3.Financial Statement Analysis Flashcards
What is balance sheet
is a snapshot of the firm’s assets and liabilities at a given point in time.
Assets = Liabilities + Shareholders’ Equity
What is goodwill
For example I buy macbook not only for its quality but also for the brand perception, reputation
What is Liquidity?
When we speak of the liquidity of an asset, we mean
o the ability to convert it to cash quickly, AND
o without a significant loss in value.
• Firms that have a fair amount of liquid assets are less likely to experience financial distress.
• But liquid assets earn a lower return. Liquidity больше но зарабатываем меньше
Trade off between liquidity and return
Basically, that means the lower risk you take the lower return you make. To make higher return with low risk then we should give up some liquidity. For instance, buying the real estate.
Or there’s another way to have a high return, but with high risk for instance buying stocks
Book Value versus Market Value
• The balance sheet provides the book value of the assets, liabilities and equity.
• Market value is the price at which the assets, liabilities or equity can actually be bought or sold.
• Market value and book value are often very different. Why?
o Some assets do not even appear on the balance sheet.
o Under certain accounting rules, assets are listed at cost (e.g. US- GAAP, HGB).
o Even if assets are listed at fair value (e.g. IFRS) real market values are not available and must be estimated.
• Therefore, the “Total Assets” line on the balance sheet is generally not a very good estimate of what the assets of the firm are actually worth.
Net Working Capital
Net working capital measures the short-term liquidity of a company
The Income Statement
Income (or Profit) = Revenue – Expenses during period
Matching principle
Accounting requires to show revenue when it accrues and match the expenses required to generate the revenue.
General structure of Income Statement
Turnover(or Revenue) - COGS =Gross Profit - Marketing and sales expenses - General and administrative expenses = Operating Profit \+ Non-opertating income - Non.operating expenses = EBIT \+ FInancial income - Financial expenses = EBT - Income Taxes = Net Income, NP or EAT
Non-Cash Items
Non-cash items are items on the income statement that represent costs but involve no cash outflow or inflow:
Depreciation
Cost of machines used up in the production process
Amortization
Reduction in the value of intangible assets
Impairment
Reduction in the value of e.g. goodwill, shares
Operating Cash Flow (OCF)
OCF is the cash flow that results from the day-to-day business of producing and selling.
Net Capital Spending (NCS)
• NCS is sometimes called capital expenditure (CAPEX).
• NCS is money spent on fixed assets (additional assets and
replacements) less money received for the sale of fixed assets.
Change in Net Working
• NWC is considered a good measure of both a company’s efficiency and its financial health.
• NWC = Current assets – Current liabilities
• The Change in NWC reflects the amounts invested in current assets
less the amounts financed by current liabilities.
Change in NWC = Ending NWC – Beginning NWC
interest -finance expense Sales – turnover or total operating revenue Cogs- Cost of sales EBIT- operating profit Net income- profit for year, net profit
Ratio Analysis
Liquidity Ratios
Current Ratio = CA / CL
o This ratio (CR) measures how much current liabilities are covered by current assets, assuming both can be converted to cash over the following 12 months.
o Rule of thumb: > 1 times (~ 1.5 – 2.5 times is considered healthy).
o High current ratio means high liquidity but also means a possible inefficient use of cash.
Liquidity Ratios
Quick Ratio = (CA – Inventory) / CL
Quick ratio measures the ability of a business to pay its short-term liabilities by having assets that are already converted into cash
o Rule of thumb: > 1 time.
Liquidity Ratios
Cash Ratio = Cash & cash equivalent / CL
o This ratio measures how much current liabilities are covered by cash or cash equivalent.
o Rule of thumb: ~ 0.2 times for the healthy company.
o For a start-up, this ratio should be higher e.g. between 0.3 and 0.5. o Too little cash (Cash Ratio «_space;0.2) increases the risk of bankruptcy.
o Too much cash (Cash Ratio»_space; 0.2) means too much-forgone interest.
Financial Leverage Ratios
Total Debt Ratio
=TL/TA
o This ratio measures how much of the company’s assets is funded by
debt.
o Rule of thumb: < 0.7 times for healthy firm.
o This ratio takes into account all debts (current and non-current) of all maturities to all creditors.
o A low percentage («_space;0.7) means that the company is less dependent on leverage i.e. money borrowed from and/or owed to others. т
o In general, the higher the ratio, the more risks the company is considered to have taken on.
Financial Leverage Ratios
Debt Equity Ratio
TL / TE
o This ratio indicates the proportion of debt and equity the company is
using to finance its assets.
o Rule of thumb: < 2 times.
o Similar to the Total Debt Ratio, a low percentage («_space;2) means that the company is using less leverage and has stronger equity position.
o A high Debt Equity Ratio means that the company has made an aggressive financing with debt. The company must therefore ensure that it generates sufficient operating profit to cover additional interest expenses.
Financial Leverage Ratios
Equity Multiplier
= TA / TE = 1 + Debt Equity Ratio
o This ratio is useful in the consideration of Return of Equity (ROE).
Financial Leverage Ratios
Times Interest Earned Ratio = EBIT / Interest
o This ratio (a.k.a Interest Coverage Ratio) indicates well the company
has its interest obligations covered.
o Rule of thumb: > 1 times.
