Ratios Used in Analytical Procedures

Question 1

Liquidity Ratios

1. Current Ratio
2. Quick Ratio (acid test)

Answer 1

1. Current Ratio = Current Assets / Current Liabilities
2. Quick or Acid Test Ratio = Quick or liquid assets / Current Liabilities
   • where liquid assets are:
     
     • Cash or equivalents
     • Current investments in marketable securities
     • net accounts receivable
   • NOTE = this ratio does NOT include inventory!!!

Question 2

Activity Ratios

1. Accounts Receivable Turnover
2. Inventory Turnover
3. Asset Turnover

Remember the general rule that with income statement / balance sheet ratios you typically use the average balance sheet amount unless the beginning and ending balances are not given!

Answer 2

1. A/R Turnover = Net Credit Sales / Avg. Net AR
2. Inventory Turnover = COGS / Avg. Inventory
3. Asset Turnover = Net Sales / Avg. Total Assets

Question 3

Profitability Ratios

1. Gross Margin Percentage
2. Net Operating Margin Percentage

Answer 3

1. GM Ratio = Gross Margin / Sales
2. Net Operating Margin Percentage Ratio = Operating Income / Sales
   
   • where OI = EBIT

Question 4

Coverage Ratios

1. Times Interest Earned
2. Debt to Equity Percentage

Answer 4

1. TII = EBIT / Interest Expense
2. D2E = Total Debt / Total Equity

Question 5

1. Accounts Receivable Turnover
2. Days Sales in Accounts Receivable

Relationship between the two if:

1. AR decreases
2. AR increases

Answer 5

1. AR Turnover = Sales / AR
2. DSAR = 365 / AR Turnover

As Sales increases, so does AR turnover, however this decreases DSAR. The relationship for sales is INVERSE.

As Sales decreases, AR turnover decreases and DSAR will increase.

• Sales and AR Turnover = Direct
• Sales and DSAR = Indirect