ACCT 222 Ch 9

Inventory Turnover

cost of goods sold/average inventory - This ratio *measures how many times a company's inventory has been sold and replaced during the year.*

Working Capital

current assets - current liabilities - Current Assets include assets most likely to be converted to cash during the next 12 months - Current Liabilities represent debts that should be paid within the next 12 months

Current ratio

current assets/current liabilities (liquidity) The current ratio measures a company's short-term debt paying ability.

divident yield

dividends per share/ Market price per share - This ratio identifies the return, in terms of cash dividends, on the current market price of the stock.

Average Days to Collect Receivables

Average collection period = 365 days/ Accounts receivable turnover *Ex*: 365 days/16.98 times = 21 days - This ratio measures, on average, *how many days it takes to collect an accounts receivable.*

All of the following are considered to be measures of a company's short-term debt paying ability except: A. inventory turnover B. avg collection period C. current ratio D. earnings per share

D. earnings per share Liquidity ratios indicate a company's ability to pay short-term debts. These ratios include working capital, current ratio, quick ratio, accounts receivable ratios, and inventory ratios. The earnings per share (EPS) ratio is a measure of earnings performance.

Methods of analysis

Horizontal Analysis -> Percentage Analysis -> Vertical Analysis -> Ratio Analysis

Profitability Ratios

Measures of the operating success of a company for a given period of time. 1. Net Margin (or Return on Sales) 2. Asset Turnover Ratio 3. Return on Investment 4. Return on Equity

Return on Equity

Net Income / Average Stockholders' Equity - This measure is often used to measure the *profitability of the stockholders' investment*

Return on Investment (ROI)

Net Income/ Average Total Assets - This is the ratio of wealth generated (net income) to the amount invested (average total assets).

Net Margin

Net Income/Sales -measure describes the *percent remaining of each sales dollar after subtracting other expenses as well as cost of goods sold.*

Quick (Acid-Test) Ratio

Quick Assets / Current Liabilities - Quick assets include Cash, Current Marketable Securities, and Accounts Receivable - This ratio measures a company's *ability to meet obligations without having to liquidate inventory.* -It does not include inventory included in current assets; hence (current assets - inventory = quick assets)

Accounts Receivable Turnover

net credit sales/average net accounts receivable - This ratio *measures how many times a company converts its receivables into cash each year*

Earnings Per Share

net income - preferred dividends / weighted average common shares outstanding - This measure indicates *how much income was earned for each share of common stock outstanding*

plant assets to long-term liabilities

net plant assets / long-term liabilities - This *ratio suggests how well long-term debt is managed to finance long-term assets*

Asset Turnover Ratio

net sales/average total assets -measures how many *sales dollars were generated for each dollar of assets invested*

Horizontal analysis

refers to studying the behavior of individual financial statement items over several accounting periods

vertical analysis

reporting an amount on a financial statement as a percentage of another item on the same financial statement

trend analysis

technique used in technical analysis that attempts to predict the future stock price movements based on recently observed trend data.

Debt to Equity Ratio

total liabilities/stockholders equity -indicates the relative proportions of debt to equity on a company's balance sheet - Stockholders like a lot of debt if the company can take advantage of positive financial leverage. - Creditors prefer less debt and more equity because equity represents a buffer of protection.

Debt to Assets Ratio

total liabilities/total assets - *measures the percentage of a company's assets that are financed by debt*

Solvency ratios

used to analyze a company's *long-term debt-paying ability* and its financing structure 1.Debt to Assets Ratio 2.Debt to Equity Ratio 3. Number of Times Interest Earned 4. Plant Assets to Long-Term Liabilities

Average Days to Sell Inventory

365/inventory turnover - This ratio *measures how many times a company's inventory has been sold and replaced during the year.*

Book Value Per Share

(stockholders equity - preferred dividends) / outstanding common shares - This ratio measures the *amount that would be distributed to holders of each share of common stock if all assets were sold at their balance sheet carrying amounts and if all creditors were paid off*

Which of the following statements regarding net margin is incorrect? A. Net margin may be calculated in several ways B. Net margin refers to the average amount of each sales dollar remaining after all expenses are subtracted C. The amount of net margin is affected by company's choice of accounting principles D. the smaller the net margin the better

*D. the smaller the net margin the better* Net margin, sometimes called operating margin, profit margin, or the return on sales ratio, describes the percentage of each sales dollar remaining after subtracting other expenses as well as cost of goods sold. Obviously, the larger the percentage, the better.

