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Flashcards in Ratios Deck (42)
1

Current ratio

current assets/current liabilities
*measures ability to discharge currently maturing obligations from existing current assets

2

What is the limitation on the current ratio?

BS account totals based on historical costs do not necessarily represent market values. A sizable amount of the current asset total might be tied up in inventory which is less liquid. Implies liquidation of assets and elimination of liabilities

3

Quick ratio (acid test)

current assets less inventories and prepaid assets/current liabilities
* measures ability to discharge currently maturing obligations based on most liquid (quick) assets

4

What is the limitation of the quick ratio?

receivables may be subject to a lengthy collection period and might have to be factored at less than carrying value if cash is needed immediately. Securities are subject to fluctuation market conditions which affect their liquidation amount

5

Inventory turnover

COGS/average inventory
* measures relative control over inventory investment. May provide basis for determining the presence of obsolete inventory or pricing problems (in case of low turnover)

6

What are the limitations of inventory turnover?

Different inventory cost flow assumptions can produce widely different inventory valuations and thus turnover ratios

7

Receivables turnover

net credit sales/average receivables
* confirms the fairness of the receivable balance. May indicate presence of possible collection problems (in case of low turnover)

8

What are the limitation of receivables turnover?

affected by significant seasonal fluctuations unless denominator is a weighted average. Poor collection policy can understate this ratio by increasing average receivables

9

Cash from operating activities to current liabilities

net cash provide by operating activities/current liabilities
* shows extent to which a company has covered its current liabilities by generation cash from normal operations.

10

What is the limitation on cash from operating activities to current liabilities?

current liabilities may understate ST demands on cash

11

Total asset turnover

net sales/average total assets
* measures how efficiently assets are used to produce sales

12

What are the limitations of total asset turnover?

does not take into account that certain assets make no tangible contribution to sales. Assumes that an asset's participation in generating sales is relative to its recorded amount. Rate of return is based on historical cost which does not reflect current values

13

Rate of return on total assets

net income plus interest expense (net of tax effect)/average total assets
* measures the productivity of assets in terms of producing income

14

What are the limitations on rate of return on total assets?

Similar to asset turnover ratio. Accrual net income subject to estimates and does not reflect actual cash return. Rate of return is based on historical asset cost which does not reflect current values.

15

Return on common stockholder's equity

net income less preferred dividends/average common stockholder's equity
* measures return on common stockholders in aggregate

16

What are the limitations of return on common stockholders' equity?

Book value of common stockholders' equity reflects historical cost and not current value. Accruals net income involves estimates and does not reflect actual cash return

17

Debit ratio

Total liabilities/total assets
*indicates extent of leverage used and creditor protection in case of insolvency

18

What is the limitation of deb ratio?

Denominator reflects historical costs and not current values

19

Debt/equity ratio

total liabilities/shareholder's equity
*determines the equity's LT debt paying ability

20

What is the limitation on debt/equity ratio?

there is a lack of uniformity in calculating this ratio

21

Equity ratio

Total stockholder's equity/total assets
* measures total asset investment provided by stockholders

22

What are the limitations of equity ratio?

assets are recorded at historical cost and not at current value

23

Times interest earned

income before interest expenses and taxes/interest expense
*measures ability to cover interest charges

24

What are the limitations of times interest earned?

Accrual income does not necessarily indicate availability of cash to pay interest charges

25

Price-earnings ratio

market price per common share/earning per share
*indicated relationship of common stock to net earnings

26

What are the limitations of price-earnings ratio?

earning per share computation subject to arbitrary assumptions and accrual income. EPS is not the only factor affecting market prices

27

Dividend yield

dividend per common share/market price per common share
*shows return to stockholders based on current market price of stock

28

What are the limitations of dividend yield?

dividend payments to stockholders are subject to many variables. The relationship between dividends paid and market prices is a reciprocal one

29

Profit margin on sales

net income/sales
*measures efficiency of earning income from sales

30

What are the limitations of profit margin on sales?

accrual income includes estimates. Income includes costs over which management has little or no control (ex:taxes)

31

Book value per common share

common stockholder's equity/common shares outstanding
*measures net assets applicable to each common share

32

What are the limitations of book value per common share?

assets are recorded at historical costs and not at current value

33

Cash flow per common share

income plus noncash adjustments/common shares outstanding
*measures resources (i.e. cash) generated per common share

34

What are the limitations of cash flow per common share

This ratio is the least understood and therefore the most likely to mislead an investor. FASB strongly recommends against the isolated disclosure of this ratio

35

Payout ratio to common shareholders

common dividends/net income less preferred dividends
*measures portion of net income to common shareholders paid out in dividends

36

What are the limitations of payout ratio to common shareholders?

income does not necessarily measure cash available for dividend payment. Heavily influenced by management policy, nature of business and stages of development - all of which diminish comparability

37

Cash from operating activities to net income

net cash provided by operations activities/net income
*shows cash flow effects of the company's net income for the period

38

What are the limitations of cash from operation activities to net income?

net income includes noncash revenues and expenses recognized by accrual accounting principles

39

What are the 5 measures of liquidity (ability to meet current debt)?

1. current ratio
2. quick ration
3. inventory turnover
4. receivables turnover
5. cash from operating activities to current liabilities

40

What are the 7 measures of return on investment?

1. total asset turnover
2. rate of return on total assets
3. return on common stockholder's equity
4. price-earnings ratio
5. dividend yield
6. profit margin on sales
7. payout ratio to common

41

What are the 6 measures of solvency (LT financing and debt-paying ability)?

1. debt to equity ratio
2. equity ratio
3. times interest earned
4. book value per common share
5. cash flow per common share
6. cash from operating activities to net income

42

What are the 4 critical considerations of which you must be continually mindful of in ratio analysis?

1. accounting methods used to state assets, liabilities, stockholder's equity, revenues and expenses are not necessarily designed to produce the most useful numbers for the purposes for which the ratios are intended
2. differences in the underlying economic events, the types of enterprises involved, the stage of development of enterprises and other factors affect comparability between enterprises
3. several ratios include the use of external market values of stock which are influenced by numerous variables over which management has little influence or control
4. management policy may influence many ratios