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Financial Statement Analysis & Accounting Ratios Flashcards

(90 cards)

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1
Q

Why is financial statement analysis absolutely necessary?

A

A company’s reported financial statements may not accurately represent the actual performance of the business.

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2
Q

What is a nonrecurring item?

A

A nonrecurring item refers to an entry that is infrequent or unusual that appears on a company’s financial statements.

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3
Q

How are non-recurring items dealt with in financial statement analysis?

A

Adjustments are made to remove non-recurring items so as to not distort the ability to analyze the business’ operating performance.

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4
Q

What are some examples of non-recurring items?

A
  • product recalls
  • litigation settlements
  • restructuring
  • company sells a business
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5
Q

What is the purpose of the income statement?

A

Summarizes the revenue and expenses for a period of time - reports the profit performance of the business.

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6
Q

Which of the “Big 3” financial statements are used to analyze profitibility?

A

the Income Statement

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7
Q

What is the purpose of the Cash Flow statement?

A

Reports the sources of a business’ cash inflows and outflows between two balance sheet dates.

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8
Q

What is the purpose of the balance sheet?

A

Reports the balance of assets, liabilities and equity at a PRECISE moment in time.

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9
Q

Since we have the income statement, why do we need the statement of cash flows?

A

Revenue does not record cash flow, because revenue is recognized as it is received (as opposed to being recorded when cash changes hand).

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10
Q

Is depreciation a cash inflow or cash outflow?

A

Neither! It is not a cash flow and must be removed from the cash flow statement.

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11
Q

How do we complete a financial statement analysis?

A
  1. Identify risks within the business and industry (SWOT analysis)
  2. Identify financial risks

(can company generate enough cash flow to meet financial obligations)

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12
Q

What is a SWOT analysis?

A

An analysis of the company’s:

  • Strengths
  • Weaknesses
  • Opportunities
  • Threats
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13
Q

What is the key reason income statments and cash flow statements do not reflect the same change in cash?

A

Revenue is recognized when it is earned.

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14
Q

What is the accounting matching principle?

A

Revenues are matched with expenses.

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15
Q

What is the normalization process?

A

The process of removing non-recurring items

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16
Q

What are the major line items on the income statement?

A

Income Statement

Total Revenues

- Cost of Goods Sold (COGS)

Gross Profit

-SG&A

-Depreciation/Amortization

Operating Profit

  • Interest expense

- Interest (income)

Pre-tax Income

- Income taxes

Net Income

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17
Q

What is included in Cost of Goods Sold?

A
  • Cost of good sold
  • direct costs
  • shipping costs
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18
Q

What is included in SG&A?

A

SG&A = Overhead

  • Sales
  • General
  • Admin
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19
Q

What is interest income?

A

Income from interest on a company’s cash

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20
Q

What is interest expense?

A

expense due to use of debt

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21
Q

Which investors have access to a company’s revenue?

  • Debt holders
  • Common stock holders
  • Preferred stock holders
A

All of the above.

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22
Q

Which investors have access to a company’s operating income?

  • Debt holders
  • Common stock holders
  • Preferred stock holders
A

All of the above

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23
Q

Which investors have access to a company’s net income?

  • Debt holders
  • Common stock holders
  • Preferred stock holders
A
  • Common stock holders
  • Preferred stock holders
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24
Q

What are some sources of revenue growth?

