Introduction to Ratio Analysis Flashcards
Liquidity measures include:
Working capital = Current Asset - Current Liabilities
Working capital ratio = Current assets / Current Liabilities
Acid test ratio (Quick Ratio)= (cash + AR + Market sec)/ CL
Defensive Interval Ratio - measures the number of times highly liquid assets cover average daily use of cash
(Cash + AR + Market Sec)/ Average Daily Cash PMTS
Times Interest Earned (TIE)- Number of time current earnings cover interest PMTs for the period
(Net Income + Interest Expense + Inc Tax Expense)/Int. Exp
Times Preferred Dividends Earned
(NET INCOME)/Annual Preferred Dividend Obligations
Operations activity measures include:
AR Turnover- Net Credit Sales / Average AR
Number of day sales in AR- Measure the average number of days to collect receivables.
= 360 ( or other days)/ Accounts receivable turnover
Inventory Turnover- Measures number of times inventory is acquired and sold during the year
= COGS / Average Inventory
Number of days supply in inventory
= 360 / inventory turnover
Define risk:
What is business risk?
What are factors related to firm and environment?
Possibility of loss or other unfavorable outcome that results in uncertainty inherent in future events
- Businesses face many identifiable risks
Business risk- brand, macro-risk a firm faces largely asa result of between the nature of the firm and the nature of its environment
Risk factors related to the firm:
- Products and services
- cost structure
- Financial structure
- Other firm specific factors
Risk factors related to the environment:
- General economic conditions
- Competition
- Customer demand
- Technology
- Etc
What are the two types of business risk?
1) Diversifiable risk (Unsystematic risk)- Elements of risk that can be eliminated through diversification of investments
- Diverse projects
- Diverse investment portfolio
- Diverse locations
2) Non-diversifiable risk (Systematic or market-related risk)- Elements of risk that cannot be eliminated through diversification of investments
- Non-diversifiable risk is related to general economic and political factors
How is general business risk measured?
Measured by the expected VARIABILITY in a firm’s earnings before interest and taxes (EBIT)
- EBIT = Earnings before Interest and Taxes
- The greater the variability in EBIT, the greater the perceived business risk.
- BETA measure of how variability in a firm’s result compare to variability in a benchmark
What is financial risk?
Common shareholders risk that result from the use of debt financing and preferred stock which require payment BEFORE common shareholders receive an return on investment
What is default risk?
Issuer of a security will not be able to make future interest or principle payments; the risk that the issuer will default on its obligations
What is interest rate risk?
Risk that increases in the market rate of interest will decease the value of outstanding debt
- There are inverse relationship between changes in the general interest rate and changes in the market value of existing debt
What is inflationary risk?
Risk that rise in general price levels will result in reduction in the purchasing power of a fixed sum of money
What is liquidity risk?
Risk that asset cannot be readily sold at fair value for cash
- Example: Investment with a “thin” market
What is political risk?
Risk associated with operations in a foreign country that has different political, governmental, cultural, ethical, market structure, or other socio-political elements than a firm’s domestic market
What is currency exchange risk?
Risk associated with changes in exchange rates between two currencies
Three subtypes:
- Foreign currency transactions- risk that transactions to be settled will lose value
- Foreign currency translation- Risk that the dollar value of translated F/S of direct foreign investments will lose value from changes in the exchange rates
- Foreign Currency Economic risk- Risk that changes in exchange rates will make future international transaction less financially viable
