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Average of ratios

Hi!  When we use ratios between BS items and IS or CFS we must every time average the BS ratios, right??? When there is a BS item with another BS item, is it necessary to average the items?? Because in my notes I have the financial leverage as averages of Assets and Equity….

Thank you

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It’s not necessary. Averaging is method used to reduce the seasonality effect. You will find, ending values are used sometimes instead, especially for analyzing companies at its mature stage.

play it again, Sam

But for the exam, when should average when chance given right? Between BS items and CF and IS items… afraid of making little silly mistakes

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No averaging on PL items, only on BS items if required.

play it again, Sam

Flashback wrote:

No averaging on PL items, only on BS items if required.

The book seems to suggest the opposite:

“A good general rule is that when an income statement or cash flow statement number is in the numerator of a ratio and a balance sheet number is in the denominator, then an average should be used for the denominator. It is generally not necessary to use averages when only balance sheet numbers are used in both the numerator and denominator because both are determined as of the same date.”

(Institute 328)

Institute, CFA. 2016 CFA Level I Volume 3 Financial Reporting and Analysis. CFA Institute, 07/2015. VitalBook file.

The citation provided is a guideline. Please check each citation for accuracy before use.

If I recall correctly there was a rule of thumb  for the exam:

With regards to FRA use average B/S values and with regards to CF use end of period values. Not sure if this is still valid though…