Accounting & auditingLesson 7 of 8 in the course Using Financial Information and Accounting

Analyzing Financial Ratios: Liquidity, Profitability, Activity, and Debt

5 flashcards · 5 quiz questions · 5 match pairs · 5 fill-in sentences · English

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Summary

Financial statements provide snapshots of a company’s operations, profitability, and financial condition. Ratio analysis connects figures from those statements to help evaluate financial strengths and weaknesses. This lesson introduces how ratios are interpreted and focuses on liquidity, a firm’s ability to meet short-term obligations.

Ratio analysis calculates and interprets relationships between financial figures, usually using data from the balance sheet and income statement. A ratio can express one financial amount in relation to another, such as current assets compared with current liabilities or profit compared with sales.

All flashcards

Net profit margin
Net profit divided by net sales; it measures the share of sales remaining as profit after expenses and taxes.
Return on equity (ROE)
Net profit divided by owners’ equity; it relates profit to owners’ investment in the firm.
Earnings per share (EPS)
Net profit divided by the number of common shares outstanding; it is not the dividend paid per share.
Inventory turnover
Cost of goods sold divided by average inventory; it indicates how quickly inventory moves through a business.
Debt-to-equity ratio
Total liabilities divided by owners’ equity; it compares creditor financing with owners’ financing.

Quiz questions

  1. How is the debt-to-equity ratio calculated?Answer: Total liabilities divided by owners’ equity.
  2. What does earnings per share express?Answer: Profit earned for each common share outstanding.
  3. How is inventory turnover calculated?Answer: Cost of goods sold divided by average inventory.
  4. What can financial ratios establish about a possible problem in a firm?Answer: They can flag potential trouble spots but do not prove a cause.
  5. What does a debt-to-equity ratio above 100% indicate?Answer: Total liabilities exceed owners’ equity.

Based on Introduction to Business 2e by Lawrence J. Gitman, Carl McDaniel, Amit Shah, Monique Reece, Linda Koffel, Bethann Talsma, James C. Hyatt (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.

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