Ch 3

Question 0

Financial ratios

Answer 0

Relationships determined from firm’s financial info

And used for comparison purposes

Question 1

Common-size statement

Answer 1

Standardized financial statement presenting all items
In percentage terms

Balance sheet items are shown as percentage of assets
Income statement items are shown as percentage of sales

Question 2

5 categories of financial ratios?

Answer 2

1 short term solvency, liquidity ratios
2 Longterm solvency, financial leverage ratios
3 asset management, turnover ratios
4 profitability ratios
5 market value ratios

Question 3

Current ratio

Answer 3

Current ratio= current assets/current liabilities

The higher the better

Question 4

Suppose a firm were to pay off some of its suppliers and short term creditors, what would happen to its current ratio?

Answer 4

It will move away from one

If its greater than 1 it will get bigger
If its less than 1 it will get smaller

Question 5

Quick ratio AKA Acid test

Answer 5

Quick ratio = (current assets - inventory)/current liabilities

Question 6

Cash ratio

Answer 6

A very short term creditor would be interested in the cash ratio

Cash ratio = cash/current liabilities

Question 7

3 types of short term solvency ratios, purpose?

Answer 7

Current ratio, quick ratio, cash ratio

Measure firms ability to pay its bills over short run without
Undue stress

Question 8

5 Longterm solvency measures, purpose?

Answer 8

1Total debt ratio, 
2debt-equity ratio, 
3equity multiplier
4 times interest earned ratio
5 cash coverage ratio
Address firms long run ability to meet its obligations

Question 9

Total debt ratio

Answer 9

Total debt ratio = (total assets - total equity)/total assets

Ex: a total debt ratio = 0.28 means company has 28%
Debt for every $1 of assets

Question 10

Debt-equity ratio

Answer 10

Debt-equity ratio = total debt/total equity

Question 11

Equity multiplier

Answer 11

Equity multiplier = total assets/ total equity

Question 12

Times interest earned ratio

Answer 12

Times interest earned ratio = EBIT/interest

Question 13

Cash coverage ratio

Answer 13

Cash coverage ratio = (EBIT + depreciation)/interest

Question 14

EBITD, EBITDA

Answer 14

EBITD = EBIT + depreciation

EBITDA = earnings before interest, taxes, depreciation
and amortization

Question 15

Amortization

Answer 15

Non cash deduction similar to depreciation except

Applies to an intangible asset (ex patents)

Question 16

5 Asset management AKA Turnover ratios, purpose?

Answer 16

1 inventory turnover
2 days' sales in inventory
3 receivables turnover
4 days' sales in receivables
5 total asset turnover

Describe how efficiently/ intensively a firm uses its assets to generate sales

Question 17

Inventory turnover

Answer 17

Inventory turnover = cost of goods sold/inventory

The higher this ratio is, the more efficiently inventory is being managed

Question 18

Receivables turnover

Answer 18

Receivables turnover = sales/accounts receivable

Question 19

Days’ sales in receivables AKA Average collection period

Answer 19

Days sales in receivables = 365/receivables turnovers

Question 20

Total asset turnover

Answer 20

Total asset turnover = sales/total assets

Ex. Total asset turnover = $0.64, so for ever $1 in assets
we generate $.64 in sales

Question 21

Capital intensity, define, equation?

Answer 21

1/total asset turnover = capital intensity

Ex if capital intensity =$1.56, it takes the company
$1.56 in assets to create $1 in sales

Question 22

Suppose you find a particular company generating $.40 in sales for every $1 of total assets.
How often does the company turnover it’s total assets?

Answer 22

Total asset turnover = .4 times per year. It takes

1/.40 = 2.5 years to turn assets over completely

Question 23

3 profitability measures, their purpose?

Answer 23

Profit margin, return on assets, return on equity

Measure how efficiently firm uses its assets and
How efficiently firm manages its operations

Question 24

Profit margin

Answer 24

Profit margin= net income/sales

Question 25

Return on Assets (ROA)

Answer 25

Return on assets = net income/total assets Measures profit per dollar of assets

Question 26

Return on equity (ROE), 2 equations?

Answer 26

Return on equity = net income/total equity = (net income/sales) x (sales/assets) x (assets/equity) Profit for every dollar of equity

Question 27

Return on book assets and return on Book equity

Answer 27

Measured rates of return of ROA and ROE

Question 28

What does it mean when a company's ROE exceeds its ROA?

Answer 28

The company uses financial leverage

Question 29

6 Market value measures, purpose?

Answer 29

``` 1 EPS 2 PE ratio 3 price-sales ratio 4 Market-to-book ratio 5 enterprise value 6 EBITDA ratio ``` Measures used to determine the market price per share

Question 30

EPS

Answer 30

EPS = net income/shares outstanding

Question 31

PE ratio

Answer 31

PE ratio = price per share/earnings per share

Question 32

Price to sales ratio, equation, when is it used?

Answer 32

Price-sales ratio = price per share/sales per share Used when company has negative earnings, so measures Revenues

Question 33

Market-to-book ratio

Answer 33

Market-to-book ratio = market value per share/book value per shr.

Question 34

Book value per share

Answer 34

Book value per share = total equity/# shares outstanding

Question 35

Enterprise value, what does it measure?

Answer 35

Enterprise value = Total market value of stock + book value of all liabilities - cash Measures value of operating assets

Question 36

EBITDA ratio, what does it measure

Answer 36

EBITDA ratio = enterprise value/EBITDA Relates value of operating assets (enterprise value) To a measure of operating cash flow generated by Assets (EBITDA)

Question 37

DuPont identity, define, equation?

Answer 37

Popular expression breaking ROE into 3 parts: Operating efficiency, asset use efficiency and Financial leverage ROE = profit margin x total asset turnover x equity multiplier

Question 38

What does it mean when google has a higher profit margin and total asset turnover compared to yahoo?

Answer 38

Google is able to generate revenues at far | lower costs than yahoo

Question 39

Dividend payout ratio

Answer 39

Dividend payout ratio = cash dividends/net income

Question 40

Retention ratio AKA plow back ratio

Answer 40

Retention ratio = addition to retained earnings/net income

Question 41

Internal financing

Answer 41

What the firm earns and plows back into the business

Question 42

External financing

Answer 42

Funds raised from borrowing money or selling stock

Question 43

Internal growth rate, equation, define?

Answer 43

Maximum possible growth rate when Firm grows only throw internal financing, so wont borrow or sell stock Internal growth rate = (ROA X b)/(1 - ROA X b) Where b is the retention

Question 44

If a firm only relies on internal financing then overtime it's ...

Answer 44

Total debt ratio will decline | As assets grow and debt remains the same

Question 45

Sustainable growth rate, equation, define?

Answer 45

Sustainable growth rate = (ROE x b)/(1 - ROE x b) Maximum possible growth rate for a firm that maintains Constant debt ratio and doesn't sell stock

Question 46

4 factors of a firm's ability to sustain growth?

Answer 46

1. Increase profit margin from internal growth 2. Increase total asset turnover, by increasing sales relative to each asset 3 Financial policy, increase debt-equity ratio 4 Dividend policy, a decrease in percentage of net income Paid as dividends will increase retention rate and internal growth

Question 47

Standard industrial classification code (SIC)

Answer 47

US government code to classify firm by its type | Of business operations