 # PRDV201: Accounting Principles I

Unit 9: Calculating Financial Ratios   In Unit 3, you learned how to prepare a company’s financial statements.  In this unit, you will learn to calculate financial ratios given a company’s financial statements.  As discussed in previous units, financial statements must be prepared in accordance with accounting principles.  Analysts often use a company’s financial statements to determine the growth and viability of a company and then decide if they want to invest in that company or not.  If every company recorded its financial transactions and prepared its financial statements differently, it would be very difficult to calculate meaningful financial ratios.

Financial statements are analyzed by calculating mathematical financial ratios using the numerical information in financial statements.  By calculating financial ratios, investors can determine the profitability or liquidity of a company without having to set foot into corporate offices or work in production facilities.  A company’s profitability and solvency (its ability to meet their financial obligations) can be calculated from the financial statements.  This unit serves as a window into the life of a financial analyst, as you learn important mathematical ratios.  In the next unit, you will delve deeper into the importance of financial ratios and examine what factors influence a company’s financial ratios.

As you complete this unit, be sure to focus on how each financial ratio is calculated and what financial statements are helpful when calculating each financial ratio.

Unit 9 Time Advisory
This unit should take approximately 3 hours to complete.

☐    Subunit 9.1: 0.75 hours

☐    Subunit 9.2: 0.75 hours

☐    Subunit 9.3: 1 hour

☐    Subunit 9.4: 0.5 hours

Unit9 Learning Outcomes
Upon successful completion of this unit, the student will be able to: - Calculate ROA, ROE, gross profit margin, and net profit margin given a company’s financial statements. - Calculate asset turnover and inventory turnover from financial statements. - Calculate a company’s current ratio, quick ratio, and working capital given financial statements, and identify the meaning of these terms. - Calculate a company’s debt-to-equity and interest coverage ratio given financial statements. - Identify financial ratios that can be calculated to determine a company’s asset utilization, short-term liquidity risk, and long-term solvency.

9.1 What Are Financial Ratios?   9.1.1 Calculating ROA   - Lecture: Khan Academy’s “ROA Discussion” Link: Khan Academy’s “ROA Discussion” (YouTube)

`````` Instructions: Please click on the link above and watch the video
lecture, which details how ROA is calculated from financial
statement values.  By the end of this lecture, you should be able to
calculate the ROA of a company by using the company’s financial
statements.

Watching this lecture and taking notes should take approximately 20
minutes.

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9.1.2 Calculating ROE   - Lecture: YouTube: Money Week’s “What Is Return on Equity?” Link: YouTube: Money Week’s “What Is Return on Equity?” (YouTube)

`````` Instructions: Please click on the link above and watch the video
lecture, which details the specifics of return on equity.  As you
view this lecture, be sure to think about how return on equity may
affect the view of a company’s profitability.  By the end of this
lecture, you should be able to calculate a company’s return on
equity when given the company’s financial statements.

Watching this lecture and taking notes should take approximately 15
minutes.

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9.1.3 Calculating Gross & Net Profit Margin   - Reading: Dr. Larry Walther’s Principles of Accounting: “Chapter 5: Special Issues for Merchants” Link: Dr. Larry Walther’s Principles of Accounting: “Chapter 5: Special Issues for Merchants” (HTML)

`````` Instructions: Please click on the link above and read the “Analysis
of a Detailed Income Statement” section of this chapter.  As you
read, take notes on the formulas used to calculate the gross and net
profit margins.  By the end of this reading, you should be able to
calculate the gross and net profit margins when given a company’s
income statements.

Reading this chapter and taking notes should take approximately 10
minutes.

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9.2 What Is Asset Utilization?   9.2.1 Calculating Asset & Inventory Turnover   - Reading: Dr. Larry Walther’s Principles of Accounting: “Chapter 8: Inventory” Link: Dr. Larry Walther’s Principles of Accounting: “Chapter 8: Inventory” (HTML)

`````` Instructions: Please click on the link above and read the
“Inventory Management” section of this chapter.  As you read, take
notes on the formula used to calculate the inventory turnover.  By
the end of this reading, you should be able to calculate the
inventory turnover when given a company’s financial statements.

Reading this chapter and taking notes should take approximately 15
minutes.

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• Activity: Dr. Larry Walther’s Principles of Accounting: “Chapter 8: Inventory: Inventory Turnover Worksheet” Link: Dr. Larry Walther’s Principles of Accounting: “Chapter 8: Inventory: Inventory Turnover Worksheet” (PDF)

Instructions: Please click on the link above and carefully read the directions before completing the worksheet.  Identify and calculate the turnover ratios indicated.  If you have difficulty completing the worksheet, refer back to the reading assigned in this subunit.

Reviewing your previous readings and completing this worksheet should take approximately 15 minutes.