Which of the following statements regarding the analysis of absolute amounts of various accounts reported on the financial statements is incorrect A. Using absolute amounts eliminates the problem of varying materiality levels B. Financial statement users w/ expertise in particular industries can look at absolute amounts and assess a company's performance in a certain area C. Economic statistics such as the gross national product are built upon totals of absolute amounts reported by businesses D. To correctly evaluate an absolute amount, the analyst must consider its relative importance

A. Using absolute amounts eliminates the problem of varying materiality levels Comparing only absolute amounts has drawbacks because materiality levels differ from company to company or even from year to year for a given company.

Which of the following statements regarding horizontal analysis is incorrect? A. a horizontal analysis involves establishing the relationship of one amount to another B. a horizontal analysis of cost of goods sold on the income statement includes dividing net income by total revenue C. in doing horizontal analysis, an account is expressed as a percentage of the previous balance of the same account D. percentage analysis attempts to eliminate the materiality problem of comparing firms of different sizes

B. a horizontal analysis of cost of goods sold on the income statement includes dividing net income by total revenue Horizontal analysis compares items over many time periods; vertical analysis compares many items within the same time period. As such, vertical analysis of cost of goods sold on the income statement includes dividing net income by total revenue.

The Phibbs Company paid total cash dividends of $200,000 on 25,000 outstanding common shares. On the most recent trading day, the common shares sold at $80. What is this company's dividend yield? A)25% B)6.4% C)16.9% D)10%

D)10% Dividend yield = Dividends per share ÷ Market price per share Dividend yield = ($200,000 ÷ 25,000 shares) ÷ $80 per share = $8 per share ÷ $80 per share = 10%

You are considering an investment in IBM stock and wish to assess the firm's long-term debt-paying ability and its use of debt financing. All of the following ratios can be used to assess solvency except: A. Number of times interest is earned. B. Debt to assets ratio. C. Debt to equity ratio. D. Net margin.

D. Net margin. Solvency ratios are used to analyze a company's long-term debt-paying ability and its financing structure. The net margin ratio describes the percentage of each sales dollar remaining after subtracting other expenses as well as cost of goods sold. It is used to assess managerial effectiveness and profitability.

Number of Times Interest is Earned Ratio

Earnings before Interest Expense and Income Taxes/ Interest Expense - This is the most common measure of a *company's ability to provide protection for its long-term creditors.*

Stock Market Ratios

analyze the earnings and dividends of a company 1. Earnings Per Share 2. Book Value 3. Price-Earnings (P/E) Ratio 4. Dividend Yield

Current assets

cash and other assets expected to be exchanged for cash or consumed within a year *Examples:* - Cash and equivalents. - Short-term investments (marketable securities). - Accounts receivable. - Inventory. - Prepaid expenses. - Any other liquid assets

Liquidity Ratios

indicate a company's *ability to pay short-term debts*. They focus on current assets and current liabilities. 1. Working Capital 2. Current Ratio 3. Quick Ratio 4. Accounts Receivable Ratios 5. Inventory Ratios

ratio analysis

involves studying various relationships between different items reported in a set of financial statements.

Current liabilities

liabilities due within a short time, usually within a year. *Examples:* - Accounts payable - Sales taxes payable - Payroll taxes payable - Income taxes payable - Interest payable - Bank account overdrafts - Accrued expenses - Customer deposits

Price-Earnings Ratio

market price per share/earnings per share -This ratio compares the *earnings of a company to the market price for a share* of the company's stock.

What does a declining ratio mean?

may be a sign of deteriorating financial condition, or it might result from eliminating obsolete inventories.