

  • Asset turnovers can be extremely low or very high depending on the Industry they operate in.
  • Asset turnover of Manufacturing firm will be on the lower side due to large asset base as compared to a companies that operates in the services sector (lower assets).
  • If the firm has seen considerable growth in assets during the year or the growth has been seasonal, then the analyst should find additional information to interpret such numbers.

Asset Turnover Ratio – Colgate Case Study Example


Asset Turnover of Colgate = Sales / Average Assets
We note that the Asset Turnover for Colgate is showing a declining trend. Asset turnover was at 1.53x in 2008, however, each year this ratio has sequentially decreased (1.26x in 2015).
Asset Turnover - Colgate
Total Asset Turnover - Ratio Analysis - Colgate 1


#12 – Net Fixed Asset Turnover

What is Net Fixed Asset Turnover?

Net Fixed Asset turnover reflects utilization of fixed assets (Property Plant and Equipment).

Net Fixed Asset Turnover Formula = Total Sales / Net Fixed Assets

Let us take a simple Net Fixed Asset Turnover calculation example.

Total Sales = $600
Net Fixed Assets = $600
Net Fixed Asset Turnover = $600 / $600 = 1.0x
This implies that for every $ spent on the fixed assets, the company is able to generate $1.0 in revenues.


Analyst Interpretation

  • This ratio should be applied to high capital intensive sectors like Automobile, Manufacturing, Metals etc.
  • You should not apply this ratio to asset light companies like Services or Internet based as the Net Fixed assets will be really low and not meaningful from analysis point of view.
  • This number can look temporarily bad if the firm has recently added greatly to its capacity in anticipation of future sales

Net Fixed Asset Turnover – Colgate Case Study Example


Net Fixed Asset Turnover of Colgate = Sales / Average Net Fixed Assets (PPE, net)
Net Fixed Asset Turnover - Colgate
Net Fixed Asset Turnover - Ratio Analysis - Colgate 1
Like the Asset Turnover, Net Fixed asset turnover is also showing a declining trend.
Net Fixed Asset turnover was at 5.0x in 2008, however, this ratio has reduced to 4.07x in 2015.


#13 – Equity Turnover

What is Equity Turnover?

Equity turnover is the ratio of Total Revenue to the Shareholder’s Equity Capital. This ratio measures how efficiency the company is deploying equity to generate sales.

Equity Turnover Ratio Formula = Total Sales / Shareholder’s Equity

Let us take a simple Equity Turnover calculation example,

Total Sales = $600
Shareholder’s Equity = $300
Equity Turnover Ratio = $600 / $300 = 2.0x.
This implies that company is generating $2.0 of sales for every $1.0 of shareholder’s equity.


Analyst Interpretation


Equity Turnover – Colgate Case Study Example


Colgate Equity Turnover = Sales / average Shareholder’s Equity
Equity Turnover Ratio - Colgate 1
We note that historically, Colgate’s Equity Turnover has been in the range of 6x-7x. However, it jumped to 37.91x in 2015.
This was primarily due to two reasons – a) Share buy back program of Colgate resulting in lowering of Equity base each year. b) Accumulated losses net of taxes (these are those losses that don’t flow into the income statement).
Equity Turnover - Ratio Analysis Colgate 1
Equity Turnover - Colgate 10K


Operating Profitability Ratios

Operating Performance Ratios measure how much are the costs relative to the sales and how much profit is generated in the overall business. We try to answer questions like “how much the profit percentage” or “Is the firm controlling its expenses by buying inventory etc at a reasonable price?”

#14 – Gross Profit Margin

What is Gross Profit Margin?

Gross Profit is the difference between Sales and the direct cost of making a product or providing service. Please note that costs like overheads, taxes, interests are not deducted here.

Gross Margin Formula = (Sales – Costs of Goods Sold)/Sales = Gross Profit / Sales

Let us take a simple Gross Margin calculation example,

Assume from the Sales of a firm is $1,000 ands its COGS is $600
Gross Profit = $1000 – $600 = $400
Gross Profit Margin = $400/$1000 = 40%


Analyst Interpretation


  • Gross Margin can vary drastically between industries. For example, digital products sold online will have extremely high Gross Margin as compared to a company that sells Laptop.
  • Gross margin is extremely useful when we look at the historical trends in the margins. If the Gross Margins has increased historically, then it could be either because of price increase or control of direct costs. However, if the Gross margins show a declining trend, then it may be because of increased competitiveness and therefore resulting in decreased sales price.
  • In some companies, Depreciation expenses are also included in Direct Costs. This is incorrect and should be shown below the Gross Profit in the Income Statement.


Gross Margins – Colgate Case Study Example


Let us calculate Colgate’s Gross Margin. Colgate’s Gross Margin = Gross Profit / Net Sales.
Gross Profit Margin - Colgate
Gross Profit margin - Ratio Analysis colgate
Please note that depreciation related to manufacturing operations are included here in Cost of Operations (Colgate 10K 2015, pg 63)
Shipping and handling costs may be reported either in Cost of Sales or Selling General and Admin Expenses. Colgate has however, reported these costs as a part of Selling General and Admin Expenses. If such expenses are included in Cost of Sales, then the Gross margin of colgate would have decreased by 770 bps from 58.6% to 50.9% and decreased by 770bps and 750 bps in 2014 and 2013 respectively.
Gross Margin - Colgate 10K
source: – Colgate 10K 2015, pg 46


#15 – Operating Profit Margin

What is Operating Profit Margin?

