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Name 2 ratios that are used to analyze a firm's liquidity position, and give their equations.
- 1. Current Ratio =
- current assets/current
- 2. Quick (acid test) ratio =
- current assets - inventories/ current
What are the characteristics of liquid assets? Give examples.
- A liquid asset is one that trades in an active market and can be quickly converted to cash at the going market price.
- This normally includes cash, marketable securities, accounts receivable and inventories.
Which current asset is typically the least liquid?
What are current liabilities?
- Accounts payable
- Short term notes payable
- current maturities of long term debt
- accrued taxes
- other accrued expenses (principally wages)
These are currently due within 1 year.
Identify 4 ratios that are used to measure how effectively a firm is managing its assets and write out their equations.
- Inventory Turnover Ratio - how often inventory is "turned over".
- Inventory turnover Ratio =
- Days Sales outstanding (average collection period) - the average length of time a firm must wait after making sale before receiving cash.
- DSO (ACP) = receivables/avg sales per
- day [ or receivables/annual sales/365
- Fixed assets turnover ratio - measures how effectively firm uses plant and equipment.
- = sales/net fixed assets
- Total assets turnover ratio - measures turnover of all the firm's assets
- = sales/total assets
How might rapid growth distort the inventory turnover ratio?
Sales occur over entire year, inventories are measured for one point in time.
What potential problem might arise when comparing different firms' fixed assets turnover ratios?
FATR = sales/net fixed assets
E.G. If comparing an old company that acquired many of its fixed assets years ago at low prices with a new company that acquired its fixed assets only recently, the old company would have a higher FATR, but this would be due to the effects of inflation (on the denominator), not necessarily due to inefficiency on the part of the new firm.
How does the use of financial leverage affect current stockholders' control position?
By raising funds through debt, stockholders can maintain control of a firm without increasing their investment.