What is acid test ratio and ROA ratio?

What is acid test ratio and ROA ratio?

Investors calculate the acid test ratio, also known as the quick ratio or the pounce ratio. This ratio excludes inventory and prepaid expenses, which the current ratio includes, and it limits assets to cash and items that the business can quickly convert to cash. This limited category of assets is known as quick or liquid assets. The acid-text ratio is calculated by dividing the liquid assets by the total current liabilities.

This ratio is also known as the pounce ratio to emphasize that you're calculating for a worst-case scenario, where the business's creditors could pounce on the business and demand quick payment of the business's liabilities. Short term creditors do not have the right to demand immediate payment, except in unusual circumstances. This ratio is a conservative way to look at a business's capability to pay its short-term liabilities.

One factor that affects the bottom-line profitability of a business is whether it uses debt to its advantage. A business may realize a financial leverage gain, meaning it earns more profit on the money it has borrowed than the interest paid for the use of the borrowed money. A good part of a business's net income for the year may be due to financial leverage. The ROA ratio is determined by dividing the earnings before interest and income tax (EBIT) by the net operating assets.

An investor compares the ROA with the interest rate at which the corporation borrowed money. If a business's ROA is 14 percent and the interest rate on its debt is 8 percent, the business's net gain on its capital is 6 percent more than what it's paying in interest.

ROA is a useful ratio for interpreting profit performance, aside from determining financial gain or loss. ROA is called a capital utilization test that measures how profit before interest and income tax was earned on the total capital employed by the business.

Related Posts:

  • What are independent auditors? What are independent auditors? Indpendent CPA auditors are like referees in the financial reporting arena. The CPA comes in, does an audit of the business's accounting system and methods and gives a report that is attached … Read More
  • What does an audit do? What does an audit do? If a business breaks the rules of accounting and ethics, it can be liable for legal sanctions against it. It can deliberately deceive its investors and lenders with false or misleading numbers in its … Read More
  • What is accounting fraud? What is accounting fraud? Accounting fraud is a deliberate and improper manipulation of the recording of sales revenue and/or expenses in order to make a company's profit performance appear better than it actually is. Some … Read More
  • What is acid test ratio and ROA ratio? What is acid test ratio and ROA ratio? Investors calculate the acid test ratio, also known as the quick ratio or the pounce ratio. This ratio excludes inventory and prepaid expenses, which the current ratio includes, and it… Read More
  • What are other ratios used in financial reporting What are other ratios used in financial reporting The dividend yield ratio tells investors how much cash income they're receiving on their stock investment in a business. This is calculated by dividing the annual cash divid… Read More

0 comments:

Post a Comment