Lecture Wk 6: FS Analysis & Interpretation with Ratios

What is EBIT?

Earnings Before Interest & Tax.

What is the formula for asset turnover?

Sales/Assets

What is the formula for profit margin?

EBIT/Sales

What is the formula for return on assets?

EBIT/Assets

What do profitability ratio represent?

Profitability ratios represent how effectively economic entities generate profit against their operational costs.

What do Efficiency ratios represent?

Efficiency ratios represent how efficiently economic entities use their assets to generate sales.

What do liquidity ratios represent?

Liquidity ratios represent an economic entity’s ability to meet short term obligations using its current assets.

What do market performance ratios represent?

Market performance ratios represent the valuation of an economic entity compared to its peers.

What are some caveats of ratio analysis?

• Accounting measurement bases vary making it hard to provide consistent valuations

• Measuring standards are prone to change, affecting comparability with other companies or measurements

• Recognition and measurement is often based on judgement rather than objective standards

What are some caveats of using benchmarks?

• comparisons must be between similar entities or the same entity at different points in time

• analysis is reliant on trends and change to tell story which may be outdated or irrelevant

• context is still heavily required

What is working capital?

Working capital = current assets - current liabilities

What is the operating cycle?

Operating cycle = inventory days + accounts receivable days

What is the cash cycle?

cash cycle = Inventory days + account receivable days - account payable days

What are inventory days?

Time from purchasing inventory on credit to time of selling.

What are account payable days?

Time from purchasing inventory on credit to time of paying back credit purchase.

What are account receivable days?

Time from sale of inventory to time at which sale is paid back.

What is the benefit of reducing the length of the operating cycle? Why does this benefit occur? How is it achieved?

Reducing the length of the operating cycle reduces working capital required during the period. This benefit occurs as the time that capital is tied up in inventory or receivables is reduced, resulting in a quicker conversion to cash. This can be achieved by holding less inventory at a time to lessen inventory days. Alternatively this can be achieved by tightening credit terms or better managing receivables.

What is the benefit of reducing the length of the cash cycle? Why does this benefit occur? How is it achieved?

Reducing teh length of the cash cycle reduces the cash required during the period. This benefit occurs as the time that cash is tied up in inventory or receivables is reduced, resuting in a quicker conversion to cash. This can be achieved by negotiating better business terms to reduce receivable days. Alternatively this can be achieved by stretching the payable period.

What is the inventory credit timeline?

1. Purchase inventory on credit

2. Paid for credit purchase

3. Sold Inventory on credit

4. Received cash from sale