Lesson 1 Flashcards
(128 cards)
1
Q
Financial statements are evaluated over a period of time. It is also called trend analysis. It determines the increase or decrease from one time period to another.
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Horizontal Analysis
2
Q
Amount of change method
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= Current Period − Prior Period
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Percent change method
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= (Current Period − Prior Period) ÷ Prior Period
4
Q
measure a comparative relationship between two components of a financial statement or statements.
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Ratios
4
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Percent of prior period method
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Current Period ÷ Prior Period
5
Q
based on the ability of the company to convert its current assets into cash.
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Liquidity
6
Q
difference between current assets and current liabilities and is measured as a dollar amount
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Net Working Capital
7
Q
= Current Assets − Current Liabilities
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Net Working Capital
8
Q
variation of net working capital. The ratio is an additional way to evaluate net working capital and its relationship to total assets.
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Net Working Capital Ratio
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Net Working Capital Ratio
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= Net Working Capital ÷ Total Assets
9
Q
measures the relationship between current assets and current liabilities
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Current Ratio
9
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Current Ratio
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= Current Assets ÷ Current Liabilities
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Quick Ratio
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= (Cash + Marketable Securities + AR) ÷ Current Liabilities
10
Q
measures the firm’s ability to meet its current obligations with its cash, marketable securities, and AR.
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Quick Ratio (aka Acid-Test Ratio)
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Q
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Liquidity
12
Q
reduces the amount in the numerator to cash and marketable securities. It is a tougher measure of liquidity than the quick ratio and the current ratio are
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Cash Ratio
13
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Cash Ratio
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= (Cash + Marketable Securities) ÷ Current Liabilities
13
Q
measures how efficiently the cash provided from operations covers the current liabilities.
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Cash Flow Ratio
13
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Cash Flow Ratio
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= Cash Provided by Operations ÷ Current Liabilities
13
Q
is the ability of a company to survive over a long period of time, in other words, the ability of the company to pay not only its current liabilities as they come due but also its long-term liabilities.
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Solvency
13
Q
measures the relationship between total liabilities and stockholders’ equity
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Debt to Equity
14
Q
Debt to Equity
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= Total Debt ÷ Equity
14
Q
measures the relationship between only the long-term liabilities and stockholders’ equity
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Long-term Debt to Equity
15
Q
measures the relationship between total liabilities and total assets. The percentage can be interpreted as how much of the assets are financed, and therefore owned, by the creditors of the company. The difference between this percentage and 100% is the amount of assets owned by the stockholders.
A
Debt to Total Assets
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Long-term Debt to Equity
= (Total Debt – Current Liabilities) ÷ Equity
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Debt to Total Assets
= Total Debt ÷ Total Assets
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is a way to measure how well earnings can cover fixed charges. The earnings amount used is earnings before fixed charges and taxes. Fixed charges include interest, required principal repayment of loans, and leases.
Fixed Charge Coverage (aka Earnings to Fixed Charges Ratio)
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Fixed Charge Coverage (aka Earnings to Fixed Charges Ratio)
= Earnings Before Fixed Charges and Taxes ÷ Fixed Charges
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is a way to measure how well earnings can cover interest expense.
Interest Coverage (aka Times Interest Earned Ratio)
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Interest Coverage (aka Times Interest Earned Ratio)
= Earning Before Interest and Taxes (EBIT) ÷ Interest Expense
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recognizes that payments for fixed charges must be made from cash and not from earnings. It answers the question of whether the company has enough cash to pay for the fixed charges it incurs.
cash flow to fixed charges ratio
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Operating leverage
a. DOL = % Change in Earnings Before Interest and Taxes (EBIT) ÷ % Change in Sales
b. DOL = Contribution Margin ÷ EBIT
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is the extent that a company's operating income (earnings before interest and taxes) will change, based on a change in sales. The company's cost structure is based on the relative amount of fixed costs to variable costs.
Operating leverage
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looks at a company's capital structure, which is the balance between debt and equity financing. Debt financing results in tax-deductible interest expense. Equity financing results in dividend payments that are not an expense reported on the income statement.
