Page 73 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 2. Performance Measurements and Standards 59

• Pretax earnings to sales ratio This is earnings before taxes divided by net sales.
In the example, this is $18,273,900 (Table 2-1) divided by $101,546,400 (Table 2-1),
indicating a ratio 0.18 earnings to 1 of net sales.

• Price dividend ratio This is also called the yield. A stock price of $10 with a divi-
dend for the last four quarters of 46¢ would have a ratio of 21.7 to 1 ($10 46¢), or
4.6 percent if expressed as a percentage (46¢ $10).
• Price to earnings ratio (P/E) This is the result of dividing the stock price by earn-
ings per share for the last four quarters. In the example, with a stock price of $10 per
share and earnings of 63¢ per share, the P/E ratio would be 15.9 to 1 ($10 63¢). A
company with a low rather than high ratio is generally a more attractive potential
investment; however, that is very simplistic. Ratios vary by industry and within indus-
try by what the company is doing. For example, the P/E ratio may be high because
the company has depressed earnings caused by large-scale start-up costs, or it might
be very low because earnings have been increased through asset sales. It is important
to analyze earnings as well as the number of shares of stock outstanding. Is the
company issuing a lot of stock to its employees? Is it buying stock back in the open
market?
• Quick assets Cash, short-term investments, short-term loans, and accounts
receivable. In the example, this is $56,810,000 (Table 2-6).
• Quick ratio See Acid test ratio.
• Quick test ratio See Acid test ratio.

• Receivables This is money due the company from sales of products or services to its
customers. In Table 2-6, this is $19,463,200, with a reserve of $784,600 for doubtful
accounts.

• Retained earnings to capital ratio This is retained earnings divided by sharehold-
er equity. In the example, this is $24,173,900 divided by $137,77,400 (Table 2-8),
indicating a ratio of 175 retained earnings to 1 of shareholder equity.
• Return This includes a wide variety of definitions of income in relation to a speci-
fied type of investment (e.g., see the various “return” definitions listed in this section).
It is important to determine if the “return” formula is for a year or a multiple of years
(e.g., three years). The advantage of a multiple-year formula is to smooth out ups and
downs. However, it may also mask poor performance. Namely, if the multiyear return
is higher than the most recent year, it means performance has deteriorated.
Conversely, if the multiyear return is lower than the most recent annual return, the
position is improving.

• Return on assets (ROA) This is net income divided by total assets. This formula is
not uncommon with capital-intensive companies and financial institutions as a meas-
urement of the return on this definition of capital. In the example, using net income of
$9,658,800 (Table 2-1) and total assets of $330,997,900 (Table 2-6), this would give an
ROA of 2.9 percent. This percentage excludes the time value of money because non-
current assets are carried on the balance sheet at historical cost less depreciation and
amortization.