Acc231-Ratios Packet-Terminology and Additional Explanations(2)

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ACCOUNTING 231 – RATIOS USED FOR ANALYSIS - Spring 2013
Explanations for each ratio, display format, type of ratio, and what it is used for, etc. General Ratios: Horizontal Analysis (Growth Rate (GR)): (Current Year – Prior Year) / Prior Year Measures change in $ numbers for one year to another. Percentage. General Used to compare same line item to itself between periods. Note 1: Can also be used to measure change in $ from Current year to Base year: CY – BY / BY Note 2: Can also be used to measure change in calculated ratios from one period to another (ie., change in current ratio from one period to another) Used to convert any/all $ data on the income statement to percentages to facilitate comparisons. Any line item can be a numerator in the ratio, but ALL C/S I/S ratios have the SAME common denominator of Net Revenue. (Net Revenues (also called Net Sales) = 100%) Percentage. General Used to compare each line item to Net Sales for a single time period Used to convert any/all $ data on the balance sheet to percentages to facilitate comparisons. Any line item can be a numerator in the ratio, but ALL C/S B/S ratios have the common denominator of Total Assets. (Total Assets = 100%) Percentage. General Used to compare each line item to Total Assets for a single time period Note: RC uses “Total Liab. + Total S/E” as the denominator when calculating the common-size ratios for liability and equity accounts. This is exactly the same total as “Total Assets” For several of the following ratios, either the numerator or the denominator use the “average” for the account specified in the formula. To get the “average” for any account, you add the beginning balance + the ending balance and divide by 2. This creates a “period of time” number for what is actually a “point in time” account.

Vertical Analysis (Common-size Income Stmt.): Income Statement line item / Net Revenues

Vertical Analysis (Common-size Balance Sheet): Balance Sheet line item / Total Assets

“Average”

Spring 2013  Copyright © School of Accountancy, Arizona State University

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Liquidity Ratios / Short-term Solvency Ratios / Short-term Liquidity Ratios: Current Ratio (C/R): Current Assets / Current Liabilities Measures short-term liquidity, the ability of a firm to meet needs for cash as they arise. Times. Liquidity ratio. Meaning: Assume current ratio = 3.3 X, interpret as “Company has $3.30 of C/A to cover every $ of C/L” Note: A C/R of 2+ generally indicates good liquidity. Excess of C/A over C/L at a point in time. $. Liquidity ratio.

Working Capital (“Net Working Capital” Kemp): Current Assets – Current Liabilities

Quick Ratio (Q/R) (also called “acid-test” ratio): Measures short-term liquidity more rigorously than the Cash + Net A/R + S/T investments* / current ratio by eliminating inventory, usually the least Current Liabilities liquid current asset (and also eliminates prepaid assets). Times. Liquidity ratio. *also referred to as “marketable securities” Meaning: Assume quick ratio = 3.3 X, interpret as “Company has $3.30 of C/A (excluding inventory and prepaid assets) to cover every $1 of C/L” Indicates days required to convert receivables into cash. Days. Liquidity ratio. Alternative formula: Meaning: Assume number of days in receivables of 36 Average Net A/R / Average daily sales (both) days, interpret as “Company converts A/R to cash every 36 days” Also called: Receivable Collection Period (Kemp) Note: Average daily sales is: Net sales / 365 Number of Days’ Sales in Inventory: 365 days / Inventory turnover ratio (RC) Indicates days required to sell inventory Days. Liquidity ratio. Alternative formula: Meaning: Assume number of days in inventory of 36 days, Average Inventory / Average Daily COGS (both) interpret as “Company converts inventory to COGS every 36 days” Also called: Days Sales in Inventory (Kemp) Note: Average daily COGS is: COGS / 365 Number of Days’ Purchases in A/P: 365 days / A/P turnover ratio (RC) Alternative...
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