Auditing Financial Ratios Flashcards
Liquidity Ratios
Liquidity ratios are measures of a firm’s S-T ability to pay maturing obiligations
Activity ratios
Activity ratios are measures of how effectively an enterprise is using its assets.
Profitability Ratios
Profitability ratios measure the financial performance of an enterprise for a given period of time period.
Investor Ratios
Investor ratios are measures that are of interest to investors.
Long-Term Debt-Paying Ability Ratio
(Coverage ratios) Coverage ratios are measuring of securities for L-T creditors/investors
7 Limitations of Ratios
- There are few industry benchmarks for comparison
- Dissimilar business units may make analysis difficult
- Inflation can reduce comparability of balance sheet items
- Manipulation of ratios by management can occur
- The choice of different GAAP can affect ratios and reduce comparability.
- Generalizations are difficult to make
- Ratios may use accounting data (e.g. fixed assets) that do not reflect FV
Work capital ratio
Current Assets - Current Liabilities
Current Ratio (Working Capital Ratio)
Current Assets / Current Liabilities
The higher the ratio indicates company ability to meet is short-term obligations, has improved.
Acid-Test Ratio
Cash Equivalents + Marketable Securities + AR
/
Current Liabilities
The higher the ratio the better because this indicates that company is meeting ST needs.
Cash Ratio
Cash equivalents + Marketable Securities
/
Current Liabilities
Account Receivable Turnover
Net Credit Sales
/
Average net receivables
This ratio indicates the receivables’ quality and indicates the success of the firm in collecting outstanding receivables. Faster turnover gives creditability to the current and acid-test ratios.
AR Turnover in days
Average net receivable / Net Credit sales 365
= 365 days / Receivable Turnover
This ratio indicates the average number of days required to collect AR.
Inventory Turnover
COGS / Average Inventory
This measures of how quickly inventory is sold is an indicator of enterprise performance. The higher the turnover, in general, the better the performance.
Inventory Turnover in Days
= Average Inventory / (COGS / 365)
= 365 days / Inventory T/O
Operating Cycle
= AR Turnover in days + Inventory turnover in days
The operating cycle indicates the number of days between the acquisition of inventory and realization of cash from selling the inventory.
Working Capital Turnover
Sales / Average Working Capital
This Ratio indicates how effectively working capital is used.
Total Asset Turnover
Net Sales / Average total Assets
This ratio is in indicator of how company makes use of its assets. A high ratio indicates effective asset use to generate saels.
AP Turnover
COGS / Average AP
This ratio indicates the number of times trade payables turn over during the year. A low turnover may indicate a delay in payment, such as from shortage of cash.
Days in AP
Average AP / (COGS / 365)
This ratio indicates the average length of time trade payables are outstanding before they are paid.
Net Profit Margin
Net Income / Net Sales
This ratio indicates profit rates and when used with the asset turnover ratio, indicates rate of return on assets.
Return on Total Assets
Net Income / Average Total Assets
Return on Assets
Net Profit Margin x Total Asset Turnover
Return on Investments
((Net Income + Interest Expense) (1-Tax Rate))
/
Average (Long-Term Liabilities + Equity)
ROI measures the performance of the firm without regard to the method of financing.
Return on Common Equity
Net Income - Preferred Dividends
/
Average Common Equity
This ratio uses net income less preferred dividends in the numerator to better measure returns accruing to common shareholders.
Net Operating Margin Percentage
Net Operating Income
/
Net Sales
Gross (Profit) Margin Percentage
Gross (Profit) Margin
/
Net Sales
Operating Cash Flow Per Share
Operating Cash Flow
/
Common Shares Outstanding
Degree of Financial Leverage
Earnings before interest and taxes / Earnings before taxes
The degree of financial leverage is the factor by which net income will change with a change in earnings before interest and taxes. The degree of financial leverage indicates the leverage factor for recurring earnings.
Earnings Per Share
Net Income - Preferred Dividends
/
Weighted Average Number of Common Shares Outstanding
Price / Earning Ratio
Market Price per share
/
Diluted EPS
Dividend Payout Ratio
Dividends per common share
/
Diluted EPS
Dividend Yield
Dividends per Common Share
/
Market Price per common share
Book Value per share
Total stockholder equity - preferred stock
/
Number of common shares outstanding
Debt Ratio
Total Liabilities
/
Total Assets
This debt ratio indicates that more than half of the assets are financed by credits.
Debt / Equity
Total Liabilities / Common Stockholders’ Equity
This ratio indicates the degree of protection to creditors in case of insolvency. The lower this ratio the better company’s position. If Ratio is very high, indicates that a majority of funds come from creditors.
Times Interest earned
Earnings before taxes and interst
/
Interest
This ratio reflects the ability of a company to cover interest charges. It uses income before interest and taxes to reflect the amount of income available to cover interest expense.
Operating Cash Flow / Total Debt
Operating Cash Flow / Total Debt
This ratio indicates the ability of the company to cover total debt with yearly cash flow.
