finance quiz module 4

converts the Accounts Payable Turnover Ratio to the number of days your Accounts Payable are outstanding. Again, this is important as you manage your cash to make sure you have enough on hand to run your business and keep your suppliers paid on time.

Accounts Payable Days

When you have calculated your Accounts Receivable Turnover Ratio, you can convert it to the actual number of days accounts receivable are outstanding.

Accounts Receivable Days on Hand

This ratio measures how quickly the company is paying its suppliers. If this result is higher than the industry benchmark, it might mean that the company is deliberately taking longer to pay its suppliers and therefore effectively using its suppliers to cover its operating expenses. This may indicate a problem. This ratio is calculated as follows: Accounts Payable/Annual Income

Accounts payable to Income Ratio

measure how well a company's management is doing in converting the goods it produces or the services it offers into cash. Time is an important aspect of these ratios since the longer it takes to leverage assets and convert them into cash creates a negative effect. A common example of an activity ratio is the Inventory Turnover ratio

Activity ratios

Once you have calculated the number of days in Accounts Receivable, Inventory and Accounts Payable for your company, you can use them to calculate your ________

Cash Cycle Accounts Receivable Days + Inventory Days - Accounts Payable Days = Cash Cycle

Net Profit Margin Ratio

Computed by the formula Net income/Net sales. This ratio measures the portion of each net sales dollar generated in net profit.

closely related to inventory turnover, this ratio will show how many days the company's inventory is "on the shelf" (as a non-earning asset) before it is sold 365/Inventory Turnover

Days Sales calculation

For most companies the greatest single category of expense that they will have to deal with is the investment in fixed assets, such as the building, the property it is located on and the equipment needed to produce their products. This calculation provides an approximate measure of how efficiently the company is using these assets to produce the products they sell. The calculation formula is as follows: Revenue/Fixed Assets

Fixed Asset Turnover

what is left after the cost of goods sold have been subtracted from net sales. Cost of goods sold, also called "cost of sales," is the price paid by your company for the products it sold during the period you are considering. It is the price of the goods, including inventory or raw materials and labor used in production, but it does not include selling or administrative expenses.

Gross Profit Margin Ratio Gross Profit / Sales x 100%

Once you have calculated the Inventory Turnover Ratio, you can convert it to the actual number of days of inventory you have on hand. This key ratio combined with the Accounts Receivable Days on Hand and Accounts Payable Days convert to what is called the Cash Cycle.

Inventory Days on Hand

this ratio represents the number of times in a given period (usually one year) that inventory had to be completely replaced. Low inventory turnover could indicate overproduction (possibly due to a flawed sales forecast) or a sudden change in market demand for the product or service. Cost of Goods Sold/Ending Inventory

Inventory Turnover

4 classifications for financial ratios

Liquidity Ratios Profitability Ratios Solvency Ratios Activity Ratios

Receivables Turnover Ratio

Number of times during a year that the average accounts receivable balance is collected (or "turns over"). It equals net credit sales divided by average accounts receivable.

this is a calculation used to compare the company's profit performance to its total sales. It is useful for comparison against competitors or against an industry benchmark. A profit margin in itself does not pay the expenses necessary to keep the business open and small business owners need to stay focused on cash flow. •Net income/Sales

Profit margin

____ _____ are a means of measuring how much profit a company can generate compared to the amount of expense it incurs to create those profits. Here also, having a number bigger than your competition means that you are out-performing them based on this measurement.

Profitability ratios

This is a more stringent version of the Current Ratio and it involves using the cash balance plus accounts receivable to get a picture of just the Liquid assets that are available to satisfy short-term debt and does not include assets that could be converted into cash. (Cash + Accounts Receivable)/Current Liabilities

Quick Ratio

this is a very important ratio in that it indicates company profitability and how efficiently the company is using its assets. This ratio is calculated as follows: Profit (either pre or post tax)/Total Assets The higher the result, the better the company's performance

Return on Assets

This is a measure of how effectively the company is allocating its capital for profitable investments. It is possible that a company could invest some of its capital in outside investments if it was determined that these outside investments would result in a greater return than investing internally After tax operating income/(Total debt + Owners Equity) If this number is greater than the Weighted Average Cost of Capital, value is being created. If it is less, value is being destroyed.

