Surgent CPA Review co-founder, Liz Kolar recently shared her quick tips on how to memorize key CPA Exam ratios. Here’s what she had to say:
Return on ratio
The first CPA Exam ratio candidates should become familiar with is the “return on” ratio. The phrase “return on” means “net income divided by.”
The formula for Return on Equity is Net Income ÷ Equity. The formula for Return on Assets is Net Income ÷ Assets.
A turnover ratio is calculated by dividing sales by what you are turning over. The numerator has to related to the denominator. For example, the formula for Receivables Turnover is Net Credit sales (not all sales) ÷ Average Net Receivables. The formula for Inventory Turnover is Cost of Goods Sold (not sales) ÷ Average Inventory.
Ratios that involve the word “to”
When you see the word “to” between two words it means “divide by.” For example, the formula for Debt to Equity is Debt ÷ Equity. The formula for Debt to Assets is Debt ÷ Assets.
Ratios that involve the word “margin”
When you see a ratio that contains a “margin,” it usually means “divide by sales”. The formula for Profit Margin is Gross profit ÷ Sales. The formula for Operating Margin is Operating Profit ÷ Sales.
Ratios to commit to memory
We recommend you commit to memory at least two additional, more complicated formulas. The first one is Earnings Per Share (EPS). The formula is Net Income minus the Preferred Dividend ÷ the Weighted Average of the Common Shares Outstanding.
The second formula is Times Interest Earned (TIE). The formula is Earnings Before Interest and Taxes (EBIT) ÷ Interest Payments.
Ratios are tested in the BEC, FAR and AUD sections of the CPA Exam. You need to be prepared to calculate the formulas and interpret the results.
These are the key ratios that every candidate should have in their repertoire before they sit for the CPA Exam. Watch the full video here: