# Short term solvency ratios

HANDOUT: Useful Financial Ratios (see attachment)

SHORT-TERM SOLVENCY RATIOS (Liquidity Ratios)

Current ratio = Current assets ÷ Current liabilities

Quick ratio = (Current assets - Inventory) ÷ Current liabilities

ACTIVITY RATIOS

Total asset turnover = Total operating revenues ÷ Average total assets

Receivables turnover = Total operating revenues ÷ Average receivables

Average collection period = Days in period ÷ Receivables turnover

Inventory turnover = Cost of goods sold ÷ Average inventory

Days in inventory = Days in period ÷ Inventory turnover

FINANCIAL LEVERAGE RATIOS

Debt ratio = Total debt ÷ Total assets

Debt-equity ratio = Total debt ÷ Total equity

Equity multiplier = Total assets ÷ Total equity

Interest coverage = Earnings before interest and taxes ÷ Interest

PROFITABILITY RATIOS

Net profit margin = Net income ÷ Total operating revenue

Operating profit margin = Earnings before interest and taxes ÷ Total operating revenues

Net return on assets = Net Income ÷ Average Total Assets

Gross return on assets = Earnings before interest and taxes ÷ Average total assets

Net[Gross] Return on assets (ROA) = Net[Gross] Profit margin × Asset Turnover

Return on equity (ROE) = Net income ÷ Average stockholders' equity

Payout ratio = Cash dividends ÷ Net Income

Retention ratio = Retained earnings ÷ Net Income = 1 - Payout ratio

MARKET VALUE RATIOS

Price-to-earnings (P/E) ratio = Market price per share ÷ Earnings per share

Dividend yield = Dividend per share ÷ Market price per share

Market-to-book (M/V) ratio = Market price per share ÷ Book value per share

Tobin's Q ratio = (Market value of debt + equity) ÷ Replacement value of total assets

DUPONT RATIO

Net profit ratio x Total asset turnover x 1+ Debt ratio

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#### Solution Preview

SHORT-TERM SOLVENCY RATIOS (Liquidity Ratios) - See attachment.

1) Current ratio

Current ratio is computed as current assets divided by current liabilities. Current assets include cash and cash equivalents, accounts receivable, marketable securities, inventory, supplies and prepaid items. Current liabilities include accounts payable, salaries payable and other short term obligations that are to be paid within a years' time. A current ratio of 2 and above is considered a benchmark for a sound liquidity position. If the current ratio is less than 2, ...

#### Solution Summary

This solution provides an explanation of current and quick ratios.