Final Chapter 12

Question 1

Profitability Ratios

Answer 1

Focus on net earnnings and how it compares to other amounts reported on the financial statements

Question 2

Profitability Ratios include

Answer 2

1. ROE
2. ROA
3. Gross profit margin
4. Net profit margin
5. Earnings per share
6. Quality of earnings

Question 3

ROE

Answer 3

• net earnings/average se
• how much earnings were generated for every dollar invested by owners
• relate net earnings vs investmend made by owners

Question 4

ROA

Answer 4

• NET EARNINGS/AVERAGE TOTAL ASSETS
• compare net earnings to the total assets used to generate net earnings
• many consider as the best overall measure of a company’s profitability

Question 5

Gross profit margin ratio (gross profit percentage)

Answer 5

=GROSS PROFIT/NET SALES
- reflect gross profit as a percent of sales
- gross profit = net sales - costs of sales

have “ratio%” cent of each dollar of sales remaining to cover other expenses

Question 6

Net profit margin ratio

Answer 6

=NET EARNINGS/NET SALES
- reflects net earnings as a percentage of sales.
- A measure of operating effieciency
- each dollar of sales generated (ratio%) cents in net earnings

there is a trade off between profit margin and sales volume

Question 7

Earnings per share (EPS)

Answer 7

= NET EARNING/AVERAGE NUMBER OF SHARES OUTSTANDING FOR THE PERIOD
- if there are preferred dividends, the amount is substracted from net earnings
- a mesure of return on investment that is based on the number of common shares outstanding
- the single most widely reported financial ratio (required by IFRS)

Managers can significantly alter EPS by selling common shares or repurchasing common shares

Question 8

QUALITY OF EARNINGS

Answer 8

= CASH FLOW FROM OPERATING/NET EARNINGS
- a ratio higher than 1 indicates high-quality earnings because each dollar of earnings is supported by one or more dollars of cash flows

Question 9

Asset turnover ratios

Answer 9

captureing how efficiently a company uses its assets

Question 10

asst turnover ratio includes

Answer 10

1. total asset turnover ratio
2. fixed asset turnover
3. receivables turnover
4. inventory turnover

Question 11

total asset turnover

Answer 11

=NET SALES/AVERAGE TOTAL ASSETS
- how well a company uses its assets to generate revenue
- on average, every dollars of assets generate (ratio) of revenu

Question 12

fixed asset turnover

Answer 12

net sales/average net fixed assets
- ability to generate sales given its investment in fixed assets (PPE)
- For each dollar invested in PPE, right of use assets, the company was able to generate (ratio) dollar in sales revenue

Question 13

receivables turnover ratio

Answer 13

= net credit sales/average net accounts receivable
- how quickly a company collects its accounts receivables
- high ratio -> company collects its account receivables many times during a year
- If credit sales are not reported separetely, use net sales as an approximation

Question 14

average days to collect receivables

Answer 14

days in a year/receivables turnover ratio

Question 15

inventory turnover ratio

Answer 15

= cost of sales/average inventory
- how quickly a company sells its inventory
- an increase in this ratio is usually favorable. However, if the ratio is too high, it may be an indication that sales were lost because desired items were not in stock.

Question 16

average days to sell inventory

Answer 16

= days in a year/inventory turnover ratio
- number of days, on average, it takes a company to sells it inventory

Question 16

Roa profit driver analysis

Answer 16

ROA = NET PROFIT MARGIN X TOTAL ASSET TURNOVER RATIO

Question 16

operating cycle

Answer 16

the time it takes for a company to pay cash to its suppliers, sell goods to its customers, and collect cash from its customers

help them evaluate company’s cash needs and is a good indicator of operating efficiency.

• acquisition of inventory
• the sale of inventory
• collection of cash from customer

Question 17

account payable turnover ratio

Answer 17

= cost of sales/ average account payable

how quick company pay back suppliers

Question 17

Liquidity ratios

Answer 17

measure a company ability to meet its short-term obligations

Question 18

Liquidity ratio includes

Answer 18

1. current ratio
2. quick ratio
3. cash ratio

Question 19

Current ratio

Answer 19

= CURRENT ASSETS/CURRENT LIABILITIES
- measures the ability of the company to pay current debts as they become due
- ratio > 1 -> current assets are sufficient to cover its current liability
- less than 1 -> want to understand how the company intends to meet its short term obli
- too high -> operating ineffiencityly when it ties up too much money in inventory or account receivables

Question 20

quick ratio

Answer 20

= quick asset/current liabilities
- is a more stringent test of liquidity than the current ratio.
- company’s immediate ability to pay current debts as they become due
- quick assets: cash, short-term investments and net accounts receivables

has (ratio) cents in cash and near cash for every 1 dollar in current liabilities

Question 21

cash ratio

Answer 21

= cash and cash equivalents/current liabilities
- measure the adequacy of available cash
- holding too much cash = not investing the cash in productive assets that will grow the business
- has (ratio) cents of cash for each dollar of current liabilitites

Question 22

solvency ratios

Answer 22

measure a company’s ability to meet its long-term obligations

Question 23

solvancy ratios include

Answer 23

1. times interest earned ratio
2. cash coverage ratio
3. debt-to-equity

Question 24

times interest earned ratio

Answer 24

= (net earnings + interest expense + income tax expense)/ interest expense
- compares the earnings available to cover interest in a period to a company’s interst obligation for the same period
- indicates a margin of protection for creditors.
- Interest expense and income tax expense are included because earnings before interest and tax are available to cover interest expense
- high ratio -> secure position for creditors

Question 25

cash coverage

Answer 25

= cash flow from op before interest and income taxes/interest paid
- some believe that times interest earned ratio is flawed because interest is paid in cash, not with earnings. These analysis prefer to use the cash coverage ratio
- measure the ability to meet its periodic interest payments through the cash generated from operations

Question 26

debt-to-equity

Answer 26

= total liabilities/shareholder’s equity
- express company debt as a proportion of its shareholder equity
- for each 1 dollar of SE, had (ratio) of liability
- debt is risky because interest payments must be made even if the company has not generated sufficient cash from operations to pay them. In contrast, dividends are always at the company’s discretion and are not legally enforeceable until they are declared.

Question 27

market ratio

Answer 27

relate the current price per share to the return that accrues to shareholders

based on the current value of an owner’s investment in a company

Question 28

Price/earnings

Answer 28

= current market price per share/earnings per shares

• relationship between the current market price per share and its earning per share
• reflect the stock’s market assessment of a company’s future performance.
• high -> earnings are expected to grow rapidly.
• shares were selling at a price close to (ratio) times its earnings per share.

Question 29

dividend yield ratio

Answer 29

= dividend per share/ market price per share
- reflect the return on investment solely due to the dividends a company pays.
- used to compare the dividend paying performance of different investment alternatives
- investors are willing to accept low dividend yileds if they expect that the price of a stock will increase while they own it
- stocks with high dividend yields often appeal to retired investors who need current income rather than future growth potential