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47 Cards in this Set

  • Front
  • Back
Leverage Ratios are also known as what and they are used for what?
Also known as capitalization ratios

provide measures of the firm's use of debt financing.
Leverage ratios are very important to whom?
Potential creditors

because it shows the firm's ability to generate the cash flow necessary to make payments on outstanding debt
Why are leverage ratios important to management?
Monitor the firm's use of debt financing
The commitment to service outstanding debt is a_____to a firm, resulting in decreased ______ and higher ________________.
fixed cost
break-even production rates
What are the two ways to finance the acquisition of any asset?
debt and equity
The answer of how much debt is too much debt is determined largely by
The nature of the business or industry
Debt to equity formula
= Debt / Equity
What does the debt to equity formula tell us?
The ratio of debt-to-owner's equity or net worth indicates...

the degree of financial leverage that you're using to enhance your return.
A rising debt-to-equity ratio may signal that...
further increases in debt caused by purchases of inventory or fixed assets should be restrained.
What are the ways to improve the debt to equity formula?
either paying off debt
increasing the amount of earnings retained in the business until after the balance sheet date.

Other Ways
Can expenses be deferred beyond the balance sheet date to increase your retained earnings?
Delaying any planned bonus expense serves to increase your retained earnings.
Repaying revolving debt (such as a line of credit) before the balance sheet date and borrowing again after the balance sheet date
Equity Ratio (formula and definition)
measures what portion of a company's assets are contributed by the owners

=Total Shareholders' Equity / Total Assets
Short Term Debt Ratio (formula and definition)
The portion of debt payable within one year to total debt

= Short Term Debt / Total Debt
or CL / TL
What does the balance between short term and long term debt tell us?
The greater the short term liabilities, the higher the pressure on a firm's cash flows
What does the short term debt ratio indicate? What about when the ratio is high?
Whether a firm will be able to satisfy its immediate financial obligations

A high ratio points to a lack of liquidity since most of the corporate debt will have to be met in the current year. However, it should be noted that a high STD Ratio presents high values both when there is maximum solvency and also when there is financial distress!
Times Interest Earned, or Interest Coverage (definition and formula)
Focuses on the interest portion of your debt payments. Measures how many times you interest obligations are covered by your earnings from operations

=[Net Income + Interest Expense(1-t)] / Interest Expense
What can you determine by comparing the ratio of earnings to interest expense?

What does it mean if it's rising or falling?
Measures the firm's ability to meet its on-going commitments to service debt previously borrowed. A TIE of 3.6 means that the firm's profits exceed interest expense it was required to pay by 360%.

The higher the ratio, the bigger your cushion and the more able the business is to meet interest payments. If it is declining over time, it's a clear indication that your financial risk is increasing
To whom is the Times Interest Earned Ratio significant? And why?
lenders of short-term debt to the firm

since short-term debt is usually paid out of current operating revenue.
Retention Ratio (definition and formula)

What is another way of calculating it?
The percent of earnings credited to Retained Earnings. In other words, the proportion of NI not paid out as dividends.

=[Net Income - Dividends] / Net Income

Because the retention ratio is the opposite of dividend payout, it can also be calculated as 1 - dividend payout ratio.
Which are the strong indicators of liquidity? (3)
1. Cash Flow Statement
2. Lines of Liquidity
2.a Liquid Assets / ST Debt
Liquid assets being cash + short term fin assets + bank accounts
2.b Liquidable Assets / ST Debt
Liquidable Assets being Ready to be Sold + Receivables + Long Term Assets not linked to operation
3. Average Collection and Payment Periods
Managers and creditors must closely monitor the firm's ability to______ . The liquidity ratios are measures that indicate a firm's ________. _________represent obligations that are typically due in one year or less
meet short-term obligations
ability to repay short-term debt
Current liabilities
Working Capital (formula)


Current Ratio (definition and formula).

What would a current ratio of 1.5 mean?
Expresses a company's ability to repay short-te

=CA / CL

A current ratio of 1.5 would mean that for every dollar in current liabilities, the firm was $1.5 in current assets.
The least liquid of current assets is often...
What concern does the current ratio not take into account that the acid test (quick ratio) does?
Inventory that is not easily sold will not be helpful in meeting short-term obligations. The quick (or acid test) ratio incorporates this concern.
Acid Test - Quick Ratio (definition and formula)
Expresses a company's ability to repay short-term creditors out of its most liquid assets

=[CA - Inv] / CL
When it comes to the acid test (quick ratio), above what value would the firm be fully covered?
If the value is greater than 1.00, it means fully covered.
The quick ratio is a more appropriate measure for industries that involve ________, such as in manufacturing.
long product production cycles
Liquidity ratio (definition and formula)
Expresses a company's ability to repay short-term creditors out of its total cash.

