Ratio Analysis Flashcards
5 traditional categories of ratios
- Short term solvency, or liquidity, ratios
- Long term solvency, or financial leverage, ratios
- Asset management, or turnover, ratios
- Profitability ratios
- Market value ratios
Short term solvency, or liquidity, ratios
Provide info about firms liquidity. Primary concern is whether or not the firm will be able to meet its obligations in the short term without undue stress.
These ratios focus on CA ad CL
Very important to creditors.
Good- CA and CL are often close to market value
Bad- like any near cash item, CA and CA can change quickly
Current ratio
CA/CL
Creditors- the higher the better
Firm- too high of ratio could mean and inefficient management of cash and other short term assets
Low current ratio might not be bad for a form with untapped LT borrowing power, b/c increase in cash would increase ratio
Quick ratio (acid test ratio)
(CA- inventory)/ Cl
Inventory is often least liquid CA, and least reliable book value, b/c quality of inventory isn’t co considered(damaged, obsolete, lost)
High inventory levels could mean that the firm overestimated demand, and could lead to a short run problem.
Cash ratio
Cash/CL
Very short term creditor might use
Long term solvency ratios( financial leverage ratios)
Firms ability to meet long run obligations. Also called leverage ratios.
Total debt ratio
Debt to equity ratio
Equity multiplier
Leverage ratio with several variations
TD ratio=(Total assets-total equity)/total assets)
Example: 3588-2591/3588
=.28 times Firm uses 28% debt, 72% equity
Debt-equity ratio= TD/TE
Example .28/.72= .39 times
Equity multiplier=
total assets/total equity
Example= 1/.72 = 1.39 times
Equity multiplier is by definition 1 plus D/E ratio
These ratios all say the same thing, if given 1, you can calculate the other two
Times interest earned(TIE)
Leverage ratio
= EBIT/interest
Also called interest coverage ratio
Measures how well a firm has its interest obligations covered
Problem- EBIT has deducted depreciation and amortization, which are non cash expenses. Does not measure true amount of cash to pay interest
Cash coverage ratio
Leverage ratio
=EBITDA/interest
Adds back no cash expenses to provide a better view of firms interest coverage.
Recent version uses
Interest bearing debt/EBITDA
Values below 1 = very strong
Asset management ratios (turnover ratios)
Attempt to show how efficiently or intensively a firm uses its assets to generate sales.
Inventory turnover and days sales in inventory
Inventory turnover =
COGS/inventory
Example: 1344/422= 3.2 times, meaning entire inventory was sold of 3.2 times during the year
The higher the ratio, the more efficiently we are managing inventory; as long as we are not
running out of stock and foregoing sales
If we know turnover, we can figure out how long it took to turnover on average.
Days sales in inventory=
365/inventory turnover
Example: 365/3.2 = 114 days
Meaning inventory sits and average of 114 days before it is sold.
Receivables turnover and days sales in receivables.
How fast a firm collects on sales.
Receivables turnover=
sales/accounts receivable
Example: 2311/188=12.3 times
Meaning we collect outstanding credit accounts and lend the money back out 12.3 during the year
Days sales in receivables =
365/ receivables turnover
= 365/12.3 = 30 days
On average, firm collects credit sales in 30 days– also called average collection period (ACP)
Total asset turnover
=sales/total assets
Example: 2311/3588 =.64 times
Meaning for every dollar in assets, firm generates .64 in sales
