Ratio and Variance Analysis Flashcards
What are ratios?
they are financial indicators that distill relevant information about a business entity by quantifying the relationship among selected items on the financial statements
key financial ratios and metrics that are used to analyze a company’s performance are classified into 4 high-level categories: profitability ratios, liquidity ratios, solvency ratios, and performance metrics
the numerator has a direct relationship with the ratio (increase in numerator results in an increase in the ratio)
the denominator has an indirect relationship with the ratio (an increase in the denominator results in a decrease in the ratio)
sometimes, when both the numerator and the denominator are affected by a given change, the final result (increase or decrease) is not easy to determine; the best way to answer questions such as these is to make up numbers and plug them into the ratio formula
What are profitability ratios?
they are measure of the success or failure of an enterprise for a given time period
gross (profit) margin = (net sales - COGS) / net sales
profit margin = net income / net sales
return on sales = income before interest income, interest expense, and taxes / net sales
return on assets (ROA) = net income / avg total assets
DuPont return on assets = (net income / net sales) * (net sales / avg total assets)…this is essentially the same as ROA, but by using profit margin (percentage return on each sale) and asset turnover (effective use of assets in generating that sale), it allows for increased analysis of the changes in the percentages
return on equity = net income / avg total equity
operating cash ratio = cash flow from operations / current liabilities
What are liquidity ratios?
they are measures of a firm’s short-term ability to pay maturing obligations (turnover ratios generally use average balances for BS components, but the CPA exam may instruct you to use year-end balances instead…read questions carefully)
current ratio = current assets / current liabilities…(the higher above 1.0 the better; measures to meet short-term obligations)
quick ratio = (cash and cash equivalents + short-term marketable securities + net receivables) / current liabilities…measures to meet short-term needs
accounts receivable turnover = net sales / avg net AR…(indicates the receivables’ quality and indicates the success of the firm in collecting outstanding receivables; faster turnover gives credibility to the current and acid-test ratios)
days sales in accounts receivable = ending net AR / (net sales / 365)…(indicates the avg number of days required to collect AR)
inventory turnover = COGS / avg inventory…(measures how quickly inventory is sold and is an indicator of enterprise performance; in general, the higher the turnover, the better the performance)
days in inventory = ending inventory / (COGS / 365)…(indicates the avg number of days required to sell inventory)
accounts payable turnover = COGS / avg AP …(indicates the number of times trade payables turn over during the year; a low turnover may indicate a delay in payment, such as a shortage of cash)
days of payables outstanding = ending AP / (COGS / 365)…indicates the avg length of time trade payables are outstanding before they are paid)
cash conversion cycle = days sales in AR + days in inventory - days of payables outstanding…(indicates the avg length of time it takes from when the company pays cash for an inventory purchase to when the company receives cash from a sale)
What are solvency ratios?
they are measures of security or protection for long-term creditors/investors
debt-to-equity = total liabilities / total equity…(indicates the degree of protection to creditors in case of insolvency; the lower this ratio the better the company’s position)
total debt ratio = total liabilities / total assets…(indicates that approximately half of the assets are financed by creditors)
equity multiplier = total assets / total equity
times interest earned = income before interest expense and taxes / interest expense OR earnings before interest and taxes / interest expense…(reflects the ability of a company to cover interest charges; it uses income before interest and taxes to reflect the amount of income available to cover interest expense)
What are performance metrics?
they are measures used to evaluate operating performance and elements of a company’s stock performance from the perspective of current and potential investors
EBITDA (earnings before interest, taxes, depreciation, and amortization) can be calculated from the income statement using either a “top-down” or “bottom-up” approach
top-down: sales - COGS - operating expenses (excluding depreciation and amortization)
bottom-up: net income + income tax expense + interest expenses + depreciation nd amortization
EPS (earnings per share) = income available to common shareholders / weighted avg common shares outstanding
price-to-earnings ratio = price per share / basic earnings per share…(indicates the investment potential of an enterprise; a rise in this ratio indicates that investors are pleased with the firm’s opportunity for growth)
dividend payout = cash dividends / net income…(indicates the portion of current earnings being paid out in dividends)
asset turnover = net sales / avg total assets…(indicates the effective use of assets; a high ratio indicates effective asset use to generate sales)
