2. Formulas for Ratio Analysis

Formula for working capital

Working capital = current assets - current liabilities.

Formula for current ratio

Current ratio = Current assets / Current liabilities

Formula for acid-test ratio

Acid-test ratio = (Cash + Short-term investments + Current receivables) / Current liabilities

Formula for accounts receivable turnover

Accounts receivable turnover = Net sales / Average accounts receivable, net

Formula for inventory turnover

Inventory turnover = Cost of goods sold / Average inventory

Formula for days’ sales uncollected

Days' sales uncollected = (Accounts receivable, net / Net sales) x 365

Formula for Day’ sales in inventory

Days' sales in inventory = (Ending inventory / Cost of goods sold) x 365

Formula for average collection period

Average collection period = 365 / Accounts receivable turnover ratio

Formula for total asset turnover

Total asset turnover = Net sales / Average total assets

What is the debt ratio?

Debt ratio = Total liabilities / Total liabilities and equity

What is the equity ratio?

Equity ratio = Total equity / Total liabilities and equity

What is the debt-to-equity ratio?

Debt-to-equity ratio = Total liabilities / Total equity

What is the times interest earned ratio?

Times interest earned = Income before interest expense and income tax expense is subtracted / Interest expense

Formula for gross margin

Gross margin = Net sales - cost of goods sold

Formula for gross margin ratio

Gross margin ratio = (Net sales - cost of goods sold) / Net sales

Formula for profit margin

Profit margin = Net income / Net sales

Formula for return on total assets

Return on total assets = Net income / Average total assets

What is an alternative formula for return on total assets?

Alternative formula for return on total assets = Profit margin x Total asset turnover

What is the formula for return on equity?

Return on equity = Net income / Average total equity

What is the formula for basic earnings per share?

Basic earnings per share = (Net income - Preferred dividends) / Weighted-average common shares outstanding

Formula for price-earnings ratio

Price-earnings ratio = Market price per common share / Earnings per share

Formula for dividend yield

Dividend yield = Annual cash dividends per share / Market price per share

What does the current ratio measure?

Short-term debt paying ability

What does a high current ratio suggest?

A strong ability to meet current obligations.

What is a guide line ratio for current ratio?

2:1 (or 1.5:1) guideline for the current ratio.

What does the acid-test ratio do?

Evaluates a company’s short-term liquidty

What does Days’ Sales Uncollected measure?

Measure how frequently a company collects acconts receivables.

What is a rough guidelines for days’ sales uncollected?

• A rough guideline is that days' sales uncollected should not exceed 1 and 1/3 times the days in its:

  1. credit period, if discounts are not offered, or

  2. discount period, if favorable discounts are offered

What does days’ sales in inventory evaluate?

Used to evaluate inventory liquidity. Estimates the number of days it will take inventory to be converted into receivables or cash.

What does total asset turnover measure?

Company’s ability to use its assets to generate sales and reflects on operating efficiency..

When is a company considered less risky in terms of capital structure?

When it has more equity than debt in its capital structure.

What does the debt-to-equity ratio measure?

Another measure of solvency

What does the times interest earned ratio measure?

Measures a company’s ability to pay interest. The larger the ratiom is, the less risky the company is for creditors. Ratio of two or more means the company is reasonably safe.

What does the gross margin ratio measure?

A company’s percent of gross margin in each dollar of net sales

What does profit margin measure?

Company’s ability to earn net income from sales

What does return on total assets measure?

Overall profitability of assets

What does return on equity measure?

Measures a company’s ability to earn income for its stockholders

What does the price-earnings ratio measure?

Measure market expectations for future growth

What is the dividend yield used for?

To compare the dividend-paying performance for idfferent companies.