Chapter 14 Flashcards
(36 cards)
Managers analyze financial statements for a variety of reasons including:
(1) to control operations;
(2) to assess the financial stability of vendors, customers, and other business partners; and
(3) to assess how their companies appear to investors and creditors.
How do managers control operations?
> To gain insight into whether their goals have been achieved or the plans have been implemented successfully, managers analyze financial statements. In part, this is how they control operations.
Another important reason for analyzing financial statements is to assess what?
> is to assess the financial stability of vendors (i.e., suppliers), customers, and other business partners.
Companies analyze the financial statements of customers to assess what?
> to assess whether they will be able to pay the amounts they owe on a timely basis.
What relationships are being made in many industries?
> companies are establishing strong relationships with a relatively small number of vendors who are willing to commit to high quality levels and short lead times.
> Many companies are also developing partnerships with other firms to produce and sell products and services.
How can a manager assess the financial stability of potential vendors, customers, and other business partners?
> financial ratio, times interest earned, which is the ratio of operating income to interest expense.
> If this ratio is less than 1, it suggests that the company will not be able to make required debt payments, which may lead to bankruptcy.
Investors and creditors carefully analyze a company’s financial statements, and managers should anticipate how their financial information will appear to these important stakeholders. Provide an example of what would be done in this situation?
> managers know that the financial statements will show a marked difference between cash flow from operations and net income and that such a difference is likely to cause investor concern, then they can communicate with investors via notes in their financial statements, press releases, or other news articles to explain the difference and, it is hoped, alleviate concern.
> Alternatively, they can avoid transactions leading to such differences. In general, managers should analyze financial statements from the perspective of their investors and creditors so they can anticipate, and fully answer, questions from these stakeholders.
What is horizontal analysis?
> Horizontal analysis consists of analyzing the dollar value and percentage changes in financial statement amounts across time.
What is Vertical analysis ?
> Vertical analysis (also called common size analysis) consists of analyzing financial statement amounts in comparison to a base amount (total assets when analyzing the balance sheet and net sales when analyzing the income statement).
In horizontal analysis, how are horizontal analyses done?
> For assets, these changes relate to receivables, merchandise inventory, land, buildings, and furniture and fixtures (all of which have increased).
> For liabilities and stockholders’ equity, major changes relate to accounts payable, long-term debt, and retained earnings.
Why do some managers manipulate earnings?
> As you well know, “You get what you measure,” and managers often are evaluated and rewarded based on the level of firm earnings. Thus, for example, if earnings are below the level specified for achieving a bonus, managers have strong incentives to manipulate earnings upward.
> Another reason to manage earnings upward might be to inflate stock prices so managers can profit from exercising their stock options.
A red flag suggesting that accounting irregularities may be a problem is:
> is a substantial difference between reported net income and operating cash flows.
is a substantial difference between reported net income and operating cash flows. What are the three we will discuss?
> management discussion and analysis, credit reports, and news articles.
The annual report of public companies contains a specific important section - what is that?
> called management discussion and analysis (abbreviated as MD&A).
> In this section, management provides stockholders and other financial statement users with explanations for financial results that are not obvious simply from reading the basic financial statements.
What do firms sell in regards to company information?
> A number of firms (e.g., Dun & Bradstreet) sell credit reports that provide information on a company’s credit history
To control operations, to assess the stability of vendors, customers, and other business partners, and to assess how their companies appear to investors and creditors, managers frequently perform financial analyses using various ratios. what are three that we will discuss?
> To control operations, to assess the stability of vendors, customers, and other business partners, and to assess how their companies appear to investors and creditors, managers frequently perform financial analyses using various ratios.
How is earnings per share (EPS) calculated?
> Earnings per share (EPS) calculated as net income less preferred dividends divided by the number of shares of common stock that are outstanding.
> Amount of earnings generated per share of common stock. The more earnings per share a company can generate, the higher its stock price.
How do you calculate Price-earnings ratio?
> Price-earnings ratio =
> Indicates how much investors are willing to pay per dollar of earnings. Generally, a high price–earnings ratio indicates that investors believe a company will have relatively high earnings growth.
How do you calculate gross margin percentage? What does it represent?
> Gross margin ÷ Net sales
> While a variety of factors affect the price–earnings ratio, including interest rates and other factors that relate to general economic conditions, a major factor is investors’ expectations of future profitability.
> Indicates how much a company earns per dollar of sales, taking into account the cost of the items it sells. Companies that have a relatively high markup on the products they sell (e.g., jewelry stores) have relatively high gross margin percentages.
How do you calculate Return on total assets?
> {Net income + [Interest expense × (1 − Tax rate)]} ÷ Total assets
> The adjustment for interest is made so that the assessment of profitability is independent of how the firm is financed. (Debt financing reduces income [due to interest expense], but equity financing does not reduce reported income.)
> The return a company is able to earn on funds invested by shareholders. A ratio higher than the return on total assets suggests that the company is making good use of leverage (debt financing).
How do you calculate return on common stockholders’ equity?
> (Net income − Preferred dividends) ÷ Common stockholders’ equity
> The return a company is able to earn on funds invested by shareholders. A ratio higher than the return on total assets suggests that the company is making good use of leverage (debt financing).
What factors affect the price-earnings ratio?
> While a variety of factors affect the price–earnings ratio, including interest rates and other factors that relate to general economic conditions, a major factor is investors’ expectations of future profitability.
When does a company have good use of financial leverage?
> This indicates that the company is making good use of financial leverage, which relates to the use of debt financing to acquire assets.
Turnover ratios reveal what?
> Turnover ratios reveal the efficiency with which a company uses its assets.
