FAR 1F - Ratios Flashcards
What is the Reserve for Bond Retirement, and how does it affect Return on Equity (ROE)?
📊 Reserve for Bond Retirement is an equity account
🔹 It should be included when calculating ROE
🔹 ROE Formula: Net Income / Average Shareholders’ Equity
What does “Open Account” mean in finance?
💳 Products/services are offered on credit
📊 Examples:
🔹 Credit Sales – Revenue before cash received
🔹 Credit Purchases – Expense before payment
What is another name for the Acid-Test Ratio?
🔄 Acid-Test Ratio = Quick Ratio
🔹 Measures liquidity without relying on inventory sales
🔹 Formula: Quick Ratio = (Cash + Marketable Securities + A/R) / Current Liabilities
How do you calculate Invested Capital?
💰 Invested Capital = Total Assets - Current Liabilities
🔹 Represents long-term capital used to generate returns
What is Economic Value Added (EVA), and what does it measure?
📈 EVA = Earnings above the required cost of capital
🔹 If ROR > Cost of Capital → Value is created
🔹 If ROR < Cost of Capital → Value is destroyed
🔹 Formula: Net Operating Profit After Taxes - (Invested Capital × WACC)
What are the economic factors of production costs?
🏭 Production Costs = Rent + Wages + Interest
❌ Not Depreciation (Depreciation is an accounting cost, not an economic cost)
What are Certainty Equivalent Adjustments?
🎲 Risk analysis technique based on utility theory
🔹 Measures how much a certain sum is worth to an investor
🔹 Helps compare certain vs. risky income
How should you treat periods in financial calculations?
📆 Pay attention to whether figures are monthly, quarterly, or annual
🔹 Annualize figures when needed
🔹 Example: If a company reports quarterly revenue, multiply by 4 to get annual revenue
What is a useful trick for remembering Turnover Ratios?
🔄 Turnover Ratio Hack
🔹 Something is OVER the turnover metric you are solving for
🔹 Example: Inventory Turnover = COGS / Average Inventory
What is a useful trick for remembering “Days” Formulas?
📆 Use the number of days in a period OVER the turnover ratio
🔹 Example: Days Sales in Inventory = 365 / Inventory Turnover
What is a useful trick for remembering Ratio Formulas?
📊 Ratio Formula Hack
🔹 Something is UNDER the ratio metric you are solving for
🔹 Example: Current Ratio = Current Assets / Current Liabilities
What is the DuPont Equation for ROE?
📈 ROE Formula (DuPont Method)
Breaks ROE into Profitability, Efficiency, and Leverage
ROE = (Net Income / Net Sales) × (Net Sales / Average Assets) × (Average Assets / Average Equity)
What is the difference between Accounting Profit and Economic Profit?
📊 Accounting Profit > Economic Profit
🔹 Accounting Profit: Net Income (doesn’t account for capital cost)
🔹 Economic Profit: Net Income - Cost of Capital
How does market price affect ratios?
📈 Look at metrics that include market prices
🔹 Example: Price/Earnings (P/E) Ratio, Market-to-Book Ratio
What is a Flexible Budget?
📉 Variance analysis tool that adjusts for actual production levels
🔹 Compares actual vs. estimated costs
What is a Continuous Budget?
📆 Budget that is updated and revised constantly
🔹 Rolling forecast over fiscal periods
What is Life-Cycle Budgeting?
🔄 Budgeting over a product’s entire life cycle
🔹 Includes R&D, production, and marketing
What is the Operating Budget?
📆 Blueprint for operations within a specific time frame
🔹 Helps with planning, coordination, motivation, and control
How do you calculate the Required Rate of Return (RRR)?
📊 RRR = Risk-Free Rate + Beta × (Market Rate - Risk-Free Rate)
🔹 Determines expected return based on risk
What is the Defensive Interval Ratio?
🛡️ Liquidity ratio that shows how long a company can pay expenses using liquid assets
🔹 Formula: Defensive Interval = (Cash + Marketable Securities + Receivables) / Daily Operating Expenses
What are Installment Sales?
💳 Sales where the buyer pays in multiple payments over time
🔹 Recognized under the installment method
Questions for Ratios
Liquidity Ratios 🏦 (Can we pay short-term obligations?)
Solvency Ratios 💰 (Can we survive long-term?)
Profitability Ratios 📈 (Are we making enough money?)
Efficiency Ratios 🔄 (How well are we using resources?)
How are formulas related to financial statements?
Balance Sheet → Liquidity & Solvency Ratios
Income Statement → Profitability Ratios
Cash Flow Statement → Operational Efficiency Ratios
What is a certainty equivalent adjustment in risk analysis?
✅ A technique based on utility theory
✅ It finds the amount of certain money an investor considers equally valuable as a risky payoff
✅ Helps measure risk aversion: More risk-averse → lower certainty equivalent 💵⚖️🎲
How does the certainty equivalent relate to risk and utility?
✅ For risk-averse investors:
Certainty Equivalent < Expected Value of the gamble
✅ Used to determine:
– Maximum one is willing to pay for a risky investment
– Minimum premium to insure against a risk 💰🛡️📉
