Cpa Review- Far 7-4 (Appendix 1: Ratio Analysis)

Front 1

Ratios

Back 1

-Financial indicators that distill relevant information about a business entity by quantifying the relationship among selected items on the F/S's.

Hint 1

-May be compared to ratios of a different period or to industry ratios. These comparative analyses identify trends that may seem important to investors, lenders, and other interested parties.

Front 2

Types of Financial Ratios

Back 2

1. Liquidity Ratios: measures a firm's short-term ability to pay maturing obligations.
2. Activity Ratios: measures how effectively an enterprise is using its assets.

Hint 2

3. Profitability Ratios: measures of the success or failure of an enterprise for a given time period.
4. Long-Term Debt-Paying Ability (Coverage) Ratios: measures of security for long-term creditors / investors.

Front 3

Liquidity Ratios

Back 3

1. Working Capital = Current Assets - Current Liabilities*
2. Current Ratio (Working Capital Ratio) = Current Assets ÷ Current Liabilities*
*Measures ability to meet short term obligations

Hint 3

3. Acid Test Ratio = (Cash equivalents + Marketable securities + Net receivables) ÷ Current liabilities*
4. Cash Ratio = (Cash equivalents + Marketable securities) ÷ Current liabilities*
*Measures ability to meet short term obligations

Front 4

Activity Ratios

Back 4

1. A/R Turnover = Net credit sales ÷ Average net receivables
-Indicates receivables quality and indicates the success of the firm in collecting outstanding receivables.
2. A/R Turnover in Days = Average net receivables ÷ (Net credit sales ÷ Receivable turnover)* or
2. A/R Turnover in Days = 365 days ÷ Receivable turnover*
*Indicates the average number of days required to collect accounts receivable.

Hint 4

3. Inventory Turnover = COGS ÷ Average Inventory
-Measure of how quickly inventory is sold, indicator of enterprise performance.
4. Inventory Turnover in Days = Average inventory ÷ (GOGS ÷ 365)* or
4. Inventory Turnover in Days = 365 days ÷ Inventory Turnover*
*Indicates the average number of days to sell inventory
5. Operating Cycle = A/R turnover in days + Inventory turnover in days
-Indicates the number of days between acquisition of inventory and realization of cash from selling the inventory.

Front 5

Activity Ratios

Back 5

1. Working Capital Turnover = Sales ÷ Average working capital
-Indicates how effectively working capital is used.

Hint 5

2. Total Asset Turnover = Net sales ÷ Average total assets
-Indicator of how the firm makes effective use of its assets, higher ratio indicates effective asset use to generate sales.

Front 6

Profitability Ratios

Back 6

1. Net Profit Margin = Net income ÷ Net sales
-Indicates the profit rate and when used w/ the asset turnover ratio, the return on assets.
2. Return on Total Assets = Net income ÷ Average total sales

Hint 6

3. DuPont Return on Assets = Net profit margin x Total asset turnover
-Net profit margin indicates the percent return on each sale while asset turnover indicates the effective use of assets in generating that sale.

Front 7

Profitability Ratios

Back 7

1. Return on Investment = (Net income + Interest expense (1 - Tax rate)) ÷ (Average (Long-term liabilities + Equity))
-Measures the performance of the firm w/out regard to the method of financing.

Hint 7

2. Return on Common Equity = (Net income - Preferred dividends) ÷ Average common equity

Front 8

Long-Term Debt-Paying Ability Ratios

Back 8

1. Debt / Equity = Total liabilities ÷ Common stockholders' equity
-Indicates the degree of protection to creditors in case of insolvency, the lower the better.
2. Debt Ratio = Total liabilities ÷ Total assets
-Indicates what amount of assets are financed by creditors

Hint 8

3. Times Interest Earned = Recurring income before taxes and interest ÷ Interest
-Reflects ability of company to cover interest charges.
4. Operating CF / Total Debt = Operating CF ÷ Total debt
-Indicates the ability of the company to cover total debt w/ yearly cash flow.

Front 9

Limitations to Ratios

Back 9

-Although easy to compute, they depend entirely on the reliability of the data on which they are based (ex: estimates and historical cost).

Hint 9

-Additional information is also valuable when analyzing a company: common size analysis (vertical and horizontal), industry statistics, trend analysis, etc.