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Short Term Solvency (Liquidity Ratios)

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They measure the ability of a firm to convert assets into cash. These ratios are suppose to gauge the ability of a firm to pay its bills as they come due. The primary concern is the firm's ability to pay its bills over the short run without undue stress.

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Current Ratio

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current assets / current liabilities the current ratio is the standard measure of any business' financial health. It will tell you whether your business is able to meet its current obligations by measuring if it has enough assets to cover its liabilities. The standard current ratio for a healthy business is 2:1 meaning it has twice as many assets as liabilities. ex: Every dollar you owe in short term coming period, you have $2 to settle. Should be closer to 2:1 but above 1:1 should be tracked monthly or quarterly,

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Quick Ratio / Acid Test

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(current assets-inventory) / current liabilities measures a business' liquidity, considered a tougher measure than the current ratio b/c it excludes inventories when counting assets. The higher the ratio is, the higher your business' level of liquidity, which usually corresponds to its financial health. Optimal quick ratio is 1:1 or higher

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Cash Ratio

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cash / current liabilities it measures the extent to which a firm can quickly liquidate assets and cover short-term liabilities

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Net Working Capital to Assets

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net working capital / total assets net working capital is often viewed as the amount of short term liquidity a firm has, the ratio of net working capital to total assets, is a measure of liquidity. more useful when compared to another firm's

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Interval Measure

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current assets / average daily operation cost the number of days a firm can finances operations without additional cash income ex: if no one came in today, the next day, etc, how long can the business be kept running?? great for small business / should be tracked regularly

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Long Term Solvency

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also known as financial leverage ratios measure the extent to which the firm has been financed by debt. They are intended to address the firm's long-run ability to meet its obligations, or more generally, its financial leverage. Failure of the firm to meet interest or sinking fund payments results in bankruptcy at the discretion of the lender.

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Total Debt Ratio

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(total assets - total equity) / total assets this ratio takes into account all debts of all maturities to all creditors. There are several definitions including the ratio of the difference between total assets and total equity to total assets. Lenders and investors often use to find if a risk for investment. small business is commonly measured 2:1 / range varies from 1:1 - 4:1

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Debt to Equity Ratio

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total debt / total equity This ratio indicates how much the company is leveraged (in debt) by comparing what is OWED to what is OWNED. A high debt to equity ratio could indicate the company may be over leveraged, and should look for ways to reduce its debt. EX: in personal use: when creditors look at your credit for loan or credit line, high owed amounts (debt ratio) compared to owned is considered a risk and line of credit will not be granted.

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Equity Multiplier

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Total assets / total equity it is a leverage ratio that is computed as the ratio of total assets to total equity

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Long Term Debt Ratio

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long term debt / (long term debt + total equity) A firm's short term debt changes constantly. In addition, accounts payable may be more of a reflection of trade practice than dent management policy. For these reasons, the long-term debt ratio, which is the ratio of long-term debt to total capitalization is frequently used by financial analysts. Great way to see where business stands.

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Times Interest Earned / Coverage Ratio

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EBIT / Interest EBIT= earnings before interest and taxes this ratio measures how well the a company has its interest obligations covered with its EBIT. The lower the ratio, the higher the company's debt burden. Under 1 is considered poor, At 1 is still risky. Should be over 1.5 or higher. Can be substituted:: earnings before utilities and taxes/ utilities OR earnings before payroll and taxes / payroll

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Cash Coverage Ratio

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(EBIT + Depreciation) / Interest this is the ratio of EBDIT (earnings before depreciation, interest, and taxes) and interest. the ability to have cash available when its time to pay interest payment. Depreciation is pulled out since it is a none cash expense. Becomes an expense on tax return and statement.

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Debt Coverage Ratio

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(net income + non-cash expenses)/debt indicates how well your cash flow covers debt and the capacity of the business to take on additional debt. How much cash profits is available to repay debt. Lenders look at this to determine if antiquate cash is available to repay loan. Needs to be bigger than 1. The higher the better!

