FAR JY 1/27/16

Question 1

Categories of Ratios

Answer 1

Liquidity/Solvency
Operational
Profitability
Equity

Question 2

Liquidity/Solvency Ratios

@Working Capital

Answer 2

CA - CL

Question 3

Liquidity/Solvency Ratios

@Current Ratio (CR)

Answer 3

CA / CL

States working capital (WC) in a ratio form.
If WC is +, then the CR > 1

Question 4

Liquidity/Solvency Ratios

Acid or Quick Ratio

Answer 4

(Cash + AR + Marketable Securities) / CL

Uses the most “liquid” assets to measure the ability to meet maturing obligations

Will always be less than the current ratio because the numerator excludes CA like inventory.

Exam: be careful to account any “Allowance for uncollectible accounts”

Question 5

Liquidity/Solvency Ratios

Times Interest Earned

Answer 5

(NI + Interest Expense + Income Tax Exp) / Interest Expense

Measures the ability of current earnings to cover interest costs for the period

Ex: (1000 + 50 + 300) / 50 = 27 times.

Question 6

Operational Ratios

@Accounts Receivable (AR) turnover

Answer 6

Net credit sales / Average AR
Ex) 1000 / {(80+90)/2}=11.76

Number of days in AR = 365/AR turnover
Ex: 365/11.76 = 31 days

Measures the average number of days required to collect receivables

Question 7

Operational Ratios

@Inventory turnover

Answer 7

Cost of Good Sold / Average Inventory
ex) 800 / {(75+85)/2} = 10

Number of days in Inventory = 365 / Inventory turnover
ex) 365/10=36.5 days

Measures the average number of days inventory is sold or used

• Beg Inv + Purchase = End Inv + COGS

*Ending inventory calculation:
Ending Inventory = Beg Inv. + Purchase - COGS

Question 8

Operating cycle

Answer 8

The operating cycle is the total period of time from the purchase of inventory, to sale, and then finally to the collection of cash from receivables.

Number of days’ sales in inventory + number of days’ sales in receivables