Chapter 3 textbook P50-end

# Chapter 3 textbook P50-end - 2.2 using financial ratios...

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2.2 using financial ratios Ratio analysis: involves methods of calculating and interpreting financial ratios to analyze and monitor the firm’s performance The basic inputs to ratio analysis are the firm’s income statement and balance sheet. Two types of ratio comparisons can be made: cross-sectional and time-series. Cross-sectional analysis: comparison of different firms’ financial ratios at the same point in time; involves comparing the firm’s ratios to those of other firms in its industry or to industry averages. Benchmarking: a type of cross-sectional analysis in which the firm’s ratio values are compared to those of a key competitor o group of competitors that it wishes to emulate Time-series analysis: evaluation of the firm’s financial performance over time using financial ratio analysis. 2.3 Liquidity Ratios Liquidity: a firm’s ability to satisfy its short-term obligations as they come due. Current ratio: a measure of liquidity calculated by dividing the firm’s current assets by its current liabilities. Current ratio = current assetscurrent liabilities The higher the current ratio ----- more liquid the firm is considered to be. Liquidity ratio = Total liquid assetsTotal current debts Indicates the percent of annual debt obligations that an individual can meet using current liquid assets Quick (Acid-test) Ratio: a measure of liquidity calculated by dividing the firm’s current assets minus inventory by its current liabilities. Quick ratio = - current assets inventorycurrent liabilities Low liquidity of inventory: 1. Inventory cannot easily sell 2. Inventory is typically sold on credit 2.4 Activity Ratios Activity ratios: measure the speed with which various accounts are converted into sales or cash –

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Chapter 3 textbook P50-end - 2.2 using financial ratios...

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