Ratios Flashcards
How are ratios grouped?
Major purpose of type of measure being analyzed
Major Purposes of types of measures being analyzed
- Liquidity/Solvency
- Operational Activity
- Profitability
- Equity/Investment Leverage
Return on Assets
Net Income/avg total assets
Liquidity Ration
Measure the ability to pay obligations as they come due
working capital
- measures extent to which CA exceed CL short term
2. measures the quantitiative relationship btwn CA & CL in terms of # of times CA can cover CL
Working Capital Equation
working capital = CA-CL
Working Capital Ratio (current Ratio)
CA/CL
CA/CL determinable effect on “Working Capital Ratio”
- Increase CA (alsone) increases Working Capital Ratio
- decrease in CA (alone) decreases WCR
- increase in CL (alone) decreases WCR
- decrease in CL (alone) increase WCR.
Acid Test ratio
quantitative relationship highly liqued assests & CL “# of times cash and assets can be convereted quickly to cash to cover CL
Acid test ratio equation
Cash+net rcvbls+ mrkt secur/CL
securities defensive-interval ratio
measures the quantitative relationship between highly liquid assets and the average daily use of cash in terms of the number of days that cash and assets can be quickly converted to support operating costs
securities defensive-interval ratio equation
(Cash + (Net) Receivables + Marketable Securities) / Average Daily Cash Expenditures
times interest earned ratio
measures the ability of current earnings to cover interest payments for a period.
times interest earned ratio equation
(Net Income + Interest Expense + Income Tax) / Interest Expense
times preferred dividend earned ratio
measures the ability of current earnings to cover preferred dividends for a period.
times preferred dividend earned ratio equation
Net Income / Annual Preferred Dividend Obligation
Accounts receivable turnover
measures the number of times that accounts receivable turnover (are incurred and collected) during a period. Indicates the quality of credit policies (and the resulting receivables) and the efficiency of collection procedures
Accounts receivable turnover equation
(Net) Credit Sales / Average (Net) Accounts Receivable (e.g., Beginning + Ending/2)
Number of days’ sales in average receivables
measures the average number of days required to collect receivables; it is a measure of the average age or receivables.
Number of days’ sales in average receivables equation
(300 or 360 or 365 (or other measure of business days in a year)) / Accounts Receivable Turnover
Inventory turnover
measures the number of times that inventory turnover (is acquired and sold or used) during a period. Indicates over or under stocking of inventory or obsolete inventory.
Inventory Turnover equation
Cost of Goods Sold / Average Inventory (e.g., Beginning + Ending/2)
Number of days’ supply in inventory
measures the number of days inventory is held before it is sold or used. Indicates the efficiency of general inventory management.
Number of days’ supply in inventory equation
(300 or 360 or 365 (or other measure of business days in a year)) / Inventory Turnover
Operating number of cycle
measures the average length of time to invest cash in inventory, convert the inventory to receivables, and collect the receivables; it measures the time to go from cash back to cash.
Operating number of cycle equation
Operating Number of Cycle = Days in Operating = Number of Days’ Sale in A/R + Length Cycle Number of Days’ Supply in Inventory
Inventory on January 1 $ 100,000
Inventory on December 31 $300,000
Net sales $2,000,000
Net purchases $700,000
What was Baxter’s inventory turnover for the year ending December 31?
Inventory turnover is the ratio of cost of goods (CGS) sold to average inventory. First, calculate CGS = beginning inventory $100,000 + purchases $700,000 ‐ ending inventory $300,000 = $500,000. Then, average inventory = (beginning inventory + ending inventory)/2 = ($100,000 + $300,000)/2 = $200,000. Turnover = $500,000/$200,000 = 2.5
Calculate COGS
COGS = BI+Purchase-EI
Debt to Equity ratio
Total Debt (Liabilities) / Owner’s Equity
Profit margin (on sales)
measures the net profitability on sales (revenue
Profit margin (on sales) equation
Net Income / (Net) Sales
Return on total assets
measures the rate of return on total assets and indicates the efficiency with which invested resources (assets) are used.
Return on total assets equation
(Net Income + (add back) Interest Expense (net of tax effect)) / Average Total Assets
Return on common stockholders’ equity
measures the rate of return (earnings) on common stockholders’ investment
Return on Common Stockholders’ Equity equation
(Net Income—Preferred Dividend (obligation for the period only)) / Average Common Stockholders’ Equity (e.g., (Beginning + Ending)/2)
Return on owners’ (all stockholders’) equity
measures the rate of return (earnings) on all stockholders’ investment
Return on owners’ (all stockholders’) equity equation
Return on Owners’ (all Stockholders’) Equity = Net Income / Average Stockholders’ Equity (e.g., (Beginning + Ending)/2)
Earnings per share (EPS—basic formula)
measures the income earned per (average) share of common stock. Indicates ability to pay dividends to common shareholders.
= (Net Income—Preferred Dividends (obligation for the period only)) / Weighted Average Number of Shares Outstanding
The price-earnings (P/E) ratio
measures the price of a share of common stock relative to its latest earnings per share. Indicates a measure of how the market values the stock, especially when compared with other stocks.
= Market Price for a Common Share / Earnings per (Common) Share (EPS)
Common Stock Dividends Pay Out Ratio
Cash Dividends to Common Shareholders / Net Income to Common Shareholder
Per share basis
measures the extent (percentage) of earnings distributed to common shareholders.
= Cash Dividends per Common Share / Earnings per Common Share
Common stock yield
measures the rate of return (yield) per share of common stock.
= Dividend per Common Share / Market Price per Common Share
debt to equity ratio
measures relative amounts of assets provided by creditors and shareholders.
= Total Liabilities / Total Shareholders’ Equity
owners’ equity ratio
measures the proportion of assets provided by shareholders.
= Shareholders’ Equity / Total Assets
debt ratio
measures the proportion of assets provided by creditors. Indicates the extent of leverage in funding the entity.
Debt Ratio = Total Liabilities / Total Assets
Book value per common stock
measures the per share amount of common shareholders’ claim to assets. (See the section on this ratio in the owner’s equity module for more details.)
Book Value per Common Stock = Common Shareholders’ Equity / Number of Outstanding Common Shares
Book value per preferred share
measures the per share amount of preferred shareholders’ claim to assets.
Book Value per Preferred Share = Preferred Shareholders’ Equity (including dividends in arrears) / Number of Outstanding Preferred Stocks
defensive interval ratio
- is the ratio of quick assets to daily operating expenditures
- The ratio indicates the length of time in days that the firm can operate with its present liquid resources
If a parent uses the equity method on its books to account for its investment in a subsidiary, which one of the following will result in an increase in the investment account on the parent’s books?
Subsidiary Reports Income
Subsidiary Declares Dividend
Subsidiary Reports Income - yes
Subsidiary Declares Dividend - no
Under the equity method, when a subsidiary reports income, the parent recognizes its share as: DR: Investment and CR: Equity Income. Therefore, the subsidiary’s reported income increases the investment account. In addition, when a subsidiary declares a dividend, the parent recognizes its share as: DR: Dividends Receivable/Cash and CR: Investment. Therefore, the subsidiary’s dividends do not increase the investment account but rather decrease the investment account.
