Financial Midterm Review

Financial Ratios •

Profitability: generation of revenues in excess of the expenses associated

o Profit margin (net profit/net sales)

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Percentage of sales left over after all other expenses

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Decreasing trendàearnings declined more than sales

o Return on assets (net profit/total assets) §

Indicates how well the assets are at generating profit

o Return on equity (net profit/avg equity) §

Effectiveness of owners’ investment at generating profit

o Vertical Analysis (SOE item/sales) §
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Percentage of sales used for that item

Efficiency: efficient use of assets o Age of accounts receivable (AR/avg daily sales=net sales/365) §

Days of sales owed by customers

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Greater the age, the more $$ required to operate because the customers have the extended use of the company’s $$

o Age of accounts payable (AP/avg daily purchases=purchases/365) §

Days of purchases owed to customers

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Indicates whether company depends too much on trade credit

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Trend of increasing age may indicate excessive inventory for its sales or that inventory is obsolete

o Age of inventory (ending inventory/avg daily COGS=COGS/365) §
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Number of days of sales before running out of inventory

Liquidity: ability to