Chapter 4

Question 1

financial ratios

Answer 1

• a number from a financial statement that has been scaled by dividing by another financial number

Question 2

ROE (return on equity) equation

Answer 2

net income / stockholder equity
* higher ROE signals a company efficiently uses equity to generate income

Question 3

current ratio equation

Answer 3

current assets / current liabilities
*ability to pay short term obligations due within a year

Question 4

quick ratio equation

Answer 4

(current assets - inventory) / current liabilities
* less than 1 indicates it doesn’t have enough assets to fully cover its current liabilities in the short term

Question 5

inventory turnover equation

Answer 5

COGS / inventory
- how often a company replaces inventory relative to sales
- higher the better, low means sign weak sales or excess inventory

Question 6

total asset turnover equation

Answer 6

net sales / total assets
- higher ratio means a company is efficient in generating revenue from assets

Question 7

total debt ratio equation

Answer 7

total debt / total equity
- greater than 1 means company has more debt than assets
- less than 1 means more assets than debt

Question 8

debt to equity ratio equation

Answer 8

total debt / total equity
- how much debt you have per 1 dollar of equity
- .5 means you have .50 of debt for every dollar

Question 9

equity multiplier

Answer 9

total assets / total equity
- high means company is using high amount of debt to finance assets

Question 10

gross profit margin

Answer 10

(net sales - GOGS) / net sales
- percent of sales remaining after the COGS is paid
- every dollar of revenue a company is earning

Question 11

operating profit margin

Answer 11

EBIT / net sales
(EBIT = earnings before interest and taxes)
- profitability, larger the better
- referred to as the EBITDA margin

Question 12

ROA (return on assets)

Answer 12

net income / total assets
- higher means company is more efficient and productive at manages at making profits

Question 13

EPS (earning per share) equation

Answer 13

net income / shares outstanding
- how much money a company makes for each share of stock
- estimates corporate value

Question 14

PE (price earning) equation

Answer 14

price per share / earning per share
- what the market is willing to pay today for a stock based on its part or future earnings

Question 15

market to book ratio

Answer 15

market value of equity / book value of equity per share
- above 1 means company’s stock is over-valued

Question 16

DuPont System

Answer 16

ROE = net profit margin x total asset turnover x equity multiplier
expressed in ratio form:
ROE = (net income / net sales) x (net sales / total assets) x (total assets / total equity)
- derived from two equations that link the firms return on assets (ROA) and return on equity (ROE)
- tells us the firms ROE is determined by three factors
- net profit margin
- total asset turnover
- equity multiplier

Question 17

enterprise value

Answer 17

market capitalization + market value of debt - cash equivalents
* potential cost to acquire a business based on the company’s capital structure

Question 18

trench analysis

Answer 18

looking at historical financial statements to see how various ratios are increasing