<http://lib.cnfolio.com/RiskAnalysisNotes02>
Introduction to Financial Risk Analysis

## Financial ratios for a single stock

Financial information for a business is summarized by 3 reports:
1. Income statement (performance)
2. Balance sheet (assets)
3. Cash flow statement (liquidity)

Income statements and cash flow statements are summary reports for a financial period indicated by starting and ending dates, e.g. quarter or annual periods.

Balance sheets are snapshot reports at a specific date, e.g. end of quarter or end of year.

A stock (also known as a share or equity) represents an ownership claim of a specific business.

There are different types of stocks with different shareholder rights and prices. Our focus is ordinary stock, which is the most common type available to the public.

Financial reports contain a large amount of descriptive and numerical information. One method of analysis is the calculation and interpretation of ratios in the financial reports. Although there are a wide variety of financial ratios in use, our focus is limited to ratios which indicate business risks.

Liquidity is a measure of the capacity of a business to maintain sufficient cash resources to pay all legitimate payment demands during normal trading activities. J.P. Morgan Chase & Co. demanded \$5 billion in additional financial collateral from Lehman Brothers Holdings Inc. on Sep 11, 2008. Four days later, the 158-year-old Wall Street giant filed for Chapter 11 bankruptcy protection.

The UK Financial Services Authority determined on Sep 27, 2008 that Bradford & Bingley didn't meet the minimum requirements as a deposit taking bank. It could not fund its lending activities. The bank was nationalized by the UK government on Sep 29, 2008.

current assets ÷ current liabilities = current ratio

Financial ratios are relative comparisons. Use the absolute value when reading numbers from financial reports.

Steps to calculate the current ratio for Arriva Group:
1. Read the 2007 balance sheet report.
2. Find the current assets sub-total of £518.9 million.
3. Find the current liabilities sub-total of £719.8 million.
£518.9 ÷ £719.8 = 0.72

Steps to calculate the current ratio ratio for Centrica:
1. Read the 2007 balance sheet report.
2. Find the current assets sub-total of £5,798 million.
3. Find the current liabilities sub-total of £5,417 million.
£5,798 ÷ £5,417 = 1.07

Steps to calculate the current ratio for John Lewis Partnership:
1. Read the 2008 balance sheet report.
2. Find the current assets sub-total of £692 million.
3. Find the current liabilities sub-total of £940.8 million.
£692 ÷ £940.8 = 0.74

( current assets – inventory ) ÷ current liabilities = quick ratio

The quick ratio is also known as the acid test.

Steps to calculate the quick ratio for Arriva Group:
1. Read the 2007 balance sheet report.
2. Find the current assets sub-total of £518.9 million.
3. Find the inventory sub-total of £41.1 million.
4. Find the current liabilities sub-total of £719.8 million.
( £518.9 – £41.1 ) ÷ £719.8 = 0.66

Steps to calculate the quick ratio for Centrica:
1. Read the 2007 balance sheet report.
2. Find the current assets sub-total of £5,798 million.
3. Find the inventory sub-total of £241 million.
4. Find the current liabilities sub-total of £5,417 million.
( £5,798 – £241 ) ÷ £5,417 = 1.03

Steps to calculate the quick ratio for John Lewis Partnership:
1. Read the 2008 balance sheet report.
2. Find the current assets sub-total of £692 million.
3. Find the inventory sub-total of £344.9 million.
4. Find the current liabilities sub-total of £940.8 million.
( £692 – £344.9 ) ÷ £940.8 = 0.37

( current assets – current liabilities ) ÷ sales = working capital to sales ratio

Steps to calculate the working capital to sales ratio for Arriva Group:
1. Read the 2007 balance sheet and income statement reports.
2. Find the current assets sub-total of £518.9 million.
3. Find the current liabilities sub-total of £719.8 million.
4. Find the sales sub-total of £2,000.7 million.
( £518.9 – £719.8 ) ÷ £2,000.7 = -0.10

Steps to calculate the working capital to sales ratio for Centrica:
1. Read the 2007 balance sheet and income statement reports.
2. Find the current assets sub-total of £5,798 million.
3. Find the current liabilities sub-total of £5,417 million.
4. Find the sales sub-total of £16,342 million.
( £5,798 – £5,417 ) ÷ £16,342 = 0.02

Steps to calculate the working capital to sales ratio for John Lewis Partnership:
1. Read the 2008 balance sheet and income statement reports.
2. Find the current assets sub-total of £692 million.
3. Find the current liabilities sub-total of £940.8 million.
4. Find the sales sub-total of £6,052.2 million.
( £692 – £940.8 ) ÷ £6,052.2 = -0.04

operating profit ÷ interest payments = interest cover ratio

Operating profit is also known as earnings before interest and taxes (EBIT).

Steps to calculate the interest cover ratio for Arriva Group:
1. Read the 2007 income statement report.
2. Find the net sales sub-total of £128 million.
3. Find the interest payments sub-total of £16.5 million.
£128 ÷ £16.5 = 7.75

Steps to calculate the interest cover ratio for Centrica:
1. Read the 2007 income statement report.
2. Find the net sales sub-total of £2,184 million.
3. Find the interest payments sub-total of £331 million.
£2,184 ÷ £331 = 6.60

Steps to calculate the interest cover ratio for John Lewis Partnership:
1. Read the 2008 income statement report.
2. Find the net sales sub-total of £411.1 million.
3. Find the interest payments sub-total of £40 million.
£411.1 ÷ £40 = 10.28

share price ÷ equity value per share = market to book ratio
shareholders' equity ÷ number of shares outstanding = equity value per share

Steps to calculate the market to book ratio for Arriva Group:
1. Read the 2007 balance sheet and notes to the accounts.
2. Find the number of shares outstanding of 198,613,572 (as of Dec 31, 2007).
3. Find the current share price of 580p (as of Oct 24, 2008).
4. Find the shareholders' equity sub-total of £710.2 million.
£710,200,000 ÷ 198,613,572 = 358p
580p ÷ 358p = 1.62

Steps to calculate the market to book ratio for Centrica:
1. Read the 2007 balance sheet and note 29 to the accounts.
2. Find the number of shares outstanding of 3,679,980,311 (as of Dec 31, 2007).
3. Find the current share price of 307.50p (as of Oct 24, 2008).
4. Find the shareholders' equity sub-total of £3,323 million.
£3,323,000,000 ÷ 3,679,980,311 = 90p
307.50p ÷ 90p = 3.42

Past financial reports for US companies listed on public stock exchanges are available for download using the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) website.
• Form type 10-K are annual financial reports
• Form type 10-Q are quarterly financial reports

Current and historical stock prices for companies listed on public stock exchanges around the world are available at the Yahoo Finance website.