Question

In: Accounting

the income statements, balance sheets and financial ratios that you learned in your Accounting courses? Which...

the income statements, balance sheets and financial ratios that you learned in your Accounting courses? Which line items in income statements and balance sheets; and which financial ratios based on the two reports can you identify that can give you clues and information on how well your supply chain is being managed?


Solutions

Expert Solution

Financial ratios are categorized as:

  • Liquidity ratios
  • Leverage ratios
  • Efficiency ratios
  • Profitability ratios

Liquidity Ratios

Liquidity ratios are financial ratios that measure a company’s ability to repay both short- and long-term obligations.

Current ratio

The current ratio measures a company’s ability to pay off its short-term liabilities with current assets:

Current ratio = Current assets / Current liabilities

Acid-test ratio (Quick ratio)

The acid-test ratio measures a company’s ability to pay off its short-term liabilities with quick assets:

Acid-test ratio = Current assets – Inventories / Current liabilities

Cash ratio

The cash ratio measures a company’s ability to pay off short-term liabilities with cash and cash equivalents:

Cash ratio = Cash and Cash equivalents / Current Liabilities

Operating cash flow ratio

The operating cash flow ratio is a measure of the number of times a company can pay off current liabilities with the cash generated in a period:

Operating cash flow ratio = Operating cash flow / Current liabilities

Leverage Financial Ratios

Leverage ratios measure the amount of capital that comes from debt.

Debt ratio

The debt ratio measures the relative amount of assets that are provided from debt:

Debt ratio = Total liabilities / Total assets

Debt to equity ratio

The debt to equity ratio calculates the total debt and financial liabilities against equity:

Debt to equity ratio = Total liabilities / Shareholder’s equity

Interest coverage ratio

The interest coverage ratio shows how easily interest expenses can be paid:

Interest coverage ratio = Operating income / Interest expenses

Efficiency Ratios

Efficiency ratios are to understand how well a company is utilizing its assets and resources.

Asset turnover ratio

The asset turnover ratio measures a company’s ability to generate sales from assets:

Asset turnover ratio = Net sales / Total assets

Inventory turnover ratio

The inventory turnover ratio measures how many times a company’s inventory is sold and replaced over a period:

Inventory turnover ratio = Cost of goods sold / Average inventory

Receivables turnover ratio

The accounts receivable turnover ratio measures how many times a company can turn receivables into cash over a period:

Receivables turnover ratio = Net credit sales / Average accounts receivable

Days sales in inventory ratio

The days sales in inventory ratio measures the average number of days that a company holds on to inventory:

Days sales in inventory ratio = 365 days / Inventory turnover ratio

Profitability Ratios

Profitability ratios measure a company’s ability to generate income relative to revenue:

Gross margin

The gross margin ratio compares the gross profit of a company to its net sales to show how much profit a company makes after paying its cost of goods sold:

Gross margin ratio = Gross profit / Net sales

Operating margin

The operating margin ratio compares the operating income of a company to its net sales:

Operating margin ratio = Operating income / Net sales

Return on assets

The return on assets ratio measures how efficiently a company is using its assets to generate profit:

Return on assets ratio = Net income / Total assets

Return on equity

The return on equity ratio measures how efficiently a company is using its equity to generate profit:

Return on equity ratio = Net income / Shareholder’s equity

B.

Inventory turnover ratio and Days inventory outstanding will provide a good understanding of supply chain management.

Inventory turnover gives the number of times the company makes sales and restore the inventory in a period and days inventory outstanding gives the understanding of the days company holds the inventory before selling it. These two ratios can be analysed in order to make better inventory management.


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