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Asset Utilization or Turnover Ratios (Activity Ratios)

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these ratios measure how efficiently or intensively a firm uses its assets to generate sales. These ratios answer the question: how has the business used its fixed and current assets?? other names for this include efficiency and asset management ratios

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Inventory Turnover

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cost of goods sold / inventory this ratio tells how often a business' inventory turn over (or sell) during the course of the year. B/c inventories are the least liquid form of asset, a high inventory turnover ratio is generally positive, On the other hand, an unusually high ratio compared to the average for your industry could mean a business is losing sales b/c of inadequate stock on hand good idea to check quarterly

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Days' Sales in Inventory

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365 days / inventory shows the average number of days it will take to sell your inventory * number of days sales @ cost in inventory most valuable when deciding in increase or decrease inventory.

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Receivables Turnover

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Sales / Accounts Receivable this number indicates how quickly customers are paying your business. The greater the number of times receivables turn over during the year, the shorter the time between sales and cash collection. ex: normal turn over: every 30 days / 12 times a year. If higher than 12, we have a problem collecting money. If lower, we don't have a problem. Should be tracked with total credit sales NOT net sales, can uncover changes in collection trends.

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Days' Sales in Receivables

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365 Days / Receivables Turnover shows the average number of days it takes to collect your accounts receivables (number of days of sales in receivable) days / RT can be # of days in month open Gives a finer view of receivables compared to receivables turnover.

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Accounts Payable Turnover

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Cost of Goods Sold / Accounts Payable the number of times a trade payable turnover during the year. Low turn over may indicate there is a shortage cash to pay bills or other reason to delay payment /// high turn over may indicate you are not taking advantage of all credit terms you have and more leveraging could be taken. shows average length of time to pay / compare to industry

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Net Working Capital Turnover

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Sales / Net Working Capital measures how much "work" we get out of our working capital. In other words, it tells how much sales the business generates for each dollar net working capital. great for trying to decide if you want to invest more money, looking for a high ratio. Comparing segments of business to each other.

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Fixed Asset Turnover

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Sales / Net Fixed Assets Measures how well the business generates sales on each dollar fixed assets. How much work/efficient/effect business is at using fixed assets. Fixed Asset Turnover ratio of 2, indicates that for every dollar in fixed assets the business generated $2 in sales. Small business will likely be a point something like .50 Helpful to compare to previous years.

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Total Asset Turnover

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Sales / Total Assets indicated how efficiently your business generated sales on each dollar of assets. most helpful ratio / should be looked at every month / this is the business' score card! ** critical indication on business' health.

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Profitability Ratio

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they measure the management's overall effectiveness in maximizing the returns generated on sales and investment. These ratios answer the question: has the business made a good profit compared to its turnover??

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Gross Profit Margin

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Gross Profit / Sales * * Gross Profit = ( sales - CGS) CGS is cost of goods sold Indicator of how much profit is earned on your products without consideration of selling administration cost. This is whats left after paying for goods sold / on every $ sold, $0.60 is left to pay remaining bills except for merchandise which was already covered. Compare to other business' in the industry and the business' health to pay

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Profit Margin (Return on Sales)

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Net Income / Sales this ratio compares after tax profit to sales. Basically, it shows how much profit comes from every dollar of sales. It can help you determine if you are making enough of a return on your sales effort. Helps you determine if prices need to be marked up // needs to be looked at monthly or quarterly

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Return on Assets (ROA)

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Net Income / Total Assets this number tells you how effective your business has been at putting its assets to work. The ROA is a test of capital utilization... how much profit (before interest and income tax) a business earned on the total capital used to make the profit. This ratio is most useful when compared with the interest rate paid on the company's debt. EX: if the ROA is 15 percent and the interest rate paid on its debt was 10 percent, the business's profit is 5 percentage points more than it paid on interest.

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Return on Equity (ROE)

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Net Income / Total Equity most important ratio!! Determines the rate of return on your investment in the business. As an owner or shareholder this is one of the most important ratios as it shows the hard facts about the business!! Are you making enough of a profit to compensate you for the risk of being in business????

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Sales Growth

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(Current Yrs Sales- Last Yrs Sales)/ Last Yrs Sales percentage increase (OR decrease) in sales between two time periods. NOTE: substitute sales for a month or quarter fir a short term trend.

