Financial Ratio Analysis Flashcards
What four things does ratio analysis measure?
Ratio analysis measures liquidity, profitability, reliance on debt financing, and effectiveness of management’s resource utilization
What are the four types of financial ratios?
Liquidity ratios, activity ratios, profitability ratios, leverage ratios
What can financial ratios be used for?
Financial ratios can be used to compare a company’s past to other companies, pinpoint problems, highlight excellence, and spot trends
Liquidity ratios measure a company’s ability to
Meet it’s short term obligations when they must be paid
Increasing liquidity reduces
The likelihood that a company will face emergencies caused by a need to raise funds to repay loans
Current ratio is
Current assets / current liabiltiea
Current ratio measures the
Ability to pay debts as they mature
Acid-test / quick ratio measures
The ability to pay debts on short notice
Acid-test/quick ratio
(Current assets - inventory) l current liabilities
What is a satisfactory current ratio?
2:1
What is a satisfactory acid-test ratio?
1:1
Activity ratios measure
Management’s effective use of company resources
What are the three activity ratios?
Inventory turnover ratio, receivables turnover ratio, total asset turnover ratio
Inventory turnover ratio
Cost of goods sold / avg inventory
Receivables turnover
Crédit sales / avg accounts receivable
Total asset turnover
Sales / avg total assets (aka invested dollars)
Profitability ratios measure
An organization’s overall financial performance by evaluating its ability to generate revenues in excess -aka profit - of operating costs and other expenaea
The three profitablity ratios are
Gross profit margin, net profit margin, return on equity
Gross profit margin
Gross profit / sales
Net profit margin
Net income/ sales
Return on equity
Net income / avg equity
Leverage ratios measure
The extent to which a company relies on debt financing
Leverage ratios are good info to provide to
Potential investors and lenders as too much debt means future problems meeting future interest payments
What are the two leverage ratios?
Debt ratio and long-term debt to equity
Debt ratio
Total liabilities/total assets
Long-term debt to equity ratio
Long-term debt / owners equity
A debt ratio of more than 50% means
A company relies more in borrowed money 🤑 (liabilities) than owner’s equity (assets)
What do financial ratios do for managerial accounting?
Relate balance sheet and income statement data to each other
Help management know a company’s strengths and weaknesses
Indicate areas in need of more investigation
