Pre-Finals Flashcards by R A.

measure the relationship between two
or more components of financial statements.

Financial Ratios

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allow businesses to follow their company’s
performance over time and uncover signs of trouble.

Financial Ratios

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offer entrepreneurs a way to evaluate
their company’s performance and compare it to other
similar businesses in their industry.

Financial Ratios

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3 Classifications of Financial Ratio

Liquidity Ratios
Solvency Ratios
Profitability Ratios

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are an important class of financial
metrics

Liquidity Ratio

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used to determine a debtor’s ability to pay off
current debt obligations without raising external capital.

Liquidity Ratio

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require a good amount of Cash and other
liquid assets like Accounts Receivable, Inventory,
Trading Securities and Prepaid Assets.

Liquidity Ratio

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A _______________ would encourage banks or
financial institutions to lend

good liquidity position

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A ________________ may scare off potential creditors.

bad liquidity position

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General Interpretations

Numerator is assets & income - the higher, the better
Numerator is liabilities & expense - the lower, the better
Days - shorter, the better

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Formula for: Working Capital

Current Assets - Current Liabilities

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Interpretation of Working Capital

The higher the Better
A positive working capital means there are enough current assets to pay all of the current liabilities at the moment
A negative working capital would mean that the company would surely default on some of their liabilities

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Formula for: Current Ratio

Current Assets ÷ Current Liabilities

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Interpretation of Current Ratio

higher the better
the higher the current ratio, the more capable a
company is of paying its short-term obligations

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Formula for Acid Test Ratio/Quick Ratio

Quick Assets ÷ Total Current Liabilities

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How to find the Quick Assets?

Cash + Cash Equivalents + Marketable Securities + Current Accounts Receivables

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Interpretation for Acid Test Ratio/Quick Ratio

the higher the better
a positive acid test ratio means it has the capability to pay its currently maturing obligations thru its quick assets.

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Formula for: Accounts Receivable Turnover Ratio

Net Credit Sales ÷ Average A/R

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How do you find the Average AR?

Beginning AR + Ending AR ÷ 2

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Interpretation for A/R Turnover Ratios

the higher the better
means a better performance from its collection department.

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States the usual number of days that it would take
before the company would be able to collect a certain
group of receivables.

Average Collection Period

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Formula for: Average Collection Period

360/365 Days ÷ A/R Turnover Ratio

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Interpretation for Average Collection Period

the shorter days, the better
mean that the company is efficient in collecting their outstanding Accounts Receivable from their customers.

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This ratio measures the number of times the
company was able to sell its entire inventory to
customers during the year.

Inventory Turnover Ratio

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Formula for: Inventory Turnover Ratio

Cost of Goods Sold / Cost of Sales ÷ Average Inventory

How to get the Average Inventory

Beginning Inventory + Ending Inventory ÷ 2

Interpretation for Inventory Turnover Ratio

- higher the better - it would mean that the company is being more effective in selling its inventory to customers.

Unsold goods for a long period of time may lead to?

Inventory obsolescence

States the number of days that it would take before a group of inventory will be entirely sold by the company.

Average days in Inventory

Formula for Average Days in Inventory

360/365 Days ÷ Inventory Turnover Ratio

Interpretation for Average Days in Inventory

- the shorter, the better - it would mean that the cash of the company is not being tied to its inventory for a very long period of time.

This is the measure on how long it would take for the company to transform its inventory back to cash.

Number of days in the operating cycle

Formula for Number of days in the operating cycle

Average Collection Period + Average Days in Inventory

Interpretation for Number of Days in Operating Cycle

- the shorter, the better - it would mean that the cash of the company is not being tied to its inventory for a very long period of time.

measure the capability of an entity to pay long term obligations as they fall due.

Solvency Ratios

Different Solvency Ratios

Debt to Total Assets Ratio Debt to Equity Ratio Times Interest Earned Ratio

proportion between the total liabilities of the company with its total assets.