A
  • Organic Growth
  • Acquisitions
  • Market Share gains
  • Sector Growth
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25
What is the **growth** formula?
_Final - Initial_ Initial
26
What does **profitibility** _measure_?
Measures management's ability to maximize revenues and control expenses
27
What are **margins**?
A means of measuring profitability in which a _financial statistic_ is **divided** **by** _sales(revenue)_.
28
1. How do you calculate gross margin? 2. What does it mean?
1. Gross Profit / Sales 2. The amount of gross profit a company earns per $1.00 of sales.
29
What are **returns**?
A means of calculating profitability as a function of a business input.
30
1. How do you calculate **Return on Assets**? 2. What is the value in this metric?
1. Net Income / Total Assets 2. The ROA figure gives investors an idea of how effective the company is in converting the money it invests into assets into net income.
31
1. How do you calculate **Return on Equity**? 2. What is the value in this metric?
1. Net Income / Shareholders equity 2. The ROE figure gives investors an idea of how effective the company is in converting the shareholders invest into the company into net income.
32
1. How do you calculate **Return on Invested Capital (ROIC)**? 2. What is the value in this metric?
1. Net Income / [Debt + Equity] 2. The ROIC figure gives investors an idea of how effective the company is at converting money invested into the company into net income.
33
34
What are **some methods** of **measuring** a company's **profitability**?
* Margins (Gross Profit Margin) * Returns (ROA, ROE, ROIC)
35
What is **EBIT** proportional to?
EBIT = Operating Income
36
What does **EBIT** _stand_ for?
**Earnings Before Interest and Taxes**
37
What is the **purpose** of *EBIT*?
**Understand the profitability** *BEFORE* the effects of **financing and taxes**
38
Why is **EBIT** preferred over **Net Income** _when_ **comparing two companies**?
The two companies may have (1) different capital structures and (2) different levels of taxation.
39
If you wanted to compare two company's operating income, which metric would you use?
EBIT
40
When people say "the line" what metric serves as "the line"?
EBIT
41
What distinction is made for items that are "above the line"?
If the income or expense is operating in nature.
42
List some items that would be "above the line"?
* Sales * COGS * SG&A * R&D
43
What distinction is made for items that are "below the line"?
Income/Expenses that are **not operating** in nature
44
List some activities that would be considered "below the line"
* Interest Income * Interest Expense * Dividend Income * Taxes
45
When looking at an income statment, how do we determine which items should be included in EBIT or EBITDA?
1. Must comb through the income statment and identify line items that are **operating** in nature.
46
**True/False:** Net Income = Cash from Operations
**False**!
47
What is the **most crucial item** *for* a **company**?
Cash
48
**What** are the **three types of line items** on a _cash flow statement_?
1. Adjustments for non-cash expenses 2. Cash Inflow (Source of Cash) 3. Cash Outflow (Usage of Cash)
49
**What** are the **four major sections** in a typical **cash flow statement**?
1. Cash flow from **operating activities** 2. Cash flow from **investing activities** 3. Cash flow from **financing activities** 4. **Net change** in cash
50
**What** is the **purpose** of the **cash flow statement**?
* **To reconcile** the changes in cash for the period.
51
**What** is the **starting point** for the **statement of cash flows**?
Net Income
52
What **line items** are seen under "**Operating Activities**" in the **cash flow statement**?
_Operating Activities_ Net Income + [Adjustments for non-cash expenses] + [Adjustment: Depreciation] + [Adjustment: Amortizaiton] + [Adjustment: Stock-based compensation] _+ [Subtract change in working capital]_ **Cash flow from operating activities**
53
What line items are seen under "**Investing Activities**" in the **cash flow statement**?
_Investing Activities_ - Capital Expenditures (CAPEX) _- Additions to definitite-life intangibles_ **Cash flow from investing activities**
54
What **line items** are seen under "**Financing Activities**" in the **cash flow statement**?
_Financing Activities_ Issuance (repayment) of revolver Issuance (repayment) of long-term debt Repurchase of equity Dividends _Option Proceeds_ **Cash flow from financing activities**
55
How does an **increase** in _accounts receivable_ impact **cash flow**?
**reduces cash flow** as your net income goes up, but you haven't received any cash.
56
