Module 24.1 - 24.3 Financial Ratios

Question 1

What are the five most important tools for ratio analysis?

Answer 1

1) Project future earnings and cash flow
2) Evaluate a firm’s flexibility
3) Assess management’s performance
4) Evaluate changes in the firm and industry over time
5) Compare the firm with industry competitors

Question 2

What are the five limitations of ratio analysis?

Answer 2

1) Financial ratios are not helpful when viewed in isolation.
2) Comparisons with other companies are made more difficult by different accounting treatments
3) It is difficult to find comparable industry ratios
4) Conclusions cannot be made by calculating a single ratio
5) Determining the target or comparison value for a ratio is difficult.

Question 3

How are horizontal common size balance sheets and income statements formed?

Answer 3

the beginning year is all 1.0 and then the following years are all in relation to the beginning year.

Question 4

What is regression analysis?

Answer 4

can be used to identify relationships between variables.

Question 5

What are activity ratios?

Answer 5

several ratios that refer to asset utilization or turnover ratios

Question 6

What are liquidity ratios?

Answer 6

refer to the ability for a firm to pay short-term obligations

Question 7

What are solvency ratios?

Answer 7

provide information on how well the company generates operating profits and net profits

Question 8

What are valuation ratios?

Answer 8

Sales per share, earnings per share, and price to cash flow per share etc.

Question 9

What is the formula for receivables turnover?

Answer 9

annual sales / average receivables

measures how efficiently a firm is managing its assets

Question 10

what is the formula for days of sales outstanding?

Answer 10

365 / receivables turnover

average collection period

Question 11

What is the formula for inventory turnover?

Answer 11

cost of goods sold / average inventory

measures a firms efficiency with respect to its processing and inventory management

Question 12

What is the formula for days of inventory on hand?

Answer 12

365 / inventory turnover

measures the average inventory processing period

Question 13

What is payables turnover?

Answer 13

purchases / average trade payables

measure the use of credit by the firm

Question 14

What is number of days of payables?

Answer 14

365 / payable turnover ratio

Question 15

What is total asset turnover?

Answer 15

revenue / average total assets

measures a firms use of total assets to create revenue

Question 16

What is fixed asset turnover?

Answer 16

revenue / average net fixed assets

measures utilization of fixed assets

Question 17

What is working capital turnover?

Answer 17

revenue / average working capital

measures how effectively a company is using its working capital

Question 18

What is the defensive interval ratio?

Answer 18

cash + marketable securities + receivables / average daily expenditures

Question 19

what is the cash conversion cycle?

What does a high cash conversion cycle imply?

Answer 19

(days sales outstanding) + (days of inventory on hand) - (number of days payable)

the company has excessive amount of capital investment in the sales process

Question 20

What is fixed charge coverage?

Answer 20

(earnings before interest and taxes + lease payments) / (interest payments + lease payments)

Question 21

What is the formula for return on assets when interest expense is given?

Answer 21

net income + interest expense (1 - tax rate) / average total assets