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BU227 - Ratio Analysis.docx

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Carolyn Mac Tavish

BU227 FINALEXAM REVIEW Part II: Ratio Analysis TYPE 1: Measuring ability to pay current liabilities CURRENT RATIO • Measures the company’s ability to pay current liabilities with current assets • Rule of thumb is 1.5:1 = current assets / current liabilities ACID TEST RATIO • Shows the company’s ability to all current liabilities if they come due immediately • Rule of thumb is 1:1 = (cash + short term investments + net receivables) / current liabilities TYPE 2: Measuring ability to sell inventory and collect receivables INVENTORY TURNOVER • Is a measure of the number of times the average level of inventory is sold during the year • Ahigher number indicates an ability to sell inventory more quickly • Too low indicates difficulty in selling inventory but too high means the business may not be keeping enough inventory on hand which could result in a lost sales if the company cannot fill orders = cost of goods sold / average inventory ACCOUNTS RECEIVABLE TURNOVER • Measures a company’s ability to collect cash from credit customers • Too high may mean credit is too tight, losing sales to good customers • Too low may mean credit terms are loose = net credit sales / average net accounts receivable DAYS SALES IN RECEIVABLES • Measures how many days sales remain as Accounts Receivable = average net accounts receivables / (net sales / 365) TYPE 3: Measuring ability to pay long-term debt DEBT RATIO • Indicates the proportion of assets financed with debt • Higher ratio translates to higher risk and more interest =
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