# Study Guide 2.1 - What is ratio analysis? A relative...

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What is ratio analysis?A relative financial analysis, Makes comparisons on a fair basis.Purposes of Ratio analysis: Evaluate the financial conditions and performance, Monitor operating performance and financial conditions, evaluate solvency andliquidity or riskiness of loans, Evaluate performance of a firm and attractiveness of investmentRatio analysis can answer the following questions:Is there sufficient cash to meet the establishment's obligations for a given time period? Are the profit of thehospitality operation reasonable? Is the level of debt acceptable in comparison with the stockholders’ investment? Is the inventory usage adequate? How do theoperation’s earnings compare with the market price of the hospitality property’s stock? Are account receivable reasonable in light of credit sales? Is the hospitalityestablishment able to service its debt?Ratios can be compared using three benchmarks: 1. Historical performance: ratio comparison over time periods for the same firm. 2.Compare across the industry– compare one firm against another firm or the industry average. 3. Compare actual ratios with target ratios1. Liquidity Ratios:Reveal the firm’s ability to meet its short-term Obligations-Sufficient cash and near cash assets to pay bills on time. -Common liquidity ratios-Current ratio (CR)Current ratio: CR =current assets (CA)/current liabilities (CL)* However, CR includes inventory, which is the least liquid item in CA and cannot beused to pay bills. - CR includes all CA -CR may not measure the true ability to pay bills on time.- Acid-test ratio (quick ratio) (ATR)Acid test ratio (quick ratio) - an improvement over CR:ATR = (CA - inventory - prepaid expenses) / CL* Excluding the least liquiditem (inventory) and prepaid expenses (money already gone)from the CA, we have “quick assets” in the numerator. Thus ATR is a more accurate measure of theability to pay bills on time. - An improvement over CR -A more accurate measure of firms’ ability to pay bills on time- Operating cash flows to current liabilitiesratio (OCFTCLR)Operating cash flow to current liabilities (OCFTCL) – It measures the ability of using operating cash flow to pay bills:OCFTCL = Operating cashflow / average CL* Average CL = (Beginning of year CL + Ending CL)/2- A firm’s ability to generate sufficient cash to pay the company’s CL- Accounts receivableturnover (ART)Accounts Receivable Turnover (ART) - how fast the firm is collecting sales money.ART = Total sales / average AR. Shows the number of times that Acct. Receivableis converted into cash during a period, the numerator represents total AR occurred during a periodwhile the denominatorindicates the average level of AR during the period.While a high ART improves liquidity, it may discourage patronage. Therefore, we should expect that:HigherART - stricter credit policy - decrease sales,Lower ART - lenient credit policy - increase sales2. Solvency ratios “Leverage ratios”:two sub-categoriesA)The degree of debt use or indebtedness – such as debt to equity ratio, debt ratio, etc.1. Debt Ratio:

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Term
Winter
Professor
Walker
Tags
Financial Ratio