Free Cash Flow

The formula for Free Cash Flow is:

Free Cash Flow = Cash Provided by Operations – Capital Expenditures – Cash Dividends

Free Cash Flow is determined from the Statement of Cash Flows. This accounting evaluation is used to determine whether the company has sufficient cash to maintain its operations, invest in new assets and pay dividends to stockholders. Essentially free cash flow is what cash is left over after the company invests in what it needs to produce a product/ service and pays the investors.

Earnings per Share

The formula for Earnings per Share is:

Earnings per Share = (Net Income – Preferred Stock Dividends) / Average Common Shares Outstanding

Earnings per Share represent how much investors earn on their investment of common stocks in a company. This is important to investors as the only reason they are investing is to make money. The formula is rather tricky to use. Note that Preferred Stock Dividends must be subtracted from Net Income. This number is then divided by the Average Common Shares Outstanding. To determine the average: Take the number of stock outstanding at the beginning of the year and add the number of stock outstanding at the end of the year. This figure is then divided by 2 to arrive at the average value.

Solvency Ratios

Solvency ratios are used to measure a company’s ability to stay in business for a long period of time. While liquidity is looking at the current situation, solvency is looking at the long-term situation. 

One common solvency ratio:

Debt to Total Asset Ratio

The formula for Debt to Total Assets Ratio is:

Debt to Total Asset Ratio = Total Liabilities / Total Assets

Debt to Total Asset Ratio is used to examine the company’s long-term ability to meet obligations. Debt-financing is risky for any business as obligations have to be paid on a particular date in time. To utilize the formula take into consideration all liabilities whether short-term or long-term. For assets add up all the assets less depreciation that the company owns. 

Long-term debts are any debts that the company has that will be paid at some time in the future beyond the current year or operating cycle. 

Interpreting results: Higher ratios means the company has less equity. With a high ratio most of the assets are being financed with debt which in turn lowers the cushion that creditors have to collect on those liabilities.

Liquidity Ratios

Liquidity ratios determine the company’s ability to pay its current obligations. 

Before investing in a company, investors would like to know whether the company is profitable enough to pay their bills and dividends on time. This is a short-term measure of the company’s performance in terms of how much cash they have available and how much of their assets are being financed with debt. 

Accounting ratios

Accountants use various ratios to evaluate different aspects of a company. 

Three major types of ratios:

• Profitability Ratios—measures the profitability of a company over a period of time. 
• Liquidity Ratios—Evaluates the short-term ability of a company to meet its obligations.
• Solvency Ratios—Analysis the long-term viability of a company.

Each major group of ratios have different formulas some will have to be memorized, others your teacher may allow for the use of a cheat sheet. 

Ratios can be presented as a;

• Percentage 18% or 0.18
• Rate 0.18 times
• Proportion 0.18: 1