Ratios Flashcards
In order to compute a meaningful ratio…?
There must be a significant relationship between the two
Define ratio analysis
Mathematical method using income statement and balance sheet data to detect trends
- Gives us a way to compare our business to another
Examples of ratio analysis
Inventory and credit management problems
Poor pricing policies
Declining sales and profitability
Does the business earn adequate profits?
Tests of Profitability
Ratio that help determine if the business is earning adequate profits
Are funds available to the business and its management being used wisely?
Debit and equity (money borrowed and money put in)
Ratio that helps determine if funds are being used wisely by the business: Test of Overall Performance
Can the firm pay its short term debts as they come due?
The ability to pay short term debts is liquidity
Can the firm pay its long term debts on a continuing basis?
Ability is known as solvency
A solvent company is one that?
Owns more than it owes
Positive net worth and manageable debt load
A company with adequate liquidity but not solvency, is one that?
Enough cash available to pay its bills but has a negative net work and debt load that is not manageable
How efficiently are the firm’s assets being managed?
Minimize assets (inventory receivable) to generate sales and income
Test of Profitability indicates?
The pharmacy’s ability to cover its expenses plus some excess to reward its owners
Test of Profitability includes?
GM %
Net Income %
Define Gross Margin Percent
Measure of profitability before expenses are considered
Gross Margin Percent Formula
(Sales-COGS)/Sales x100
GM% means
that much of each dollar of sales is available to cover expenses and profit
Low GM% might result from?
Low prices
Improper purchasing
Shoplifting or other theft
Owners or employees not ringing up sales right
Normal Pharmacy GM% is?
22-28%
Define Net Income Percentage
Measure of the profitability after expenses are consider
NI% Formula
Net income/sales x100
NI% tells you?
that amount of every dollar of sales is available to cover profit
Tells the owner how much you are making!
NI can increased by?
Raising prices without effecting sales
Purchase goods at lower cost
Decreasing expenses
Normal Net Income for pharmacies?
2-5%
Define Test of OVerall Performance
Indicates if funds (debt and equity) available to the business and its management are being used wisely
Debit consist of
funds borrowed by the business
Equity consist of
funds that the owners have invested in the business
Test of overall performance are
Return on equity
Return on assests
Return on Equity
How effectively are funds invested in the firm have been used
Making enough money to make the risk of being in business for owners
ROE =
Net income/OE x100
For every dollar they invest, they get X amount cents back
How can ROE be altered?
Increase NI
Decrease expenses
Decrease OE
How can you decrease OE?
Borrow more funds and withdraw capital (financial leverage)
Decrease assets
Hold less inventory
What is the normal ROE?
20%+
ROA
Measures how effectively all funds available to the manager have been used to generate a return
ROA =
NI/total assets x 100
For every dollar we invested, you receive X cents of income
How can you alter Return on Assets?
Increase NI
Decrease assets
Manage accounts receivable and inventories
Normal ROA?
Greater than 10% (13-15%)
Define Test of Liquidity
Can the firm pay its short term debt as they come due
Tests of liquidity are
Current Ratio
Quick Ratio
Accounts payable period
Current Ratio
compares a pharmacy’s current assets (supply cash to pay current debt) with its current debt
CR =
Current assets/current liabilities
Tells you how many dollars of current assets for every dollar of current liability
Creditors prefer:
high CR (between 2-3.8)
Quick Ratio
Acid Test
Measures the excess of very liquid current assets
Could the firm pay its current debt if it were not able to sell its inventory
QR =
(current assets - inventory)/current liabilities
X dollars of very current assets for every dollar of current liabities
QR should be
1.1-2
Accounts Payable Period indicates
how long it takes the pharmacy to pay for its credit purchases
Avg # of days between when a pharmacy makes a purchase on credit and when it pays for the puchase
APP =
Accounts Payable/Purchases per day
X days between when the pharmacy makes a purchase on credit and when it pays for the purchase
APP average
21 days
Debt to equity ratio measures
A business’ abiliity to meet its long term debt payments
Compare about the pharmacy has borrowed to the OE
Debit vs Equity
Debit must be repaid according to a set schedule regardless of whether the firm is profitable
Equity is funds that have been invested in the business
Debit to Equity Ratios are
Current liabilities to OE
Long term debit to OE
Total debit to OE
Financial leverage
Financial leverage equation
(Total Debit + OE) /OE
Lenders prefer that pharmacies have _____ debt to equity
low
Low debit to equity ratios indicates
the owner has more invested in the business than the bank does, owner should have a strong incentive to do well
Normal debit to equity ratios
50%-80%
Tests of efficiency
How efficiently the pharmacy’s assets are being used
Given level of activity with the smallest possible investment in assets
Test of efficiency are
Accounts Receivable Collection Period
Inventory turnover
Asset turnover
Two test of efficiency for hospital
Hospital inventory turnover
Personnel expense per occupied bed
Accounts Receivable Collection Period
An estimate of the average number of days it takes the pharmacy to collect an account receivable
Should be no greater than 1.5X the firms credit terms
Longer periods of time indicate
poor credit management or customers are not paying on time
ARCP =
Accounts receivable/net credit sales per day
Inventory turnover
Measures the rate of movement of inventory
Indicates that the pharmacy is being run with a minimum investment in inventory
If the ITO is too high
Pharmacy may frequently find itself out of stock
How can you increase ITO
increasing sales without increasing inventory or decreasing inventory while maintaining sales
ITO =
Cost of goods sold/average inventory at cost
Asset turnover
Measures how efficiently the pharmacy’s total assets are used
High ATO indicates that,
The pharmacy is being operated with minimum investment in assets
How can you improve ATO
Increase sales while holding asset investment constant
Decreasing asset investment while increasing or maintaining sales
ATO =
Sales/total assets
Hospital inventory turnover (HITO) =
Annual purchases at costs/average inventory at cost
Normal HITO
10.6
Personnel Expense Per Occupied Bed
Total annual pharmacy payroll/occupied beds (= # of licensed beds X average occupancy rate)
Normal PEPOB
$4,559
