Rational Investing with Ratios

Implementing Ratios with Enterprise Value and Behavioral Finance

Yannick Coulon

• Publisher: Palgrave Pivot
• Year: 2019
• ISBN:
  9783030342654
• Topic: Business
• Subtopic: Finanza d'impresa
• Index: Business

Explaining the underlying logic behind financial ratios, this book adds to the discussion on the importance and implementation of ratios and illustrates the essential role that they play in company evaluations and investment screening. The author explores how ratios establish a proportional relationship between accounting and market data, and when well-integrated into a global company vision, can become powerful indicators capable of outlining relevant information and identifying warning signs. Going beyond merely listing possible ratios and looking further into their implementation, each ratio family is demonstrated with numerous graphs and practical case studies involving companies such as Amazon, Walmart and Alibaba. With a focus on behavioral finance and enterprise value, this innovative Palgrave Pivot will be of interest to investors, bankers and entrepreneurs, as well as finance scholars and students.

© The Author(s) 2020

Y. CoulonRational Investing with Ratioshttps://doi.org/10.1007/978-3-030-34265-4_1

Begin Abstract

1. Presentation of Key Financial Metrics and Enterprise Value

Yannick Coulon¹

(1)

Brest Business School, Brittany, France

Yannick Coulon

Abstract

The first chapter outlines the essential metrics used in financial ratios. The core of the chapter focuses on operating assets, capital employed and mostly on enterprise value (EV). EV is an essential metric that will be extensively used in profitability ratios. Several short case studies and illustrations are included. Key takeaways on metrics and their limitations conclude the chapter.

Keywords

Operating assetsCapital employedEnterprise valueCore and non-core assetsExcess or surplus cash

The original version of this chapter was revised. The figures 1.14 and 1.15 were replaced and the discrepancy between the PDF and ePub has been fixed in this revised version. A correction to this chapter can be found at https://​doi.​org/​10.​1007/​978-3-030-34265-4_​8

A correction to this publication are available online at https://​doi.​org/​10.​1007/​978-3-030-34265-4_​8

End Abstract

1.1 The Balance Sheet, Income and Cash Flow Statements

Financial statements provide essential accounting data extensively used in ratio analysis. We therefore start with a short summary highlighting the key features of the three financial statements, namely the balance sheet, the income statement and the cash flow statement.

1.1.1 The Balance Sheet

The balance sheet is a snapshot of a firm’s wealth at the end of an accounting period (year or quarter). Figure 1.1 shows how a balance sheet is conceptualized.

Fig. 1.1

Two conceptual presentations of a balance sheet

“Book value” is the valuation method used in most balance sheets. The net asset price is the historical cost of an asset minus its accumulated depreciation or amortization (i.e., net book value).

Market value is not often used in balance sheets for two main reasons:

• In many countries, an upward asset price adjustment is viewed as a taxable gain.
• In a non-efficient financial market, a market value is not always fair and very often volatile (even unknown for most private non-listed companies). A book value, with all its drawbacks, is stable. The balance sheet can be aggregated as illustrated in Fig. 1.2.

Fig. 1.2

Main building blocks of a balance sheet

The following graphic shows a more detailed presentation of a balance sheet (Fig. 1.3).

Fig. 1.3

Main balance sheet line items

Liability Versus Debt, Definition and Scope

In a broad sense, a debt is equivalent to a liability. It refers to an obligation toward a creditor, whether a supplier, a government, an employee or a financial institution.

A debt can also be strictly understood as a financial or interest-bearing obligation such as a bank loan, bond, note, line of credit or overdraft.

To avoid any confusion, we will use the term “financial debt” (interest-bearing debt) in its specific context and “liabilities” in a more inclusive and broader sense (any obligation needed to be repaid or delivered/serviced).

As an example, accounts payable are not included in our definition of “financial debt” as they rarely bear any interest and are more commercial than financial.

We will differentiate current financial debt (a loan with a maturity of less than one year) from the current portion of long-term debt. The former is regrouped under the general heading “short-term financial debt,” the latter under “CPLTD.”

Figure 1.4 provides a detailed view of current assets and liabilities.

Fig. 1.4

Main current assets and liabilities

The book adopts the two-sided/column European format, which firstly lists fixed assets (from fixed to liquid) and equity (from long-term to short-term). Format used has no impact on ratio calculation or interpretation.

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