chap 7 common financial ratios

Question 1

what are the 2 ratios creditors and investors use to assess a company ability to pay its long term debt

Answer 1

debt to equity= total liabilities/total equity, shows extent of the use of debt in financing a company times interest earned= operating income/interest expense, shows if you can make your interest payments from cash flow from operations

Question 2

a company ability to generate cash for payment of obligatiions, expansion, and dividends is heavily dependent on _____

Answer 2

profitability

Question 3

general financial analysis using general ratios may be effective for identifying what?

Answer 3

possible problem areas where the auditro may do additional analysis and audit testing or buesiness problem areas where they can provide assistance

Question 4

companies need a reasonable level of liquidity to pay their debts as they come due (current liabilities). what are the 3 rastios that measure liquidity?

Answer 4

cash ratio quick ratio current ratio

Question 5

what is the quick ratios?

Answer 5

cash+marketable securities+ net accounts receivable/current liabilities

Question 6

the most important comparisons to use when using general financial ratios are what?

Answer 6

comparisons to previous years for the company, comparisons to industry averages comparisons to similar companies for the same year

Question 7

what is the most widely used profitability ratio

Answer 7

EPS= net income/average commom shares outstanding

Question 8

what are the liquidity activity ratios?

Answer 8

account recievable turnover= net sales/average gross recievables days to collect receivables= 365/A/R turnover inventory turnover= COGS/average inventory days to sell inventyory = 365/inventory turnover

Question 9

how do auditors use the inventory turnover ratio?

Answer 9

to identify potential inventory obsolescence

Question 10

what is the cash ratio?

Answer 10

cash+marketable securities/current liabilities

Question 11

how do auditos use the A/R turnover ratio?

Answer 11

to assess the reasonableness of the allowance for uncollectible accounts

Question 12

if the company doesnt have sufficient cash and cash like items to meet its obligations, the key to its debt paying ability is what?

Answer 12

the time it takes to convert less liquid current assets like inventory and A/R into cash which is measured by liquidity activity ratios

Question 13

how are the use of general financial ratios as an analytical procedure useful? (3)

Answer 13

1. understandind recent events 2. understanding the financial status of the business 3. viewing the statements from the perspective of a user

Question 14

what is the current ratio?

Answer 14

current assets/current liabilities