Unit 4 Ratios

Question 1

why are ratios useful

Answer 1

help standardize info from financial statements for comparison

Question 2

describe flexibility of ratios

Answer 2

any numbers of ratios can be used, modified or created for a unique situation

Question 3

describe how ratios allow focus

Answer 3

help spot trends and point in a direction to investigate

Question 4

describe how ratios allow evaluation

Answer 4

evaluate if a firm is reaching its stated goals

Question 5

benchmarking

Answer 5

process of doing a financial analysis on a firm and comparing it to other similar firms

Question 6

Types of comparison methods

Answer 6

Trend analysis
Cross-Sectional analysis
Progress Measurement

Question 7

Describe Trend Analysis

Answer 7

look at a firms ratios over time

Question 8

Describe Cross-Sectional Analysis

Answer 8

compare ratios between firm and peer group

Question 9

Describe Progress Measurement

Answer 9

compare ratios to goals

Question 10

2 pitfalls to ratios

Answer 10

Timing issues

Accounting issues

Question 11

2 types of timing issues with pitfalls

Answer 11

Seasonal firms - different growth rates in different seasons
High-growth firms - balance sheets are from one point in time, income statements are an average over 1 year. Growth was much slower at start of year, creating timing issue. Can mitigate by using average of 2 balance sheets.

Question 12

Describe accounting issues with ratios

Answer 12

firms can have different accounting policies and may appear different, even though they are economically identical ie each may use different inventory systems

Question 13

5 types of ratios

Answer 13

Liquidity
Activity (efficiency)
Leverage (financing, solvency)
Profitability
Market

Question 14

Describe liquidity ratios

Answer 14

measure ability to meet short term obligations

Question 15

Describe Activity ratios

Answer 15

aka efficiency ratios

measure how well a firm uses assets to generate cash

Question 16

Describe Leverage ratios

Answer 16

aka financing/solvency ratios
measure how a firm in financed
proportions of equity and debt to finance assets

Question 17

Describe Profitability ratios

Answer 17

directly judge how profitable a company is compared to past or to competitors

Question 18

Describe Market ratios

Answer 18

evaluate if stock is overvalued or undervalued

Question 19

Current Ratio

Answer 19

Liquidity Ratio
CA/CL
use current assets to pay current liabilities
higher CR means better ability to pa short term obligations

Question 20

Quick Ratio

Answer 20

Liquidity Ratio (acid test ratio)
CA-I/CL
remove inventory from Current Ratio
use immediate assets to pay liabilities

Question 21

Accounts Receivable Turnover

Answer 21

Activity Ratio
CSAR
ability to collect credit payments, times per year
evaluate with trend analysis

Question 22

Average Collection Period

Answer 22

Activity Ratio
365/ART
days to collect all credit payments
indicates tightness of credit standards

Question 23

Inventory Turnover

Answer 23

Activity Ratio
COGS/I
measure if sufficient inventory is on hand
evaluate with cross sectional analysis

Question 24

Total Asset Turnover

Answer 24

Activity Ratio
SA
asset use efficiency
higher TAT means firm is generating more sales per asset $
trend and xsec

Question 25

Fixed Asset Turnover

Answer 25

Activity Ratio SFA remove current assets from TAT, which are influenced by risk preferences exclude risk preference from asset use efficiency

Question 26

Operating Income Return on Investment

Answer 26

Activity Ratio (Profitability) OIA measure profit as pct of assets Looks only at operations to evaluate asset use efficiency How much pre tax, pre financing $ generated per asset $

Question 27

Debt Ratio

Answer 27

Leverage Ratio TL/TA proportion of assets financed with debt aggressiveness in leveraging debt

Question 28

Debt to Equity Ratio

Answer 28

Leverage Ratio LE ability to use equity to pay debt

Question 29

Times Interest Earned

Answer 29

Leverage Ratio EBIT/I ability to pay interest with earnings

Question 30

Return on Assets

Answer 30

``` Profitability Ratio NIA proportion of earnings related to assets higher ROA is better use in xsec analysis ```

Question 31

Return on Equity

Answer 31

Profitability Ratio NIE ROE>ROA means better use of debt

Question 32

Gross Margin

Answer 32

``` Profitability Ratio PS percentage of gross profit from sales shows how much waste is minimized in production process use in cross sectional analysis ```

Question 33

Operating Margin

Answer 33

Profitability Ratio EBIT/S pretax -compare firms with different capital structures

Question 34

Net Profit Margin

Answer 34

``` Profitability Ratio NIS measures profit as a pct of sales positive means value created used in trend and xsec ```

Question 35

Market to Book Ratio

Answer 35

Market Ratio MVEBVE >1 growth, <1 value

Question 36

Price to Earnings Ratio

Answer 36

Market Ratio PPSEPS predict value of stock, firm

Question 37

COGS

Answer 37

Cost of Goods Sold

Question 38

EBIT

Answer 38

Earnings before Interest and Tax

Question 39

Dupont framework formula

Answer 39

ROE = Net Profit Margin x Total Asset Turnover x Leverage Multiplier

Question 40

summary of Dupont framework formula

Answer 40

ROE = NPM x TAT x Leverage Multiplier

Question 41

Dupont alternate formula

Answer 41

ROE = ROA x Leverage Multiplier

Question 42

Meaning of dupont framework

Answer 42

ROE is a function of Operating efficiency, Asset efficiency and financing policy

Question 43

Meaning of alternate dupont framework formula

Answer 43

Return on all investors is measured by profitability and asset use efficiency The effect of capital structure appears only in ROE