Ratios Financial Ratios Essay

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Chapter 8: Accounting Equations and Financial Statements

Assets = Liabilities + Owners equity
Basis of a balance sheet
Profit = Revenue – Expenses
Activities described on an income statement
Cash flow = Receipts – Disbursements
Basis of each cash flow statement
Owners equity = Assets – Liabilities
What you have = What you own – What you owe Income statement a financial statement that shows the revenue and expenses of a firm, allowing you to calculate the profit or loss produced in a specific period of time.
Benchmarking a comparison of a firm’s financial ratios to industry leaders.
Industry average analysis a comparison of a firm’s financial ratios to the industry averages.
Trend analysis a comparison of a single firm’s present performance with its own past performance, preferably for more than two years.
Liquidity ratios financial ratios used to measure a firm’s ability to meet its short-term obligations to creditors as they come due.
Liquidity= how quickly an asset can be turned into the amount of cash it is currently worth.
Current ratio a financial ratio that measures the number of times the firm can cover its current liabilities with its current assets.
Current ratio = current assets/current liabilities
Quick acid test ratio a financial ratio that measures the firm’s ability to meet its current obligations with the most liquid of its current assets.
Quick ratio = (current assets – inventory)/ current liabilities
Activity ratios financial ratios that measure the speed with which various asset accounts are converted into sales or cash
Used to measure how efficiently a firm uses its assets
4 important activity ratios: inventory turnover, average collection period, fixed asset turnover, and total asset turnover
Inventory turnover measures the liquidity of the firm’s inventory—how quickly goods are sold & replenished.
Inventory turnover = cost of goods sold/inventory
Average Collection Period a measure of how long it takes a firm to convert a credit sale (internal store credit, not credit card sales) into a usable form like cash.
Average collection period = accounts receivable/ average sales per day
Fixed asset turnover measures how efficiently the firm is using its assets to generate sales (important for businesses with a lot of equipment or buildings)
Fixed asset turnover = sales/net fixed assets
Total asset turnover measures how efficiently the firm uses all of its assets to generate sales (high ratio= good overall management)
Total asset turnover = sales/total assets
Leverage ratios financial ratios that measure the extent to which a firm
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