Lesson 7 Flashcards
(15 cards)
What are liquidity ratios?
Are concerned with the ability of the business to meet its short-term obligations.
It is important to note that you need to take into consideration company’s industry norms, financial health, and specific circumstances when analyzing liquidity ratios.
Mention the 3 types of liquidity ratios
- Current ratio
- Acid test ratio
- Operating cash flow to maturing obligations
What is current ratio
Measures if a company can pay its short-term debts using current (liquid) assets.
Ideal ratio: 2:1 (twice as many assets as liabilities)
Formula:
Current assets/Current liabilities
What is Acid test ratio
Measures if a company can pay its short-term debts using only the most liquid assets (excluding inventory).
Acceptable ratio: 1:1 or higher
Formula:
Current assets (excluding inventory)/Current liabilities
What is Cash from operations to maturing obligations
Measures if the business generates enough cash from operations to pay short-term liabilities.
Formula:
Cash from operations/Current liabilities
Note: Uses cash flow instead of just asset values. this is because cash is immediately usable in the cash flow statement. Assets are not necessarily usable immediately.
What is operating cash cycle
Operating Cash Cycle shows how many days it takes for a company to turn inventory and other resources into cash from sales
Short OCC = Business gets cash quickly = Strong liquidity
Long OCC = Cash is tied up = Liquidity problems
Formula:
OCC = Average inventory holding period + Average settlement period for receivables − average settlement period for payables
What is financial gearing
Occurs when a business uses borrowed money (debt) instead of just owners’ money (equity)
This adds financial risk, especially if interest rates are high.
What is gearing ratio
Shows how much of the company is financed by long-term debt.
Higher percentage = higher debt = more financial risk
Formula:
Long-term liabilities/(share capital+ reserves+long-term liabilities)*100
What is interest cover ratio
Shows how easily the company can pay interest on its debt using its operating profit
A ratio of 1.5 means the profit is 1.5 times the interest bill
A low ratio or a big drop is risky for lenders
Formula:
Operating profit/Interest payable
What are investment ratios
Used by shareholders to asses the returns on their investments
What is dividend payout ratio
Percentage of profit paid to shareholders
Formula:
Dividends/Earnings*100
What is dividend yield ratio
Percentage return based on share price.
This can help investors to assess the cash return on their investment in the business
Formula:
Dividend per share/Market price*100
What is earnings per share
Profit made for each share
Formula:
Earnings/Number of shares
What is cash from operations per share
Cash earned per share from real business operations.
More reliable than Earnings per share (short term)
Formula:
Cash from operations per share/ Number of shares
What is price/earnings ratio (P/E ratio)
Shows how much investors pay for each dollar of earnings
High P/E = High growth expectations.
Formula:
Market price per share/Earnings per share
