Financial Metrics
Operational Ratios
Calculating Inventory Turnover and the Current Ratio (working capital).
Questions provide simplified balance sheets and income statement excerpts. Inventory Turnover questions require identifying COGS and inventory from separate statements. Current Ratio questions present a list of balance sheet items (some current, some long-term) and test whether you correctly isolate the current-period items before calculating.
What the exam tests
Formula-to-Term Identification
A formula is given; identify the ratio: 'Cost of Sales ÷ Average Inventory Balance' = Inventory Turnover Ratio.
Ratio Definition and Purpose
Identify what a ratio measures: the Current Ratio measures a company's ability to pay its short-term debts when due.
Quantitative Calculation
Solve for a specific ratio value using provided financial data: identify the correct variables and perform the division.
Component Classification
Categorize financial statement items correctly for ratio use: distinguish Current Assets and Current Liabilities from long-term items for the Current Ratio.
Structural Recognition
Key rules
- ›Inventory Turnover = Cost of Goods Sold (Income Statement) ÷ Average Inventory (Balance Sheet).
- ›Average Inventory = (Beginning Inventory + Ending Inventory) ÷ 2.
- ›Current Ratio = Current Assets ÷ Current Liabilities (both from the Balance Sheet).
- ›A Current Ratio ≥ 1.0 means current assets cover current liabilities; < 1.0 signals liquidity risk.
Common traps
- !Using Revenue instead of Cost of Goods Sold as the numerator in Inventory Turnover.
Analytical Discrimination (Current vs. Long-Term)
Key rules
- ›Current Assets: cash, A/R, inventory, and prepaid expenses, all expected to convert to cash within one year.
- ›Current Liabilities: A/P, accrued expenses, and short-term notes payable, all due within one year.
- ›Exclude long-term assets (PP&E, intangibles) and long-term liabilities (bonds payable) from the Current Ratio.
Common traps
- !Including long-term debt in Current Liabilities, which artificially lowers the Current Ratio.
Interpretive Data Extraction
Key rules
- ›For Inventory Turnover: extract COGS (Income Statement) and beginning/ending inventory (Balance Sheet).
- ›For Current Ratio: sum only the current-classified assets and liabilities, and ignore all long-term items.
- ›If only one inventory figure is given, use it directly rather than averaging.
Common traps
- !Averaging inventory when only one period's balance is provided.
Arithmetical Accuracy
Key rules
- ›Carry at least two decimal places for turnover calculations. A result of 4.67 vs. 4.7 can affect ranking questions.
- ›Verify Current Ratio: re-add current assets and current liabilities separately before dividing.
Try one
Cost of sales divided by the average inventory balance equals which ratio?
Inventory Turnover = Cost of Goods Sold (cost of sales) divided by Average Inventory. It shows how many times inventory is sold and replaced during a period.
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