FAR 2_08B

  1. What is the formula for the Operating Cycle? Is this a Liquidity, Activity, Profitability, or Coverage ratio? What is a good outcome and why?
    • (Inventory Turnover in Days + A/R Turnover in Days)
    • Activity
    • Fewer days is better. This is how long it takes to sell inventory (in days) and then convert the sale to cash. It’s the total time from investment by the company (we paid for inventory) until we get our money back in cash.
  2. What is the formula for the Working Capital Turnover? Is this a Liquidity, Activity, Profitability, or Coverage ratio? What is a good outcome?
    • Sales / Average Working Capital
    • Activity
    • Higher is better; good upward trend; Indicates how effectively working capital is used to generate sales.
  3. What is the formula for Total Asset Turnover? Is this a Liquidity, Activity, Profitability, or Coverage ratio? What is a good outcome?
    • Net Sales / Average Total Assets (use Total not Current assets)
    • Higher is better; good upward trend; indicates how effectively total assets are used to generate sales.
  4. What is the formula for the Net Profit Margin? Is this a Liquidity, Activity, Profitability, or Coverage ratio? What is a good outcome?
    • Net Income / Net Sales
    • Profitability
    • Higher is better. This ratio is used with the asset turnover ratio to determine a rate of return on assets.
  5. What is the formula for the Return on Total Assets? Is this a Liquidity, Activity, Profitability, or Coverage ratio? What is a good outcome? How is this ratio used?
    • Net Income / Average Total Assets
    • Profitability
    • Higher is better.
    • This determines the rate of return on assets.
  6. What is the formula for the DuPont Return on Assets? Is this a Liquidity, Activity, Profitability, or Coverage ratio? What is a good outcome? How is this ratio used?
    • Net Profit Margin / Total Asset Turnover OR
    • (Net Income / Net Sales) x (Net Sales / Average Total Assets)
    • Profitability
    • Higher is better
    • This determines the rate of return on assets. This formula helps determine which change in a ratio is causing the change in rate of return – is it the profit margin increasing or decreasing or the change in asset turnover.
  7. What is the formula for the Return on Common Equity? Is this a Liquidity, Activity, Profitability, or Coverage ratio? What is a good outcome?
    • (Net Income – Preferred Dividends) / Average Common Equity
    • Profitability
    • Higher is better.
    • This determines the income available to common shareholders divided by the equity available to common shareholders
  8. What is the formula for the Debt-to-Equity Ratio? Is this a Liquidity, Activity, Profitability, or Coverage ratio? What does this ratio indicate?
    • Total Liabilities / Common Stockholders’ Equity
    • Coverage
    • If the ratio is >1 (liabilities > equity) then the company used debt to finance the assets. This places greater risk for the stockholders b/c creditors receive their portion first.
    • If the ratio is <1 (liabilities < equity) then the company used stock to finance the assets. This means less risk for stockholders, but also means more stockholders are involved so each gets less of the profits.
  9. What is the formula for the Debt-to-Asset Ratio? Is this a Liquidity, Activity, Profitability, or Coverage ratio? What does this ratio indicate?
    • Total Liabilities / Total Assets
    • Coverage
    • How much of the assets are financed by creditors. If the ratio is 0.5 then 50% of the assets are financed by creditors.
  10. What is the formula for the Times Interest Earned? Is this a Liquidity, Activity, Profitability, or Coverage ratio? What does this ratio indicate?
    • EBIT / Interest
    • Coverage
    • Indicates if the company can cover the interest charges. This is frequently used in debt covenants.
  11. What is the formula for the Operating Cash Flow / Total Debt? Is this a Liquidity, Activity, Profitability, or Coverage ratio? What does this ratio indicate?
    • Operating Cash Flow / Total Debt
    • Coverage
    • Higher is better
  12. What does Horizontal Analysis measure?
    Trends over time or changes from period to period
  13. What does Vertical Analysis measure?
    Allows for comparison against other companies as it calculates all incomes and expenses against a common category (such as sales). So, operating expenses as a percentage of sales for a small company can be compared to the same ratio of a large company.
Author
BethM
ID
338346
Card Set
FAR 2_08B
Description
Becker Review 2018
Updated