Sec 1 - Liquidity/Solvency Ratios

Question 1

Financial Statement Ratio Analysis :

Answer 1

• The development of quantitative relationships between various elements of a firm’s financial statements.

Question 2

Ratio Groupings

Answer 2

• Ratios can be grouped according to the major purpose or type of measure being analyzed. The major purposes or types of measures being analyzed are:

1. Liquidity/Solvency;
2. Operational Activity;
3. Profitability;
4. Leverage.

Question 3

Return on Assets (ROA)

Answer 3

• Measures operating performance independent of financing.

Question 4

Return on Equity (ROE)

Answer 4

• Explicitly *includes the amount and cost of financing*.

Question 5

Liquidity Ratios (also known as Solvency Ratios)

Answer 5

• Measure the ability of the firm to pay its obligations as they become due.

Question 6

Working Capital

Answer 6

• Measures the extent to which current assets exceed current liabilities and, thus, are uncommitted in the short term.
• It is expressed as:
• Working Capital =
• Current Assets - Current Liability

Question 7

Working Capital Ratio (WCR)

“current” ratio.

Answer 7

• Working Capital Ratio = Current Assets / Current Liabilities
• Measures the quantitative relationship between current assets and current liabilities _in terms of the “number of times” current assets can cover current liabilities_.
• Is a _widely used measure of the firm’s ability to pay its current liabilities._

Question 8

Changes in Current Assets and/or Current Liabilities have determinable effects on the Working Capital Ratio

Answer 8

• WCR = Current Assets / Current Liabilities
• An increase in current assets (alone) increases the WCR.
• A decrease in current assets (alone) decreases the WCR.
• An increase in current liabilities (alone) decreases the WCR.
• A decrease in current liabilities (alone) increases the WCR.
• If the WCR equals 1.00:
  
  • equal increases or equal decreases in current assets and liabilities will not change the WCR; it will remain 1.00.
• If the WCR exceeds 1.00:
  
  • Equal increases in current assets and liabilities decrease the WCR.
  • Equal decreases in current assets and liabilities increase the WCR.
• If the WCR is less than 1.00:
  
  • Equal increases in current assets and liabilities increase the WCR.
  • Equal decreases in current assets and liabilities decreases the WCR.

Question 9

Acid-Test Ratio

(also known as Quick Ratio)

Answer 9

• Acid-Test Ratio (also known as Quick Ratio) =
• (Cash + (Net) Receivables + Marketable Securities) / Current Liabilities
• Measures the quantitative relationship between highly liquid assets and current liabilities in terms of the “number of times” that cash and assets that can be converted quickly to cash cover current liabilities.

Question 10

Securities Defensive-Interval Ratios

Answer 10

• Securities Defensive-Interval Ratios =
• (Cash + (Net) Receivables + Marketable Securities) / Average Daily Cash Expenditures
• 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.

Question 11

Times Interest Earned Ratios

Answer 11

• Times Interest Earned Ratios =
• (Net Income + Interest Expense + Income Tax) / Interest Expense
• Measures the ability of current earnings to cover interest payments for a period.

Question 12

Times Preferred Dividend Earned Ratio

Answer 12

• Times Preferred Dividend Earned Ratio =
• Net Income / Annual Preferred Dividend Obligation
• Measures the ability of current earnings to cover preferred dividends for a period.