CFA Level I · CFA Level I Exam

Financial Analysis Techniques: formula sheet

Full chapter guide

Key formulas

Six phases of the framework: Purpose and context → Collect data → Process data → Analyze and interpret → Develop and communicate conclusions → Follow up; Learn the order. Questions often ask which phase an activity belongs to.
Common-size income statement item: Line item ÷ Revenue × 100; Revenue is the base. Net profit margin is the bottom line of this statement.
Common-size balance sheet item: Line item ÷ Total assets × 100; Total assets is the base, so the right-hand side also sums to 100%.
Ratio: Ratio = Numerator ÷ Denominator; Interpret relative to history, peers and industry, not in isolation.
Vertical common-size item: Common-size % = Line item ÷ Base item × 100; Base is revenue for the income statement and total assets (or total liabilities and equity) for the balance sheet.
Trend index (horizontal): Index = Value in year t ÷ Value in base year × 100; The base year equals 100. Choose a normal, representative year as the base.
Year-over-year change: Change % = (Value t − Value t−1) ÷ Value t−1 × 100; Index minus 100 gives the cumulative percentage change since the base year.
Common-size cash flow base: Item % = Cash flow item ÷ Total revenue × 100; An alternative is to express items as a share of total cash inflows or outflows. Use the base the question states.
Debt-to-assets ratio: Total debt ÷ Total assets; Total debt means interest-bearing borrowings, not all liabilities.
Debt-to-capital ratio: Total debt ÷ (Total debt + Total shareholders' equity); Capital is debt plus equity. Result is between 0 and 1 when both are positive.
Debt-to-equity ratio: Total debt ÷ Total shareholders' equity; Can be above 1. Equity is book value.
Converting between the two: D/E = (D/C) ÷ (1 − D/C); D/C = (D/E) ÷ (1 + D/E); Handy when a question gives one ratio and asks for the other.
Financial leverage ratio: Average total assets ÷ Average total equity; Also called the equity multiplier. It uses all assets, not just debt.
Interest coverage: EBIT ÷ Interest payments; Uses earnings before interest and taxes. Interest is the financing cost, not net income.
Fixed charge coverage: (EBIT + Lease payments) ÷ (Interest payments + Lease payments); Adds lease payments to both top and bottom.
Gross profit margin: (Revenue − COGS) ÷ Revenue; Measures production cost and pricing power.
Operating profit margin: Operating income ÷ Revenue; Deducts operating expenses as well as COGS.
Pretax margin and net profit margin: EBT ÷ Revenue; Net income ÷ Revenue; Net margin is after interest and tax.
Return on assets (ROA): Net income ÷ Average total assets; Use average assets unless the question says to use ending balances.
Return on equity (ROE): Net income ÷ Average shareholders' equity; Total shareholders' equity. Preferred dividends are handled in a separate measure, return on common equity.
Equity multiplier: Average total assets ÷ Average total equity; Higher value means more financial leverage.
3-step DuPont: ROE = (Net income ÷ Revenue) × (Revenue ÷ Average assets) × (Average assets ÷ Average equity); Net margin × asset turnover × equity multiplier. Also ROA = net margin × asset turnover.
5-step DuPont: ROE = (NI ÷ EBT) × (EBT ÷ EBIT) × (EBIT ÷ Revenue) × (Revenue ÷ Avg assets) × (Avg assets ÷ Avg equity); Tax burden × interest burden × EBIT margin × asset turnover × equity multiplier.
Return on total capital: EBIT ÷ (Short-term debt + Long-term debt + Equity); Measures return to all capital providers before interest and tax.
Price-to-earnings ratio: P/E = Price per share ÷ EPS; The inverse, EPS ÷ price, is the earnings yield.
Price-to-book ratio: P/B = Price per share ÷ Book value per share; Book value per share = shareholders' equity ÷ shares outstanding. For common equity only, remove preferred equity first.
Dividend payout ratio: Payout ratio = Dividends ÷ Net income = DPS ÷ EPS; Use common dividends and earnings available to common shareholders.
Retention rate: Retention rate = 1 − Payout ratio; Also called the earnings retention ratio.
Dividend yield: Dividend yield = DPS ÷ Price per share; Uses the same price and period as the DPS.
Sustainable growth rate: g = Retention rate × ROE; Assumes constant ROE and payout, and no new equity issued.
Price to cash flow: P/CF = Price per share ÷ Cash flow per share; The cash flow measure used (CFO, FCF or EBITDA-based) must be stated or consistent.
Segment margin: Segment margin = Segment profit ÷ Segment revenue; Segment profit is the measure reviewed by management. Compare with the consolidated margin and with other segments.
Segment ROA: Segment ROA = Segment profit ÷ Segment assets; Segment profit is the measure reviewed by management, which often excludes unallocated corporate costs. ROA equals segment margin × segment asset turnover (revenue ÷ segment assets).
Debt-to-equity: Total debt ÷ Total shareholders' equity; Leverage measure. Check whether the question defines debt as total debt or total liabilities.
Debt-to-EBITDA: Total debt ÷ EBITDA; Common credit leverage measure. Higher means weaker credit quality.
Interest coverage: EBIT ÷ Interest expense; Shows how many times operating profit covers interest. Higher is safer.
EBITDA interest coverage: EBITDA ÷ Interest expense; Always at least as high as EBIT coverage when D&A is positive.
Fixed charge coverage: (EBIT + Lease payments) ÷ (Interest + Lease payments); Use the version the question gives. Definitions vary.
Cash flow to debt: CFO ÷ Total debt; Cash-based measure of repayment capacity.
Current ratio: Current assets ÷ Current liabilities; Short-term liquidity measure.
Quick ratio: (Cash + Marketable securities + Receivables) ÷ Current liabilities; Stricter liquidity test that excludes inventory.

