Financial Ratios M7 Flashcards
What happens to the ratio if the numerator and denominator drops by the same amount?
- If the numerator is smaller than the denominator it carries the most weight and the ratio direction will follow the numerator.
- If the denominator is smaller than the numerator it carries the most weight and the ratio direction will follow the denominator.
What is company trade securities considered?
Current Assets.
Proper Bad Debt write-off Journal
Write-off of an unusually large receivable would result in no change to the ratio. Net accounts receivable (gross accounts receivable – allowance for doubtful accounts) would not change, as a write-off results in a debit to allowance for doubtful accounts and a credit to accounts receivable.
What does investors use each financial statement for?
- Liquidity ratios and coverage ratios focus on balance sheet account balances.
- Income statement information is primarily used for profitability analysis.
- The statement of retained earnings is primarily a reconciliation of the retained earnings account.
- The statement of cash flows assesses cash inflows and cash outflows.
What is the directional relationship between the ratio numerator, denominator and results?
- If the results goes down that means the numerator goes down and/or the denominator had to go up.
- If the results goes up that means the numerator went up and/or the denominator had to go down.
ACTIVITY RATIO USES
Activity ratios measures how effective a firm is in using it’s assets.
ACTIVITY RATIOS: Inventory Turnover Ratio
Inventory Turnover Ratio = Cost of goods sold / Average inventory
How to analyze Inventory turnover?
- If cost of goods sold decreases, the inventory turnover ratio would also decrease.
- If the Inventory Turnover Ratio increased significantly, this means a smaller amount of inventory is on hand TY vs. LY if sales remain the same
ACTIVITY RATIOS: Accounts Receivable Turnover Ratio
Accounts Receivable Turnover Ratio: net sales / by average accounts receivable (net)
How to Analyze Accounts Receivable Turnover Ratio?
- The accounts receivable turnover ratio is calculated as sales (net) / average accounts receivable (net). More aggressive collection policies will result in a decrease in the receivables balance, which in turn causes the turnover ratio to increase.
- A deterioration in the aging of receivables implies a greater receivables balance, which would cause the turnover ratio to decline.
- If sales remain the same while this ratio increases, receivables have likely declined.
- Recording fictitious sales generally has the same impact on revenues and receivables: both would be overstated by the same dollar amount.
- A substantially lower accounts receivable turnover ratio may indicate collectability issues.
ACTIVITY RATIOS: Asset Turnover Ratio
Asset turnover: Sales (net) / average total assets
How to analyze the Asset Turnover Ratio?
- If Asset Turnover goes up, this indicates that either the net sales jumped or the Asset base went down.
ACITVITY RATIOS: Days Sales in Accounts Receivable
Days Sales in AR = ending accounts receivable (net) / the credit sales (net) / 365
OR
Average net receivables × (365 / Net credit sales)
Days sales in accounts receivable = $1,200 / ($7,200 / 365) = 60.8 days
ACTIVITY RATIOS: Accounts Payable Turnover
Accounts payable turnover cost of goods sold ÷ average accounts payable
What does LIQUIDITY RATIOS measure?
A firm’s short-term ability to pay its debt.
