Financial Ratios

Question 1

What do profitability ratios measures?

Answer 1

the ability of the firm to earn an adequate return or its ability to effectively employ its resources

Question 2

Gross profit margin

Answer 2

(Sales-COGS)/Sales

Question 3

What does the gross profit margin indicate?

Answer 3

gross profit earned on each dollar of sales

Question 4

Operating profit margin

Answer 4

EBIT/Sales

Question 5

What does the operating profit margin indicate?

Answer 5

operating profits earned on each dollar of sales

Question 6

Return on Assets

Answer 6

Net Income/Avg. Total Assets

Question 7

What does the return on assets indicate

Answer 7

firm’s overall efficiency in the use of capital

Question 8

Return on Equity

Answer 8

Net Income/Avg. Equity

Question 9

What does the return on equity indicate

Answer 9

the firms return shareholders

Question 10

What are efficiency ratios?

Answer 10

measures selected aspects of the firm’s operational efficiency

Question 11

Accounts Receivable Turnover

Answer 11

Sales (Credit)/Avg Accounts Receivable

Question 12

What does a higher A/R turnover mean?

Answer 12

The higher the better as this means that the AR is not being turned into bad debts; but if too rapid it could indicate too tight of credit policies resulting in reduced sales

Question 13

Avg Collection Period (Days of Sales)

Answer 13

365 days/AR Turnover

Question 14

Inventory Turnover

Answer 14

COGS/Avg Inventory

Question 15

What does a higher inventory turnover ratio mean?

Answer 15

generally the higher the better but if too rapid could indicate that stock is running out

Question 16

Days of Inventory on Hand

Answer 16

365/Inventory Turnover

Question 17

Asset Turnover

Answer 17

Sales/Avg. Total Assets

Question 18

what does the asset turnover show?

Answer 18

the level of sales being generated per dollar of investment in assets

Question 19

Asset Turnover in days

Answer 19

365 days/Asset turnover

Question 20

Accounts Payable Turnover

Answer 20

Purchases/ Avg. Accounts Payable

Question 21

Days Payable Outstanding

Answer 21

365 days/AP Turnover

Question 22

Current ratio

Answer 22

current assets/current liabilities

Question 23

What does the current ratio indicate

Answer 23

the ability to pay current liabilities with current assets

Question 24

Quick Ratio (Acid-Test Ratio)

Answer 24

Current Assets-Inventory-Prepaids/Current Liabilties

Question 25

Cash Conversion Cycle

Answer 25

Average Collection Period+Days of Inventory-Days Payable

Question 26

What do solvency ratios measure?

Answer 26

the firm’s debt position on balance sheet and its ability to service debt

Question 27

Debt Ratio

Answer 27

total liabilities/total asset

Question 28

Debt to equity

Answer 28

total liabilities/total equity

Question 29

What does the debt to equity ratio indicate

Answer 29

the relative proportion by which firm is financed through debt vs shareholder’s equity

Question 30

Debt Service Coverage

Answer 30

Net Operating Income/(Principal + Interest Payments)

Question 31

Times Interest Eaerned

Answer 31

EBIT/Interest Expense

Question 32

What does the time interest earned ratio represent

Answer 32

indicates the number of time the EBIT covers the interest expense.
Reflects accounting earnings rather than cash flow
Debtors are interested in cash flow (ability to pay principal and interest ) as well as the value of security

Question 33

Working Capital

Answer 33

current assets- current liabilties

Measure of liquidity