Quick revision

Common-size statements divide income statement items by revenue and balance sheet items by total assets.
Trend analysis compares the same item across periods, often indexed to a base year.
Inventory turnover = cost of goods sold ÷ average inventory; days of inventory = 365 ÷ turnover.
Cash conversion cycle = days of inventory + days of sales outstanding − days of payables.
Current ratio = current assets ÷ current liabilities; quick ratio excludes inventory and other less liquid current assets.
Debt-to-equity and similar leverage ratios measure financial risk; interest coverage = EBIT ÷ interest expense.
Net profit margin = net income ÷ revenue; ROE = net income ÷ average equity.
Three-step DuPont: ROE = net profit margin × asset turnover × financial leverage.
Financial leverage = average total assets ÷ average equity.
P/E = price per share ÷ earnings per share; compare it only against similar companies or the company's own history.
Segment data shows which businesses drive profit, but segments may be defined differently from company to company.
Ratios depend on accounting choices, so check for different policies, one-off items and window dressing before comparing.

Common mistakes

Putting ratio calculation in the analysis and interpretation phase. Fix: Calculation and adjustment belong to processing. Interpretation is a separate phase that answers the question.
Using the wrong base for common-size statements. Fix: Income statement uses revenue. Balance sheet uses total assets.
Using the wrong base, such as dividing balance sheet items by revenue. Fix: Say it aloud: income statement over revenue, balance sheet over total assets.
Mixing up vertical and horizontal analysis. Fix: Vertical means within one period, as a share of a base. Horizontal means across periods, as a change from a base year.
Mixing up the denominators of debt-to-equity and debt-to-capital. Fix: Say it aloud: capital means debt plus equity. Debt-to-capital must be below 1; debt-to-equity can be higher.
Using net income instead of EBIT in interest coverage. Fix: Interest coverage is EBIT ÷ interest. Net income is already after interest, so it would understate the cushion.
Using ending balances when the question gives opening and closing figures. Fix: Average the opening and closing totals for assets and equity unless the question says to use year-end figures.
Confusing gross margin with operating margin. Fix: Gross margin deducts only COGS. Operating margin also deducts operating expenses such as SG&A and depreciation.
Giving the payout ratio when asked for the retention rate, or the reverse. Fix: Underline which one is asked. Compute payout first, then subtract from 1 only if retention is required.
Using total net income without deducting preferred dividends for EPS or payout. Fix: Use earnings available to common shareholders, that is net income minus preferred dividends.

Exam tips

Memorize the six phases in order. Questions usually place one activity and ask which phase it is.
In common-size questions, check the base before you divide.
Expect questions that ask which tool suits a purpose, such as comparing firms of different size.
Reject options that claim one ratio or one source is enough to reach a conclusion.
There is no penalty for a wrong answer, so always choose one option, narrowing to two by order and base checks.
Read the base in the stem. If it says total assets or revenue, use that exactly.
On three-option questions, first eliminate options that compute the wrong ratio, such as dividing by the wrong base.
Expect interpretation items: a percentage rose or fell, and you pick the likely cause or the correct conclusion.