FAR, Financial Accounting and Reporting
Sources for Financial Ratios and Performance Metrics
Last reviewed
The standards and authorities behind PocketCPA's FAR lessons on Financial Ratios and Performance Metrics. The topic rests on Financial analysis.
About this topic
A ratio sets one figure from the financial statements over another so that the two can be compared. Ratio analysis takes the raw dollar figures on the balance sheet, income statement, and statement of cash flows and turns them into comparable measures of liquidity, efficiency, solvency, and profitability.
A single number, "net income of $90,000", means little standing alone. Expressed as a ratio, "a 9 percent net margin" or "a return on equity of 24 percent", it becomes comparable over time and against competitors.
Key points
- Liquidity ratios (current, quick) measure the ability to meet short-term obligations.
- Profitability ratios use a flow over an average balance, and the numerator must match what the denominator is carried at.
- Turnover ratios (receivables, inventory, payables) measure efficiency; the numerator must match the asset's cost basis.
- DuPont analysis decomposes ROE into profit margin, asset turnover, and financial leverage.
- Leverage ratios (debt-to-equity, times interest earned) measure long-term solvency and the ability to service debt.
What the lessons cover
- The running example
- Liquidity ratios
- Activity and efficiency ratios
- Solvency and leverage ratios
- Profitability ratios
- The DuPont decomposition of ROE
- Interpretation and limitations
- How a transaction moves a ratio
- Debt covenants: testing, curing, and the trap in the cure
- Common-size and trend analysis
- A full pass over one set of statements
- Reading the question for the right input
- Quick reference: formulas, inputs, and the swap the exam makes
Authoritative references
- ASC 260-10-45-10, basic earnings per share: income available to common stockholders divided by the weighted-average number of common shares outstanding.
- ASC 260-10-45-11, the income measure for basic earnings per share: income from continuing operations when that line is reported, less preferred dividends.
- ASC 260, the earnings per share Topic, which supplies the per-share figures used in the price-earnings and dividend ratios.
The liquidity, activity, solvency, profitability, and DuPont ratios and the common-size and trend analysis in this unit are standard financial analysis conventions rather than Codification requirements, so they carry no pinpoint citation.
How PocketCPA uses these sources
Every lesson is written in original words and cites the paragraph each rule comes from. No standard's text is reproduced. How lessons and questions are written and checked is set out in our methodology.