Operating profit or Earnings Before Interest and Taxes (EBIT) margin measures the rate of profit on sales after operating expenses. Operating income can be thought of as the “bottom line” from operations.Operating Profit Margin = EBIT / Sales

Let us take a simple Operating Profit Margin calculation example,

We will use the previous example.
Assume from the Sales of a firm is $1,000 ands its COGS is $600
SG&A expense = $100
Depreciation and Amortization = $50
EBIT = Gross Profit – SG&A – D&A = $400 – $100 – $50 = $250
EBIT Margin = $250/$1000 = 25%


Analyst Interpretation

  • Please note that some analyst take EBITDA (Earning before interest taxes depreciation and amortization) instead of EBIT as Operating Profit. If this is so, they assume that depreciation and amortization are non-operating expenses.
  • Most analyst prefer taking EBIT as Operating Profit. Operating Profit Margin is most commonly tracked by analysts
  • You need to be mindful of the fact that many companies include non recurring items (gains/losses) in SG&A or other expenses above EBIT. This may increase or decrease the EBIT Margins and skew your historical analysis.

Operating Profit Margin – Colgate Case Study Example

Colgate’s Operating Profit = EBIT / Net Sales
Operating Profit Margin - Colgate
Operating Profit Margin - Ratio Analysis - Colgate
Historically, Colgate’s Operating Profit has remained in the range of 20%-23%
However, in 2015, Colgate’s EBIT Margin decreased significantly to 17.4%. This was primarily due to change in accounting terms for CP Venezuela entity (as explained below)
EBIT Margin - Colgate 10K

  • Colgate derives more than 75% income from outside of United States. The company is exposed to changes in economic conditions, exchange rates volatilities and political uncertainty in some countries.
  • Once such country has been Venezuela, where operating environment has been very challenging for Colgate and economic uncertainty due to wide exchange rate devaluations. Additionally, due to price controls, Colgate has restricted ability to implement price increases without governmental approval.
  • Colgate’s ability to generate income continue to be negatively affected by these difficult geo-political conditions.
  • As a result, effective from December 31st, 2015, Colgate is no longer including the results of CP Venezuela in its consolidated income statement and began accounting of its CP Venezuela entity using Cost method of accounting. As a result, the company has taken pre-tax charge of $1.084 billion in 2015.
  • This has resulting in decrease of Operating Margin of Colgate in 2015.

Operating Profit margin - Colgate 10K


#16 – Net Margin

What is Net Margin?

Net Margin is basically the net effect of operating as well as financing decisions taken by the company. It is call as Net Margin because in the numerator we have Net Income (Net of all the operating expenses, interest expenses as well as taxes)

Net Margin Formula = Net Income / Sales

Let us take a simple Net Margin calculation example,  Continuing with our previous example, EBIT = $250, Sales = $1000.

We now assume that interest is $100 and taxes is charges at the rate of 30%.EBIT = $250
Interest = $100
EBT = $150
Taxes = $45
Net Profit = $105
Net Profit Margin = $105/$1000 = 10.5%


Analyst Interpretation

  • Like Gross margins, Net Margins can also vary drastically across industries. For example Retail is a very low margin business (~5%) whereas a website selling digital products may have Net Profit Margin in excess of 40%.
  • Net Margins is useful for comparison between companies within the same industry due to similar product and cost structure.
  • Net Profit Margins can vary historically due to presence of non recurring items or non operating items.

Net Margin – Colgate Case Study Example

Let us have a look at the Net Margin of Colgate.Net Profit Margin - Colgate

  • Historically, Net Margin for Colgate has been in the range of 12.5% – 15%.
  • However, it decreased substantially in 2015 to 8.6% primarily due to CP Venezuela Accounting changes (reasons described in EBIT margin discussion).

Net Profit Margin - Ratio Analysis Colgate


#17 – Return on Total Assets

What is Return on Total Assets?

Return on Assets or Return on Total Assets relates to the firm’s earnings to all capital invested in the business.

Two important things to note there –

  • Please note that in the denominator, we have Total Assets which basically takes care of both the Debt and Equity Holders.
  • Likewise in the numerator, the Earnings should reflect something that is before the payment of interest.
Return on Total Asset Formula = EBIT / Total Assets.

Let us take a simple Return on Total example,

Company A has an EBIT of $500 and Total Assets = $2000
Return on Total Assets = $500/$2000 = 25%
This implies that the company is generating a Return  on Total Assets of 25%.


Analyst Interpretation

  • Many analysts use the numerator as Net Income + Interest Expenses instead of EBIT. They basically are deducting the taxes.
  • Return on Assets can be low or high depending on the type of industry. If the company operates in a capital intensive sector (Asset heavy), then the return on assets may be on the lower side. However, if the company is Asset Light (services or internet company), they tend to have have a higher Return on Assets.

Return on Total Assets – Colgate’s Case Study Example


Let us now calculate the Return on total Assets of Colgate. Colgate’s Return On Total Assets = EBIT / Average total assets
Return on Total Assets - Colgate 1
Colgate’s Return on total assets have been declining since 2010. Most recently, it has declined to its lowest to 21.9%. Why?
Let’s investigate….
Two reasons can contribute to decrease – either the denominator i.e. average assets have increased significantly or the Numerator Net Sales have dropped significantly.
In Colgate’s case, the total assets have infact decreased in 2015. This leaves us to look at the Net Sales figure.
We note that the overall Net sales has decreased by as much as 7% in 2015.
Net Sales - Colgate 10K
We note that the primary reason for sales decrease for the negative impact due to foreign exchange of 11.5%.
Organic sales of colgate has however increased by 5% in 2015.
Return on Total Assets - Ratio Analysis Colgate


#18 – Return on Total Equity

What is Return on total Equity?

