# Auditing Financial Ratios Flashcards

Liquidity Ratios

Liquidity ratios are measures of a firm’s S-T ability to pay maturing obiligations

Activity ratios

Activity ratios are measures of how effectively an enterprise is using its assets.

Profitability Ratios

Profitability ratios measure the financial performance of an enterprise for a given period of time period.

Investor Ratios

Investor ratios are measures that are of interest to investors.

Long-Term Debt-Paying Ability Ratio

(Coverage ratios) Coverage ratios are measuring of securities for L-T creditors/investors

7 Limitations of Ratios

- There are few industry benchmarks for comparison
- Dissimilar business units may make analysis difficult
- Inflation can reduce comparability of balance sheet items
- Manipulation of ratios by management can occur
- The choice of different GAAP can affect ratios and reduce comparability.
- Generalizations are difficult to make
- Ratios may use accounting data (e.g. fixed assets) that do not reflect FV

Work capital ratio

Current Assets - Current Liabilities

Current Ratio (Working Capital Ratio)

Current Assets / Current Liabilities

The higher the ratio indicates company ability to meet is short-term obligations, has improved.

Acid-Test Ratio

Cash Equivalents + Marketable Securities + AR

/

Current Liabilities

The higher the ratio the better because this indicates that company is meeting ST needs.

Cash Ratio

Cash equivalents + Marketable Securities

/

Current Liabilities

Account Receivable Turnover

Net Credit Sales

/

Average net receivables

This ratio indicates the receivables’ quality and indicates the success of the firm in collecting outstanding receivables. Faster turnover gives creditability to the current and acid-test ratios.

AR Turnover in days

Average net receivable / Net Credit sales 365

= 365 days / Receivable Turnover

This ratio indicates the average number of days required to collect AR.

Inventory Turnover

COGS / Average Inventory

This measures of how quickly inventory is sold is an indicator of enterprise performance. The higher the turnover, in general, the better the performance.

Inventory Turnover in Days

= Average Inventory / (COGS / 365)

= 365 days / Inventory T/O

Operating Cycle

= AR Turnover in days + Inventory turnover in days

The operating cycle indicates the number of days between the acquisition of inventory and realization of cash from selling the inventory.