Analytical Procedures

Question 1

What do liquidity ratios measure?

Answer 1

Liquidity ratios measure an entity’s short-term ability to meet its obligations.

Question 2

What is the definition of working capital?

Answer 2

Working Capital = Current Assets - Current Liabilities

Question 3

What is the current ratio?

Answer 3

Current Assets / Current Liabilities

Question 4

What is the quick or acid-test ratio?

Answer 4

Current Assets (Cash + Marketable Securities + AR) / Current Liabilities

Question 5

What is the current cash to debt ratio?

Answer 5

Net cash from operations / Average current liabilities

Question 6

What do activity or efficiency ratios measure?

Answer 6

These ratios measure an entity’s effectiveness in putting their assets to use.

Question 7

What is the asset turnover ratio?

Answer 7

Net sales / Average total assets

Question 8

What is the receivable turnover ratio?

Answer 8

Net (credit) sales / Average (net) trade receivables

Question 9

What is the number of days sales in receivables?

Answer 9

365 days / Receivable turnover

Question 10

What is the inventory turnover ratio?

Answer 10

Cost of goods sold / Average inventory

Question 11

What is number of days sales in inventory?

Answer 11

365 days / Inventory turnover ratio

Question 12

What do profitability ratios measure?

Answer 12

Profitability ratios measure an entity’s operating success or failure for a period of time.

Question 13

How is profit margin on sales calculated?

Answer 13

Net income / Net sales

Question 14

How is the gross profit percentage calculated?

Answer 14

(Sales - Cost of goods sold) / Sales

Question 15

How is the rate of return on assets (ROA) calculated?

Answer 15

Net income / Average total assets

Question 16

How is the rate of return on common stockholders’ equity (ROE) calculated?

Answer 16

(Net income - Dividends to preferred shareholders) / Average common stockholders’ equity

Question 17

How is earnings per share (EPS) calculated?

Answer 17

(Net income - preferred dividends) / average number of common shares outstanding

Question 18

How is the price - earnings (P-E ratio) calculated?

Answer 18

Market price of stock / Earnings per share

Question 19

What do coverage or leverage ratios measure?

Answer 19

These ratios measure an entity’s ability to meet its obligations over time. In other words, they are measures of long-term risk to creditors and the extent to which the entity has borrowed up to its available capacity.

Question 20

What is the debt to total assets ratio?

Answer 20

Total liabilities / Total assets

Question 21

What is the debt to equity ratio?

Answer 21

Total liabilities / Total stockholders’ equity

Question 22

What is the times interest earned ratio?

Answer 22

Income before interest expense and income taxes / interest expense

Question 23

What is the cash to debt coverage ratio?

Answer 23

Net cash from operations / Average total liabilities

Question 24

How is earnings per share increased?

Answer 24

Journal entries with a net effect of increasing earnings or decreasing outstanding shares increases the ratio.

Question 25

How is days sales in accounts receivable decreased?

Answer 25

An increase in sales increases the accounts receivable turnover, but decreases the days sales in accounts receivable. An increase in accounts receivable decreases the accounts receivable turnover, but increases the days sales in accounts receivable. Equal changes in sales and accounts receivable decrease the accounts receivable turnover and increase the days sales in accounts receivable.

Question 26

When does gross profit increase?

Answer 26

Gross profit increases when the net change in sales minus cost of goods sold is positive.