A3 - Financial Ratios

Question 1

what are the key financial ratios in auditing?

Answer 1

1. Liquidity ratios: measures a firm’s short term ability to pay maturing obligations
2. Activity ratios: measures how effectively an entity is using its assets
3. Profitability ratios: measure the financial performance of an entity for a given time period
4. Investor ratios: measures that are of interest of investors
5. Long-term (solvency) debt-paying ability ratios (coverage ratios): measures of security for long-term creditors/investors

Question 2

what are the most common ratios to know?

Answer 2

• Current ratios = Current assets / Current Liabilities
• Quick ratios = (Current assets - inventory - prepaid expenses) / current liabilities
• AR turnover = Sales (net) / Avg. AR (net)
• Inventory turnover = COGS / Avg. Inventory
• Days in sale AR = Ending AR(net) / (Sales(net)/365)
• Days in Inventory = Ending Inventory / (COGS/365)
• Days in Payable Outstanding = Ending AP / (COGS/365)