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Performance categories

K
Written by Kailey Buxbaum
Updated over 3 months ago

If you've had a chance to review some of our other Methodology documents like FHR Model 101 | Rapid Ratings Help Center or scanned the FHR Report and seen Section 2: FHR History and Performance Category Analysis, you'll know that the 68 ratios we use to produce the FHR are divided into different categories. In this document, we'll take you through the details of the divisions.

Background: Why 68 ratios and how are they applied?

Conventional approaches to modeling financial risk often employ a one-size-fits-all approach, relying on a small number of variables and a single model to understand all companies. We differentiate ourselves by providing many additional perspectives that enable more robust analysis of a company’s operations. This is achieved by applying 68 different financial ratios which address the company’s overall profitability, cost structure, capital structure efficiency, working capital efficiency, leverage, liquidity and earnings performance.

In order to calculate the FHR, we apply a two-fold process which involves dynamically integrating our Core Health model with Resilience Indicators.

  1. The Core Health model assigns proprietary weightings to 62 efficiency ratios according to one of our 24 unique industry models. The weightings, in turn, result from exhaustive and continuing analysis of our proprietary database. The sum of these weightings becomes the rated company’s Core Health Score (zero = worst to 100 = best)

  2. Next, we incorporate 11 Resilience Indicators (5 existing and 6 additional ratios) which measure a company’s leverage, liquidity and earnings performance. They interact dynamically with the Core Health Score to indicate lower or higher short‐term risk

  3. This final step results in an overarching risk score known as the Financial Health Rating (zero = worst to 100 = best)

Note: We use a different set of inputs for banks, insurance firms, and financial diversified firms because these firms have unique financial line items in their reports, but we follow the same modeling framework.

Step 1: Performance Category Scores

Each of the 62 weighted efficiency ratios underlying the Core Health Score are allocated into one of four performance categories: Operating Profitability, Net Profitability, Cost Structure Efficiency, and Capital Structure Efficiency. Each performance category is assigned a score between zero and 100 (zero = worst to 100 = best).

Operating Profitability: provides an upstream scan of the efficiency in generating profitability

  1. Operating Profit / Capital Employed

  2. Operating Profit / Shareholder Equity

  3. Operating Profit / Total Revenue

  4. Operating Profit / Total Assets

  5. Operating Profit Before Depreciation / Capital Employed

  6. Operating Profit Before Depreciation / Total Revenue

  7. Operating Profit Before Depreciation / Total Assets

  8. Operating Profit Before Depreciation / Shareholder Equity

  9. Gross Profit / Capital Employed

  10. Gross Profit / Total Revenue

  11. Gross Profit / Total Assets

Net Profitability: provides a downstream scan of the efficiency in generating profitability

  1. Operating Profit After Tax / Capital Employed

  2. Operating Profit After Tax / Shareholder Equity

  3. Operating Profit After Tax / Total Revenue

  4. Operating Profit After Tax / Total Assets

  5. Net Profit After Tax / Capital Employed

  6. Net Profit After Tax / Shareholder Equity

  7. Net Profit After Tax / Total Revenue

  8. Net Profit After Tax / Total Assets

  9. Net Profit Before Tax / Capital Employed

  10. Net Profit Before Tax / Shareholder Equity

  11. Net Profit Before Tax / Total Revenue

  12. Net Profit Before Tax / Total Assets

Cost Structure Efficiency: is based on a number of ratios incorporating variables such as cost of goods sold, staff costs, other operating expenditures, depreciation, interest expense, and corporate income tax relative to a base such as total revenue and total expenditures

  1. Cost of Goods Sold / Total Revenue

  2. Cost of Goods Sold / Total Cash Operating Expenditure

  3. Depreciation / Total Revenue

  4. Depreciation / Total Cash Operating Expenditure

  5. Interest Expense / Total Revenue

  6. Interest Expense / Total Cash Operating Expenditure

  7. Interest Expense / Staff Costs

  8. Other Operating Expense / Total Revenue

  9. Other Operating Expense / Total Cash Operating Expenditure

  10. Staff Costs / Total Revenue

  11. Staff Costs / Total Cash Operating Expenditure

  12. Tax Expense / Total Revenue

  13. Tax Expense / Total Cash Operating Expenditure

  14. Operating Profit / Interest Expense

  15. Interest Expense / Total Liabilities

  16. Total Revenue / Inventories

  17. Total Revenue / Staff Costs

  18. Operating Profit after Tax / Interest Expense

Capital Structure Efficiency: examines the main elements of the capital structure (current liabilities, term liabilities, total liabilities, equity, current assets and total assets) relative to various bases such as capital employed, operating revenue, total liabilities and total assets

  1. Term Liabilities / Capital Employed

  2. Total Liabilities / Total Revenue

  3. Shareholder Equity / Total Assets

  4. Total Liabilities / Total Assets

  5. Current Assets / Total Assets

  6. Current Assets / Total Liabilities

  7. Current Liabilities / Total Assets

  8. Current Liabilities / Total Liabilities

  9. Total Revenue / Capital Employed

  10. Total Revenue / Shareholder Equity

  11. Total Revenue / Total Assets

Other Ratios: Additional ratios which contribute to the overall FHR but are not allocated to a specific Performance Score

  1. Current Assets / Current Liabilities

  2. Quick Assets / Capital Employed

  3. Quick Assets / Current Assets

  4. Quick Assets / Current Liabilities

  5. Quick Assets / Total Assets

  6. Quick Assets / Total Revenue

  7. Working Capital / Capital Employed

  8. Working Capital / Total Revenue

  9. Working Capital / Total Assets

  10. Total Revenue / Working Capital

Step 2: Resilience Ratios

The 11 resilience ratios are designed to fine‐tune the Core Health model and sharpen our estimates of the probability of default. Of those 11 ratios, 5 ratios are already in the Core Health model and an additional 6 resilience ratios bring the total number of tested ratios to 68.

Leverage: is a solvency metric that depicts the extent to which a firm’s assets are dependent on debt as compared to equity

  1. Total Debt / Total Assets

Liquidity: measures the ability of the firm to survive any short‐term crises that drain its asset reserves

  1. Cash / Current Liabilities

  2. Cash From Operations / Current Liabilities

  3. Working Capital / Total Assets

Earnings Performance: is focused on profitability characteristics with respect to meeting internal and external obligations

  1. Cash From Operations / Current Debt Service

  2. Operating Profit / Current Debt Service

  3. Operating Profit / Interest Expense

  4. Operating Profit / Total Assets

  5. Net Profit / Total Assets

  6. Cost of Goods Sold / Sales

  7. Retained Earnings / Total Assets

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