Ratios

Question 1

Liquidity ratios (also known as solvency ratios) : Measures of an entity’s short-term ability to meet its obligations.

Answer 1

a. Working capital = current assets - current liabilities. This is a definition, not a ratio.
b. Current ratio = current assets/current liabilities.
c. Quick ratio (acid-test ratio) = (cash + marketable securities + A/R)/ current liabilities.
d. Current cash to debt ratio = net cash from operations/ average current liabilities.

Question 2

Activity ratios (also known as turnover or efficiency ratios) : Measures of an entity’s effectiveness putting its assets to use.

Answer 2

e. Asset turnover = net sales/ average total assets.
f. Receivable turnover = net (credit) sales/ average trade receivable (net).
g. Number of days sales in receivables = 365 days/ receivable turnover.
h. Inventory turnover = cost of goods sold/ average inventory.
i. Number of days sales in inventory = 365 days/ inventory turnover

Question 3

Profitability ratios : Measures of an entity’s operating success (failure) for a period of time.

Answer 3

j. Profit margin on sales = net income/ net sales.
k. Gross profit percentage = (sales - cost of goods sold)/ sales.
l. Rate of return on assets = net income/ average total assets.
m. Rate of return on common stockholders’ equity = (net income - dividends attributable to preferred stockholders)/ average common stockholders’ equity.
n. Earnings per share = (net income - preferred dividends)/average number of common shares outstanding.
o. Price earnings ratio (“P-E ratio”) = market price of stock/ earnings per share.

Question 4

Coverage ratios (also known as leverage ratios) : Measures of the entity’s ability to meet its obligations over time. (That is, measures of long-term risk to creditors and the extent to which the entity has borrowed up to its available capacity.)

Answer 4

p. Debt to total assets ratio = total liabilities/ total assets.
q. Debt to equity ratio = total liabilities/ total stockholders’ equity.
r. Times interest earned = income before interest expense and income taxes/ interest expense.
s. Cash to debt coverage ratio = net cash from operations/ average total liabilities.

Question 5

Working Capital (liquidity ratio)

Answer 5

Current Assets- Current Liabilities

Question 6

Current Ratio (liquidity Ratio)

Answer 6

Current Assets/Current Liabilities

Question 7

Quick Ratio AKA Acid Test Ratio (liquidity ratio)

Answer 7

Cash+Marketable Securities+ A/R/ Current Liabilities

Question 8

Cash Ratio (liquidity ratio)

Answer 8

Cash equivalents +Marketable Securites/Current Liabilities

Question 9

Accounts Receivable turnover (activity ratio)

Answer 9

Net Credit Sales/Average Net Receivables

This ratio 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

Question 10

Accounts Receivable turnover in days (activity Ratio)

Answer 10

Average net receivables/(Net Credit Sales/365)

or

365 days/receivables turnover

indicates the number of days required to collect A/R

Question 11

Inventory Turnover (activity Ratio)

Answer 11

Cost of Goods sold/Average Inventory

Measure of how quickly inventory is sold. The higher the turnover the better the performance.

Question 12

Inventory Turnover in days (activity Ratio)

Answer 12

Average inventory /(Cost of goods sold/365)

or

365 days/inventory turnover

indicates the number of days required to sell inventory

Question 13

Net Profit Margin (Profitability Ratio) -

Answer 13

Net income/Net Sales

This ratio indicates profit rate

Question 14

Return on Total Assets ( profitability ratios)

Answer 14

Net income/ Average total assets