Return on Total Equity means the rate of return earned on the Total Equity of the firm. Can be thought of dollar profits a company generates on each dollar investment of Total Equity.Please note Total Equity = Ordinary Capital + Reserves + Preference + MinorityInterests

Return on Total Equity Formula = Net Income / Total Equity

Let us take a simple Return on Total Equity example.

Net Income = $50
Total Equity = $500
Return on Total Equity = $50/$500 = 10%
Return on total equity is 10%


Analyst Interpretation


  • Please note that the Net income will be before the preference dividends and minority interest are paid.
  • Higher Return on Total Equity implies higher return to the Stakeholders.


Return on Total Equity – Colgate Case Study Example


  • Colgate’s Return on Total Equity = Net Income (before pref dividends & minority interest) / average total equity.
  • Please do remember to take the Net income before minority interest payments in colgate. This is because we are using the total equity (including the non controlling assets).
  • We note that the Return on Total Equity has jumped to 230.9%. This is despite the fact that the Net Income has decreased 34% in 2015.
  • This result is somehow not making much sense here and cannot be interpreted as the Return On total Equity that will continue in the future.
  • Return on Total Equity has jumped primarily due to decrease in denominator – Shareholder’s equity (increase in treasury stock because of buy back and also because of accumulated losses that flow through the Shareholder’s Equity)

Return on Total Equity - Ratio Analysis Colgate 1

Return on Total Equity - Ratio Analysis Colgate


#19 – Return on Equity or Return on Owner’s Equity

What is ROE?

Return on equity or Return on Owner’s Equity is based only on the common shareholder’s equity. Preferred dividends and minority interests are deducted from Net Income as they are a priority claim.Return on equity provides us with the Rate of return earned on the Common Shareholder’s Equity.

ROE or Return on Equity Formula = Net Income (after pref dividends and minority interest) / Common Shareholder’s Equity

Let us take a simple ROE calculation example,

Net Income = $50
Total Equity = $500
Shareholder’s Equity = $400
ROE (owners) = $50 / $400 = 12.5%
ROE of the company is 12.5%

Analyst Interpretation


  • Since common shareholder’s equity is a year end number, some analyst prefer taking the average shareholder’s equity (average of beginning and year end)
  • ROE can be basically considered as profitability ratio from shareholder’s point of view. This provides how much returns on generated from shareholder’s investments, not from the overall company investments in assets. (Please note Total Investments = Shareholder’s Equity + Liability that includes Current Liabilities and Long term Liabilities)
  • ROE should be analyzed over a period of time (5 to 10 year period) in order to get a better picture of the growth of the company. Higher ROE does not get passed directly to the shareholder’s. Higher ROE -> Higher Stock Prices.

ROE Calculation – Colgate Case Study Example


ROE - Colgate 2
Like the Return on Total Equity, Return on Equity has jumped significantly to 327.2% in 2015.
This has happened despite 34% decrease in the Net Income in 2015.
Return on Equity also jumped because of the decrease in Shareholder’s Equity because of the much lower base in 2015. (reasons as discussed earlier in Return on Total Equity).
Return on Equity - Ratio Analysis Colgate


#20 – Dupont ROE

What is Dupont ROE?

Dupont ROE is nothing but an extended way of writing an ROE formula. It divides ROE into several ratios that collectively equal ROE while individually providing insight to most important term in ratio analysis.

Dupont ROE formula
= (Net Income / Sales) x (Sales / Total Assets)  x (Total Assets / Shareholder’s Equity)

The above formula is nothing but the ROE formula = Net Income / Shareholder’s Equity

Let us take a simple Dupont ROE calculation example.

Net Income = $50
Sales = $500
Total Assets = $200
Shareholder’s Equity = $400
Gross Margin = Net Income / Sales = $50 / $500 = 10%
Asset Turnover = Sales / Total Assets = $500/$200 = 2.5x
Asset Leverage = Total Asset / Shareholder’s Equity = $200 / $400 = 0.5
Dupont ROE = 10% x 2.5 x 0.5 = 12.5%


Analyst Interpretation

  • Dupont ROE formula provides with with additional ways to analyze the ROE ratio and helps us find out reason to the final number.
  • The first term (Net Income/Sales) is nothing but the Net Profit Margin. We know that Retail sector operates on low profit margin, however, software product based company may operating on high profit margin.
  • The second term here is (Sales/Total Assets), we normally call this term as Asset turnovers. It provides us with a measure of how efficiently the assets are being utilized.
  • The third term here is (Total Assets / Shareholder’s Equity), we call this ratio as Asset Leverage. Asset leverage gives insight into how the company may be able to finance the purchase of new assets. A higher Asset leverage does not mean that it is better than the low multiplier. We need to look at the financial health of the company by performing full ratio analysis.

Dupont ROE – Colgate Case Study Example


Colgate Dupont ROE = (Net Income / Sales) x (Sales / Total Assets)  x (Total Assets / Shareholder’s Equity)
Please note that the Net Income is after the minority shareholder’s payment.
Also, the shareholder’s equity consists of only the common shareholder’s of Colgate.
Dupont ROE 1
We note that the asset turnover has shown a declining trend over the past 7-8 years.
Profitability has also declined over the past 5-6 years
However, ROE has not shown a declining trend. It is increasing overall. This is because of the Financial Leverage (average total assets / average total equity). You will note that the Financial Leverage has shown a stead increase over the past 5 years and is currently standing at 30x.

