Chapter 4 Flashcards
Liquidity Ratios
Give an idea of a firm’s ability to pay off debts that are maturing within a year
Asset Management Ratios
Give an idea of how efficiently a firm is using its assets
Debt Management Ratios
Give an idea of how the firm has financed its assets as well as the firm’s ability to repay long term debts
Profitability Ratios
Give an idea of how profitably the firm is operating and utilizing its assets
Market Value Ratios
Give an idea of what investors think about the firm and its future prospects
Current Ratio
Indicates the extent to which current liabilities are covered by those assets expected to be converted to cash in the near future
If a firm is in trouble, it pays liabilities off more slowly and begins to borrow more money. This increases liabilities and the current ratio will fall.
High current ratio could be good, but could also indicate that the firm has too much old inventory. In which case the assets are not being managed efficiently.
Quick Ratio
Measures a firms ability to pay off short-term obligations without relying on the sale of inventories
Inventory Turnover Ratio
Indicates how many times inventory is turned over during the year
Excess inventory is unproductive and represents a low rate of return
Days Sales Outstanding Ratio (DSO)
Indicates the average length of time the firm must wait after making a sale before it receives cash
Higher than average suggests customers are not paying bills on time. This makes it hard for the company to pay off debts and make more investments. They are not collecting their revenue.
Fixed Assets Turnover Ratio
Measures how effectively the firm uses its plant and equipment
Total Assets Turnover Ratio
Measures how effectively the firm uses its total assets
If it is low, inventories should be reduced and receivables should be collected faster, which could help improve operations
Total Debt to Total Capital Ratio
Measures the percentage of the firm’s capital provided by debtholders
Creditors prefer low debt ratios because the lower the ratio, the greater cushion against creditors losses in the event of liquidation
Creditors are more reluctant to lend a firm money if the firm is at a high risk of going bankrupt
Times Earned Interest (TIE) Ratio
A measure of the firm’s ability to meet its annual payments
It is the extent to which operating income can decline before the firm is unable to meet its annual interest costs
Operating Margin
Measures operating income
Profit Margin
Measures net income per dollar of sales
If a firm has more debt, it will have higher interest charges which will pull down the net income, resulting in a lower profit margin
If a firm sets a high price on its products, it may earn a high return but might not make many sales. Be concerned about turnover.
