Chapter 5: Financial Ratios Flashcards
company’s cash position and its ability to pay its bills as the come due
Liquidity
Formula of Current ratio
=current assets / current liabilities
Formula of Quick Ratio
= (current assets –inventory- prepaid expenses) / current liabilities
eliminates inventory as it could be stale, worn or not saleable
Quick ratio
is the ability of a business to pay its long- term obligations
Solvency
indication of long term solvency
Leverage ratios
indicates the amount of capital or resources financed by creditors and the amount provided by owners
Financial Structure
refers to the ability of a business to invest excess available resources or raise needed funds through borrowings without difficulty in times of need
Capacity for Adaptation
LEVERAGE RATIOS
- DEBT RATIO
- EQUITY RATIO
- TIMES INTERES EARNED RATIO
the percentage assets funded by creditors
DEBT RATIO
Formula of Debt Ratio
= total liabilities/ total assets
the percentage of assets funded by the owners
EQUITY RATIO
Formula of Equity Ratio
= total equity/total assets
extend to which a company’s operations cover the interest expense
TIMES INTEREST EARNED RATIO
Formula of Time Interest Earned Ratio
= operating income/interest expense
PROFITABILITY RATIOS
- Gross profit margin
- Operating profit margin
- Net profit margin or return on sales
assess financial health
Gross profit margin
Formula of Gross profit margin
= gross profit/net sales
revenues left after variable/operating costs
Operating profit margin
Formula of Operating profit margin
= operating profit/net sales
over all profitability of the company
Net profit margin or return on sales
Formula of Net profit margin or return on sales
= income each peso of sales generate – net income/net sales
Disadvantages of Financial ratios
- Large firms has different divisions in different industries(industry- average ratios may be difficult)
- Inflation and increasing prices may distort balance
- Seasonal factors affects income statement
- A company may have good and bad ratios making it difficult to tell if a company is weak or strong
Compute ratios
- dividend pay-out
- plowback ratio
cash dividends/net income
pay- out ratio
opposite of pay-out ratio. The portion of income that does not get paid out as dividends. Retention ratio.
plowback ratio
Profitability Ratio
- Return on Sales (ROS) = profit after taxes sales
- Return on Equity (ROE) = profit after taxes owner’s equity
- Return on Assets (ROA) = profit after taxes total assets
- Return on Sales (ROS)
= profit after taxes / sales
- Return on Equity (ROE)
= profit after taxes / owner’s equity
- Return on Assets (ROA)
= profit after taxes / total assets