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Cost of Goods Sold to sales

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COGS / Sales percentage of sales used to pay for expenses which vary directly with sales. Look for a stable ratio /// when jumps around there is a huge problem!

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SG to Sales

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SG / Sales SG is Selling, General, Admin. Expenses percentage of selling, general and administrative cost to sales. can be done with almost any expense, doesn't matter if a small expense. Look for steady or decrease

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Market Value Ratios (Investor Ratios)

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these measures are based, in part, on information not necessarily contained in financial statements - the market price per share of the stock. They can only be calculated directly from publicly traded companies.

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Earning Per Share (EPS)

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Net Income / Number of Shares Outstanding the portion of a firm's profit allocated to each outstanding share of common stock. It is a performance indicator that expresses the company's net income in relation to the number of ordinary shares issued. Important to investors they can show how the company is doing over time. If the firm's earning per share is consistently growing the stock should perform well or you should be able to find outside investors.

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Price-Earning Ratio (PE)

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Price Per Share / Earnings Per Share A PE ratio of 5 means the shares sell for five times earnings, or one could say the shares have or "carry" a PE multiple of 5 Use when trying to find // investors pay per dollar current earnings

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Market to Book Ratio

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Market Value Per Share / Book Value Per Share# * book value per share = total equity / # of outstanding shares Since book value per share is an accounting number, it reflects historical cost. Therefore, the market-to-book ratio compares the market value of the firm's investment to their cost.

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Book Value Per Share

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total equity / # of outstanding shares

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Dividends Per Share (DPS)

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Dividends Paid / # of Shares Outstanding Portion of the company's profits per share paid to shareholders.

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Dividend Yield

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Dividends Per Share / Current Share Price This is the return on a stock as a result of a dividends paid /// return to investors. High dividend yield is valued, but watch out for dividend yields with low stock!

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dividend

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a sum of money paid regularly (typically quarterly) by a company to its shareholders out of its profits (or reserves).

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mixed cost

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are costs that have both fixed and variable components

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Variable Cost

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a cost that increases or decreases IN TOTAL on direct proportion to increase or decrease in the volume of activity. Volume is the measure or degree of an activity of a business action that affects costs... the more volume, the more cost incurred. Changes proportionaley to changes in volume; when volume increases, total cost increases. When volume decreases, total cost decreases. Other things affected by volume include selling, producing, driving and calling. ** total variable cost fluctuate with changes in volume, but the variable cost per unit remains constant.

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Fixed Cost

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A cost that remains the same IN TOTAL, regardless of changes over wide ranges of volume of activity. Changes INVERSELY to changes in volume. When volume increases, cost per unit decreases. When volume decreases, cost per unit increases. Ex: rent, salaries, property tax and depreciation. ** Total fixed cost remain constant, but the fixed cost per unit is inversely proportional to volume.

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Mixed Cost

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A cost that has both fixed and variable components ex: cell phone $100 per month for 100 minutes and additional $0.10 per each minute after 100 ex: car / the more miles you drive, the more you spend on gas and oil changes, so those cost are VARIABLE. The cost you incur for insurance is FIXED, the amount does not change based on number of miles driven, there for it is a mixed cost.

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Variable Cost per Unit

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change in total cost / change in volume of activity (highest cost-lowest cost) / (highest volume - lowest volume)

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total fixed cost

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total mixed cost - total variable cost total mixed cost - ( variable cost per unit x number of units)

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total mixed cost

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(variable cost per unit x number of units) + total fixed cost

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total manufacturing maintenance cost

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( $ per tablet x number of tablets) + total fixed cost

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Relevant Range

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the range of volume where total fixed cost and variable cost per unit remain constant Needed to estimate cost b/c total fixed cost can differ from one relevant range to another / the variable cost per unit can differ in various relevant ranges

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Cost Principle

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A principle that states that acquired assets and services should be recorded at their ACTUAL cost

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Sole Propietorship

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A business with a SINGLE owner

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Partnership

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A business with TWO or MORE OWNERS and not organized as a corporation

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Limited-Liability Company (LLC)

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A company in which each member is only liable for his or her own actions

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Going Concern Assumption

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Assumed that the entity will remain in operation for the foreseeable future

