Ratio's for measuring accounting performance Flashcards
ROA
A measure of return on total investment in a firm. Larger is usually better. (profit after taxes/total assets)
ROE
A measure of return on total equity investment in a firm. Larger is usually better. (profit after taxes/total stockholder’s equity)
Gross profit margin
A measure of sales available to cover operating expenses and still generate a profit. Larger is usually better. (sales- cost of goods sold/sales)
Earnings per share (EPS)
A measure of profit available to owners of common stock. Larger is usually better. (profit after taxes - preferred stock dividends)/number of shares of common stock outstanding)
Price earnings ratio (p/e)
A measure of anticipated firm performance—a high p/e ratio tends to indicate that the stock market anticipates strong future performance. Larger is usually better.
Cash flow per share
A measure of funds available to fund activities above current level of costs. Larger is usually better.
Current ratio
A measure of the ability of a firm to cover its current liabilities with assets that can be converted into cash in the short term. Recommended in the range of 2 to 3.
Quick ratio
A measure of the ability of a firm to meet its short-term obligations without selling off its current inventory. A ratio of 1 is thought to be acceptable in many industries.
Debts to assets
A measure of the extent to which debt has financed a firm’s business activities. The higher, the greater the risk of bankruptcy.
Debt to equity
A measure of the use of debt versus equity to finance a firm’s business activities. Generally recommended less than 1.
Times interest earned
A measure of how much a firm’s profits can decline and still meet its interest obligations. Should be well above 1.
Inventory turnover
A measure of the speed with which a firm’s inventory is turning over. In many industries, higher inventory turnover is better.
Accounts receivable turnover
A measure of the average time it takes a firm to collect on credit sales. In many industries, faster accounts receivable turnover is better.
Average collection period
A measure of the time it takes a firm to receive payment after a sale has been made. In many industries, shorter collection periods are better.
Profitability ratios
These ratios have some measure of profit in the numerator and some measure of firm’s size or assets in the denominator.
Liquidity ratios
These ratios focus on the ability of a firm to meet its short-term financial obligations.
Leverage ratios
Ratios in this category focus on the level of a firm’s financial flexibility. This includes its ability to obtain more debt.
Activity ratios
Ratios focus on the level of activity in a firm’s business.
What is the interpretation of the WACC?
The ideal situation is: WACC < ROA (return on assets) > Industry average return on assets
WACC is lower than the firms ROA: this is good because the costs of the firm’s capital are lower than the returns, thus making money, ROA is better than the industry average, this indicates competitive advantage.
Emergent strategies
Theories of how to gain competitive advantage in an industry that emerge over time or that have been radically reshaped once they are initially implemented.
Intended strategies
The simplest way of thinking about a firm’s strategy to assume that firms choose and implement their strategies exactly as described by the strategic management process.
WACC
(Market value of debt/firm’s market value) x after tax cost of debt + (market value of equity/firm’s market value) x cost of equity
Cost of equity
Risk-free rate of return + B (expected market return - risk free rate of return)