Formula for Total Asset Turnover

Total asset turnover measures the efficiency with which assets are used to generate sales. The formula is: $$\text{Total asset turnover} = \frac{\text{Sales}}{\text{Average total assets}}$$

Variations in Turnover Calculations

Turnover calculations can vary for accounts receivable, plant and equipment, and total operating assets.

Formula for Inventory Turnover

Inventory turnover measures the efficiency of the firm’s inventory management practices. The formula is: $$\text{Inventory turnover} = \frac{\text{Cost of goods sold}}{\text{Average inventories}}$$

Number of Days' Sales in Accounts Receivable

This measure shows the average age of the accounts receivable and reflects the efficiency of the firm’s collection policies. The formula is: $$\text{Number of days$$

Average Day’s Sales Calculation

Average day’s sales is used to calculate the number of days' sales in accounts receivable. The formula is: $$\text{Average day’s sales} = \frac{\text{Annual sales}}{365}$$

Number of days' sales in inventory formula

Number of days' sales in inventory = Inventory @Y-E / Average day's COGS

Average day's cost of goods sold formula

Average day's COGS = Annual COGS / 365

Used by investors to evaluate the market price of a company's common stock relative to other companies and the market as a whole.

The market price is equal to the earnings per share multiplied by the P/E ratio.

Used by common/preferred stock investors; average dividend yield on common stock has been 3-6% and for preferred stock 5-8%.

Dividend Payout Ratio

Reflects the dividend policy of the company.

Stable or gradually changing periodic dividends.

Additional dividends that may be declared and paid out after an especially profitable year.

DuPont Model: ROI Formula

ROI = Margin x Turnover = net inc/sales x sales/avg total A

Definition of Margin in DuPont Model

Margin expresses the net income resulting from each dollar of sales.

Definition of Turnover in DuPont Model

Turnover shows the efficiency with which assets are used to generate sales.

General Model for Return on Equity (ROE)

ROE = $$\frac{Net Income}{Average Total Stockholders$$

This ratio gives the rate of return on that portion of the assets provided by the owners/stockholders of the entity.

Variation of ROE with Preferred Stock

Net income is reduced by the amount of the preferred stock dividend requirement, and only common stockholders' equity is used in the denominator.

Price/Earnings Ratio (P/E Ratio) Formula

Price/Earnings Ratio = $$\frac{Market Price per Share}{Earnings per Share}$$

This ratio expresses the relative expensiveness of a share of a firm’s common stock, showing how much investors are willing to pay for the stock relative to earnings.

Dividend yield explanation

Expresses part of the stockholder’s ROI; rate of return represented by the annual cash dividend. The other part comes from the change in the market value of the stock during the year, called the capital gain or loss.

Dividend payout ratio

Annual dividend per share /Earnings per share

Dividend payout ratio explanation

Expresses the proportion of earnings paid as dividends to common stockholders. Used to estimate future dividends if earnings can be estimated.

Preferred dividend coverage ratio

Net income / Preferred dividend requirement

Preferred dividend coverage ratio explanation

Expresses the ability of the firm to meet its preferred stock dividend requirement. A higher ratio indicates a lower probability of discontinuing dividends on common stock.

The use of debt to finance the assets of the entity; magnifies the ROE relative to the ROI.

Financial leverage measures

Debt ratio and debt/equity ratio

Times interest earned ratio

Shows the relationship of earnings before interest and taxes (operating income) to interest expense. A greater ratio indicates more confidence in the firm’s ability to cover interest expenses.

Debt ratio = $$\frac{Total\ liabilities}{Total\ liabilities\ and\ stockholders$$

Debt/equity ratio formula

Debt/equity ratio = $$\frac{Total\ liabilities}{Total\ stockholders$$

Times interest earned formula

Times interest earned = $$\frac{Earnings\ before\ interest\ and\ taxes}{Interest\ expense}$$

Purpose of financial leverage measures

Shows the proportion of debt in the capital structure and reflects the risk caused by interest and principal requirements of debt.

Book value per share of common stock formula

Book value per share of common stock = $$\frac{Common\ stockholders$$

Common size financial statements

Used for comparing and evaluating the operating results of a company over a number of years by presenting the balance sheet and income statement in a percentage format.

CH11 Financial Statement Analysis Ratios Flashcards

Student preview

43 questions

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1.

FLASHCARD QUESTION

Front

Financial statement analysis ratios are grouped into how many categories?

Back

Four categories: Liquidity, Activity, Profitability, Debt or Financial leverage.

2.

FLASHCARD QUESTION

Front

Liquidity measure includes:

Back

Measures of working capital, current ratio, and acid-test ratio.

3.

FLASHCARD QUESTION

Front

Formula for working capital:

Back

Working capital = Current A - Current L

4.

FLASHCARD QUESTION

Front

Formula for the current ratio:

Back

Current ratio = Current A / Current L

5.

FLASHCARD QUESTION

Front

Formula for the acid-test ratio:

Back

Acid-test ratio = (Cash + Acct Rec.) / Current L

6.

FLASHCARD QUESTION

Front

Acid-test ratio excludes:

Back

Inventories and other nonliquid current assets.

7.

FLASHCARD QUESTION

Front

Impact of efficient use of assets on the firm’s ROI

Back

Efficient use of assets impacts the firm's Return on Investment (ROI) by improving the relationship between asset levels and sales.

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