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Monetary Unit Assumption

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The assumption that requires the items on the financial statement to be measured in terms of monetary units

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Audit

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An examination of a company's financial statements and records

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Sarbanes-Oxley (SOX)

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Requires companies to review internal control and take responsibility for the accuracy and completeness of their financial reports

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Accounting Equation

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The basic tool of accounting, measuring the resources of the business (what the business owns or has control of) and the claims to those resources (what the business owes to creditors and to the owner) Assets = Liabilities + Equity

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Assets

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Economic resources that are expected to benefit the business in the future. Something the business owns or has control of

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Liabilities

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Debts that are owned to CREDITORS

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Equity

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The owner's claim to the assets of the business

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Owner's Capital

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Owner contribution to a busines

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Revenues

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Amounts earned from delivering goods or services to customers

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Expenses

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The cost of selling goods or services

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Owner's Withdrawals

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Payment of equity to the owner

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Net Income

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The result of operations that occurs when total revenues are greater than total expenses.

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Net Loss

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The result of operations that occurs when total expenses are greater than total revenues

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Transaction

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An event that affects the financial position of the business and can be measured reliably in dollar amounts

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Financial Statements

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Business documents that are used to communicate information needed to make business decisions

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Income Statement

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Reports the net income or net loss of the business for a specific period 1. Header: includes the name of the business, the title of that statement, and the time period for the report 2. The Revenue accounts are always listed first and then subtotaled if necessary 3. Each expense account is listed separately from largest to smallest and then subtotaled in necessary 4. Net income is calculated as total revenues minus total expenses

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Statement of Owner's Equity

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Shows the changes in the owner's capital account for a specific period 1. Header: includes the name of the business, the title of that statement, and the time period for the report 2. The beginning capital is first listed 3. Owner contribution and net income are added to the beginning capital. (net income is transferred from the income statement) 4. The Owner's Withdrawal is subtracted from capital. If there had been a net loss, this would also be subtracted.

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Balance Sheet

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Reports on the assets, liabilities, and owner's equity of the business as of a specific date 1. Header: includes the name of the business, the title of that statement, and a specific date for the report 2. T account Assets on the left / Liabilities on the right 3. Each asset account is listed separately and then totaled. CASH IS ALWAYS LISTED FIRST. 4. Liabilities are listed separately and then totaled. Liabilities that are to be paid are listed first! 5. The ending owner's capital is taken directly from the statement of owner's equity 6. The balance sheet must always balance!! Assets = liabilities + owner's equity

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Statement of Cash Flows

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Reports on a business's cash receipts and cash payments for a specific period. 1. Header: includes the name of the business, the title of that statement, and the time period for the report 2. Operating activities involve cash receipts for services provided and cash payments for expenses paid 3. Investing activities include the purchase and sale of land and equipment for cash. 4. Financing activities include cash contributions by the owner and owner withdrawals of cash. 5. The ending cash balance must match the cash balance on the balance sheet.

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Stakeholders

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want to know how the company is doing financially. Who are stakeholders? creditors, investors, employees, management - anyone who has an interest in the viability of the company.

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Horizontal Analysis

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Compares two financial statements to determine dollar and percentage changes / horizontally or side by side computing dollar changes: current year balance - prior year balance computing percentage changes: dollar change/base period

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Trend Percentages

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form of horizontal analysis base year selected and set equal to 100% trend%= any year $/base year$

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vertical anaylysis

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shows relationship of each item to a base amount on financial statements -income statement - each item expressed as percentage of net sales -balance sheet - each item expressed as percentage of total assets ** analysis of up & down

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Benchmarking

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comparing a company with another leading company two types: -against a key competitor (heinz vs del monte) -against the industry average done to make sure our company is maintaining the lead or comparable to competitor

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what is the purpose of stakeholders performing financial analysis on companies' financial statements?

answer

to make informed decisions about a company

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what are the two steps required to compute a percentage change in comparative financial statements?

answer

computing a percentage change in comparative statements requires two steps: 1. compute the dollar amount of the change from the earlier period to the later period 2. divide the dollar amount of change by the earlier period amount. We call the earlier period the base period. current year - prior year dollar change/base period

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what are the purposes of trend percentages?

