Unit 3: Flashcards
What does an activity ratio measure?
Activity ratios measure how quickly the two major noncash assets (receivables and inventory) are converted to cash.
What is the formula to calculate the accounts receivable turnover ratio?
Accounts receivable turnover = Net credit sales ÷ Average accounts receivable
How is days’ sales outstanding in receivables calculated?
Days’ sales outstanding in receivables = Days in year ÷ Accounts receivable turnover
What is the formula to calculate the inventory turnover ratio?
Inventory turnover = Cost of goods sold ÷ Average inventory
How is days’ sales in inventory calculated?
Days’ sales in inventory = Days in year ÷ Inventory turnover
How is the accounts payable turnover ratio calculated?
Accounts payable turnover = Purchases ÷ Average accounts payable
What is the formula for the days’ purchases in accounts payable?
Days’ purchases in accounts payable = Days in year ÷ Accounts payable turnover
How is the operating cycle calculated?
Operating cycle = Days’ sales outstanding in receivables + Days’ sales in inventory
How is the cash cycle calculated?
Cash cycle = Operating cycle – Days’ purchases in accounts payable
How is the total assets turnover ratio calculated?
Total assets turnover ratio = Net sales ÷ Average total assets
Which is better, an asset turnover ratio of 2.1 or 2.9?
For all activity ratios, a higher turnover is preferable to a lower turnover. Thus, 2.9 is better than 2.1.
Common benchmarks used in ratio analysis include (3)
Industry norms
The aggregate economy
A firm’s past performance
Ratio analysis can be used to (5)
Analyze financial statements
Judge efficiency
Locate weakness(es)
Formulate plans
Compare performance
Limitations of ratio analysis include
Use of estimates
Management’s incentive(s) to manipulate financial items
Earnings quality
Inflation
Differences in accounting policies among firms
Seasonal factors
