Chapter 3: Analysis of Financial Statements Flashcards

Question

Inventory turnover ratio

Answer 1

= cost of goods sold (including depreciation) / inventories depreciation included because virtually all depreciation associated with producing products? (some sources define it as sales/ inventories)

Answer 2

= cost of goods sold (including depreciation) / inventories depreciation included because virtually all depreciation associated with producing products? (some sources define it as sales/ inventories) Number of times inventory is sold out and restocked ("turned over") each year low may mean holding too much inventory

Answer 3

Ratios that show the relationship of a firm's cash and other current assets to its current liabilities (firm's short term ability to pay obligations)

Answer 4

= current assets / current liabilities relevance of this ratio depends on perspective creditors: high current ratio = current assets available to cover liabilities Shareholders: high current ratio may mean too much money tied up in nonproductive assets flag if wildly different from industry average

Answer 5

aka acid test ratio = (current assets - inventories) / current liabilities or = (cash + short term investments+ net accounts receivable)/ current liabilities measurement of firm's ability to pay off short-term obligations without relying on the sale of inventories if below 1 would have to sell inventory to pay off current liabilities if they were all called

Answer 6

one that trades in an active market. Can be converted quickly to cash at the going price

Answer 7

ratio of total assets to common equity the extent to which a firm uses debt financing shows the factor by which ROA is scaled up to determine ROE is the magnifying effect that debt has on ROE and shareholder risk

Answer 8

- financing part of a firm with debt means shareholders can control a firm with smaller equity investments - shareholders returns magnified if assets generate higher pre-tax return than the interest rate on debt (conversely losses magnified if pre-tax ROA is below interest rate) - if a company has high leverage a small decline in performance may cause the firm's value to fall below it's total debt ergo creditor's position riskier as leverage increases

Answer 9

aka leverage ratios show: - a firm's use of debt relative to equity - it's ability to pay interest in principle help judge likelihood of defaulting on deby

Answer 10

aka debt ratio = total debt/ total assets percentage of funds provided by investors other than preferred or commDeon shareholders

Answer 11

= total debt / total common equity (amount of debt for every dollar of equity)

Answer 12

= stock price x number of shares

Answer 13

= total debt / (Total debt + market value of equity)

Answer 14

shows the extent to which a firm's assets are NOT supported by equity = total liabilities / total assets

Answer 15

a set of rations that measure how effectively a firm is managing it's assets (also asset management ratios) = return on equity / return on assets = (net income/ common equity) / (net income/ total asset) the factor by which ROA is mulitipled to determine ROE = 1/(1- liabilities-to-assets ratio)

Answer 16

TIE ratio aka interest coverage ratio = EBIT / interest expense measures extent to which operating income can decline before the firm is unable to meet its annual interest costs uses EBIT because interest is paid with pre-tax dollars.

Answer 17

- interest not the only fixed financial charge. need to pay down debt/ lease payments - EBIT is not all cash flow available to service debt (esp. if firm has high non-cash expenses)

Answer 18

Takes all "cash" earnings into account and all financial charges = (EBITDA + lease payments) / (Interest + principal payments + lease payments) must add back in lease payments because it has already been removed from EBITDA but is part of financial charges of most use to relatively short-term lenders (period where depreciation-generated funds can be used to service debt instead of going back into the plant and equiptment

Answer 19

required annual payment designed to reduce the balance of a bond or preferred stock issue

Answer 20

relate a company's stock price to it's earnings, cash flow, and book value per share. measure the value of a company's stock relative to another company

Answer 21

P/E ratio shows how much investors are willing to pay per dollar of reported profits = price per share / earnings per share compare to industry numbers higher for firms with strong growth prospects

Answer 22

P/FCP = price per share / free cash flow per share pertinent because stock price depends on a company's ability to generate free cash flow)

Answer 23

= price / EBITDA measure of operating performance that removes non-operating items (income/ taxes)

Answer 24

M/B ratio indicator of how investors regard the company = market price per share / book value per share (aka market value of equity / total common equity reported in FS) Market value: forward looking (expectations of future cash flows) Book value: past looking (historical investments/ earnings)

Answer 25

= Total common equity / shares outstanding

Answer 26

aka Market cap total market value of equity in a company = price per share x total number of shares

Answer 27

Examination of a single ratio over time (can be compared against the trend in the industry on average)

Answer 28

all income statement items are divided by sales and all balance sheet items are divided by total assets thus a common size income statement shows each item as a percentage of sales and a common size balance sheet shows each item as a percentage of total assets facilitates comparisons of financial statements over time and across companies

Answer 29

calculates growth rates for all income statement items and all balance sheet accounts relative to a base year

Answer 30

a formula showing that the rate of return on equity can be found as the profit margin multiplied by the product of total assets turnover and the equity multiplier ROE = PM * total asset turnover * equity multiplier helps show how managerial actions affecting profitability, asset efficiency and financial leverage interact to determine return on equity

Answer 31

ROE = (net income / sales) * (sales/ total assets) * (Total assets / common equity) (Same as ROE = Profit margin * total assets turnover * equity multiplier)

Answer 32

ROE = (net income/ total assets) x (total assets / common equity) = ROA * equity multipler

Answer 33

When a firm compares its rations to other leading (benchmark) companies in the same industry

Answer 34

- industry averages are only somewhat meaningful to large firms that operate different divisions in different industries - goals for high-level performance better set against industry leaders than average ratios - inflation may distort firm's balance sheets (historical cost vs replacement value) - distortion from seasonal effects (when balance sheet inventory closes), minimized by using monthly averages for inventory calculations - "window dressing" by firms - distortion from different choices of accounting methods

Answer 35

techniques employed by firms to make their financial statements look better than they really are - manipulation of timing for assets and liabilities

Answer 36

- to what extent are the company's revenues tied to one key customer or key product? - to what extent does the company rely on a single supplier? - what percentage of the company's business is generated overseas? - what are the probable actions of current competitors and the likelihood of additional new competitors? - do the company's future prospects depend critically on the success of products currently in the pipeline or existing products? - how do the legal and regulatory environments affect the company?

Chapter 3: Analysis of Financial Statements Flashcards

(60 cards)