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Question 1

Pass key: the numerator has a _______ relationship with the ratio?

Answer 1

direct relationship.

When the numerator increases, the ratio increases

Question 2

Pass Key: the denominator has a ______ relationship with the ratio?

Answer 2

indirect relationship.

When the denominator increases, the ratio decreases.

Question 3

Gross Profit Margin

Answer 3

(sales (net) - cost of goods sold) / (sales (net))

important because this is showing the percent of revenue per sale

Question 4

Profit Margin

Answer 4

net income/ sales (net)

showing the percent of income generated per sale

Question 5

Return on sales

Answer 5

(income before interest income, interest expense, and taxes) / sales (net)

Question 6

Return on assets (ROA)

Answer 6

net income / average total assets

showing the amount of income generated for the assets that it owns

Question 7

Dupont Return on Assets

Answer 7

(Net income / sales (net))* (sales (net)/average total assets)

more precise than ROA, as it takes into account the income change per sale and the sales per asset.

Question 8

Return on Equity

Answer 8

(net income-preferred dividends)/average total equity

shows the income generated for the amount of equity in the company

Question 9

Operating cash flow ratio

Answer 9

cash flow from operations/ current liabilities

indicates the companies health as to show the cash they generate per their debt

Question 10

Current ratio

Answer 10

current assets/current liabilities

shows the companies ability to meet their short term obligations. if it is below industry average it means they would have a harder time meeting short term obligations.

Question 11

Quick ratio

Answer 11

(cash equivalents + short term marketable securities + receivable (net))/ current liabilities

current assets not included in the numerator are inventory and prepaid expenses because its the assets that could be used “quick” to pay off debt if need be. if it is below industry average, means they would have a hard time meeting short term obligations

Question 12

Accounts Receivable Turnover

Answer 12

Sales (net) / average accounts receivable (net)

represents how well the firm is at collecting outstanding receivables. so if the answer was 1.75 times, that means for every 1.75 sales, they were collecting money owed to them. Faster turnover gives credibility to the current and acid-test ratios.

Question 13

Days Sales in Accounts Receivable

Answer 13

Ending accounts receivable (net)/ (sales (net)/ 365)

shows how many days on average it takes to collect receivables

Question 14

Inventory Turnover

Answer 14

cost of goods sold/ average inventory

indicates how quickly inventory is sold. in general, the higher the ratio, the better the performance

Question 15

Days in inventory

Answer 15

ending inventory/ (cost of goods sold/365)

indicates the number of days on average it takes to sell inventory

Question 16

Accounts Payable turnover

Answer 16

cost of goods sold/ average accounts payable

Indicates how long it took for the company to pay its suppliers. A low number may indicate a delay in payment potentially from a shortage of cash. Indicates that cash coming (because something was sold so generate cost of goods sold) and then if they are paying off payables with that.

Question 17

Days of payables outstanding

Answer 17

Ending accounts payable / (cost of goods sold/365)

Indicates how many days it took to pay suppliers

Question 18

Cash Conversion Cycle

Answer 18

Days sales in accounts receivable + days in inventory – days of payables outstanding

Shows the average length of time it takes from when the company pays cash for an inventory purchase to when the company receives cash from a sale.

Question 19

Debt-to-equity

Answer 19

total liabilities / total equity

Indicates the how protected the company is against its debts (in case of insolvency). The lower the number the better because it shows you have more equity to support your debt.

Question 20

Total debt ratio

Answer 20

total liabilities / total assets

Indicates the amount of assets they have that are financed by creditors

Question 21

Equity Multiplier

Answer 21

total assets/ total equity

Because Assets = liabilities + equity, this ratio shows how much of the assets are supported by equity. When the ratio is higher that means more debt is used to support the assets than equity.

Question 22

Times Interest Earned

Answer 22

Income before interest expense and taxes / interest expense) or could be (earnings before interest and taxes/ interest expense)

Indicates the amount of times income could be used to cover the companies interest charges.

Question 23

EBITDA Earnings Before Interest, taxes, depreciation, and amortization:

Answer 23

Top down approach: Sales – cost of goods sold – operating expenses (excluding depreciation and amortization)

Bottom-up approach: Net income + Income tax expense + interest expenses + Depreciation and amortization

Question 24

Earnings per share

Answer 24

Income available to common shareholders / weighted average common shares outstanding

Shows how much money a company makes for each share of its common stock

Question 25

Price-to-earnings ratio

Answer 25

price per share / basic earnings per share

Shows the price of stock relative to its earnings

A rise in this ratio indicates that investors are pleased with the firms opportunity for growth

Question 26

Dividend Payout

Answer 26

Cash dividends / net income

How the portion of current earnings being paid out in dividends

Question 27

Asset Turnover

Answer 27

Sales (net) / Average total assets

Shows how a company makes effective use of its assets. A high ratio indicates effective use of assets to generate sales

Question 28

Horizontal analysis

Answer 28

measures dollar and percentage change over a period of time. helps identify material changes over time.

Question 29

Vertical Analysis

Answer 29

helpful to express statement items in a common size, such as percentages of a common number. Assists in period to period comparisons, but can also allow for comparability among other entities as the statement is in a common size format.

Question 30

Contribution Margin

Answer 30

Revenue (or sales) - all variable costs

Question 31

Variance Analysis: Actual vs Flexible vs. Budget

Answer 31

• Actual results @ actual: uses actual input units at their actual prices
• Flexible budget variances: difference between actual results @ actual and Flexible budget @ actual (planned cost)
• Flexible budget @ actual (planned cost): uses actual input units at their budgeted prices
• Sales activity (volume) variances: difference between the flexible budget @ actual and the master budget
• Master budget: uses budgeted input units at their budgeted prices/
• Total master budget variances: difference between actual results @ actual and master budget

Question 32

Pass key: turnover ratios

Answer 32

Turnover ratios generally user average balances for balance sheet components. However, on some recent CPA questions people have been instructed to use year-end balances instead so read carefully.

Question 33

If inventory is sold at cost, how is Net profit margin impacted?

Answer 33

net income does not change but net sales increases. so the overall ratio decreases.

Question 34

When calculating the quick ratio, what do you do if allowance for uncollectible accounts is listed?

Answer 34

Subtract it from accounts receivable balance and use the net amount in numerator of the equation

Question 35

When calculating Accounts Receivable Turnover, what do you do when allowance for doubtful accounts is listed?

Answer 35

When calculating average accounts receivable:
Step 1: for each year take accounts receivable and subtract the allowance for doubtful accounts value
step 2: take the new AR net values and add them together, then divide by 2 for the average.
step 3: divide the current year sales (net) by the value found in step 2