Finance Chapter 3

liquidity ratios measure the relationships between a firms liquid (or current) assets and its current liabilities
current ratio The broadest liquidity measure- measures the dollars of current assets available to pay each dollar of current liabilities.
Inventories are – least liquid of a firm’s current assets- current asset for which book values are least reliable measures of market value
They are the current assets on which.. losses are most likely to occur- if firm must sell inventory to pay upcoming bills, they will most likely have to discount it in order to liquidate
Acid test measures a firm’s ability to pay off short-term obligations without relying on inventory sales
Cash ratio measures a firm’s ability to pay short term obligations with its available cash and marketable securities
asset management ratios measure how efficiently a firm uses its assets – (inventory, accounts receivable, and fixed assets), – how efficiently the firm managers its accounts payable
Allows managers and investors to… evaluate whether a firm is holding a reasonable amount of each type of asset and whether management uses each type of asset to effectively generate sales
Inventory management decide the trade off between the advantages of holding sufficient levels of inventory to keep production process going versus the costs of holding large amounts of inventory.
Inventory turnover Measures the number of dollars of sales produced per dollar of inventory
Days sales in inventory Measures the number of days that inventory is held before the final product is sold
A/r management Managers must consider the trade-off between the advantages of increased sales by offering customers better terms – versus the disadvantages of financing large amounts of accounts receivable
Average collection period (ACP) Measures the number of days accounts receivable are held before the firm collects cash from the sale
Accounts receivable turnover measures the number of dollars of sales produced per dollar of accounts receivable
Accounts payable management Managers must consider the trade-off between maximizing the use of free financing that raw material suppliers offer versus the risk of losing the opportunity to buy on account.
Average payment period (APP) Measures the number of days that the firm holds account payable before it has to extend cash to pay for its purchases.- high
Accounts payable turnover – Measures the dollar cost of goods sold per dollar of accounts payable- low
Fixed asset turnover measures the number of dollars of sales produced per dollar of fixed assets- high
Sales to working capital measures number of dollars of sales produced per dollar of net working capital – high
Note about fixed assets age of a firm’s fixed assets will affect the fixed asset turnover ratio level- firm with newer fixed assets will have a lower fixed asset turnover ratio
total asset turnover measures number of dollars of sales produced per dollar of total assets- high
capital intensity measures dollars of total assets needed to produce a dollar of sales- low
The more debt a firm uses as a percentage of total assets… the greater is its financial leverage
debt management ratios measure the extent to which the firm uses debt versus equity to finance its assets
debt ratio measures the percentages of total assets financed with debt
debt to equity measures dollars of debt financing used for every dollar of equity financing
Equity multiplier measures dollars of assets on the balance sheet for every dollar of equity financing
The lower of all those three ratios, the less debt and more equity a firm uses to finance its assets
When firms do well financial leverage creates more cash flows to share with stockholders- magnifies the return to the stockholders of the firm
Times interest earned measures number of dollars of operating earnings available to meet each dollar of interest obligations on the firms debt
Fixed-charge coverage measures number of dollars of operating earning available to meet firm’s interest obligation and other fixed charges
cash coverage measures number of dollars of operating cash available to meet each dollar of interest and other fixed charges the firm covers
Managers, investors and anaylsts can determine… whether a firm has taken on too much debt by using these three ratios
A value of one for these ratios means that 1 dollar of earnings or cash is available to meet each dollar of interest or fixed charge obligations
The higher these ratios… the more equity and less debt the firm uses to finance its assets
Profitability ratios ratios that show the combined effects of liquidity, asset management, and debt management on the firms overall operating costs- best known ratios
firm values (or stock prices) react… quickly to unexpected changes in these ratios
Profit margin percentage of sales left after all firm expenses are deducted- high means that firm has low expenses relative to sales
basic earnings power Measures the operating return on the firm’s assets, regardless of financial leverage and taxes. – measures the operating profit (EBIT) earned per dollar of assets on the firm’s balance sheet.
return on assets Measures the overall return on the firm’s assets, including financial leverage and taxes.- net income earned per dollar of assets on the firm’s balance sheet.
Return on equity Measures the return on the common stockholders’ investment in the assets of the firm. – It is the net income earned per dollar of common stockholders’ equity.
Value of a firm’s ROE is affected by net income, but also amount of financial leverage or debt that a firm uses- high ROE is a positive sign
Dividend payout % of net income available to common stockholders that the firms actually pays as cash to these investors- aka how much of the profit the firm retains versus how much it pays out- low

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