Ratio Analysis – Risk

Risk analysis examines the uncertainty of income for the firm and for an investor
 Total firm risks can be decomposed into three basic sources – 1) Business risk 2) Financial
Risk 3) External Liquidity Risk

Risk Analysis Ratios

Business Risk

Wikipdedia defines as “the possibility a company will have lower than anticipated profits or experience a loss rather than taking a profit”. If you look at the income statement, there are many line items that contribute to the risk of making losses. In this context, we discus three kinds of business risks – Total Leverage, Operating leverage and Financial Leverage.

# 21. Operating Leverage

What is Operating Leverage?

Operating leverage is the percentage change in operating profit relative to sales.Operating leverage is a measure of how sensitive the operating income is to the change in revenues.
Please note that greater use of fixed costs, greater the impact of a change in sales on the operating income of a company.

Operating Leverage Formula = % change in EBIT / % change in Sales.

Let us take a simple Operating Leverage calculation example.

Sales 2015 = $500, EBIT 2015 = $200
Sales 2014 = $400, EBIT 2014 = $150
% change in EBIT = ($200-$150)/$100 = 50%
% change in Sales = ($500-$400)/$400 = 25%
Operating Leverage = 50/25 = 2.0x
This means that for Operating profit changes by 2% for every 1% change in Sales.


Analyst Interpretation

  • Greater the fixed costs, higher is the operating leverage.
  • Between five to ten years of data should be used for calculating Operating Leverages

Operating Leverage – Colgate Case Study Example

  • Colgate’s Operating Leverage = % change in EBIT / % change in Sales
  • I have calculated the operating leverages for each year from 2008 – 2015.
  • Colgate’s operating leverage is very volatile as it ranges from 1x to 5x (excluding the year of 2009 where sales growth was almost 0%).
  • It is expected that Colgate’s Operating leverage to be higher as we note that Colgate has made significant investments in Property, plant and equipment as well as intangible assets. Both these long term assets account for more than 40% of the total assets.

Operating Leverage - Colgate


# 22. Financial Leverage

What is Financial leverage?

Financial leverage is the percentage change in Net profit relative to Operating Profit. Financial leverage measures how sensitive the Net Income is to the change in Operating Income.Financial leverage primarily originates from company’s financing decisions (usage of debt). Like in the operating leverage, fixed assets leads to higher operating leverage. In Financial leverage, the usage of debt primarily increases the financial risk as they need to payoff interest

Financial Leverage formula = % change in Net Income / % change in EBIT

Let us take a simple Financial Leverage calculation example,

Net Income 2015 = $120, EBIT 2015 = $200
Net Income 2014 = $40, EBIT 2014 = $150
% change in EBIT = ($200-$150)/$100 = 50%
% change in Net Income = ($120-$40)/$40 = 200%
Financial Leverage = 200/50 = 4.0x
This means that for Net Income changes by 4% for every 1% change in Operating Profit.


Analyst Interpretation

  • Greater the Debt, higher is the Financial leverage.
  • Between five to ten years of data should be used for calculating Financial Leverages

Colgate Case Study

Financial Leverage Formula - Colgate
Colgate’s Financial Leverage has been relatively stable between 0.90x – 1.69x (excluding the 2014 financial leverage number)

# 23. Total Leverage

What is Total Leverage?

Total leverage is the percentage change in Net profit relative to its Sales. Total leverage measures how sensitive the Net Income is to the change in Sales.

Total Leverage Formula = % change in Net Profit / % change in Sales

= Operating Leverage x Financial Leverage

Let us take a simple Total Leverage calculation example,

Sales 2015 = $500, EBIT 2015 = $200, Net Income 2015 = $120
Sales 2014 = $400, EBIT 2014 = $150, Net Income 2014 = $40
% change in Sales = ($500-$400)/$400 = 25%
% change in EBIT = ($200-$150)/$100 = 50%
% change in Net Income = ($120-$40)/$40 = 200%
Total Leverage = % change in Net Income / % change in Sales =200/25 = 8x.
Total Leverage = Operating Leverage x Financial Leverage = 2 x 4 = 8x (Operating and Financial Leverage calculated earlier)
This implies for every 1% change in Sales, the Net Profit moves by 8%.


Analyst Interpretation

Higher sensitivity could be because of higher operating leverage (higher fixed cost) and higher financial leverage (higher debt)5-10 years of data should be taken to calculate the total leverage.

Total Leverage – Colgate Case Study Example

Let us now look at the Total Leverage of Colgate.
Operating and Financial Leverage
Total Leverage Formula - Colgate

  • Colgate’s Operating leverage is higher as we note that Colgate has made significant investments in Property, plant and equipment as well as intangible assets.
  • However, Colgate’s Financial Leverage is pretty stable.


Financial Risk

Financial risk is the type of risk primarily associated with the risk of default on the company loan. We discuss 3 types of financial risk ratios – Leverage Ratio, Interest Coverage Ratio and DSCR ratio.

# – 24. Leverage Ratio or Debt to Equity Ratio

What is Leverage Ratio?

How much debt does the firm employ in relation to its use of equity? This is an important ratio for bankers as it provides company’s ability to pay off debt using its own capital. Generally lower the ratio better it is.Debt includes current debt + long term debt

Leverage Ratio Formula = Total Debt (current + long term) / Shareholder’s Equity

Let us take a simple Leverage Ratio calculation example.

