Chapter 2 - Theory Flashcards
What financial statements measure the flow of income, expenses, and cash over time?
Income statement and statement of cash flows.
What does the balance sheet show?
Snapshot of business investment and financing at a point in time.
What are the two dimensions in which ratios are analyzed?
Across time for the same firm (trend analysis)
and
across firms (benchmark analysis).
What do growth rates capture? + what are they
Growth rates measure how fast something (like sales, profits, investment value or a company) is increasing over time, and they capture the speed of improvement or expansion from one period to the next.
How is growth in financial terms generally divided?
Growth due to operations and growth due to inflation.
What are profitability ratios?
Profitability ratios are tools we use to understand how well a business is making money. In other words, they show how good a company is at turning sales or investments into profits.
What does the Gross Income Margin tell us?
The Gross Income Margin tells us how much profit a company keeps from its sales after covering just the cost of making the product, showing how efficiently it produces or sells its goods.
What does the Operating Income Margin (EBIT Margin) tell us?
How much profit is the business making from its core operations—before interest and taxes—compared to its sales?
What does the Net Income Margin tell us?
Profit retained per dollar of revenue after all expenses.
Define Operating Income.
Profit from core business activities, excluding taxes and financing.
(= EBIT)
Define Operating cash flows.
Operating Cash Flows (OCF) are the actual cash a business gets from its regular day-to-day activities—like selling products or providing services—after paying the basic running costs like salaries, rent, and inventory.
excluding financing and investing activities.
(only core business activities)
What is Total capital?
Total Capital is the total amount of money a company uses to run its business and grow.
It comes from two main sources:
- Equity – money from the owners or shareholders
- Debt – money borrowed, like loans or bonds
What is the formula for Du Pont Analysis of ROA and ROE?
+ explain the components & what it is
🧠 What is Du Pont Analysis?
A way to break down ROA and ROE into smaller parts so you can understand:
- Where profits are really coming from
- If it’s because of good business or just debt
🔹ROA (Return on Assets)
Formula: Net Profit Margin × Asset Turnover
Net Profit Margin = Profit per dollar of sales
Ex: 10% margin = $0.10 profit on $1 sale
Asset Turnover = Sales per dollar of assets
Ex: $2 sales from $1 of assets
👉 ROA shows how efficiently you use assets to make money / profit.
🔹ROE (Return on Equity)
Formula: Net Profit Margin × Asset Turnover × Equity Multiplier
Equity Multiplier = Assets ÷ Equity
Higher = more debt use
- Because if equity is small compared to assets, the
rest must be funded by debt — so a higher equity multiplier means more assets are financed with
debt.
👉 ROE shows how well you use investors’ money — and how much debt boosts returns.
What do financial leverage ratios indicate? + what are they
Financial leverage ratios show how much a company relies on debt to finance its operations. They help investors and creditors understand a company’s financial risk — especially whether it can handle its debt obligations.
metrics that compare a company’s debt to another financial metric, such as equity or assets.
Define Debt ratio.
Total Debt / total assets
Measueress how much total debt is financed by the total assets a company has
Define Long-term debt-to-equity ratio.
The long-term debt-to-equity ratio measures how much of a company’s financing comes from long-term debt compared to shareholders’ equity. It shows how heavily a company relies on long-term borrowing to fund its operations.
What does the Times Interest Earned ratio indicate?
The Times Interest Earned (TIE) ratio shows how easily a company can pay its interest on debt using its earnings,
kind of like asking: “How many times over can you cover your loan payments with your income?”
What are Asset Management Ratios?
Asset Management Ratios show how well a company is using its assets to generate sales or profits
— in simple terms, they measure efficiency.
Examples of these ratios:
- Inventory Turnover = How often you sell and replace inventory
- Asset Turnover = How much sales you make for each dollar of assets
- Receivables Turnover = How quickly customers pay you back
Define Receivables Turnover.
Receivables Turnover is a measure of how many times a business collects its average accounts receivable during a period, showing how efficiently it turns credit sales into cash.
Define Inventory Turnover.
How often a company sells through its inventory annually.
Define Fixed Asset Turnover.
Revenue generation from fixed assets.
Define Total Asset Turnover.
Revenue generation from total assets.
What is the purpose of Days calculations?
Time taken to convert operations into cash.
What is the Cash Conversion Cycle (CCC)?
Time to turn resources into cash through operations.
