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15 Cards in this Set
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Ratio Analysis (purpose) |
enables comparisons over time, across firms and help identify financial strengths and weaknesses |
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3 Ratio Analysis Concepts |
1. The names given to ratios usually indicate the elements to be used -i.e. debt to equity ratio = total debt / owner's equity
2. The names given indicate the function to be performed -i.e. return "on" assets = NI / assets
3. When using BS value with IS value, must get average balance for BS value -IS value is for the year, BS value is a point in time
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4 Major Purposes of Ratios |
1. liquidity/solvency
2. operational activity
3. profitability
4. equity/investment leverage |
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Liquidity (solvency) defined |
measures the ability of a firm to pay its debts |
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7 Major Liquidity Measures |
1. Working Capital 2. Working Capital Ratio 3. Acid Test (Quick) Ratio 4. Defensive-Interval Ratio 5. Average Collection Period 6. Times Interest Earned Ratio 7. Times Preferred Dividends Earned Ratio |
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Working capital (defined & computation) |
measures the extent to which assets are uncommitted in the short term
WIC = Current Assets - Current Liabilities |
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Working Capital (Current) Ratio defined & Computation |
measures the number of times that current assets can cover current liabilities
WCR = Current Assets / Current Liabilities
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if WCR > 1, then |
-equal increases in CA and CL decreases WCR -equal decreases in CA and CL increases WCR -can increase by paying off AP
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If WCR < 1, then |
-equal increases in CA and CL increase WCR -equal decreases in CA and CL decrease WCR |
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Acid Test (Quick) Ratio defined and computation |
measures the relationship between highly liquid assets and liabilities in terms of the number of times that cash and assets could quickly be converted to cover liabilities
ATR= (Cash + Net Receivables + Marketable Securities) / Current Liabilities
-Can be increased quickly by selling obsolete inventory at a loss
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Limitation of ATR |
fluctuating market prices of ST investments may adversely affect the ratio |
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Defensive-Interval Ratio (defined and computed) |
measures the relationship between highly liquid assets and the average daily use of cash in terms of the # of days that cash and assets can be quickly converted to support operating costs
DIR= (cash + net receivables + marketable securities) / Average Daily Cash expenditures |
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Average Collection Period (defined and computed) |
average number of days required to convert AR to cash
ACP = (Days in Year*Average AR) / Credit sale for the period |
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Times Interest Earned Ratio (defined and computed) |
measures the ability of current earnings to cover interest payments for a period
TIER = (NI + Int Expense + Income Tax Expense) / Int Expense |
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Times Preferred Dividends Earned Ratio (defined and computed) |
measures the ability of current earnings to cover preferred dividends for a period
TPDER = NI / Annual Preferred Div Obligation |
