Ratios—Liquidity/Solvency & Operational

Question 1

4 types of financial ratios:

• 1. l___.
• 2. o___.
• 3. p___.
• 4. e___.

Answer 1

4 types of financial ratios:

• 1. liquidity/solvency
• 2. operational activity
• 3. profitability
• 4. equity/Investment Leverage

Question 2

Liquidity/Solvency Ratios:

• 1. what do the liquidity ratios measure?
• 2. Working Capital / WCR
     * 1. equations for WC and WCR?
     * 2. what do WC and WCR measure?
     * 3. how changes in CA and CL affect the WCR?
• 3. Quick Ratio / Acid-Test Ratio
     * 1. equation?
     * 2. measure?
• 4. Times Interest Earned Ratio
     * 1. equation?
     * 2. measure?
• 5. Times Preferred Dividend Earned Ratio
     * 1. equation?
     * 2. measure?
• 6. Cash Availability or Interval Ratio
     * 1. equation?
     * 2. measure?

Answer 2

Liquidity/Solvency Ratios:

• 1. measure the ability of the firm to pay its obligations as they become due.
• 2. WC / WCR
     * 1. WC = CA - CL; WCR = CA / CL; Current Ratio is also called “Working Captial Ratio (WCR).”
     * 2. WC measures the extent to which CA exceed CL; WCR measures the ability to pay CL.
     * 3.
     
     • An increase in CA alone increases the WCR.
     • A decrease in CA alone decreases the WCR
     • An increase in CL alone decreases the WCR.
     • A decrease in CL alone increases the WCR.
     • If WCR = 1, equal increases or equal decreases in CA and CL will not change the WCR, it will remain 1.
     • If the WCR > 1, equal increases in CA and CL decrease the WCR; equal decreases in CA and CL increase the WCR.
     • If the WCR < 1, equal increases in CA and CL increase the WCR; equal decreases in CA and CL decrease the WCR.
• 3. Quick Ratio / Acid-Test Ratio
     * 1. = (Cash + Net AR + ST Securities) / CL.
     * 2. measures number of times highly liquid assets can be converted quickly to cash to cover CL.
• 4. Times Interest Earned Ratio
     * 1. = (Net Income + Interest Expense + Income Tax) / Interest Expense or EBIT / Interest Expense.
     * 2. measures the ability of current earnings to cover interest payments for a period.
• 5. Times Preferred Dividend Earned Ratio
     * 1. = NI / Annual Preferred Dividend Obligation.
     * 2. measures the ability of current earnings to cover preferred dividends for a period.
• 6. Cash Availability or Interval Ratio
     * 1. = (Cash + Marketable Securities + Net Receivables) / Average Daily Cash Expenditures.
     * 2. measures the ability of highly liquid assets to support average daily use of cash.

Question 3

Operational Activity Ratios:

• 1. what do the operational activity ratios measure?
• 2. A/R Turnover
     * 1. equation?
     * 2. measure?
• 3. Number of Days’ Sales in AR
     * 1. equation?
     * 2. measure?
• 4. Inventory Turnover
     * 1. equation?
     * 2. measure?
• 5. Number of Days’ Supply in Inventory
     * 1. equation?
     * 2. measure?
• 6. Operating Number of Cycle = Days in Operating
     * 1. equation?
     * 2. measure?

Answer 3

Operational Activity Ratios:

• 1. measure the efficiency with which a firm carries out its operating activities.
• 2. A/R Turnover
     * 1. Net Credit Sales / Average Net AR.
     * 2. measures the number of times that AR are incurred and collected during a period, quality of credit policies, and efficiency of collection procedures.
• 3. Number of Days’ Sales in AR
     * 1. (300 or 360 or 365 or other measure of business days in a year) / AR Turnover.
     * 2. measures the average number of days required to collect receivables or the average age of receivables.
• 4. Inventory Turnover
     * 1. COGS / Average Inventory.
     * 2. measures the number of times that inventory turns over (is acquired and sold or used) during a period. Indicates over or under stocking of inventory or obsolete inventory.
• 5. Number of Days’ Supply in Inventory
     * 1. (300 or 360 or 365 or other measure of business days in a year) / Inventory Turnover.
     * 2. measures the number of days inventory is held before it is sold or used. Indicates the efficiency of general inventory management.
• 6. Days in Operating
     * 1. Number of Days’ Supply in Inventory + Number of Days’ Sale in AR.
     * 2. measures the average length of time for buy inventory–sell inventory–collect receivables.

Question 4

CPAexcel Flashcards

• 1. What is financial statement ratio analysis?
• 2. List the formula for times preferred dividend.
• 3. List the working capital ratio formula.
• 4. List the A/R Turnover ratio formula.
• 5. List the formula for inventory turnover.
• 6. List the formula for times interest earned.
• 7. List the formula for Number of Days’ Sales in AR.
• 8. List the cash availability or interval ratio formula.
• 9. What do operational activity ratios measure?
• 10. List the formula for Number of Days’ Supply in Inventory.
• 11. List the formula for the Acid Test or Quick Ratio.
• 12. What do liquidity (or solvency) ratios measure?
• 13. What are the general types of ratios?
• 14. List the formula for Operating Cycle Length.
• 15. List the formula for working capital.

Answer 4

CPAexcel Flashcards

• 1. The development of quantitative relationships between various elements of a firm’s financial statements.
• 2. = NI / Annual Preferred Dividend Obligation.
• 3. = CA / CL.
• 4. = Net Credit Sales / Average Net AR.
• 5. = COGS / Average Inventory.
• 6. = EBIT / Interest Expense = (NI + Interest Expense + Income Tax Expense) / Interest Expense.
• 7. = 365 / AR Turnover.
• 8. = (Cash + Net Receivables + Marketable Securities) / Average Daily Cash Expenditures.
• 9. They measure the efficiency with which a firm carries out its operating activities.
• 10. = 365 / Inventory Turnover.
• 11. = (Cash+Net Receivables+Marketable Securities) / CL.
• 12. Measure the ability of the firm to pay its debts as they come due.
• 13. (1) Liquidity/Solvency; (2) Operational Activity; (3) Profitability; (4) Equity/Investment Leverage.
• 14. = Days’ Sales in AR + Days’ Supply in Inventory.
• 15. = CA - CL.