The Formula Sheet Flashcards
What is liquidity?
the availability of cash and near-cash to meet obligations
What is solvency?
the ability to meet debt obligations (interest obligations and payment of principal value)
What does the Return on Equity (ROE) measure?
how effectively a company uses its assets to build revenue
What does a company wants for ROE?
higher
What is the relationship between debt and default risk?
debt increases default risk
What is default risk?
the more liabilities you have, the less likely it becomes that you’ll be able to pay all of them
What is Return on Assets (ROA)?
it measures how profitable the assets are
What does a company want for ROA?
higher
How would you increase your ROA?
- target higher profit margins
- increase asset turnover
The two components that make up ROA are:
profit margin and asset turnover
What does Gross Profit Margin (GPM) measure?
the % of each sales dollar left over after product costs are subtracted
What does Expenses-to-Sales (ETS) measure?
the % of each sales dollar that covers a specific expense item
What does Asset Turnover measure?
how effectively a company is using its assets to generate revenue
What does a company want for Asset Turnover?
higher
What does Accounts Receivable Turnover measure?
how effectively a company collects the $$ clients owe them on credit
What does a company want for Accounts Receivable Turnover?
higher
What does Inventory Turnover measure?
the flow of goods out of inventory relative to the balance in inventory
What does a company want for Inventory Turnover, and why?
higher because it predicts stronger sales
Current Ratio is a measurement of (liquidity/solvency).
liquidity
Quick Ratio is a measurement of (liquidity/solvency).
liquidity
Operating Cash Flow to Current Liabilities (OCFCL) is a measurement of (liquidity/solvency).
liquidity
Times Interest Earned is a measurement of (liquidity/solvency).
solvency
Debt-to-Equity is a measurement of (liquidity/solvency).
solvency
What does the Current Ratio measure?
if companies will meet their short-term obligations
What does a company want for Current Ratio and why?
higher, preferably above 2, because it shows that they have the assets available to pay off their liabilities (very liquid)
What does the Quick Ratio measure?
a company’s ability to use cash to retire liabilities quickly
What does a company want for Quick Ratio and why?
higher, preferably above 1, to show that a company can quickly pay off liabilities with cash (very liquid)
What does Times Interest Earned measure?
shows how many times a company could pay its interest expenses with pretax income
What does a company want for Times Interest Earned and why?
higher, implies smaller default risk
What does Debt-to-Equity measure?
how reliant on stockholder financing and loans a company is
What does a company want for Debt-to-Equity and why?
lower, because higher means there is lower solvency which means more default risk
True or false: A company wants to be both liquid and solvent.
true!!