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trend percentages are a form of horizontal analysis. trends indicate the direction a business is taking. How have sales changed over a fire year period?? what trend does net income show? these questions can be answered by trend percentages over a period of time such as 3-5 years.

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Vertical analysis shows what relationship?

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Income statement - each item expressed as percentage of net sales balance sheet - each item expressed as percentage of total assets.

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what are 5 types of ratios?

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ability to pay current liabilities ability to sell invent pry and collect receivables ability to pay long term debt measures profitability analyzing stock as an investment

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ability to pay current liabilities ratios

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working capital, current ratio and acid-test ratio

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working capital

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measures ability to meet short-term obligations current assets - current liabilties

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current ratio

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most widely used proportion of current assets ti current liabilities current assets / current liabilities

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acid-test ratio

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tells if company could pay all of its current liabilities immediately (cash + short term investments+net current receivables)/current liabilities

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Principal or Maturity Value

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Amount borrower must pay back on maturity date

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Maturity Date

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Date on which borrower must pay principal to the bondholders

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Stated Interest Rate

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Annual rate of interest borrower pays to bondholders

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Bonds payable

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large company issues bonds to public to raise money * company pays interest (usually semi-annually) to bondholders bondholders receive interest

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Bondholders

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mulitple lenders each bondholder receives bonds certificate that shows 1/ amount borrowed (principal) 2/ maturity date 3/ interest rate

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Term Bonds

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all mature at same date

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Serial Bonds

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mature in installments at regular intervals

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Secured Bonds

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bondholders has right to assets if company fails to pay principal or interest

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Debenture

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Unsecured; not backed by company's assets companies do NOT normally do debenture bonds ex) signature loan, not backed

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Maturity (par) value

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ex $1,000 bond issued for $1,000 no discount or premium

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Discount

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ex $1,000 bond issued for $980 issued below maturity value

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Premium

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ex $1,000 bond issued for $1,015 issued above maturity value

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Name 3 short-term liability accounts

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- accounts payable -unearned revenue -short-term notes payable -sales tax payable -salary payable

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Name the 3 likelihoods of contingent liabilities

answer

-remote -reasonably possible -probable

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name the 3 bond terms

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principal amount maturity date stated interest rate

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what are the 4 types of bonds

answer

-term bonds -serial bonds -secured bonds -debenture

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ability to sell inventory and collect receivables

answer

-inventory turnover -accounts receivable turnover -day's-sales-in receivables

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inventory turnover

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measures number of times a company sells inventory during a year cost of goods sold / average inventory

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accounts receivable turnover

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measures ability to collect cash from credit customers net credit sales / average accounts receivable

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day's-sales-in-receivables

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measures ability to collect receivables step #1 net sales/ 365= average day's sales step #2 average net accounts receivable / average day's sales

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ability to pay long-term debt

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- debt ratio - times-interest-earned ratio

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debt ratio

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shows portion of assets financed with debt the higher the ratio, the higher the risk! total liabilities / total assets

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times-interest-earned ratio

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measures number of times income can cover interest expense high ratio indicated ease in paying interest operating income / interest expense

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measuring profitability

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- return on net sales - return on total assets - return on common stockholder's equity - earnings per share

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return on net sales

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percent of each sales dollar earned as net income net income / net sales

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return on total assets

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measures success in using assets to earn a profit (net income+interest expense)/average total assets

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return on common stockholders' equity

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how much income is earned for dollar invested by common shareholders (net income-preferred dividends)/average common equity

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earnings per share

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net income earned for each share of common (net income-preferred dividends)/number of common shares outstanding

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Leverage

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trading on the equity / company borrows at a lower rate invest the money to earn a higher rate can increase profits during good times **** not happening now due to economy

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Analyzing stock investments

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-price/earnings ratio (PE) -dividend yield -book value

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price/earnings ratio (pe)

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market price compared to earnings per share (EPS) market price per share/earnings per share

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dividend yield

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percent of market value that is returned as dividends dividends per share / market price per share

question

book value

answer

common equity per share some argue its relevance to investors common equity/common shares outstanding

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