Flashcards in Ratios Deck (42)
current assets/current liabilities
*measures ability to discharge currently maturing obligations from existing current assets
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
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
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
* measures relative control over inventory investment. May provide basis for determining the presence of obsolete inventory or pricing problems (in case of low turnover)
What are the limitations of inventory turnover?
Different inventory cost flow assumptions can produce widely different inventory valuations and thus turnover ratios
net credit sales/average receivables
* confirms the fairness of the receivable balance. May indicate presence of possible collection problems (in case of low turnover)
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
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.
What is the limitation on cash from operating activities to current liabilities?
current liabilities may understate ST demands on cash
Total asset turnover
net sales/average total assets
* measures how efficiently assets are used to produce sales
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
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
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.
Return on common stockholder's equity
net income less preferred dividends/average common stockholder's equity
* measures return on common stockholders in aggregate
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
Total liabilities/total assets
*indicates extent of leverage used and creditor protection in case of insolvency
What is the limitation of deb ratio?
Denominator reflects historical costs and not current values
total liabilities/shareholder's equity
*determines the equity's LT debt paying ability
What is the limitation on debt/equity ratio?
there is a lack of uniformity in calculating this ratio
Total stockholder's equity/total assets
* measures total asset investment provided by stockholders
What are the limitations of equity ratio?
assets are recorded at historical cost and not at current value
Times interest earned
income before interest expenses and taxes/interest expense
*measures ability to cover interest charges
What are the limitations of times interest earned?
Accrual income does not necessarily indicate availability of cash to pay interest charges
market price per common share/earning per share
*indicated relationship of common stock to net earnings
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
dividend per common share/market price per common share
*shows return to stockholders based on current market price of stock
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
Profit margin on sales
*measures efficiency of earning income from sales
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)
Book value per common share
common stockholder's equity/common shares outstanding
*measures net assets applicable to each common share
What are the limitations of book value per common share?
assets are recorded at historical costs and not at current value
Cash flow per common share
income plus noncash adjustments/common shares outstanding
*measures resources (i.e. cash) generated per common share
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
Payout ratio to common shareholders
common dividends/net income less preferred dividends
*measures portion of net income to common shareholders paid out in dividends
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
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
What are the limitations of cash from operation activities to net income?
net income includes noncash revenues and expenses recognized by accrual accounting principles
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
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
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