FAR2 MR8 - Ratio Analysis

Question 1

Liquidity Ratios

Answer 1

Measures short term risk of distress or ability to meet maturing obligations.

BS current Year/BS current year

Question 2

Working Capital

Answer 2

WC = Current Assets - Current Liabilities

Question 3

Current Ratio

Answer 3

CR = Current Assets/Current Liabilities

Question 4

Acid Test (Quick) Ratio

Answer 4

All current assets, except inventory and prepaids. More liquid/conservative.

ATR = ( Cash + Cash Equiv + Mkt Sec + Net Rec)/ Current Liabilities

Question 5

Cash Ratio

Answer 5

All current assets excluding inventory and AR. Most liquid and most conservative.

Cash Ratio = (Cash + Cash Equi + Mkt Sec)/Current Liabilities

Question 6

Activity Turnover Ratios

Answer 6

The greater than the standard the better. Measures the assets are used to generate revenues.

Question 7

AR Turnover

Answer 7

AR Turnover = Net Sales/Average AR

Question 8

AR Turnover in Days

Answer 8

AR Turnover in Days = 365/AR Turnover

*This is good when it is less than or equal to the standard

Question 9

Inventory Turnover

Answer 9

Inventory Turnover = COGS/Average Inventory
*If COG is not given, then:
COGS = Beg Inv + Purch - End Inv

Question 10

Inventory Turnover in Days

Answer 10

Inventory Turnover in Days = 365/Inventory Turnover
*This is good when it is equal to the standard. If too low, selling it too fast, which equates to giving it away. If the number of days is too high, slowing moving.

Question 11

Operating Cycle

Answer 11

OC = AR Turnover in Days + Inventory Turnover in Days

Question 12

Working Capital Turnover

Answer 12

WC Turnover = Sales/ Average Working Capital

*Working Capital = Current Assets - Current Liabilities

Question 13

Total Asset Turnover

Answer 13

Total Asset Turnover = Net Sales/Average Total Assets

*A high ratio indicates effective use of assets to generate sales.

Question 14

Profitability (Return) Ratios

Answer 14

Measures the success/failure of an enterprise over given period of time. Generally, you want these ratios greater than or equal to the standard.

Question 15

Net Profit Margin

Answer 15

NPM = NI/Net sales

Question 16

Return on Total Assets

Answer 16

ROA = NI/Average Total Assets

Question 17

Return on Equity

Answer 17

ROE = NI - Preferred Dividends/Average Common Equity

*This is good when it is greater than or equal to the required rate of return

Question 18

Coverage Ratio

Answer 18

• Measures security or protection for long-term creditors/investors. Long term assessment (capital structure).
• *Generally, the higher the coverage ratio the better.

Question 19

Debt to Equity

Answer 19

D/E = Total Liabilities/Common Stockholders Equity

• The lower the ratio the better the company’s position.
• *The higher the ratio indicates there is more debt, which is riskier

Question 20

Debt to Assets or Debt Ratio

Answer 20

D/A = Total Liabilities/Total Assets

• Shows the % of assets financed by debt
• *The higher the ratio, the riskier

Question 21

Times Interest Earned

Answer 21

Times Interest Earned = EBIT/Interest

• Shows a company’s ability to cover interest charges. Uses income before interest and taxes to reflect the amount available to cover interest expense
• *The higher the better

Question 22

Operating Cash Flow/Total Debt

Answer 22

Operating CF/Total Debt = Operating CF/Total Debt

Question 23

Limitations of Ratios

Answer 23

• Relies on the reliability of the data

- Additional info is needed to evaluate (benchmark)

Question 24

Horizontal Analysis

Answer 24

Evaluates trends and period-to-period change

Question 25

Vertical Analysis

Answer 25

• Elements are expressed as a percentage of a common number (i.e. income as statement elements as a % of sales revenue)
• Assists in period-to-period comparison, but allows for comparability among other entities