4 - Analysis of Financial Statements

Question 1

Help us evaluate financial statements; used to make comparisons

Answer 1

Ratios

Question 2

5 Categories of Ratios:

Answer 2

1. Liquidity
2. Asset Management
3. Debt Management
4. Profitability
5. Market Value

Question 3

Give an idea of firm’s ability to pay off debts that mature within a year

Answer 3

Liquidity ratios

Question 4

How efficiently the firm is using its assets

Answer 4

Asset management ratios

Question 5

How the firm has financed its assets as well as the firm’s ability to repay its long-term debt

Answer 5

Debt management ratios

Question 6

How profitably the firm is operating and utilizing its assets

Answer 6

Profitability ratios

Question 7

What investors think about the firm and its future prospects

Answer 7

Market value ratios

Question 8

Shows how many times the particular asset is “turned over” during the year

Answer 8

Inventory Turnover Ratio

Question 9

Term originated with old Yankee peddler; what he actually sold

Answer 9

Turnover

Question 10

Represents the average length of time the firm must wait after making a sale before receiving cash

Answer 10

Days Sales Outstanding (DSO) Ratio

Question 11

Days Sales Outstanding (DSO) Ratio is also called

Answer 11

Average Collection Period (ACP)

Question 12

Measures how effectively the firm uses its plant and equipment

Answer 12

Fixed Assets Turnover Ratio

Question 13

Measures how effectively the firm uses its total assets

Answer 13

Total Assets Turnover Ratio

Question 14

Firms with relatively high debt ratios typically have higher expected returns when economy is normal, if in times with lower returns, it could possibly face

Answer 14

bankruptcy

Question 15

2 Procedures Analysists Use to Examine Firm’s Debt:

Answer 15

1. Check BS to determine portion of total funds represented by debt
2. Review the IS to see the extent to which interest is covered by operating profits

Question 16

Measures the percentage of the firm’s capital provided by debtholders

Answer 16

Total Debt to Total Capital

Question 17

Generally refer to the total debt to total capital ratio

Answer 17

Company’s debt ratio

Question 18

Measure of the firm’s ability to meet its annual interest payments

Answer 18

Times-Interest-Earned (TIE) Ratio

Question 19

Group of ratios that show the combined effects of liquidity, asset management, and debt on operating results

Answer 19

Profitability Ratios

Question 20

Measures operating income (EBIT) per dollar of sales

Answer 20

Operating Margin

Question 21

Measures net income per dollar or sales

Answer 21

Profit Margin/Net Profit Margin

Question 22

Interest changes pull down

Answer 22

net income

Question 23

Measures the rate of return on the firm’s assets

Answer 23

Return on Total Assets (ROA)

Question 24

Measures the rate of return on common stockholder’s investment

Answer 24

Return on Common Equity (ROE)

Question 25

Measures the total return that the company has provided for its investors

Answer 25

Return on Invested Capital (ROIC)

Question 26

Indicates the ability of the firm's assets to generate operating income

Answer 26

Basic Earning Power (BEP) Ratio

Question 27

Single best accounting measure of performance

Answer 27

Return on Common Equity (ROE)

Question 28

Related the firm's stock price to its earnings and book value per share

Answer 28

Market Value Ratios

Question 29

Market Value Ratios are used in 3 primary ways:

Answer 29

1. by investors 2. by investment bankers 3. by firms

Question 30

Shows how much investors are willing to pay per dollar of reported profits

Answer 30

Price/Earnings (P/E) Ratio

Question 31

Ratio of a stock's market price to its book value

Answer 31

Market/Book (M/B) Ratio

Question 32

Looks at the relative market value of all the company's key financial claims; not heavily influenced by the company's debt and tax situations

Answer 32

Enterprise Value/EBITDA (EV/EBITDA) Ratio

Question 33

Shows the relationships among asset management, debt management, and profitability ratios

Answer 33

DuPont Equation

Question 34

Develop by the chemical giant's financial staff in 1920s

Answer 34

DuPont Equation

Question 35

"Multiplier" that tells us how many times the profit margin is earned each year

Answer 35

Total assets turnover

Question 36

Adjustment factor

Answer 36

Equity multiplier

Question 37

Help identify ways to improve its performance

Answer 37

DuPont Equation

Question 38

Study various expense items and work with engineers, purchasing agents, and other operating personnel, to seek ways to cut costs.

Answer 38

Cost accountants

Question 39

Investigate ways to speed up collections, which would reduce accounts receivable and improve the quality of the total assets turnover ratio

Answer 39

Credit manager

Question 40

Analyze the effects of alternative debt policies, showing how changes in leverage would affect both the expected ROE and the risk of bankruptcy

Answer 40

Financial staff

Question 41

3 Problems that are likely to arise if firm relies too heavily on ROE to measure performance:

Answer 41

1. ROE does not consider risk 2. Does not consider the amount of invested capital 3. Focus on ROE can cause managers to turn down profitable projects

Question 42

Project's ROE must be combined with its size and risk to determine its effect on shareholder value

Answer 42

1. ROE 2. Risk 3. Capital invested

Question 43

Process of comparing a particular company with a subset of top competitors in its industry; makes it easy to see exactly where a company stands relative to the competition.

Answer 43

Benchmarking

Question 44

Companies used for the comparison

Answer 44

Benchmark companies

Question 45

Analysis of firm's financial ratios over time; used to estimate the likelihood of improvement or deterioration in its financial condition

Answer 45

Trend Analysis

Question 46

Techniques employed by firms to make their financial statements look better than they really are

Answer 46

Window Dressing Techniques

Question 47

Ratio analysis is used by 3 main groups:

Answer 47

1. managers 2. credit analysts 3. stock analysts