Current Debt = $100
Long Term Debt = $900
Shareholder’s Equity = $500
Leverage Ratio = ($100 + $900) / $500 = 2.0x


Analyst Interpretation

  • A lower ratio is generally considered better as it shows greater asset coverage of liabilities with own capital.
  • Capital intensive sectors generally show a higher debt to equity ratio (leverage ratio) as compared to services sector.
  • If the leverage ratio is increasing over time, then it may be concluded that the firm is unable to generate sufficient cash flows from its core operations and is relying on external debt to stay afloat.

Leverage Ratio – Colgate Case Study Example

Leverage Ratio of Colgate = (Current portion of long term debt + Long term Debt) / Shareholder’s Equity.
Leverage Ratio - Colgate
We note that the leverage ratio has been increasing since 2009. The Debt to Equity has increased from 0.98x in 2009 to 4.44x in 2014. Also, please note that the Equity Capital for 2015 was negative and hence, the ratio was not calculated.
Debt to Equity Ratio - Ratio Analysis Colgate
We note that the Debt Ratio in 2014 was at 0.80.
Debt Ratio - Colgate Ratio Analysis
Leverage ratio has been increasing due to two reasons –
Shareholder’s equity is decreasing steadily over the years due to buy back of shares as well as accumulated losses that flow to the Shareholder’s Equity.
Additionally, we note that  Colgate has been systematically increasing debt to support its capital structure strategy objectives to funds its business and growth initiatives, as well as to minimize its risk adjust weighted average cost of capital.
Long Term Debt - Colgate 10K
Colgate 10K, 2015 (pg 41)


# 25. Interest Coverage Ratio

What is Interest Coverage Ratio?

This ratio signifies the ability of the firm to pay interest on the assumed debt.

Interest Coverage Formula = EBITDA / Interest Expense

Please note that EBITDA = EBIT + Depreciation & Amortization

Let us take a simple Interest Coverage Ratio calculation example,

EBIT = $500
Depreciation and Amortization = $100
Interest Expense = $50
EBITDA = $500 + $100 = $600
Interest Coverage Ratio = $600 / $50 = 12.0x


Analyst Interpretation

  • Capital intensive firms have higher depreciation and amortization resulting in lower operating profit (EBIT)
  • In such cases, EBITDA is one of the most important measure as it is the amount available to payoff interest (depreciation and amortization is non cash expense).
  • Higher interest coverage ratios implies greater ability of the firm to payoff its interests.
  • If Interest coverage is less than 1, then EBITDA is not sufficient to payoff interest, which implies finding other ways to arrange funds.

Interest Coverage Ratio – Colgate Case Study Example

Colgate’s Interest Coverage Ratio = EBITDA / Interest Expense.
Please note that depreciation and amortization expenses are not provided in the income statement. These were taken from the Cash Flow statements.
Also, Interest expense shown in the Income Statement is the net number (Interest Expense – Interest Income)
Interest Coverage Formula - colgate
Colgate has a very healthy Interest coverage ratio. More than 100x in the past two years.
We also note that in 2013, the Net Interest Expense was negative. Hence the ratio was not calculated.
Interest Coverage Formula - colgate ratio analysis


# 26. Debt Service Coverage Ratio (DSCR)

What is DSCR?

Debt Service Coverage Ratio tells us whether the Operating Income is sufficient to payoff all obligations that are related to debt in an year. It also includes committed lease payments.Debt servicing consists of not only the interest, but also some principal portion also is repaid annually.

Debt Service Coverage Formula = Operating Income / Debt Service

Operating Income is nothing but EBIT

Debt Service is Principal Payments + Interest Payments + Lease Payments

Let us take a simple DSCR calculation example,

EBIT = $500
Pricipal Payment = $125
Interest Payment = $50
Lease Payments = $25
Debt Service = $125 + $50 + %25 = $200
DSCR = EBIT / Debt Service = $500/$200 = 2.5x


Analyst Interpretation


  • A DSCR of less than 1.0 implies that the operating cash flows are not sufficient enough for Debt Servicing implying negative cash flows.
  • This is pretty useful matrix from Bank’s point of view, especially when they give loans against property to individuals


DSCR – Colgate’s Case Study Example


Colgate’s Debt Service Coverage Ratio = Operating Income / Debt Service
Debt Service = Principal Repayment of Debt + Interest Payment + Lease Obligations
For Colgate, we get the Debt service obligations from its 10K reports.
DSCR calculations - Colgate
Colgate 10K 2015, pg 43.
Please note that you get the forecast of the Debt Service in the 10K reports.
For finding out the historical Debt Service Payments, you need to refer to the 10Ks prior to 2015.
DSCR Formula - Colgate
As noted from the graph below, we see that the Debt Service Coverage Ratio or DSCR for Colgate is health at around 2.78.
However, the DSCR has deteriorated a bit in the recent past.
DSCR calculations - Colgate Ratio Analysis

You can click here for a detailed indepth article on DSCR Ratio

Ratio Analysis – External Liquidity Risk

#27 – Bid Ask Spread

What is Bid Ask Spread?

Bid – Ask Spread is a very important parameter that helps us understand how the stock prices gets affected with purchase or sale of stocks. Bid is the highest price that the buyer is willing to pay
Ask is the lowest price at which the seller is willing to sell.

Let us take a simple Bid Ask Spread calculation example.

If the bid price is $75 and the ask price is $80, then the bid-ask spread is the the difference between the ask price and the bid price.$80 – $75 = $5.


Analyst Interpretation

  • External market liquidity is an important source of risk to investors.
  • If the bid-ask spread is low, then the investors are able to buy or sell assets with little price changes.
  • Also,  another factor of external market liquidity is the dollar value of shares traded

External Liquidity Risk – Colgate Case Study Example


Let us look at Colgate Bid Ask Spread.
As we note from the below snapshot, Bid = 74.12 and Ask = $74.35
Bid Ask Spread = 74.35 – 74.12 = 0.23
Bid Ask Spread Colgatesource : Yahoo Finance


#28 – Trading Volume

What is Trading Volume?

