Management in the digital age Quiz 1 Determining the Ratios

Solvency (Liquidity) Ratios

Ratios that measure if a company can meet its financial obligations on time, from a lender's perspective.

Efficiency (Activity) Ratios

Ratios that measure how effective a company's operations are and how actively it's using its assets, from a management perspective.

Profitability Ratios

Ratios that measure if a firm is yielding advantageous returns or results, from an owner's perspective.

Current Ratio

Measures: The degree to which current assets cover current liabilities. A ratio >1 shows liquidity, and 2 or more is generally strong.

Quick Ratio (Acid-Test Ratio)

Measures: If a firm can meet its obligations with its most liquid assets if sales suddenly stop. A ratio of 1.0 or higher is considered satisfactory.

Current Liabilities to Net Worth Ratio

Measures: The amount due to creditors within a year as a percentage of the owners' capital. A rule of thumb is that it should not exceed 60%.

Total Liabilities to Net Worth Ratio

Measures: The impact of long-term debt on the company. In general, total liabilities should not exceed net worth (100%).

Fixed Assets to Net Worth Ratio

Measures: The extent to which owners' cash is "frozen" in assets like buildings and machinery. A ratio higher than 75% may indicate over-investment and vulnerability.

Collection Period

Measures: The average time (in days) it takes for customers to pay their bills.

Sales to Inventory (Inventory Turnover)

Measures: How rapidly merchandise is being sold. Low figures indicate excessively high inventory.

Asset to Sales Ratio

Measures: Whether a company is handling too high a volume of sales in relation to its investment.

Accounts Payable to Sales Ratio

Measures: The speed with which a company pays its vendors. A high number suggests the company is using supplier credit to float operations.

Return on Sales (Profit Margin)

Measures: The level of profit generated from each dollar of sales, which indicates the efficiency of the operation.

Return on Assets (ROA)

Measures: A critical indicator of how efficiently a company is using its assets to generate profits.

Return on Net Worth (ROE)

This is the "final measure" of profitability, showing the return relative to the owners' investment. A return of at least 10% is generally considered desirable.

Purpose of Ratio Analysis

To evaluate a firm's financial ratios, look at trends, and compare them to industry averages. It helps understand a company's financial health, identify trends, and benchmark against competitors.