The Formula Sheet

Question 1

What is liquidity?

Answer 1

the availability of cash and near-cash to meet obligations

Question 2

What is solvency?

Answer 2

the ability to meet debt obligations (interest obligations and payment of principal value)

Question 3

What does the Return on Equity (ROE) measure?

Answer 3

how effectively a company uses its assets to build revenue

Question 4

What does a company wants for ROE?

Answer 4

higher

Question 5

What is the relationship between debt and default risk?

Answer 5

debt increases default risk

Question 6

What is default risk?

Answer 6

the more liabilities you have, the less likely it becomes that you’ll be able to pay all of them

Question 7

What is Return on Assets (ROA)?

Answer 7

it measures how profitable the assets are

Question 8

What does a company want for ROA?

Answer 8

higher

Question 9

How would you increase your ROA?

Answer 9

• target higher profit margins
• increase asset turnover

Question 10

The two components that make up ROA are:

Answer 10

profit margin and asset turnover

Question 11

What does Gross Profit Margin (GPM) measure?

Answer 11

the % of each sales dollar left over after product costs are subtracted

Question 12

What does Expenses-to-Sales (ETS) measure?

Answer 12

the % of each sales dollar that covers a specific expense item

Question 13

What does Asset Turnover measure?

Answer 13

how effectively a company is using its assets to generate revenue

Question 14

What does a company want for Asset Turnover?

Answer 14

higher

Question 15

What does Accounts Receivable Turnover measure?

Answer 15

how effectively a company collects the $$ clients owe them on credit

Question 16

What does a company want for Accounts Receivable Turnover?

Answer 16

higher

Question 17

What does Inventory Turnover measure?

Answer 17

the flow of goods out of inventory relative to the balance in inventory

Question 18

What does a company want for Inventory Turnover, and why?

Answer 18

higher because it predicts stronger sales

Question 19

Current Ratio is a measurement of (liquidity/solvency).

Answer 19

liquidity

Question 20

Quick Ratio is a measurement of (liquidity/solvency).

Answer 20

liquidity

Question 21

Operating Cash Flow to Current Liabilities (OCFCL) is a measurement of (liquidity/solvency).

Answer 21

liquidity

Question 22

Times Interest Earned is a measurement of (liquidity/solvency).

Answer 22

solvency

Question 23

Debt-to-Equity is a measurement of (liquidity/solvency).

Answer 23

solvency

Question 24

What does the Current Ratio measure?

Answer 24

if companies will meet their short-term obligations

Question 25

What does a company want for Current Ratio and why?

Answer 25

higher, preferably above 2, because it shows that they have the assets available to pay off their liabilities (very liquid)

Question 26

What does the Quick Ratio measure?

Answer 26

a company’s ability to use cash to retire liabilities quickly

Question 27

What does a company want for Quick Ratio and why?

Answer 27

higher, preferably above 1, to show that a company can quickly pay off liabilities with cash (very liquid)

Question 28

What does Times Interest Earned measure?

Answer 28

shows how many times a company could pay its interest expenses with pretax income

Question 29

What does a company want for Times Interest Earned and why?

Answer 29

higher, implies smaller default risk

Question 30

What does Debt-to-Equity measure?

Answer 30

how reliant on stockholder financing and loans a company is

Question 31

What does a company want for Debt-to-Equity and why?

Answer 31

lower, because higher means there is lower solvency which means more default risk

Question 32

True or false: A company wants to be both liquid and solvent.

Answer 32

true!!