Unit 1: Activity Ratios Flashcards
How is the cash flow ratio calculated?
Cash flow ratio =
Cash flow from operations /
Current liabilities
Define solvency
Solvency refers to the ability of a business to meet its long-term obligations. This ability is related to the extent to which the business uses debt versus equity financing.
What is a capital structure?
A firm’s capital structure includes its sources of financing, both long- and short-term. The sources of financing may be either in the form of debt (external financing) or equity (internal financing).
How is the total debt to total capital ratio calculated?
Total debt to total capital ratio =
Total debt /
Total capital
What is the formula to calculate the debt to equity ratio?
Debt to equity ratio =
Total debt /
Stockholders’ equity
How is the debt to total assets ratio calculated?
Debt to total assets ratio =
Total liabilities /
Total assets
How is the times interest earned ratio calculated?
Times interest earned ratio =
EBIT /
Interest expense
Define leverage.
Leverage is the relative amount of fixed cost in a firm’s overall cost structure.
What is the cause of operating leverage?
Operating leverage arises from the use of a high level of plant assets and machinery in the production process, revealed through charges for depreciation, property taxes, etc.
What is the cause of financial leverage?
Financial leverage arises from the use of a high level of debt in the firm’s financing structure, revealed through amounts paid out for interest.
How is the degree of operating leverage (DOL) calculated?
The DOL is generally calculated in one of two ways:
DOL (single period) =
Contribution margin / Operating income or EBIT
DOL (% change) =
% change in operating income or EBIT / % change in sales
How is the degree of financial leverage (DFL) calculated?
The DFL is generally calculated in one of two ways:
DFL (single period) =
EBIT / Earnings before taxes
DFL (% change) =
% change in net income / % change in EBIT
What is the purpose of common-size financial statements?
Common-size financial statements restate financial statement line items in terms of percentages of a given amount so that the financial statements of steadily growing firms and firms of different sizes can be analyzed and compared.
How are items on common-size financial statements expressed?
Items on a common-size income statement are expressed as percentages of sales.
Items on a common-size balance sheet are expressed as percentages of assets, liabilities, or stockholders’ equity.
Define liquidity.
Liquidity is a firm’s ability to pay its current obligations as they come due and thus remain in business in the short run.
