Financial Ratios P1 Flashcards
Define Activity Ratio
This category includes several ratios also referred to asset utilization or turnover ratios (e.g., inventory turnover, receivables turnover, and total assets turnover). They often give indications of how well a firm utilizes various assets such as inventory and fixed assets to generate revenue and cash.
Define Liqudity Ratios
Liquidity here refers to the ability to pay short-term obligations as they come due.
Define Solvency Ratios
Solvency ratios give the analyst information on the firm’s financial leverage and ability to meet its longer-term obligations.
Define Profitability Ratios
Profitability ratios provide information on how well the company generates operating profits and net profits from its sales.
Define Valuation Ratios
Ways of comparing the relative valuation of companies. Sales per share, earnings per share, and price to cash flow per share are examples of ratios.
Calculate and explain receivables turnover
Explain How Balance Sheet and Income Statement Items are compared
Sales / Average Receivables.
The accounts receivables turnover ratio measures the number of times a company collects its average accounts receivable balance. It is a quantification of a company’s effectiveness in collecting outstanding balances from clients and managing its line of credit process.
A high receivables turnover ratio could be the result of doing an excellent job of managing credit terms and collections. On the other hand, it might indicate that a company has stringent credit terms, offers a large discount for early payment, or charges high penalties for late payment. A company that has excessively stringent credit terms will lose sales as a result. Insight into why a company has a high receivables turnover rate can be gained from looking at the company’s revenue growth compared to peers
The balance sheet item is taken as the average, rather than year end balance. This is achieved by adding Starting Balance to Closing Balance and dividing by 2.
Calculate and explain Days of Sales Outstanding Ratio
365 / Receivables Turnover
The average number of days it takes for customers to pay their bills
This is the inverse of the Receivables Turnover
Calculate and explain Inventory Turnover
COGS / Average Inventory
The inventory turnover ratio is a measure of how many times the inventory is sold and replaced over a given period A company can then divide the days in the period, typically a fiscal year, by the inventory turnover ratio to calculate how many days it takes, on average, to sell its inventory (Days of inventory on hand).
Inventory turnover that is high may indicate effective management of inventory, but could also result from holding inventory levels too low so that sales are lost when orders cannot be filled immediately. A low inventory turnover ratio relative to peers could indicate that some inventory is obsolete and slow-selling. In either case, examining revenue growth relative to peers can provide more insight into whether inventory is well or poorly managed.
Calculate and explain Days of Inventory on Hand
365 / Inventory Turnover
This is the Inverse of Inventory Turnover
Calculate and explain Payables Turnover
Purchases / Average Trade Payables
The accounts payable turnover ratio is a short-term liquidity measure used to quantify the rate at which a company pays off its suppliers. Accounts payable turnover shows how many times a company pays off its accounts payable during a period.
Accounts payable are short-term debt that a company owes to its suppliers and creditors. The accounts payable turnover ratio shows how efficient a company is at paying its suppliers and short-term debts.
Calculate and explain Number of days of payables
365 / Payables Turnover
The average amount of time it takes for a company to pay it’s bills.
A high payables turnover ratio relative to peers may indicate that a company is not fully taking advantage of supplier credit terms, or that the company is paying suppliers early to take advantage of discounts. A payables turnover rate that is low relative to that of peer companies may indicate that a company is having problems with short-term cash flows or, alternatively, that a company is simply taking advantage of lenient terms negotiated with suppliers. As with inventory turnover, examining other ratios (in this case liquidity ratios) can provide insight into which interpretation of a relatively high or low payables turnover ratio is more likely.
Calculate and explain Total Asset Turnover
Revenue / Average total assets
The asset turnover ratio, also known as the total asset turnover ratio, measures the efficiency with which a company uses its assets to produce sales. The asset turnover ratio formula is equal to net sales divided by the total or average assets of a company
Different types of industries might have considerably different turnover ratios.
It is desirable for the total asset turnover ratio to be close to the industry norm. Low asset turnover ratios might mean that the company has too much capital tied up in its asset base. A turnover ratio that is too high might imply that the firm has too few assets for potential sales, or that the asset base is outdated.
Calculate Fixed Asset Turnover
Revenue / Average total fixed assets
Low fixed asset turnover might mean that the company has too much capital tied up in its asset base or is using the assets it has inefficiently. A turnover ratio that is too high might imply that the firm has obsolete equipment, or at a minimum, that the firm will probably have to incur capital expenditures in the near future to increase capacity to support growing revenues.
Calculate Working Capital Turnover. And calculate working capital
Revenue / Average working capital
Current Assets - Current Liabilities
Calculate and Explain the Current Ratio
Current Assets / Current Liabilities
It is the best known measure of liquidity
The higher the current ratio, the more likely it is that the company will be able to pay its short-term bills. A current ratio of less than one means that the company has negative working capital and is probably facing a liquidity crisis. Working capital equals current assets minus current liabilities.
