Ratio and Measures for Working Capital Management
What does the "times-interest-earned ratio" measure? How is it expressed as a formula?
-Measures the ability of current earnings to cover interest payments for a period (Net Income + Interest Expense + Income Tax Expense)/Interest Expense
What does the "number of days' sales in average receivables ratio" measure? How is it expressed as a formula?
-Measures the average number of days required to collect receivables Number of Days Sales in Average Receivables = 365 (or other days)/Accounts Receivable Turnover.
What does "working capital" measure? How is it expressed as a formula?
-Measures the extent to which current assets exceed current liabilities and, thus, are uncommitted in the short term Working Capital = Current Assets - Current Liabilities
What does the "number of days' supply in inventory ratio" measure? How is it expressed as a formula?
-Measures the number of days inventory is held before it is sold or used Number of Days Supply in Inventory = 365 (or other days)/Inventory Turnover
What does the "accounts receivable turnover ratio" measure? How is it expressed as a formula?
-Measures the number of times that accounts receivable turnover (are incurred and collected) during a period Accounts Receivable Turnover = Credit Sales/Average Net Accounts Receivable -Useful in assessing credit policies and collection efficiency
What does the "inventory turnover ratio" measure? How is it expressed as a formula?
-Measures the number of times that inventory is acquired and sold or used during a period Inventory Turnover = Cost of Goods Sold/Average Inventory -Useful in assessing overstocking/understocking of inventory and obsolete inventory.
What does the asset turnover ratio measure? How is it expressed as a formula?
-Measures the number of times that total assets is represented by sales during a period Annual sales/Average total assets -Shows how well total assets are being used to generate revenue.
What does the "working-capital ratio" (also called the "current ratio") measure? How is it expressed as a formula?
-Measures the quantitative relationship between current assets and current liabilities in terms of the "number of times" current assets can cover current liabilities; Working Capital Ratio = Current Assets/Current Liabilities
What does the "acid test ratio" (also called the "quick ratio") measure? How is it expressed as a formula?
-Measures the relationship between highly liquid assets and current liabilities Acid Test Ratio = (Cash [Cash Equivalents] + Net Accounts Receivable + Marketable Securities)/Current Liabilities
What does the "defensive-interval ratio" measure? How is it expressed as a formula?
-Measures the relationship between highly liquid assets and the ave Defensive-Interval Ratio = (Cash [Cash Equivalents] + Net Accounts Receivable + Marketable Securities)/Average Daily Cash Expenditures
Describe the benefits provided by ratio analysis.
-Provides measures and enables comparisons of a firm's operating and financial activities and position for a single firm over time and across firms. -Facilitates identification of a firm's operating and financial strengths and weaknesses.
What does the "operating cycle length" measure? How is it expressed as a formula?
Measures the average length of time to acquire inventory, convert the inventory to receivables, and collect the receivables; it can be measured as: Operating cycle length = Number of days' sales in average receivables + Number of days' supply in inventory
Describe operational activity measures.
Ratios (and other measures) that measure the efficiency with which a firm carries out its operating activities.
When a ratio requires using a balance sheet value together with an income statement value, how should the balance sheet value be determined?
When a balance sheet value is used together with an income statement value in a ratio, the balance sheet value must be an average balance for the period covered by the income statement, not the balance at year-end (or other point in time).
