Financial Ratios Exam 2

Liquidity Ratios

can we pay out short term bills?

Current vs quick ratio

quick ratio does not use the firm’s inventory in calculating ability to pay short term bills

why might quick ratio be more relevant in a financial analysis

in some industries, firms may not be able to convert inventory to cash in time to help pay short term obligations

accounts payable ratio

how many times per year does the firm pay its suppliers

what might explain a decreasing account payable ratio?

-worsening financial position

-increasing power over suppliers

times interest earned (earning before interest and taxes / interest expense)

a decreasing ratio indicates a decreased ability to meet debt obligations

TIE ratio of 5 means the firm’s EBIT is 5 times the amount of their interest expense

accounts receivable turnover (revenue / accounts receivable)

measures the efficiency of the firm in collecting that which is owed by customers

the higher the AR turnover ratio means a firm is better than a competitor in converting short term debt into revenue (cash)

Fixed asset turnover ratio (revenue / fixed assets)

indicates how much revenue is generated per dollar of fixed assets

a higher F.A. ratio indicates greater efficiency

gross profit margin

percent of revenue remaining after deducting cost of goods sold (variable expenses)

EBITDA

measure of firms earnings before interest taxes, depreciation and amortization

non-cash expenses

those expenses that are recorded in the income statement but do not involve an actual cash transaction.

common example is depreciation

depreciation

practice of deducting the cost of a tangible fixed asset over its useful life. this allows the firm to account for a decrease in the asset’s value over time.

ex: vehicle ages it decreases in value. this “decrease” can be charged against net income, thus reducing net income and taxes

examples of fixed or tangible assets

buildings

equipment

office furniture

land

amortization

practice of deducting an intangible asset’s cost over its useful life. examples:

patents and trademarks

franchise agreements

copyrights

cost of issuing bonds to raise capital