Trading volume refers to the average number of shares traded in a day or over a period of time. When the average trading volume is high, this implies that the stock has high liquidity (can be easily traded).  Numerous buyers and sellers provide liquidity.

Let us take a simple Trading Volume example.

There are two companies – Company A and B.
Average daily traded volume of Company A is 1000 and that of Company B is 1 million.

Which company is more liquid? Obviously company B as there is more investors interest and traded more.

Analyst Interpretation

  • If the trading volume is high, then investors will show more interest in the stock that may help in increase of the share price.
  • If the trading volume is low, then less investors will have interest in the stocks. Such stock will be less expensive due to unwillingness of investors to buy such stocks.

Trading Volume – Colgate’s Case Study Example


Let us look at the trading volume of Colgate. We note from the below table that Colgate traded volume was at around 1.85 million shares. This is a fairly liquid stock.Colgate Trading Volume Chart


Ratio Analysis – Growth

Growth rate is one of the most important parameter when we look at analyzing a company. As a company becomes bigger and bigger, its growth tapers and reaches a long term sustainable growth rate. In this we discuss how sustainable growth rates are important.

#29 – Sustainable Growth

What is Sustainable Growth?

Company’s topline growth is one of the most important parameter for investors as well as creditors. It helps the investor forecast the growth in earnings and valuations.

It is important to find the sustainable growth rate of the company. Sustainable growth rate is a function of two variables:
 What is the rate of return on equity (which gives the maximum possible growth)?
 How much of that growth is put to work through earnings retention (rather than being paid out in
Sustainable Growth Rate Formula = ROE x Retention rate

Let us take a simple Sustainable Growth calculation example.

ROE = 20%
Dividend Payout ratio = 30%
Sustainable Growth Rate = ROE x Retention Rate = 20% x (1-0.3) = 14%


Analyst Interpretation

  • If the company is not growing then there can be greater chances of default on the debt. Company’s growth phase is generally dividend into three parts – Hyper growth period, Maturity Phase, Decline Phase
  • Sustainable Growth rate formula is primarily applicable in the Mature Phase.

Sustainable Growth – Colgate’s Case Study Example


Let us now look at the sustainable growth rate of Colgate. Sustainable. We note that the sustainable ROE as per the formula comes out to be around 11.6% in 2015. However, for all earlier years, it is in excess of 40% (which seems highly unlikely).Due to recent volatility in foreign exchange (leading to sales volatility) and buy backs done by the management (leading to an increase in ROE), the sustainable growth is not making sense here.
Sustainable Growth - Colgate Case Study


Now that we have calculated all 29 ratios, you should appreciate that financial statement analysis includes learning about the company from all dimensions. A single ratio does not provide us with a full understanding of the company. All the ratios needs to be looked at cohesively and are interconnected. We noted that Colgate has been an amazing company with solid fundamentals.

Now that you have done fundamental analysis of Colgate, you can move forward and learn Financial Modeling (forecasting of Colgate’s Financial Statements)

What do you think?


  1. By Jorge Lapa on

    Hi Dheeraj
    Your article is very useful to learn analyze company’s condition, could you send me the ratio analysis excel sheet?


  2. By Phineas Magagula on

    Hi Dheeraj,
    This is a very useful article and comments. May you please send me the file as I am failing to download. Thanks a lot.


  3. By razane khatib on

    Amazing explanation Dheeraj. Thank you alot. May i have a copy of the templates plz as well. thank you so much


  4. By Apoorv Tiwari on

    hey dheeraj i am one for your followers i just want to thank you for this content you have put here…….this is amazing putting all this knowledge in a structured form requires huge amount of efforts all your post are very detailed thank you sir once again….you are doing great and wish you all the success in life and in general.

    I would request you to please send me the template of Ratio Analysis.


  5. By julita on

    Your article is very useful to learn analyze company’s condition, could you send me the ratio analysis excel sheet?


  6. By Shoaib Ibrahim on

    Hello Dagestan,
    Really insightful work. Please share both templates and guide. Would appreciate such an amazing work on cash flow statement.




  7. By Deepika on

    Hi Dheeraj, your posts are too good for a beginner to understand. I would like to have the excel template to have more meaningful insight. Your posts helps me alot and keep up your good work.. keep writing. Good Day


  8. By Naseer Ahmed on

    Hi Dheeraj, you are really helping the financial aspirants. Can you please send me the file Solved and Unsolved excel?


  9. By Deepika on

    Hi Dheeraj, Your post is awesome with very strong explanation. You are doing a great work.
    can you please send me the excel template to have more meaningful insight from the article.


  10. By Esmie Ngagwe on

    Hey Dheeraj,
    This is very useful indeed. I work as an auditor and my work requires a great deal of analytical skill…I am even considering Financial analysis courses…

    Great job


  11. By Stuart Heeks on

    Hi Dheeraj, This is a very good spreadsheet and will prove very useful for our trainees. Please could you email me the spreadsheet?


  12. By Renee Gosselin on

    Wow! Congratulations for your great work!

    Can you please send me the Ratio Analysis Solved and Unsolved Excel files?

    Thank you


  13. By Durga Prasad on

    Hi Dheeraj,great job and I hope to get these kind of articles going forward as well. Can you please send the file to my mail.