9.2.2 Calculating Days Inventory Held   - Lecture: YouTube: TreasuryOcean’s “Inventory Conversion Period” Link: YouTube: TreasuryOcean’s “Inventory Conversion Period” (YouTube)

`````` Instructions: Please click on the link above and watch the video
lecture, which details the specifics of how inventory turnover can
be used to calculate the days that inventory is held.  By the end of
this lecture, you should be able to calculate a company’s days
inventory held when given the company’s inventory turnover.  You
should also be able to qualitatively explain what this calculation
means for the company.  Please note that to calculate the days held
inventory, divide 365 (number of days in a year) by the inventory
turnover.

Watching this lecture and taking notes should take approximately 5
minutes.

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9.2.3 Calculating Days Receivables Outstanding   - Reading: Dr. Larry Walther’s Principles of Accounting: “Chapter 7: Accounts Receivable” Link: Dr. Larry Walther’s Principles of Accounting: “Chapter 7: Accounts Receivable” (HTML)

`````` Instructions: Please click on the link above and read the
“Monitoring and Managing Accounts Receivable” section of this
chapter.  As you read, take notes on the formula used to calculate
the accounts receivable turnover and accounts receivable days
outstanding.  By the end of this reading, you should be able to
calculate both the accounts receivable turnover and the accounts
receivable days outstanding when given a company’s income
statements.

Reading this chapter and taking notes should take approximately 10
minutes.

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9.3 What Are Liquidity Ratios?   9.3.1 Calculating the Quick & Current Ratio   - Reading: Dr. Larry Walther’s Principles of Accounting: “Chapter 4: Reporting Cycle” Link: Dr. Larry Walther’s Principles of Accounting: “Chapter 4: Reporting Cycle” (HTML)

`````` Instructions: Please click on the link above and read the “Current
Ratio” section of this chapter.  As you read, take notes on the
formulas used to calculate the quick and current ratios.  By the end
of this reading, you should be able to calculate the quick and
current ratios when given a company’s financial statements.

Reading this chapter and taking notes should take approximately 10
minutes.

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• Activity: Principles of Accounting: Dr. Larry Walther’s “Chapter 4: Inventory: Current and Quick Ratio Worksheet: Current and Quick Ratio Worksheet” Link: Principles of Accounting: Dr. Larry Walther’s “Chapter 4: Inventory: Current and Quick Ratio Worksheet: Current and Quick Ratio Worksheet” (PDF)

Instructions: Please click on the link above and carefully read the directions before completing the worksheet.  Identify the needed financial data and calculate the current and quick ratios.  If you have difficulty completing the worksheet, refer back to the reading assigned in this subunit.

Reviewing your previous readings and completing this worksheet should take approximately 15 minutes.

9.3.2 Calculating Working Capital   - Reading: Dr. Larry Walther’s Principles of Accounting: “Chapter 4: Reporting Cycle” Link: Dr. Larry Walther’s Principles of Accounting: “Chapter 4: Reporting Cycle” (HTML)

`````` Instructions: Please click on the link above and read the “Working
Capital” section of this chapter.  As you read, take notes on the
formula used to calculate the working capital.  By the end of this
reading, you should be able to calculate a company’s working capital
when given a company’s financial statements.

Reading this chapter and taking notes should take approximately 10
minutes.

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9.3.3 Calculating the Cash Conversion Cycle   - Lecture: YouTube: Econo McCall’s “Cash Conversion Cycle” Link: YouTube: Econo McCall’s “Cash Conversion Cycle” (YouTube)

`````` Instructions: Please click on the link above and watch the video
lecture, which details the definition of the cash conversion cycle
and what financial data is needed to calculate a company’s cash
conversion cycle.  As you view this lecture, be sure to pay close
attention to the financial statements needed to calculate this
cycle.  By the end of this lecture, you should be able to calculate
the cash conversion cycle and explain its significance in
understanding the financial operations of a company.

Watching this lecture and taking notes should take approximately 15
minutes.

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9.4 What Are Long-Term Solvency Ratios?   9.4.1 Calculating the Debt-to-Equity Ratio   - Reading: Dr. Larry Walther’s Principles of Accounting: “Chapter 13: Long-Term Obligations” Link: Dr. Larry Walther’s Principles of Accounting: “Chapter 13: Long-Term Obligations” (HTML)

`````` Instructions: Please click on the link above and read the
“Analysis, Commitments, and Leases” section of this chapter.  As you
read, take notes on the formula used to calculate the debt to equity
ratio.  By the end of this reading, you should be able to calculate
a company’s debt to equity ratio when given a company’s financial
statements.

Reading this chapter and taking notes should take approximately 5
minutes.

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• Activity: Dr. Larry Walther’s Principles of Accounting: “Chapter 13: Long-Term Obligation: Debt to Equity Practice Worksheet” Link: Dr. Larry Walther’s Principles of Accounting: “Chapter 13: Long-Term Obligation: Debt to Equity Practice Worksheet” (PDF)

Instructions: Please click on the link above and carefully read the directions before completing the worksheet.  Identify the needed financial data and calculate the debt to equity ratios indicated.  If you have difficulty completing the worksheet, refer back to the reading assigned in this sub-subunit.

Reviewing your previous readings and completing this worksheet should take approximately 15 minutes.

9.4.2 Calculating the Times Interest Earned Ratio   - Reading: Dr. Larry Walther’s Principles of Accounting: “Chapter 13: Long-Term Obligations” Link: Dr. Larry Walther’s Principles of Accounting: “Chapter 13: Long-Term Obligations” (HTML)

`````` Instructions: Please click on the link above and read the
“Analysis, Commitments, and Leases” section of this chapter.  As you
read, take notes on the formula used to calculate the times interest
earned ratio.  By the end of this reading, you should be able to
calculate a company’s times interest earned ratio when given a
company’s financial statements.

Reading this chapter and taking notes should take approximately 5
minutes.