F2M8 Flashcards
Ratios
Pass key: the numerator has a _______ relationship with the ratio?
direct relationship.
When the numerator increases, the ratio increases
Pass Key: the denominator has a ______ relationship with the ratio?
indirect relationship.
When the denominator increases, the ratio decreases.
Gross Profit Margin
(sales (net) - cost of goods sold) / (sales (net))
important because this is showing the percent of revenue per sale
Profit Margin
net income/ sales (net)
showing the percent of income generated per sale
Return on sales
(income before interest income, interest expense, and taxes) / sales (net)
Return on assets (ROA)
net income / average total assets
showing the amount of income generated for the assets that it owns
Dupont Return on Assets
(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.
Return on Equity
(net income-preferred dividends)/average total equity
shows the income generated for the amount of equity in the company
Operating cash flow ratio
cash flow from operations/ current liabilities
indicates the companies health as to show the cash they generate per their debt
Current ratio
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.
Quick ratio
(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
Accounts Receivable Turnover
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.
Days Sales in Accounts Receivable
Ending accounts receivable (net)/ (sales (net)/ 365)
shows how many days on average it takes to collect receivables
Inventory Turnover
cost of goods sold/ average inventory
indicates how quickly inventory is sold. in general, the higher the ratio, the better the performance
Days in inventory
ending inventory/ (cost of goods sold/365)
indicates the number of days on average it takes to sell inventory
Accounts Payable turnover
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.
Days of payables outstanding
Ending accounts payable / (cost of goods sold/365)
Indicates how many days it took to pay suppliers
Cash Conversion Cycle
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.
Debt-to-equity
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.
Total debt ratio
total liabilities / total assets
Indicates the amount of assets they have that are financed by creditors
Equity Multiplier
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.
Times Interest Earned
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.
EBITDA Earnings Before Interest, taxes, depreciation, and amortization:
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
Earnings per share
Income available to common shareholders / weighted average common shares outstanding
Shows how much money a company makes for each share of its common stock
Price-to-earnings ratio
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
Dividend Payout
Cash dividends / net income
How the portion of current earnings being paid out in dividends
Asset Turnover
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
Horizontal analysis
measures dollar and percentage change over a period of time. helps identify material changes over time.
Vertical Analysis
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.
Contribution Margin
Revenue (or sales) - all variable costs
Variance Analysis: Actual vs Flexible vs. Budget
- 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
Pass key: turnover ratios
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.
If inventory is sold at cost, how is Net profit margin impacted?
net income does not change but net sales increases. so the overall ratio decreases.
When calculating the quick ratio, what do you do if allowance for uncollectible accounts is listed?
Subtract it from accounts receivable balance and use the net amount in numerator of the equation
When calculating Accounts Receivable Turnover, what do you do when allowance for doubtful accounts is listed?
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