  14. By srikanth thogarchedu on

    excellent work, appreciated.
    can you please share the excel template for my reference and practice?

    thank you


  15. By Muhammad Aimash on

    Great Work. Thanks for this. I can totally see the number of hours you must have spent to get this done. Can I also get a copy of the excel template.

    Kind Regards,
    Muhammad Aimash


  16. By Simon on

    Dear Dheeraj,
    Good job, deep explanation!
    Could you pls send me the templates (solved & unsolved) and PDF of this article?
    Many thanks!


  17. By Prakash Deo on

    This was a wonderful article and became easy learning for me. Could you please share those templates with me so that i could benefit form it even more. Thank you in advance.


  18. By Mujahid Rasul on

    Really a Great stuff and thank you for your patience for very clearly explaining FS analysis in great detail.

    Can you please email me the excel templates? Both solved and unsolved.




  19. By Danish Cooper on

    Cash and Cash equivalents has increased from 4.2% in 2007 and is currently standing at 8.1% of the total assets. Why a built-up of cash?
    This above is one of the many questions one must ask while doing vertical analysis. Could you guide me on how to answer this and other such questions?
    Thank you.


    • By on

      Hi Danish,

      Good question :-)
      The vertical and horizontal anlaysis provides us with the questions and not the answers. We need to go deep into the annual report to find out the reason for the same. Best place to start with is the Management Discussion and Analysis section. In this they do discuss the variations, growth figures etc.



  20. By Ruth on

    Hi Dheeraj, thanks for this excellent study. Helped me learn some new approaches. Wold you be able to email me the template? Hope to see more from you :)


  21. By Hugo Catacora on

    Hi Dheeraj
    Excellent work, Could you please send me the template (both solved and unsolved) and PDF for this lesson on my email ?
    Thanks in advance.


  22. By Yan on

    Hello Dheeraj,

    Many thanks for this nice and intuitive guide.

    Could you please provide me as well with solved and unsolved .xls documents ?

    Best Regards,



  23. By Vinay on

    Hi Dheeraj. How are you? Great stuff and thank you for your patience for expalianing FS analysis in great detail.

    Can you pls mail me the excel templates. Both solved and unsolved.

    Thanks a ton.


  24. By Suresh Raghavan on

    Hi Sir,

    Excellent work and Knowledgeable content,you have made an outstanding effort to describe these ratio analysis.

    can you please send me the template.

    Thanks in advance!!


  25. By Sushila Palan on

    Thanks for sharing your wonderful analysis. May I request excel templates for ratios and PDF for this lesson ?



  26. By Ravinder Chana on

    Please could you also send me the files?

    You must be getting hundreds of emails requesting templates?



    • By Dheeraj Vaidya on

      Hey Wendy, many thanks for the appreciation. Have sent the templates of ratio analysis to you.


  27. By Erik on

    Hi Dheeraj,
    You have a gift! I stumbled on your site during work hours (some look at TMZ, I look at finance websites) and I had to get back to my job so as not to cheat my clients. Great work. May I too have the practice template?


  28. By Shukhrat Azizmamamdov on

    Thank you for sharing that kind of information. It is indeed helpful. Please be kind to share with me the template. Many thanks


  29. By Srivani Sampat on

    Very Very well explained. Thanks for taking the time. Would you please send the templates, would be useful for me.



    This is awesome. nice work Mr Dheeraj. I would like to know whether is there any template regarding with efficiency ratio of the bank. eg tax management efficiency ratio, expense control efficiency ratio, asset management efficiency ratio and fund management efficiency ratio.Sir, do you mind send me this template soved and unsolved.
    Btw, it’s really really great job.


    • By Dheeraj Vaidya on

      Thanks Nur for the appreciation :-). As of now i don’t have any ready material on the ratios you mentioned. Will prepare one on it soon. Have sent you the financial anlaysis templates.


  31. By Sothea on

    Hi Dheeraj Vaidya,

    This is very very good financial materials. Is there a PDF template? Could you share it?

    Thanks with regards,


    • By Dheeraj Vaidya on

      Thanks Sothea. As of now, i don’t have the PDF as of now. However, i have emailed you the excel ratio templates.


  32. By Moses on

    That’s lots of knowledge shared free of charge shapen the world.
    God bless you so much for sharing, we’ll always be grateful


  33. By Rupali on

    Thank you for making this concept so easy. Excellent work.
    May I request you for the excel templates for practice.



  34. By Liisa on

    Amasing work Dheeraj! So well and clearly explained. I would really appeciate if you could send me the templates. Many thanks in advance!


  35. By John on

    Hi Dheeraj,

    Very useful and informative template.. very interesting explanations…
    Is it possible to get copy of template to me?

    Saudi Arabia


  36. By Alessandro Gradilone on

    Hi, wonderful material and information you compiled here, congratulations. Can you send me the excel and all material, or send me the link for me to download it? Thank you!


    • By Dheeraj Vaidya on

      Hi Alessandro, thanks for the appreciation. Have sent the financial analysis excel at your email id.


  37. By Jose Miranda on

    Excellent. I rally like how you split it into the 3 methods. I would be grateful to receive the templates and guide.


  38. By Chinagorom on

    Wow. Brilliant work here Sir. very easy to understand. God bless you for the effort. Wow. Would appreciate if you send to me also please.
    Thank you


  39. By Zoran Jovanovski on

    This whole thing, this is so kind of you. Not many pleople like you in today’s world Dheeraj. Could you please send me the financial analyses template, please. Wish you all the best. Thanks


  40. By Sagar chaudhary on

    Hello sir…. Thanks for sharing this article… It is very helpful in understanding a complex topic… Thanks a lot.. :) Sir could you please share this template with me…


  41. By Alex on

    Great work! Thanks so much for your explanation to the ratio anlysis in a clear Way.

