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WGU C214 Financial Managment Topic 4
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Gravity
Terms in this set (36)
Standardization
to gain insight when comparing companies & finances
Flexibility
ratio analysis is not governed by GAAP; best analysts achieve the greatest benefits
Focus
ratios allow for quick discover of area that need investigation
Liquidity
ability to meet short-tem obligations
Current Ratio (liquidity)
Current assets/current liabilities
higher ratio= likelyhood of ability to meet short term obligations
Quick Ratio (liquidity)
Current assets - inventory/current liabilities
higher ratio= greater ability to meet short term obligations
Accounts Recievable Turnover (liquidity)
Credit sales/AR
ratio of 12= company collects entire AR 12 times per year
Average Collection Period/ACP (liquidity)
365/AR turnover
# indicates the number of times per year receivables are turned
Inventory Turnover (liquidity)
COGS/Inventory
# of times company turns it receivalbes in a year
Days on Hand/DOH (liquidity)
365/Inventory Turnover
how many days of inventory the company has on hand
Efficiency Ratios
measure how effectively a company uses assets to generate sales or profit
Total Asset Turnover/TAT (efficiency)
Sales/Total Assets
how many dollars in sales generated per dollar of assets
Fixed Asset Turnover/FAT (efficiency)
Sales/Fixed Assets
sales generated per dollar of fixed assets
Operating Income Return on Investment/OIROI (efficiency)
EBIT/Total Assets
operating profit generated per dollar of assets
Financing Ratios
describes what proportions the firm uses equity and/or debt to finance assets
Debt Ratio (financing)
Total Liabilities/Total Assets
measures the proportion of the firm's assets financed with debt
Interest-Bearing Debt to Total Capital/IBDTC (financing)
Interest-Bearing debt/Interest-Bearing debt + owners' equity
precise measure of a firm's finacial structure
Times Interest Earned Ratio/TIE (financing)
EBIT/Interest Expense
how many times a company can pay interest expense given operating profit
Financial Leverage Ratio/FLR (financing)
Total Assets/Equity
amount of debt financed with equity
Profitability Ratios
profit from sales or investment
Return on Assest/ROA (profit-investment)
Net Income/Total Assets
earnings as a % of the capital invested
Return of Equity/ROE (profit-investment)
Net Income/Owners' Equity
earnings as a % of each dollar invested
Gross Margin (profit-sales)
Gross Profit/Sales
% of revenue remaining after COGS
Operating Margin (profit-sales)
EBIT/Sales
% of sales remaining after COGS
Net Margin (profit-sales)
Net Income/Sales
% of revenue for equity holders after all costs are covered
DuPont Equation
ROE= Net Income/Sales x Sales/Total Assets x Assets/Equity
= Net Margin x TAT x FLR
Three tools for ROE
1. Higher Margins- decrease cost relative to sales (higher net margin)
2. Greater Efficiency- increase sales relative to assets (higher TAT)
3. Lever up- increase debt relative to equity (higher FLR)
Trend Analysis
examines firm's ratios over time (back 5 yrs, forcasting 3 yrs)
Cross-sectional analysis
comparing a firm's ratios to a peer group
Internal Goal Monitoring
ratios can measure progress relative to specific goal set within the company
Common pitfall for analysts
1. Timing issues- mixing data from income statement & balance sheet
2. Accounting issues- understanding accounting choices before assuming their ratios are comparable
External risk with ratios
changes in macro-economic cycle, competitive forces, the technological environment & demographic/societal changes
Interal risk with ratios
financial viability & flexibility of the firm, willingness to continually innovate, the attitude towards compliance with laws and controll, and company culture
Legalities with ratios
firms will have to operate within prevailing legal constraints
Social resonsibility with ratios
employee relations, human capital development, strong communities and schools & environmental issues all provide value maximization for a firm's social stewardship
Scrubbing data
making financial statements comparable to peer firms by: matching fiscal year ends (recast) & reconcil accounting difference
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