Return on Total Capital (Also called Return on Invested Capital)

measure a company's ability to pay its short-term and long-term obligations. They are important because they are actually measuring the all-important cash flow and not the company's net income; two very different things. In order for these ratios to have real meaning the results need to be compared against an industry standard or companies in the same industry. This is because some industries are very debt-intensive and others are not, so a cross-industry comparison will have no relevance.

Solvency ratios

measure the stability of a company and its ability to repay debt.

Solvency ratios

measures the number of time Accounts Payable turned over during a time period. Much like our previous turnover ratios, you want to understand how long your Accounts Payable are on your books.

The Accounts Payable Turnover Ratio

measures the number of time accounts receivable turned over during a time period. A higher ratio indicates a shorter time between making a sale and collecting the cash.

The Accounts Receivable Turnover Ratio

is a measure of how dependent a company is on debt financing as compared to owner's equity. It shows how much of a business is owned and how much is owed.

The Debt-to-Worth Ratio (or Leverage Ratio)

measures the number of times inventory "turned over" or was converted to sales during a time period. It may also be called the Cost of Sales to Inventory Ratio. It is a good indication of purchasing and production efficiency.

The Inventory Turnover Ratio

is the relationship between the profits of your company and your total assets. It is a measure of how effectively you utilized your company's assets to make a profit. It is a common ratio used to compare how well you performed in relationship to your peers in your industry.

The Return on Assets Ratio

a reflection of financial strength. It is the number of times a company's current assets exceed its current liabilities, which is an indication of the solvency of the business.

The current ratio

an indicator of your company's earning power from its current operations. This isthe core source of your company's cash flow, and an increase in the operating profit margin from one period to the next is considered a sign of a healthy, growing company. If your company's operating income is not sufficient to generate the cash you need to keep operating, you must find other sources of cash.

The operating profit margin Operating Profit Margin = Operating Profit / Sales x 100%

Days Sales in Receivables

The ratio of average net accounts receivable to one day's sales. The ratio tells how many days it takes to collect the average level of accounts receivable. 365 days / Accounts receivable turnover ratio.

Net Sales to Working Capital

The relationship between Net Sales and Working Capital is a measurement of the efficiency in the way working capital is being used by the business. It shows how working capital is supporting sales. Net Sales to Working Capital Ratio = Net Sales / Net Working Capital

______ _______is a measure of cash flow and is not a real ratio.

Working capital Working Capital = Total Current Assets - Total Current Liabilities

Liquidity Ratios

intended to measure a company's ability to pay its short-term obligations They test how "liquid" a company is by looking at its supply of cash or near-cash assets and comparing them with the expenses the company has to cover in the near future The "bigger" the ratio the better the company's ability to pay its short-term bills since the math for calculating the ratios has cash included in the numerator.

measure your company's ability to cover its expenses. The two most common ______ ratios are the current ratio and the quick ratio. Both are based on balance sheet items.

liquidity

measure the relationship between the profits your company generates and assets that are being used. Compute it using data from both the income statement and the balance sheet.

return on assets Net Profit Before Taxes / Total Assets x 100

Considered the most important profitability ratio by many executives. It measures the return on the owner's investment. For you as a small business owner, the return on investment figure can help you decide whether all of your hard work has been worth it.

return on investment Return on Investment = Net Profit Before Taxes / Net Worth

also called the "acid test" ratio. That's because it looks only at a company's most liquid assets and compares them to current liabilities. It tests whether a business can meet its obligations even if adverse conditions occur.

the quick ratio

current ratio

this measures the amount of current assets available to cover the amount of current liabilities that the company has to cover. It includes the cash on hand and assets that could be easily converted to cash (if needed). Current Assets/Current Liabilities

Solvency Ratios

•Debt to Equity: Total Debt/Total Shareholders Equity •Debt to Assets: Total Debt/Total Assets •Debt to Capital: Total Debt/Total Debt + Total Shareholder's Equity