Financial analysis and valuation
The Ratio Read
Name the ratio, plug the exact numerator over denominator, and watch the sales versus COGS swap and the inventory exclusion.
How the exam words it
- -The stem hands you a balance sheet and income statement and asks for a named ratio such as the quick ratio or times interest earned.
- -It gives turnovers and asks you to convert them to days, or to build the operating or cash conversion cycle.
- -It supplies net margin, asset turnover, and an equity multiplier and asks for ROE through the DuPont model.
- -It asks for a common-size percentage, stating one line as a percent of net sales or total assets.
The playbook
- 1Identify the ratio and write its exact numerator and denominator: the quick ratio excludes inventory and prepaids, and times interest earned uses EBIT over interest.
- 2Split the turnover ratios by their base: inventory and payables turnover use cost of goods sold, receivables turnover uses net credit sales, and use average balances when two years are given.
- 3Convert a turnover to days by dividing 365 by the turnover, then build the cash conversion cycle as days inventory plus DSO minus days payable.
- 4For DuPont, multiply net margin by asset turnover by the equity multiplier, remembering the first two terms alone equal ROA before leverage.
The trap
Slipping inventory into the quick ratio, or using sales in inventory turnover. The quick ratio excludes inventory and prepaids, and inventory turnover uses cost of goods sold.
How the exam varies it
The same pattern, re-skinned along these axes:
Which ratio: liquidity, solvency, activity, or profitabilityA raw ratio versus a turnover converted into daysA single ratio versus the three-part DuPont decomposition
Drill this pattern
8 questions of The Ratio Read from across the AUD topics. Clear it by getting 5 right with a streak of 3.