Ratio's for measuring accounting performance

Question 1

ROA

Answer 1

A measure of return on total investment in a firm. Larger is usually better. (profit after taxes/total assets)

Question 2

ROE

Answer 2

A measure of return on total equity investment in a firm. Larger is usually better. (profit after taxes/total stockholder’s equity)

Question 3

Gross profit margin

Answer 3

A measure of sales available to cover operating expenses and still generate a profit. Larger is usually better. (sales- cost of goods sold/sales)

Question 4

Earnings per share (EPS)

Answer 4

A measure of profit available to owners of common stock. Larger is usually better. (profit after taxes - preferred stock dividends)/number of shares of common stock outstanding)

Question 5

Price earnings ratio (p/e)

Answer 5

A measure of anticipated firm performance—a high p/e ratio tends to indicate that the stock market anticipates strong future performance. Larger is usually better.

Question 6

Cash flow per share

Answer 6

A measure of funds available to fund activities above current level of costs. Larger is usually better.

Question 7

Current ratio

Answer 7

A measure of the ability of a firm to cover its current liabilities with assets that can be converted into cash in the short term. Recommended in the range of 2 to 3.

Question 8

Quick ratio

Answer 8

A measure of the ability of a firm to meet its short-term obligations without selling off its current inventory. A ratio of 1 is thought to be acceptable in many industries.

Question 9

Debts to assets

Answer 9

A measure of the extent to which debt has financed a firm’s business activities. The higher, the greater the risk of bankruptcy.

Question 10

Debt to equity

Answer 10

A measure of the use of debt versus equity to finance a firm’s business activities. Generally recommended less than 1.

Question 11

Times interest earned

Answer 11

A measure of how much a firm’s profits can decline and still meet its interest obligations. Should be well above 1.

Question 12

Inventory turnover

Answer 12

A measure of the speed with which a firm’s inventory is turning over. In many industries, higher inventory turnover is better.

Question 13

Accounts receivable turnover

Answer 13

A measure of the average time it takes a firm to collect on credit sales. In many industries, faster accounts receivable turnover is better.

Question 14

Average collection period

Answer 14

A measure of the time it takes a firm to receive payment after a sale has been made. In many industries, shorter collection periods are better.

Question 15

Profitability ratios

Answer 15

These ratios have some measure of profit in the numerator and some measure of firm’s size or assets in the denominator.

Question 16

Liquidity ratios

Answer 16

These ratios focus on the ability of a firm to meet its short-term financial obligations.

Question 17

Leverage ratios

Answer 17

Ratios in this category focus on the level of a firm’s financial flexibility. This includes its ability to obtain more debt.

Question 18

Activity ratios

Answer 18

Ratios focus on the level of activity in a firm’s business.

Question 19

What is the interpretation of the WACC?

Answer 19

The ideal situation is: WACC < ROA (return on assets) > Industry average return on assets

WACC is lower than the firms ROA: this is good because the costs of the firm’s capital are lower than the returns, thus making money, ROA is better than the industry average, this indicates competitive advantage.

Question 20

Emergent strategies

Answer 20

Theories of how to gain competitive advantage in an industry that emerge over time or that have been radically reshaped once they are initially implemented.

Question 21

Intended strategies

Answer 21

The simplest way of thinking about a firm’s strategy to assume that firms choose and implement their strategies exactly as described by the strategic management process.

Question 22

WACC

Answer 22

(Market value of debt/firm’s market value) x after tax cost of debt + (market value of equity/firm’s market value) x cost of equity

Question 23

Cost of equity

Answer 23

Risk-free rate of return + B (expected market return - risk free rate of return)