Finance Exam 1- ch.3

Current ratio will be close to .... if less than x, we expect NWC to be ....

. Absent some extraordinary circumstances, we would expect to see a current ratio of at least 1; a current ratio of less than 1 would mean that net working capital (current assets less current liabilities) is negative

Financial ratios are traditionally grouped into the following categories: (5)

1) Short-term solvency, or liquidity, ratios. 2) Long-term solvency, or financial leverage, ratios. 3) Asset management, or turnover, ratios. 4) Profitability ratios. 5) Market value ratios.

Total debt ratio gives us 2 important ratios:

1) debt-equity ratio 2) equity multiplier

Long term solvency: (3 types)

1) total debt ratio 2) times interest earned 3) cash coverage

Quick ratio

Current Assets- Liabilities/ current liabilities

DU Point

The Du Pont identity allows analysts to take a closer look at which relationships drive ROE and can help determine which areas of operations are especially strong or need improvement.

The dupont identity tells us that ROE is impacted by 3 things

The DuPont identity tells us that ROE is affected by three things: 1) Operating efficiency (as measured by profit margin). 2) Asset use efficiency (as measured by total asset turnover). 3) Financial leverage (as measured by the equity multiplier).

total debt ratio

The total debt ratio is equal to (1- 1/Equity Multiplier). This is important because it means that equity multiplier is a measure of financial leverage.

Common Size statements

To start making comparisons, one obvious thing we might try to do is to somehow standardize the financial statements. One common and useful way of doing this is to work with percentages instead of total dollars. The resulting financial statements are calle

ratios are based on the

balance sheet (not the income sheet)

The purpose of EV Ratio is to

better estimate how much it would take to buy all of the outstanding stock of a firm and also to pay off the debt. The adjustment for cash is to recognize that if we were a buyer the cash could be used immediately to buy back debt or pay a dividend.

Current Ratio

current assets/current liabilities --- type of short term solvency

Current Ratio is a measure of

current ratio is a measure of short-term liquidity.

Long term solvency measures aka

financial leverage ratios or leverage ratios

short term looks focuses on

focus on current assets and current liabilities advantage: their book values and market values are likely to be similar disadvantage: can change fairly rapidly so today's amounts are not reliable to guide the future

Short term solvency

intended to provide information about a firm's liquidity measures - primary concern is the firms ability to pay its bills over the short run without undue stress - aka liquidity measures

Return on Assets ratio is a

is a measure of profit per dollar of assets. It can be defined several ways

EBITDA ratio

is a profitability ratio that looks more directly at operating cash flows than does net income and does not include the effect of capital structure or taxes.

In quick ratio, inventory is ______ and book values are/aren't reliable

is often the least liquid current asset & book values are least reliable as measures of market value because the quality of the inventory isn't considered... inventory is a sign of short term trouble

Financial ratios

of avoiding the problems involved in comparing companies of different sizes is to calculate and compare

Cash ratio would interest a very ____________ creditor

short-term Cash/ current liabilities

To a creditor particularly a short-term creditor such as a supplier, the higher the current ratio

the better...... To the firm, a high current ratio indicates liquidity, but it also may indicate an inefficient use of cash and other short-term assets. Absent some extraordinary circumstances, we would expect to see a current ratio of at least 1; a current ratio of less than 1 would mean that net working capital (current assets less current liabilities) is negative.

if you have a high current and a low quick this means you have a lot of inventory. Not an issue unless your inventory doesnt have a high turn over rate

this means you dont have short term solvency and you cannot liquidate things fast