accounting Made Simple 09

Question 1

1. Of the FINANCIAL LEVERAGE RATIOS, what is the DEBT RATIO?

Answer 1

( liabilities / assets ).

It shows what portion of a company’s assets has been financed with debt.

Question 2

2. Which ratio is used to show the ratio of financing via debt to financing via capital from investors?

Answer 2

DEBT TO EQUITY RATIO;

liabilities / owner’s equity

Question 3

3. What is one benefit of FINANCIAL LEVERAGE?

Answer 3

The more highly leveraged a company is, the greatest its return on equity will be for a given amount of net income.

Question 4

4. EXAMPLE: ABC Construction has 100k assets, 100k liabilities, and net income for the year is 15k, for a RETURN ON EQUITY of 15%.
   If they had 50k in assets and 150k in liabilities, ROI would be:

Answer 4

30% ( 15k / 50k ), thereby offering the company’s owners twice as great a return on their money.

Question 5

5. Therefore, when a company’s DEBT TO EQUITY RATIO increases, the company’s ROI:

Answer 5

INCREASES as well, even though NET INCOME REMAINS THE SAME.

Question 6

6. What is the purpose of the ASSET TURNOVER RATIOS?

Answer 6

They seek to show how efficiently a company uses its assets.

Question 7

7. What is the INVENTORY TURNOVER RATIO?

Answer 7

( COGS / Average Inventory )

It shows how many times a company’s inventory is sold and replaced over the course of a period.

Question 8

8. How is the ‘AVERAGE INVENTORY’ part of the INVENTORY TURNOVER RATIO calculated?

Answer 8

[ ( beginning inventory + ending inventory ) / 2 ]

Question 9

9. Explain the INVENTORY PERIOD RATIO.

Answer 9

( 365 / inventory turnover ).

A higher INVENTORY TURNOVER ( and thus a lower inventory period ) shows that the company’s inventory is selling quickly and is indicative that management is doing a good job of stocking products that are in demand.