Ratio Analysis Flashcards
Process of using financial analysis to determine the health of a firm
Ratio Analysis
Ratio Analysis is a popular tool for three reasons
Standardization
Flexibility
Focus
One of the four classifications of ratios designed to measure the ability of a firm to pay its near-term obligations
Liquidity Ratios
Liquidity Ratios speak to a firm’s ability to meet
Short-Term Obligations
Most Common Liquidity Ratios
Current Ratio
Quick Ratio
Accounts Receivable Turnover
Average Collection Period
Inventory Turnover
Days on Hand
Current Assets / Current Liabilities
Current Ratio
Higher current ratios are usually interpreted to mean
better likelihood that the firm will be able to meet its short-term obligations
(Current Assets- Inventory) / Current Liabilities
Quick Ratio
A company with a high quick ratio is usually viewed as having
Greater ability to meet short-term obligations
Credit Sales / Accounts Receivable
Accounts Receivable Turnover
Accounts receivable turnover describes
The number of times a firm’s AR account turns over in a year
An AR ratio of 12 means
The company collects its entire AR 12 times a year, or about once a month
365/AR Turnover
Average Collection Period (ACP)
These two ratios can provide the same information
Average Collection Period and Accounts Receivable Turnover
COGS/Inventory
Inventory Turnover
Inventory Turnover is the number of times the firm
Turns over (sells) inventory annually
365 / Inventory Turnover
Days on Hand (DOH)
DOH simply converts the inventory turnover into a
Day count metric
If inventory turnover is 2, the firm has about how many days of inventory on hand?
180
(365/2)
One of the four classifications of ratios designed to see how well the firm is using its assets and investments
Efficiency Ratios
Efficiency ratios measure how effectively a company/management team uses assets to
Generate sales or profits
The most commonly used efficiency ratios are
Total Asset Turnover (TAT)
Fixed Asset Turnover (FAT)
Operating Income Return on Investment (OIROI)
Sales / Total Assets =
Total Asset Turnover
A TAT of three indicates that for every $1 of assets,
the firm is generating $3 in sales
Sales / Fixed Assets =
Fixed Asset Turnover
Fixed assets include all
Non-Current Assets, or total assets minus current assets
Managers with low risk tolerance will maintain
Higher Current Asset Levels
A company’s fixed asset holdings are largely determined by
the industry in which it operates
EBIT/Total Assets =
Operating Income Return on Investments (OIROI)
OIROI describes the relationship between
operating profit (EBIT) and the company’s asset base
OIROI tells us
how much pre-tax, pre-financing profit the company generates per dollar of assets
All assets must be
Financed
One of the four classifications of ratios designed to measure how the firm finances its operations
Financing Ratios
Common Financing Ratios are
Debt Ratio
Interest-Bearing Debt to Total Capital
Times Interest Earned Ratio
Financial Leverage Ratio
Total Liabilities / Total Assets
Debt Ratio
The debt ratio measure the proportion of
the firm’s assets financed with debt
A debt ratio of .4 means
for every dollar of assets held by the firm, 40 cents is financed with debt
Interest-Bearing Debt / (Interest-Bearing Debt + Owners’ Equity) =
Interest Bearing Debt to Total Capital (IBDTC)
Interest-Bearing Debt to Total Capital is a more precise measure of a firm’s
financial structure
EBIT / Interest Expense =
The Times Interest Earned (TIE) Ratio
The Times interest earned ratio tells us how many times a company
can pay interest expense given operating profit
Total Assets / Equity =
Financial Leverage Ratio (FLR)
The Financial Leverage Ratio is similar to the
Debt Ratio
One of the four classifications of ratios designed to measure the profitability of the firm
Profitability Ratios
Common Profitability Ratios are:
Return on Assets
Return on Equity
Gross Margin
Operating Margin
Net Margin
Net Income / Total Assets
Return on Assets
Net Income / Owners’ Equity
Return on Equity
One of the most important metrics by which managers are evaluated
Return on Equity
A firm that is effectively using debt will have an ROE that _______ ROA
Exceeds
Gross Profit / Sales
Gross Margin
Gross margin measures the percent of revenue remaining after the
Cost of Goods Sold
High gross margins are usually associated with
an efficient production process
EBIT/ Sales =
Operating Margin
The percent of sales remaining after covering the costs of goods sold AND operating expenses
Operating Margin
Operating margin is frequently compared with
different capital structures
The portion of a firm’s assets that are financed by either liabilities (debt) or by equity
Capital Structures
The mix of debt and equity is referred to as the
Capital Structure
Net Income / Sales
Net Margin
Measures the percent of revenue that drops to the bottom line
Net Margin
All ratio analysis should be
integrative
The DuPont equation indicates that ROE is a function of
operating efficiency
The DuPont equation indicates that TAT is a function of
Asset Efficiency
The DuPont equation indicates that FLR is a function of
Financing policy
The three main comparison standards for ratio analysis
Trend Analysis
Cross-Sectional Analysis
Internal Goal Monitoring
An analysis used to examine a firm’s ratios over time
Trend Analysis
Frequently, trend analysis looks back
5 years
The trend analysis can sometimes forecast forward
3 years
An analysis used to compare a firm’s ratios to a peer group
Cross-Sectional Analysis
Ratios can measure progress relative to specific goals set within the company
Internal Goal Monitoring
