Exam 3 (Chapter 3)

Sources of Cash - what does this mean for an asset account?

Decrease in asset accounts (accounts receivable, inventory, and net

fixed assets)

Uses of Cash - what does this mean for the asset accounts?

Increase in asset account (cash and other current assets)

Statement of Cash Flows

statement that summarizes the sources and uses of cash

On the statement of cash flows.. what are the 3 categories?

Operating Activity, investment activity, Financing Activity

Operating Activity

includes net income and changes in most current accounts

investment activity

includes changes in fixed assets

Financing Activity

includes changes in notes payable, long-term debt, and equity accounts, as well as dividends

Common-Size Balance Sheets:

Compute all accounts as a percent of total assets

Common-Size Income Statements:

Compute all line items as a percent of sales

Categories of Financial Ratios

1. Short-term solvency or liquidity ratios

2. Long-term solvency or financial leverage ratios

3. Asset management or turnover ratios

4. Profitability ratios

5. Market value ratios

current ratio equation

current assets/ current liabilities

quick ratio

current assets - inventory / current liabilities

current ratio meaning

a company’s short-term liquidity and its ability to pay off its short-term financial obligations (debts and bills due within one year) using its short-term assets

quick ratio meaning

The quick ratio measures a company's short-term liquidity and its ability to pay off immediate financial obligations using its most liquid assets

cash ratio equation

cash / current liabilities

cash ratio meaning

The cash ratio measures a company's ability to cover its short-term liabilities using strictly its most liquid assets—cash and cash equivalents (such as marketable securities and T-bills)—without selling inventory or collecting accounts receivable

net working capital to total assets equation

net working capital / total assets

interval measure equation

current assets / average daily operating costs

total debt ratio equation

total assets - total equity / total assets

Net working capital to total assets meaning

Low values might indicate relatively low levels of liquidity

Interval measure indicates…

how long the business can continue

total debt ratio meaning

Considers all debts of all maturities to all

creditors and has two useful variations:

• Debt-equity ratio

• Equity multiplier

measures the proportion of a company's total assets that are financed by debt or total liabilities

long term debt ratio equation

long term debt/ long term debt + total equity

long term debt ratio meaning

measures a company's solvency by showing what percentage of its assets is financed with debt that lasts for more than one year.

equity multiplier

total assets/total equity

equity multiplier measures what?

measures financial leverage—specifically, the proportion of a company's total assets that are financed by shareholders' equity versus debt

profit margin equation

net income / sales

profit margin measures

Profit margin is a measure of the firm’s operating efficiency – how well it

controls costs (i.e., how much money it generates in profit for every dollar in

sales)

debt equity ratio

total debt/total equity

times interest earned ratio equation

EBIT / interest

cash coverage ratio equation

EBIT + Depreciation / interest

inventory turnover equation

COGS / inventory

days sales in inventory

365 days / inventory turnover

receivables turnover equation

sales / accounts receivable

days sales in receivables equation

365 days / receivables turnover

NWC turnover equation

sales / NWC

fixed asset turnover equation

sales / net fixed assets

total asset turnover equation

sales / total assets

DuPont Identity

allows us to get a big picture of how the puzzle pieces of

different ratios fit together

DuPont Identity equation

ROE = PM x TAT x EM

Total asset turnover is a measure…

of the firm’s asset use efficiency – how well does it manage its assets

Equity multiplier is a measure…

of the firm’s financial leverage

Why Evaluate Financial Statements?

External uses:

• Creditors

• Suppliers

• Customers

• Stockholders

Why Evaluate Financial Statements? Internal uses:

• Performance evaluation – compensation and comparison between

divisions

• Planning for the future – guide in estimating future cash flows