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 |