=(Cash + equivalents) / CL
When it comes to the liquidity ratio, above what value would the firm be fully covered?
Because it shows the number of times short-term liabilities are covered by cash, then If the value is greater than 1.00, it means fully covered.
Efficiency Ratios (definition)
Ratios that are typically used to analyze how well a company uses its assets and liabilities internally. They can calculate the turnover of receivables, the repayment of liabilities, the quantity and usage of equity and the general use of inventory and machinery. 
When are efficiency ratios meaningful?

Also, efficiency ratios are important because an improvement in the ratios usually translate to _____.
When compared to peers in the same industry and can identify businesses that are better managed relative to others

improved profitability
Asset Turnover (definition and formula)
Indicates relationship between assets and revenue.

Useful to determine the amount of sales that are generated from each dollar of assets

=Sales / TA
Companies with low _______ tend to have _____ asset turnover, and the opposite to be true. For companies in the retail industry, you would expect a very ___ asset turnover.
amount of sales that are generated from each dollar of assets

profit margins


The asset turnover ratio is more useful for _____ companies to check if in fact they are growing revenue in proportion to sales.
What is the relationship between ROA and AT?

What is the restaurant example?
ROA = margin * AT
ROA = EBI / Assets = (EBI/Sales)*(Sales / Assets)

A restaurant would be better off with a margin of 20% and an asset turnover of 2 than a margin of 30% and an asset turnover of 1.
Inventory Turnover (definition and formula)
Gives a general view on the inventories of a company. The result represents how many times the inventory was used and replaced again.

= Sales / Average Inventory
Inventory Turnover:
This number is representative for ____ time period. If the value of the inventory-turnover ratio is low, then it indicates that the management team _____________.
a one year
doesn't do its job properly in managing inventories
When it comes to inventory turnover, the main goal of the management team is to
find the most efficient level of resources which will help them meet the orders of their clients.
The level of inventory that should be kept depends from one company to another. For instance _______ and _______ should have a higher level of inventory, whereas ______ and ________ require lower levels of inventories
manufacturers and retailers
software makers or advertising companies
Accounts Receivable Turnover Ratio (definition and formula)
The number of times accounts receivable amount is collected throughout the year.

=Annual Credit Sales / Average AR
What does a high AR Turnover tells us versus a low one?
A high accounts receivable turnover ratio indicates a tight credit policy.

A low or declining accounts receivable turnover ratio indicates a collection problem, part of which may be due to bad debts.
Collection Period (Average Collection Period) Ratio (2 formulas and definition)
The collection period or average collection period shows the cost in extending credit to customers. It should be compared to competitors to see if the credit given, or customer risk, is in line with the industry standards.
What does a high collection period show?
shows a high cost in extending credit to customers.
Creditors / Accounts Payable Turnover Ratio (definition and 2 formulas)
Signifies the credit period enjoyed by the firm in paying its creditors. Can be calculated as creditors turnover ratio and as Average Payment period.

Creditors Turnover = Credit Purchase / Average Trade Creditors

Average Payment Period = Trade Creditors / Average Daily Credit Purchase

Average Daily Credit Purchase = Credit Purchase / No. Working Days in a Year
What does the average payment period show?

What are the significances of high and low values?
represents the number of days by the firm to pay its creditors. A high creditors turnover ratio or a lower credit period ratio signifies that the creditors are being paid promptly. This situation enhances the credit worthiness of the company. However a very favorable ratio to this effect also shows that the business is not taking the full advantage of credit facilities allowed by the creditors.
Cost Management Ratios

What used to be the most significant expenses (apart from COGS) that make it useful to monitor their evolution?
Used to monitor evolution of expenses.

Depreciation/ Sales
Salaries and benefits / Sales
Financial expenses / Sales
How should one proceed analyzing a company?
First: analyze the evolution of industry and company

Perform a trend analysis and common size analysis to find out which are the factors driving changes

Once here, financial ratios can be calculated

Start analyzing profitability:
∆ Sales, ∆ EBITDA, ∆ NE
Are there any economic or financial problems?
A) If financial:
Analyze leverage: Debt/Equity
Does it affect liquidity? (CFS)
If this is a short temr problem, does it arise due to financial or commercial operations? (ACP, APP, STdebt/total debt, TIE)
Is pay-out policy adequate?
Which are the perspectives? Market ratios (PER)(TSR)