Download Study Unit 2 - CMAPrepCourse

Part 2
Study Unit 2.1– 2.3
Ratio Analysis
Liquidity Ratios
• Liquidity is the firm’s ability to pay its current
obligations as they come due. - Short run
– How easy is it to convert assets to cash.
• Liquidity ratios relates liquid assets to current
liabilities.
– Current assets – converted to cash within 1 year or
operating cycle.
• Current asset ratios – Firm’s ability to operate in short term.
• Current assets/liabilities are shown in descending order of
liquidity.
Liquidity Ratios
• Liquidity is the firm’s ability to pay its current
obligations as they come due. - Short run
– How easy is it to convert assets to cash.
• Liquidity ratios relates liquid assets to current liabilities.
– Current assets – converted to cash within 1 year or operating
cycle.
• Current asset ratios – Firm’s ability to operate in short term.
• Current assets/liabilities are shown in descending order of liquidity.
• Net Working Capital = Current assets – Current Liabilities
– How much capital is left after paying current obligations.
Liquidity Ratios
• Current ratio = Current Assets / Current Liabilities
• Most common liquidity measurement
– Low ratio = Possible liquidity problems
– High ratio = Management not investing assets
• Should be proportional to the operating cycle.
– Shorter operating cycles may justify lower ratio.
• Converting to cash quicker.
• Evaluate A/R and inventory turn
• LIFO lowers ratio.
Liquidity Ratios
• Quick ratio – (Acid test) = Cash + Mkt Securities + Net
receivables / Current liabilities
– Avoids inventory valuation issues.
– Conservative approach.
• Cash ratio = Cash + Mkt Securities/Current Liab.
• Cash Flow ratio = C/F from Operations/Cur. Liab.
• Net Working Capital ratio = Cur. Assets – Cur. Liab./Total
Assets
– Most conservative of working capital ratios.
• Liability liquidity – The ease of issuing new debt/funds.
Activity Measures
• Measures how quickly noncash assets are converted to
cash.
• Over a period of time. Includes I/S data.
• The Balance Sheet data should always be an average
• A/R Turnover = Net credit sales / Ave. A/R
– Efficiency of A/R collections.
– High ratio : Customers pay promptly.
– Highly seasonal should use monthly A/R average.
Activity Measures
• Days’ Sales Outstanding (DSO)
• DSO = Days in year / AR turnover
– Average collection period in days.
– May use 365, 360 or 300 days
– Compared to credit terms to determine if customers pay
within terms.
Activity Measures
• Inventory turnover = COGS / Ave. Inventory
– Measures efficiency of inventory management.
– High ratio : Quicker inventory turns
• Inventory not obsolete, not carrying excess.
– Highly seasonal should use monthly Inv. average.
– LIFO valuation not comparable to other methods.
– Inventory turnover is industry specific.
• Grocery vs. Concrete
• Days’ Sales in Inventory = Days in year/Inv. Turnover
– How many days sales are tied up in inventory.
Activity Measures
• Accounts Payable Turnover = Purchases / Ave. AP
– Highly seasonal should use monthly Payables average.
• Days’ Purchases in Accounts Payable (DPO)
• DPO =Days in year / AP Turnover
– Compared to credit terms to determine if the firm is
paying within terms.
Activity Measures
• Operating Cycle = DSI + DSO
– The amount of time to convert inventory to cash.
– Figure 2-2 Page 67
• Cash Cycle = Operating Cycle – DPO
– Is the days that cash is tied up as another asset.
Activity Measures
• Fixed Assets Turnover Ratio = Net Sales / Ave. Net PP&E
– How efficiently the company deploys its investment in plant
assets to generate revenues.
– Higher turnover is preferable.
– Affected by the capital intensiveness of the company and its
industry, by the age of the assets, and by depreciation
method used.
• Total Assets Turnover Ratio = Net Sales / Ave. Total Assets
– Higher turnover is preferable.
– Exclude assets that do not relate to sales. Ex: investments
Calculate: Current Year Net Working Capital
Calculate: Current Year Net Working Capital
Current Assets – Current Liabilities $760 – 390 = $370,000
Calculate: Current Year Current Ratio
Calculate: Current Year Current Ratio
Current Assets / Current Liabilities 760 / 390 = 1.949
Calculate: Current Year Quick (Acid Test) Ratio
Calculate: Current Year Quick (Acid Test) Ratio
Cash + Mkt Securities + Net Rec / Current Liabilities
(325 + 165 + 120 + 55) / 390 = 1.705
Calculate: Current Year Cash Ratio
Calculate: Current Year Cash Ratio
Cash + Mkt Securities / Current Liabilities
(325 + 165) / 390 = 1.256
Calculate: Current Year Net Working Capital Ratio
Calculate: Current Year Net Working Capital Ratio
Current Assets - Current Liabilities / Total Assets
(760 – 390) / 1,800 = .206
Calculate: CY AR Turnover
* All sales are 365 day credit sales
Calculate: CY AR Turnover
Net Credit Sales / Ave. AR
1,800 / ((120 + 115) /2) = 15.3
Calculate: CY DSO
* All sales are 365 day credit sales
Calculate: CY DSO
Days in Year / AR Turnover
365 / 15.3 = 23.9 Days
Calculate: CY Inventory Turnover
* All sales are 365 day credit sales
Calculate: CY Inventory Turnover
COGS / Ave. Inventory
1650 / (85 +55)/2 = 23.6
Calculate: CY DSI
Days in Year / Inventory Turnover
365 / 23.6 = 15.5 Days
Calculate: CY AP Turnover
Purchases
*CY = $1,760,000 PY = $1,440,000
Calculate: CY AP Turnover
Purchases / Ave AP
$1,760 / (150 + 75) /2 = 15.6
Calculate: CY DPO
Calculate: CY DPO
Days in Year / AP Turnover
365 / 15.6 = 23.4 Days
Calculate: CY Operating Cycle
Calculate: CY Operating Cycle
DSO + DSI
23.9 + 15.5 = 39.4 Days
Calculate: CY Cash Cycle
Calculate: CY Cash Cycle
Operating Cycle - DPO
39.4 – 23.4 = 16.0 Days
Calculate: CY Fixed Asset Turnover Ratio
Calculate: CY Fixed Asset Turnover Ratio
Net Sales / Ave PP&E
$1,800 / (915+ 845)/2 = 2.05
Calculate: CY Total Asset Turnover Ratio
Calculate: CY Total Asset Turnover Ratio
Net Sales / Ave Total Assets
$1,800 / (1,800 + 1,600)/2 = 1.06