Chapter 13 Analysis of Financial Statements a. A liquidity ratio is a ratio that shows the relationship of a firm’s cash and other current assets to its current liabilities. The current ratio is found by dividing current assets by current liabilities. It indicates the extent to which current liabilities are covered by those assets expected to be converted to cash in the near future. | Chapter 13 Analysis of Financial Statements ANSWERS TO END-OF-CHAPTER QUESTIONS 13-1 a. A liquidity ratio is a ratio that shows the relationship of a firm s cash and other current assets to its current liabilities. The current ratio is found by dividing current assets by current liabilities. It indicates the extent to which current liabilities are covered by those assets expected to be converted to cash in the near future. The quick or acid test ratio is found by taking current assets less inventories and then dividing by current liabilities. b. Asset management ratios are a set of ratios that measure how effectively a firm is managing its assets. The inventory turnover ratio is sales divided by inventories. Days sales outstanding is used to appraise accounts receivable and indicates the length of time the firm must wait after making a sale before receiving cash. It is found by dividing receivables by average sales per day. The fixed assets turnover ratio measures how effectively the firm uses its plant and equipment. It is the ratio of sales to net fixed assets. Total assets turnover ratio measures the turnover of all the firm s assets it is calculated by dividing sales by total assets. c. Financial leverage ratios measure the use of debt financing. The debt ratio is the ratio of total debt to total assets it measures the percentage of funds provided by creditors. The times-interest-earned ratio is determined by dividing earnings before interest and taxes by the interest charges. This ratio measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs. The EBITDA coverage ratio is similar to the times-interest-earned ratio but it recognizes that many firms lease assets and also must make sinking fund payments. It is found by adding EBITDA and lease payments then dividing this total by interest charges lease payments and sinking fund payments over one minus the tax rate. d. Profitability ratios are a group of
