Pre-Finals Flashcards
measure the relationship between two
or more components of financial statements.
Financial Ratios
allow businesses to follow their company’s
performance over time and uncover signs of trouble.
Financial Ratios
offer entrepreneurs a way to evaluate
their company’s performance and compare it to other
similar businesses in their industry.
Financial Ratios
3 Classifications of Financial Ratio
- Liquidity Ratios
- Solvency Ratios
- Profitability Ratios
are an important class of financial
metrics
Liquidity Ratio
used to determine a debtor’s ability to pay off
current debt obligations without raising external capital.
Liquidity Ratio
require a good amount of Cash and other
liquid assets like Accounts Receivable, Inventory,
Trading Securities and Prepaid Assets.
Liquidity Ratio
A _______________ would encourage banks or
financial institutions to lend
good liquidity position
A ________________ may scare off potential creditors.
bad liquidity position
General Interpretations
Numerator is assets & income - the higher, the better
Numerator is liabilities & expense - the lower, the better
Days - shorter, the better
Formula for: Working Capital
Current Assets - Current Liabilities
Interpretation of Working Capital
- The higher the Better
- A positive working capital means there are enough current assets to pay all of the current liabilities at the moment
- A negative working capital would mean that the company would surely default on some of their liabilities
Formula for: Current Ratio
Current Assets ÷ Current Liabilities
Interpretation of Current Ratio
- higher the better
- the higher the current ratio, the more capable a
company is of paying its short-term obligations
Formula for Acid Test Ratio/Quick Ratio
Quick Assets ÷ Total Current Liabilities
How to find the Quick Assets?
Cash + Cash Equivalents + Marketable Securities + Current Accounts Receivables
Interpretation for Acid Test Ratio/Quick Ratio
- the higher the better
- a positive acid test ratio means it has the capability to pay its currently maturing obligations thru its quick assets.
Formula for: Accounts Receivable Turnover Ratio
Net Credit Sales ÷ Average A/R
How do you find the Average AR?
Beginning AR + Ending AR ÷ 2
Interpretation for A/R Turnover Ratios
- the higher the better
- means a better performance from its collection department.
States the usual number of days that it would take
before the company would be able to collect a certain
group of receivables.
Average Collection Period
Formula for: Average Collection Period
360/365 Days ÷ A/R Turnover Ratio
Interpretation for Average Collection Period
- the shorter days, the better
- mean that the company is efficient in collecting their outstanding Accounts Receivable from their customers.
This ratio measures the number of times the
company was able to sell its entire inventory to
customers during the year.
Inventory Turnover Ratio
Formula for: Inventory Turnover Ratio
Cost of Goods Sold / Cost of Sales ÷ Average Inventory
How to get the Average Inventory
Beginning Inventory + Ending Inventory ÷ 2
Interpretation for Inventory Turnover Ratio
- higher the better
- it would mean that the company is being more effective in selling its inventory to customers.
Unsold goods for a long period of time may lead to?
Inventory obsolescence
States the number of days that it would take before a
group of inventory will be entirely sold by the
company.
Average days in Inventory
Formula for Average Days in Inventory
360/365 Days ÷ Inventory Turnover Ratio
Interpretation for Average Days in Inventory
- the shorter, the better
- it would mean that the cash of the company is not being tied to its inventory for a very long period of time.
This is the measure on how long it would take for
the company to transform its inventory back to
cash.
Number of days in the operating cycle
Formula for Number of days in the operating cycle
Average Collection Period + Average Days in Inventory
Interpretation for Number of Days in Operating Cycle
- the shorter, the better
- it would mean that the cash of the company is not being tied to its inventory for a very long period of time.
measure the capability of an entity to pay long term obligations as they fall due.
Solvency Ratios
Different Solvency Ratios
Debt to Total Assets Ratio
Debt to Equity Ratio
Times Interest Earned Ratio
proportion between the total liabilities of the company with its total assets.
Debt to Total Assets Ratio
The debt ratio shows how much of the assets of the company were given by creditors.
