Communicating Accounting Information and Analyzing Financial Statements - Chapter 12

Comprehensive vocabulary flashcards covering profitability, asset turnover, liquidity, solvency, market ratios, the operating cycle, and the DuPont model from Chapter 12.

Profitability

A primary measure of the overall success and survival of a company that evaluates the adequacy of net earnings relative to other financial statement items.

Return on Equity (ROE)

A profitability ratio, also referred to as return on owners' investment, that reflects the return investors earn on the capital invested in a company: $\text{Return on Equity} = \frac{\text{Net Earnings}}{\text{Average Shareholders' Equity}}$

Return on Assets (ROA)

A profitability ratio that compares net earnings to the total assets (total investment) used to generate those earnings: $\text{Return on Assets} = \frac{\text{Net Earnings}}{\text{Average Total Assets}}$

Gross Profit Margin Ratio

A profitability ratio (also known as the gross profit percentage) that reflects gross profit as a percentage of sales, calculated as: $\text{Gross Profit Margin Ratio} = \frac{\text{Gross Profit}}{\text{Net Sales}}$

Net Profit Margin Ratio

A profitability ratio that measures the percentage of each sales dollar, on average, that represents net earnings: $\text{Net Profit Margin Ratio} = \frac{\text{Net Earnings}}{\text{Net Sales}}$

Earnings per Share (EPS) Ratio

A measure of the return on investment based on the number of shares outstanding rather than dollar balances reported on the statement of financial position: $\text{Earnings per Share} = \frac{\text{Net Earnings Available to Common Shareholders}}{\text{Average Number of Common Shares Outstanding}}$

Quality of Earnings Ratio

A ratio evaluating whether reported net earnings are backed by operating cash flows, where a ratio higher than $1$ indicates high-quality earnings: $\text{Quality of Earnings Ratio} = \frac{\text{Cash Flows from Operating Activities}}{\text{Net Earnings}}$

Asset Turnover Ratios

A category of financial ratios that captures how efficiently and effectively a company utilizes its assets to generate revenue.

Total Asset Turnover Ratio

An asset turnover ratio that measures how effectively a company uses its aggregate assets to generate revenue: $\text{Total Asset Turnover} = \frac{\text{Net Sales}}{\text{Average Total Assets}}$

Fixed Asset Turnover Ratio

An asset turnover ratio focusing narrowly on how effectively a company utilizes its property, plant, and equipment to generate revenue: $\text{Fixed Asset Turnover Ratio} = \frac{\text{Net Sales}}{\text{Average Net Fixed Assets}}$

Receivables Turnover Ratio

A turnover ratio measuring how quickly a company collects cash from credit customers: $\text{Receivables Turnover Ratio} = \frac{\text{Net Credit Sales}}{\text{Average Net Accounts Receivable}}$

Average Days to Collect Receivables

The receivables turnover ratio converted to a time basis (also known as the average collection period): $\text{Average Days to Collect Receivables} = \frac{\text{Days in a Year}}{\text{Receivables Turnover Ratio}}$

Inventory Turnover Ratio

A measure of operating efficiency that reflects the relationship of inventory to the volume of sales during the period: $\text{Inventory Turnover Ratio} = \frac{\text{Cost of Sales}}{\text{Average Inventory}}$

Accounts Payable Turnover Ratio

An operating cycle ratio that reflects the frequency and speed associated with the operating activity of purchasing inventory.

Operating Cycle

The time required for a company to complete four distinct phases: purchasing goods and services, paying cash to suppliers, selling goods and services to customers, and collecting cash from customers.

ROA Profit Driver Analysis

A framework that breaks down Return on Assets into two components—Net Profit Margin and Total Asset Turnover Ratio—to assess business strategy execution: $\text{ROA} = \text{Net Profit Margin} \times \text{Total Asset Turnover Ratio}$ $\frac{\text{Net Earnings}}{\text{Average Total Assets}} = \frac{\text{Net Earnings}}{\text{Net Sales}} \times \frac{\text{Net Sales}}{\text{Average Total Assets}}$

DuPont Model

An analytical model that breaks down Return on Equity into three components: net profit margin, total asset turnover ratio, and financial leverage: $\text{ROE} = \text{Net Profit Margin} \times \text{Total Asset Turnover Ratio} \times \text{Financial Leverage}$ $\frac{\text{Net Earnings}}{\text{Average Shareholders' Equity}} = \frac{\text{Net Earnings}}{\text{Net Sales}} \times \frac{\text{Net Sales}}{\text{Average Total Assets}} \times \frac{\text{Average Total Assets}}{\text{Average Shareholders' Equity}}$

Liquidity

A company's ability to satisfy its short-term debt obligations, typically assessed by evaluating current assets in relation to current liabilities.

Current Ratio

A liquidity ratio measuring a company's ability to settle current liabilities using current assets at a specific date: $\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}$

Quick Ratio

A stringent liquidity test (also known as the acid test) comparing quick assets (cash and near-cash assets) against current liabilities: $\text{Quick Ratio} = \frac{\text{Quick Assets}}{\text{Current Liabilities}}$

Cash Ratio

A liquidity ratio that evaluates the immediate adequacy of available cash and near-cash instruments relative to short-term obligations: $\text{Cash Ratio} = \frac{\text{Cash} + \text{Cash Equivalents}}{\text{Current Liabilities}}$

Solvency

A company's ability to meet its long-term financial obligations and commitments over extended periods.

Times Interest Earned Ratio

A solvency metric indicating a company's margin of protection for creditors in meeting contractual interest charges: $\text{Times Interest Earned Ratio} = \frac{\text{Net Earnings} + \text{Interest Expense} + \text{Income Tax Expense}}{\text{Interest Expense}}$

Cash Coverage Ratio

A solvency ratio comparing cash generated from operations before interest and taxes against the cash required for interest payments: $\text{Cash Coverage Ratio} = \frac{\text{Cash Flows from Operating Activities (Before Interest and Taxes)}}{\text{Interest Paid}}$

Debt-to-Equity Ratio

A solvency ratio expressing a company's total debt obligations as a proportion of total equity financing: $\text{Debt-to-Equity Ratio} = \frac{\text{Total Liabilities}}{\text{Shareholders' Equity}}$

Market Ratios

Financial ratios that relate the current market price per share to the economic return accruing to owners, based on the current market value of equity.

Price/Earnings (P/E) Ratio

A market ratio measuring the multiple that the market is willing to pay per dollar of current earnings: $\text{Price/Earnings Ratio} = \frac{\text{Current Market Price Per Share}}{\text{Earnings Per Share}}$

Dividend Yield Ratio

A market ratio measuring the cash return from dividends relative to the prevailing market price of the share: $\text{Dividend Yield Ratio} = \frac{\text{Dividends Per Share}}{\text{Market Price Per Share}}$