chapter 19 Flashcards
horizontal analysis
- analysis of the change from year to year in individual statement items
vertical analysis
- involves restating the dollar amount of each item reported on an individual financial statement as a percentage
ratio analysis
- dividing the dollar amount of one item reported in the financial statement by the dollar amount of another item reported.
- purpose is to express a relationship between two relevant items
Liquidity
how quickly a business can convert its to cash and whether a business has sufficient assets to cover its liabilities (current assets)
- current ratio
- quick ratio
- receivables turnover
- average collection period
- inventory ratio
• Current ratio
ability of a firm to pay off its short term debts in 12 months or less hence its current liabilities
o if current ratio is 1.1 then ir represents that the firm has $1.10 worth of current assets to cover each $1 of current liabilities
o if the current ratio is less than 1 or less than 100% then the firm will struggle to pay off its long term debts
o if the current ratio is between 1 and 2 then the firm should be able to cover its short term debts
o if the ratio is greater than 2 than the firm will easily be able to pay its short term debts or the firm is not efficiently utilizing its assets
• Quick ratio
o Is the ability to pay back its short term debt using its more liquid current assets like deposits
o if it is 1.1 then it has $1.10 of highly liquid assets to cover current liabilities
o nech mark is 0.9 so in an emergency the firm will be unable to pay back its liabilities with its most liquid assets vice versa
• Receivables turnover
o How many times the firm is payed by its creditors and measures the effectiveness of credit collection procedures by the firm
o Hence prevent possible bad debts
• Average Collection Period
o The average number of days it take for receivable to be payed
o Most firms give discount in 10 days and pay with 30 days
o If over 30 days the business has inefficient collection procedures and accounts receivables will be delayed
• Inventory ratio
o Represents how liquid inventory is over a period of time
o Hence how many times inventory is sold over the period
Financial stability/ Gearing/ Leverage
ability for the firm to operate in the long term hence covering its non current liabilities while having sufficient net working capital to operate in the short term
• A highly geared business basically means the business is heavily reliant on external finances such as longs hence has high interest payments and loan repayments and therefore
- debt ratio
- equity ratio
- capitalisation ratio
- times interest earned
- asset turnover ratio
• Debt Ratio
o Is how reliant on external finances hence high ratio high gearing there for high level of external finances
• Equity Ratio
o Is basically measures of safety to creditors in the event of liquidation,
• Capitalization ratio
o The extent to which assets are financed by equity
o 2 is 50% equity 50% debt
• Times interest earned
o Ability to satisfy periodic borrowings from current profits
• Asset turnover ratio
o Is how efficiently assets are being used to raise revenue
Cash flow return on asset
Ability to make returns on assets in terms of the cash flows from operating activities
Profitability
Used to evaluate the firms financial performance across the accounting period
Return on asset
Rate of return earned by management
