3 - Ratios Flashcards
What is used to determine a company’s ability to pay off short term debt obligations?
Liquidity ratios
The higher the liquidity ratio the…
Higher the margin of safety that the company possessed to cover short term debts.
The lower the liquidity ratio the…
less likely they will be able to pay off debts in an emergency.
What is the working capital ratio?
Working Capital Ratio = current assets/ current liabilities
What does a working capital ratio of below 1 mean?
Indicates negative working capital
What does a working capital ratio over 2 mean?
Means the company is not investing excess assets
What is a good WC ratio?
Between 1.2 and 2.0 is sufficient
Quick ratio (acid test) =
Quick ratio = (current assets - inventories)/ current liabilities
What is the difference between the WC ratio and the Quick ratio?
The Quick ratio takes out the inventory you have because it may not be as easy to sell it and turn it into cash.
The higher the quick ratio…
the better the company’s liquidity position is.
Asset turnover ratio
A class of financial metrics and is used to measure the turnover of assets such as inventory and AR.
What is Inventory Turnover Ratio used for?
A ratio showing how many times a company’s inventory is sold and replaced over a period of time.
Asset Turnover ratio =
Inventory Turnover ratio = Sales/Inventory or CGS/Average Inventory
AR Collection Period
Approx. amount of time it takes for a business to received payments owed.
Given in terms of receivables, from its customers and clients.
What is the AR Collection period equation?
ARCP = Average AR/Average Daily Sales
ROA
Return on Assets = Net Profit/Total Assets
Profitability ratios
Used to asses a businesses ability to generate earnings as compared to it’s expenses. Having the same ration compared to previous period is a good sign. Must have background knowledge.
ROE
Return on Equity = Net income/shareholders equity
ROI
Used to calculate a gain from an investment. ROI = gain from investment - cost of investment / cost of investment
ROCE =
Return on capital employed
ROCE
ROCE = EBIT / capital employed (assets - liability)
Debt ratios
Always cheaper to borrow the money then to get someone to invest.
You can have too little debt and too much debt. Maybe you have too much money just sitting around and you should be using it to invest.
debt ratio
Debt ratio = total debt/total assets.
debt equity ratio
debt equity ratio = total liabilities/ total shareholders equity