How does an **increase** in _accounts payable_ impact **cash flow**?
**Increases cash flow** as cash is received but COGS not paid out to supplier yet.
57
58
How should we think of "investing activities"?
think of it as CAPEX
59
How is **CAPEX** related to **Depreciation**?
Should be of comparable magnitude.
60
**Depreciation Exercise** Click on the image to access the question
**Click on the image below to see the answer**
61
What is **amortization**?
Amortization is an accounting technique used to **periodically lower the book value of a loan or intangible asset over a set period of time.**
62
What **metric** is used as a *proxy* for **operating cash flow**?
EBITDA
63
Why shouldn't **EBIT** be used as a *proxy* from **operating cash flow**?
Because **EBIT reflects depreciation and amortizaiton** which are _non-cash expenses_.
64
**What** are some of the **weaknesses** for using **EBITDA** as "**actual**" cash flow?
EBITDA doesn't include: * Changes in WC * CAPEX * Additions to intangibles (such as purchase of software licenses) * Interest Expense * Tax Expense * Debt Paydown * Dividends
65
What is the purpose of the balance sheet?
provides a snapshot (ending balance) of the company's financial position
66
What is the **typical time frame** for when a _current asset_ or _current liability_ will be **due**?
1 year
67
**What** is the **typical time frame** for when a _long-term (LT) asset_ or _LT liability_ will be **due**?
Due after 1 year
68
**What** is an _activity ratio_?
Activity ratios measure the **efficiency of a business** in turning over its assets
69
What are **three** *important* **activity ratios**?
1. Accounts Receivable Turnover 2. Inventory Turnover 3. Accounts Payable Turnover
70
**How** do you calculate **Accounts Receivable** **T****urnover**?
ART = Sales / AR
71
**What** does **Accounts Receivable Turnover** *indicate*?
Indicates how efficient the business is at turning a sale into cash
72
How do you calculate **Accounts Receivable Days**?
ART / Days
73
What does *Accounts Receivable Days* indicate?
The average amount of time it takes before a cash payment is collected.
74
75
What does the **inventory turnover** ratio convey?
Inventory turnover is a ratio showing **how many times a company has sold and replaced inventory during a given period.**
76
How do you calculate inventory turnover ratio?
COGS / Inventory
77
**What** does **Accounts Payable Turnover** *convey*?
Accounts payable turnover shows how many times a company pays off its accounts payable during a period.
78
How is Accounts Payable Turnover calculated?
COGS / AP
79
**What** are the **two** common _liquidity ratios_? (and how are they calculated)
* Working Capital (CA - CL) * Current Ratio (CA / CL)
80
**Why** is it better for a company to turn over its **working capital faster**?
A **quicker turnover ratio** *means* the company is able to _quickly convert assets to cash_.
81
What is the _equation_ for the **Cash Conversion Cycle**?
CCC = INV Days + AR Days - AP Days
82
**What** do _liquidity ratios_ **indicate**?
The company's ability to convert an asset into cash quickly
83
**What** do **Balance Sheet leverage ratios** *indicate*?
A leverage ratio is any one of several financial measurements that assesses the ability of a company to meet its financial obligations (debt).
84
**What** are **two** *common* **Balance Sheet** **leverage ratios** and **how** are they **calculated**?
1. Debt-to-Capital ratio (D/EV) 2. *Net Debt*-to-Capital ratio (Debt - Cash / EV)
85
**What** are **two** common **Cash Flow leverage ratios** and **how** are they **calculated**?
1. Debt-to-EBIT (Total Debt / EBIT) 2. Debt-to-EBITDA (Total Debt/EBITDA)
86
**What** does **Debt-to-EBIT** (Total Debt / EBIT) **convey**?
How many years of the current level of operating income is required to pay of the entire debt balance.
87
**What** does **Debt-to-EBITDA** (Total Debt / EBITDA) **convey**?
How many years of the current level of operating cash flow is required to pay off the entire debt balance.
88
**What** are **coverage ratios**?
A coverage ratio, broadly, is a metric intended to measure a company's ability to service its debt and meet its financial obligations, such as interest payments or dividends
89
**What** are **two** common **coverage ratios** and _how_ are they **calculated**?
1. EBITDA Coverage (EBITDA / Interest Expense) 2. EBIT Coverage (EBIT/Interest Expense)
90
If a company had a low coverage ratio such as *EBITDA Coverage,* what would that indicate to stakeholders?
A poor ability to pay off debt or dividends.

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