Topic 2 Flashcards
(24 cards)
What is the main purpose of financial ratio analysis?
To analyze a firm’s financial performance using various ratios
What are the four key areas covered by financial ratios?
- Liquidity
- Activity
- Leverage
- Profitability
What does the current ratio measure?
A firm’s ability to meet its short-term liabilities as they come due
When is a firm considered solvent based on the current ratio?
When the current ratio is equal to 1 or higher
What is the formula for the quick ratio?
(Cash + marketable securities + receivables) / Current liabilities
What do activity ratios indicate?
How effectively the company is using its assets to generate sales
What does the inventory turnover ratio measure?
Cost of goods sold / Ending inventory
What does a low inventory turnover suggest?
The firm is not efficiently managing its inventory
What is the average collection period formula?
Accounts Receivable / Average Sales per day
What does a high accounts receivable turnover ratio indicate?
The firm’s credit policies may be too stringent
What is the fixed asset turnover ratio?
Net Sales / Net Fixed Assets
What does the debt-equity ratio measure?
The extent of a company’s indebtedness
What is the formula for interest coverage?
EBIT / Interest
What does the gross profit margin measure?
(Sales − Cost of Goods Sold) ÷ Sales
What is the operating profit margin formula?
Operating Profit ÷ Sales
What does the net profit margin measure?
Earnings Available for Common Stockholders ÷ Sales
What is the return on assets (ROA) formula?
(Net Profit + Interest expense) / Total assets
What is the return on equity (ROE) formula?
(Net Profit - Preferred dividends) / Shareholder funds
What are the three components of the DuPont system of analysis?
- Profit on sales
- Efficiency of asset use
- Use of financial leverage
What does the equity multiplier represent?
Total assets / Equity
What does an increase in ROE due to net profit margin or asset turnover indicate?
A positive sign for the company
What can increase in the equity multiplier indicate?
Higher financial risk for the company
Fill in the blank: A single ratio does not generally provide sufficient information from which to judge the overall performance of the firm, and ratios should be calculated using financial statements dated at the _______.
same time
True or False: It is preferable to use financial statements from different accounting methods for ratio analysis.
False