    And now I have a question needing your comments further as following:
    About the ratio of DSCR, I read some articles before using EBITDA as numerator instead of EBIT. It maybe have different interpretation in concept for measuring, I think. But to measure the operating cash folllow enough or not covering the debt payment in 1 year, EBITDA may be a better indicator on operating cash flow. How do you think?

    Anyway, could you share me the templates for better learning?



    • By Dheeraj Vaidya on

      Hi Alex, you are right! thanks for pointing this out. We could have used EBITDA which is a much better measure of operating cash flows.
      I have resent you the templates.


  42. By Rajeeb kumquat sahoo on

    Hi Dheeraj,

    Really awesome!

    You explained it so well. Can you share all the templates?



  43. By Abdullah Bajammal on

    Thank you soo much for this great explanation. Actually I got a job last week in a corporate banking sector which is all about this lesson. I appreciate what you have done. God bless you. Please mail it to me



  44. By Ajish Kumar M on

    Dear Sir,

    very good work that you have done. Its very helpful for the entry level Financial analysts those who have strong passion to do.

    Thank you so much… Expecting more article like this from you..


  45. By Korede Adeshina on

    Hello Sir, I would like to have this material in a downloadable form. Also, I am from Nigeria, is it possible to pay for your courses using a Nigeria debit card?
    Many thanks in advance


    • By Dheeraj Vaidya on

      Hi Korede,
      It is very much possible to pay from Nigerian Debit Card. Just that while registering and making payment, please choose 2checkout option.


  46. By Jeremie V. Miramonte on

    Good day!

    Please let me have also the template / excel copy for the module please..Thanks in advance sir!


  47. By Olawale on

    Thanks for this wonderful presentation, need to move on to the financial modelling. Good job. Could you please send me the template? Will definitely connect with you directly.



  48. By Harold T Chipadza on

    Awesome work. May you please send me the templates as well.

    Thank you for the effort and keep up the passion


    • By Dheeraj Vaidya on

      thanks Harold for the appreciation. I am glad you found this useful. Have shared the financial statement analysis template in your email id.


  49. By Nikhil Kumar on

    Hi Dheeraj,

    Awesome work!! Really super helpful. Would really appreciate if you could send me the excel template for this.



  50. By Wajid Ali on

    Great job

    send me templates. it will be very helpful for me. once again its a professional work that you have done.


  51. By Satish Gaekwad on

    Hi Dheeraj

    Amazing dissection of a topic that most non-finance people find so complex – your effort to persevere & simplify the core messages is appreciated.

    Please also send me the templates.



  52. By Steve Ambassa on

    Hello Sir,
    Very nice job thanks again for your share.

    Is there any templates downloadable for this guide


  53. By Scott Johnston on

    Done all of these analysis techniques but yours brings it together very nice and neat. Great job.
    Would you be so kind to send me the templates?


    Scott Johnston


  54. By Sanjay on

    Hi Dheeraj, great portal, the content is very well graphically designed. I found some unanswered queries from your blog. I would be really thankful to you if you can provide the Ratio Analysis Solved and Unsolved Excel!



  55. By Martin on

    Hi Dheeraj,

    Thanks for the great work and for sharing. Please kindly send me the Ratio Analysis Solved and Unsolved .
    Have a nice day.
    Thank You


  56. By Cindy Njoga on

    I love how you have simplified everything!
    Thanks could you please send me the solved and unsolved template.


  57. By Fadhili Wafula Lumongi on

    This is a wonderful and comprehensive insight into ratio analysis. Kindly mail me the excel template.


  58. By ronak on

    Hello ,
    Dheeraj Sir, great job

    Kindly send me the Ratio Analysis Solved and Unsolved .
    Have a nice day.
    Thank You


  59. By Papadopoulos Evris on

    amazing guide!really good job Mr Dheeraj!Can you send me the solved and unsolved templates please?


  60. By Prasanth Kumar on

    Hi Dheeraj Vaidya,
    Excellent and you have made an outstanding effort to describe these. Thank you very much.


  61. By Neeraj Kumar Tiwari on

    Dear Dheeraj

    You are simply doing great job
    Hats off to you

    Neeraj Tiwari
    Credit Rating Analyst
    Brick Works Rating


  62. By Seyi on

    Thanks Dheeraj for these informative , well detailed ,

    I will appreciate if I can get the PDF version of your work.



    • By Dheeraj Vaidya on

      Hi Seyi,

      Unfortunately, I dont’ have a PDF version as of now. Let me see if i can prepare one.



  63. By Carl on

    Thank you Mr. Dheeraj for this fantastic post. This is helping us alot in our endeavors in knowing the fundamentals in investment strategy. Your continuous sharing of knowledge is highly appreciated. Thank you sir.


  64. By Priti Ragini on


    Kindly send me a ratio analysis excel sheet . It would be a great favor to me.

    with regards


  65. By Mohammed Akther Hussain on

    Dheeraj Vaidya Saheb.
    Hum ap ko aur ap ki taleem ko tahey dil sey Salam Karteen hein.
    Hum bahuth khush huey khaz kar key ap IIM AUR IIT SEY TALEEM HASIL KAREY HEIN


  66. By Pratik Biyani on

    You are simply so Awesome! You are doing a great job for the investing community

    Sir, can you please send me the Ratio Analysis Solved and Unsolved Excel!

    Thank you


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