26. Financial ratios

Question 1

1. Quick or acid test ratio

Answer 1

Cash, marketable sec, net a/r
Divided by
Current Liab

No inventory, no p/p

Measures immediate st liquidity
If 0.5:1 then. ⬇️CA/⬇️CL= ⬇️quick A

Question 2

Current ratio

Answer 2

Current assets (w inventory)
——————————
Current liability

Measures st debt paying ability

If 1.5:1 Then ⬇️CA/ ⬇️CL = ⬆️ Current ratio

Question 3

Current cash debt coverage ratio

Answer 3

Ave current liabilities

Liquidity

Measures ability to pay off it’s CL in a given yr from it’s ops

Question 4

Working capital

Answer 4

Current A - Current L

Measures co’s solvency

Question 5

5. Receivables turnover - Activity

Answer 5

Ave net trade a/r

A/r - allow d/a

Measures liquidity of receivables

Question 6

Inventory turnover - activity

Answer 6

Ave inventory

📍Gross profit % ⬇️, can lead to ⬆️ IT Ratio.
(not CGS decrease, since this would lead to also ⬇️ITRatio)

Measures liquidity of inventory

Question 7

Asset turnover - activity

Answer 7

Ave Total Assets

Measures how efficiently assets are used to generate sales

Question 8

Receivables, inventory, asset Turnover in days

Average collection period for ar =
Number of days’ sales in ave ar

Answer 8

360/ receiv or inventory or asset turnover

Question 9

9. # of days supply in ave inventory

Or ave days sales in inventory - activity

Answer 9

360/ inventory turnover ratio or

Or ave (end) inv. / ave inv. sold per day

Measures # of days required to sell inventory

Question 10

Average number of days to collect A/R

Or ave collection period for A/R

Answer 10

360/ receivables turnover

Or Ave A/R
——————————-
Net credit sales /360 days

A/R
Inventory

Measures # days required to collect receivables

Question 11

📍Selling inventory on acct will ⬆️Current Ratio

📍Test question

Answer 11

dr a/r 100
Cr sales rev 100
Dr CGS 80
Cr inventory 80

⬆️a/r for sales price will ⬇️inventory for the cost
Assuming sales price is > cost of inventory, CA would ⬆️ as would Current ratio

Question 12

Exercise of stock option will
⬆️ cash
⬆️ S/E
But liability remains the same

Answer 12

Thus debt-to-equity ⬇️ = total debt / SE

Question 13

Operating cycle

Answer 13

[ave days to collect a/r] + [ave days sales inv]
______________________________
2

Question 14

Profit margin on sales (gross margin) - profitability

Answer 14

Net sales

Measures n/i generated by each dollar of sales

Question 15

Rate of ROA - profitability

Answer 15

Ave total assets

Measures profitability of owner’s investment

Question 16

Debt to equity - coverage

Answer 16

Total debt L
————– = ———–
S/E C/S + RE

Shows creditors the corp’s ability to sustain losses

Question 17

Current ratio:

Cash used to pay A/P

• current ratio greater than 1:1
• current ratio less than 1:1

Answer 17

• ⬆️ current ratio

- ⬇️ current ratio

Question 18

1.5:1

.05:1

Answer 18

⬇️

⬆️
⬇️

Question 19

To ⬆️ IT ratio

Cgsold/ ave inv

Answer 19

X cgs decreased
X ar turonver increases
X total assr turn inc
Ok gross profit percentage decreased

For ITO to inc, either cgs increase or ave inv decrease