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