Debt to Total Assets Ratio

The debt ratio shows how much of the assets of the company were given by creditors.

Debt to Total Assets Ratio

Formula for Debt to Total Assets Ratio

Total Debts ÷ Total Assets

Interpretation for Debt to Total Assets Ratio

- the lower, the better - There is a bigger probability of collection in the future if there are fewer liabilities to pay.

Compares the liabilities of the company with its equity.

Debt to Equity Ratio

Formula for Debt to Equity Ratio

Total Liabilities ÷ Total Equity (shareholder's equity)

Interpretation for Debt to Equity Ratio

- the lower, the better - it would indicate a healthier solvency position for the company.

Shows the proportion between the Earning Before Interest and Taxes (EBIT) of the company and its interest expense.

Times Interest Earned Ratio

an indicator on how many times can the EBIT cover its finance cost of borrowing.

Times Interest Earned Ratio

related to the solvency situation of the company because interest expense is always a part of long term borrowing.

Times Interest Earned Ratio

Formula for Times Interest Earned Ratio

EBIT ÷ Total Interest Expense

how can you calculate for EBIT?

EBIT = Revenue − COGS − Operating Expenses EBIT = Net Income + Interest + Taxes

Interpretation for Times Interest Earned Ratio

- the higher, the better - it would indicate that it the company is worthy to borrow money from others

One of the primary reasons why stockholders invest in a certain company is the chance of earning profits.

Profitability Ratios

What are the different Profabilty Ratios?

Gross Profit Ratio Profit Margin Ratio Operating Expenses to Sales Ratio Return on Investment Ratio -> Return on Assets -> Return on Equity Asset Turnover Ratio

proportion of the gross profit of the company with its nets sales.

Gross Profit Ratio

How to calculate for Gross Profit

Net Sales - Cost of Sales

How to calculate for Net Sales

(Gross) Sales - (Sales Discount + Sales Return & Allowance)

Formula for Gross Profit Ratio

Gross Profit ÷ Net Sales x 100

Interpretation for Gross Profit Ratio

- the higher, the better - It means that it was able to generate more sales from the smaller cost of goods sold that it has. *The gross profit ratio can be improved by continuously finding inventories with lower cost, without sacrificing its quality.*

measures the proportion between the NIAT and the net sales of the company.

Profit Margin Ratio

a more precise measure of the company’s profitability because it has already considered the operating expenses and other expenses of the entity.

Profit Margin Ratio

Formula for Profit Margin Ratio

NIAT ÷ Net Sales

Interpretation of Profit Margin Ratio

- the higher, the better

aside from the cost of goods sold, is one of the biggest expenses of every company.

Operating Expenses

Further Classification of Operating Expenses

General and Administrative Expenses Selling Expenses.

Formula for Operating Expenses to Sales Ratio

Operating Expense ÷ Net Sales x 100

Interpretation of Operating Expenses to Sales Ratio

- the lower, the better - The goal is to generate as much sales with the minimum possible operating expenses.

Two variations of Return on Investment Ratio:

Return on Assets Return on Equity

the average total assets being used may come predominantly from creditors.

Return on Assets

Formula for Return on Assets

Net Income After Tax ÷ Average Total Assets (answer in percent)

How to compute for the Average Total Assets?

Beginning Total Assets + Ending Total Assets ÷ 2

Interpretation of Return on Assets

- the higher, the better - goal is to generate as much profit based on the available assets during the year.

a more specific computation of a company’s profitability because the denominator being used is the one coming from stockholders or owner alone.

Return on Equity

Formula for Return on Equity

Net Income After Tax ÷ Average Equity

How to compute for the Average Equity?

Beginning Equity + Ending Equity ÷ 2

Interpretations of Return on Equity

- higher the better

measures the correlation between the assets owned by the company and the net sales being generated by such properties.

Asset Turnover Ratio

Formula for Asset Turnover Ratio

Net Sales ÷ Average Total Assets

Interpretation of Asset Turnover Ratio

- the higher, the better