Debt to Total Assets Ratio
Formula for Debt to Total Assets Ratio
Total Debts ÷ Total Assets
Interpretation for Debt to Total Assets Ratio
- the lower, the better
- There is a bigger probability of collection in the future if there are fewer liabilities to pay.
Compares the liabilities of the company with its equity.
Debt to Equity Ratio
Formula for Debt to Equity Ratio
Total Liabilities ÷ Total Equity (shareholder’s equity)
Interpretation for Debt to Equity Ratio
- the lower, the better
- it would indicate a healthier solvency position for the company.
Shows the proportion between the Earning Before Interest and Taxes (EBIT) of the company and its interest expense.
Times Interest Earned Ratio
an indicator on how many times can the EBIT cover its
finance cost of borrowing.
Times Interest Earned Ratio
related to the solvency situation of the company
because interest expense is always a part of long term
borrowing.
Times Interest Earned Ratio
Formula for Times Interest Earned Ratio
EBIT ÷ Total Interest Expense
how can you calculate for EBIT?
EBIT = Revenue − COGS − Operating Expenses
EBIT = Net Income + Interest + Taxes
Interpretation for Times Interest Earned Ratio
- the higher, the better
- it would indicate that it the company is worthy to borrow money from others
One of the primary reasons why stockholders
invest in a certain company is the chance of
earning profits.
Profitability Ratios
What are the different Profabilty Ratios?
Gross Profit Ratio
Profit Margin Ratio
Operating Expenses to Sales Ratio
Return on Investment Ratio
-> Return on Assets
-> Return on Equity
Asset Turnover Ratio
proportion of the gross profit of the company
with its nets sales.
Gross Profit Ratio
How to calculate for Gross Profit
Net Sales - Cost of Sales
How to calculate for Net Sales
(Gross) Sales - (Sales Discount + Sales Return & Allowance)
Formula for Gross Profit Ratio
Gross Profit ÷ Net Sales x 100
Interpretation for Gross Profit Ratio
- the higher, the better
- It means that it was able to generate more sales from the smaller cost of goods sold that it has.
The gross profit ratio can be improved by continuously finding inventories with lower cost, without sacrificing its quality.
measures the proportion between the NIAT and
the net sales of the company.
Profit Margin Ratio
a more precise measure of the company’s profitability
because it has already considered the operating expenses and other expenses of the entity.
Profit Margin Ratio
Formula for Profit Margin Ratio
NIAT ÷ Net Sales
Interpretation of Profit Margin Ratio
- the higher, the better
aside from the cost of goods sold, is
one of the biggest expenses of every company.
Operating Expenses
Further Classification of Operating Expenses
General and Administrative Expenses
Selling Expenses.
Formula for Operating Expenses to Sales Ratio
Operating Expense ÷ Net Sales x 100
Interpretation of Operating Expenses to Sales Ratio
- the lower, the better
- The goal is to generate as much sales with the minimum possible operating expenses.
Two variations of Return on Investment Ratio:
Return on Assets
Return on Equity
the average total assets being used may
come predominantly from creditors.
Return on Assets
Formula for Return on Assets
Net Income After Tax ÷ Average Total Assets
(answer in percent)
How to compute for the Average Total Assets?
Beginning Total Assets + Ending Total Assets ÷ 2
Interpretation of Return on Assets
- the higher, the better
- goal is to generate as much profit based on the available assets during the year.
a more specific computation of a company’s profitability
because the denominator being used is the one coming from stockholders or owner alone.
Return on Equity
Formula for Return on Equity
Net Income After Tax ÷ Average Equity
How to compute for the Average Equity?
Beginning Equity + Ending Equity ÷ 2
Interpretations of Return on Equity
- higher the better
measures the correlation between the assets owned by
the company and the net sales being generated by such
properties.
Asset Turnover Ratio
Formula for Asset Turnover Ratio
Net Sales ÷ Average Total Assets
Interpretation of Asset Turnover Ratio
- the higher, the better