Financial Leverage
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Financial Leverage
a. DFL = % Change in Net Income ÷ % Change in EBIT
b. DFL = EBIT ÷ EBT
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cash flow to fixed charges ratio
= (Cash from Operations + Fixed Charges + Tax Payments) ÷ Fixed Charges
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Horizontal Analysis: Amount of Change Method
Current Period - Prior Period = Amount of Change
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Horizontal Analysis: Percent Change Method
(Current Period - Prior Period) / Prior Period = Growth Rate
(Latest period - Prior period) / Base year = % increase or decrease
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Horizontal Analysis: Percent of Prior Period Method
Current Period / Prior Period = % Increase or Decrease
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Net Working Capital
= Current Assets - Current Liabilities
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Net Working Capital Ratio
= Net Working Capital / Total Assets
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Current Ratio
= Current Assets / Current Liabilities
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Quick Ratio (Acid Test Ratio)
= (Cash + Mrktbl. Secs. + AR) / Current Liabilities
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Cash Ratio
= (Cash + Mrktbl. Secs.) / Current Liabilities
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Cash Flow Ratio (Current Cash Debt Coverage Ratio)
= Cash Provided by Operations / Current Liabilies
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Debt to Equity
= Total Debt / Equity
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Long-term Debt to Equity
= (Total Debt - Current Liabilities) / Equity
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Debt to Total Assets
= Total Debt / Total Assets
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Fixed Charge Coverage (Earnings to Fixed Charges)
= Earnings before fixed charges and tax / fixed charges
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Interest Coverage Ratio (Times Interes Earned or TIE)
= EBIT / Interest Expenses
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Cash Flow to Fixed Charges Ratio
= (Cash from operations + Fixed Charges + Tax Payments) / Fixed Charges
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Degree of Operating Leverage (DOL)
= % Change in EBIT / % Change in Sales
= Contribution Margin / EBIT
Cost Structure
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Degree of Financial Leverage (DFL)
= % Change in Net Income / % Change in EBIT
= EBIT / EBT
Capital Structure
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Financial Leverage
= Total Assets / Total Equity
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Degree of Total Leverage
= DOL x DFL
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Inventory Turnover Ratio
= COGS / Ave. Inventory
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Day Sales in Inventory
= 365 days / Inventory Turnover Ratio
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Accounts Receivable Turnover Ratio
= Credit Sales / Ave. AR
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Day Sales in Receivables
= 365 days / AR Turnover
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Accounts Payable Turnover Ratio
= Credit Purchases / Average AP
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Days Purchases in AP
= 365 days / AP Turnover
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Operating Cycle
= Day Sales in AR + Day sales in Inventory
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Cash Cycle
= Day Sales in AR + Day Sales in Inventory - Day Purchases in AP
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Asset Turnover
= Net Sales / Ave. Total Assets
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Fixed Asset Turnover (Fixed Assets are productive assets)
= Net Sales / Ave. PPE
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Gross Margin
= Gross Profit / Net Sales
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Operating Profit Margin
= Operatn Income (EBIT) / Net Sales
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Profit Margin
= Net Income / Sales
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Return on Assets
= Net Income / Average Total Assets
Indicates the profitailityof Assets
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Return on Equity
= Net Income / Average Equity
Profitaility of the investment by commn stockholders
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Market to Book Value Ratio
= Current Stock Price / Book Value per Share
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Book Value per Sare
= (Total SHE - Pref. Equity) / No. of Common Stocks Outstanding
Amount of net assets owned by common stockholders
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Price to Earnings Ratio (PE Ratio)
= Market Price per Share / EPS
Investor's assessment of the future earnings of the company
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Earnings Per Share (EPS)
= (Net Income - Pref. Dividends) / Weighted Ave. Common Shares Outstanding
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Effect of Stock Options on Diluted EPS
Only increases the weighted average commin shares outstanding
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Effect of Stock Warrants on Diluted EPS
Only increases the weighted average common sgares outstanding
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Effect of Convertible Bonds on Diluted EPS
Increases the weighted average common shares outstanding and net income (by the amount of after tax interesr saved)
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Effect of convertible preferred stocks on Diluted EPS
Increases the weighted average no. of common shares outstanding and preferred dividends are no longer subtracted to net income
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What are yields?
Returns to shareholders
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Earnings Yield
= EPS / Market price per share
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Dividend Yield
= Anual dividend per share / market price per share
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Dividend Payout Ratio - % of earnings that was pai out in dividends to common shareholders
= Common Dividends / Earnings Available to Common Shareholders
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Shareholder Return
= (Ending stock price - Beginning stock price + annual dividend per share) / Beginning stock price
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Four Limtations of Ratio Analysis:
1. It is not enough to calculate one ratio and make a determination about the financial health of the firm. Multiple Calculations must be made and analyzed.
2. It is important to compare to industry averages or result from previous years
3. Two firms must be in the same industry
5. Focus on how the amounts were derived
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5 Limitations of the Usefulness of Ratio Analysis:
1. Choice of Inventory Valuation Method (FIFO vs. LIFO)
2. Composition if Current Assets
3. Choice of Depreciation Method
4. Earnings per Share (management can change the denominator through purchase of treasury stock which would decrease denominator and increase EPS)
5. Return on Assets
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The SEC has the _______, which contains all of the company's fillings.
Edgar Database
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Example of Financial Websites:
1. CNN Money
2. Google Finance
3. Yahoo! Finance
4. The Wall Street Journal
5. Financial Times
6. Bloomberg
7. Reuters
8. Morningstar
*1-3 Free
** 4-7 Free with Paid Subs.
*** 8 Free Subs. Only
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Key to a Successful Analysis:
1. Know what amounts are used in the calculations
2. Compenents of the calculations are consistent
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Key to a Successful Analysis: (Additional Analysis)
1. Compare the current year results to prior years, a competitor's results, and industry averages
2. Determine if there have been any changes in accounting methods
3. Determine if there have been any acquisitions or divestures during the year
4. Be familiar with the industry, sector, and market the company operates in.
78
ROA (Dupont Model)
= (Net Income / Sales) x (Sales / Ave. Total Assets)
= Net Profit Margin x Assets Turnover
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ROE (Dupont Model)
= (Net Income / Ave. Total Assets) x (Ave. Total Assets / Ave. Equity)
= ROA x Financial Leverage
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Assets can be defined as:
1. Ave. Total Assets for a 2-yr time period
2. Total Assets for a specific time period
3. Operating Assets (PPE) - Used to generate income
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Equity can be defined as:
1. Ave. Common SHE for a 2-yr time period.
2. Common SHE for a specific time period
3. Total SHE (Includes both pref. and comm. SHE)
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Income or Return can be defined as:
1. Net Income
2. Net Income less Pref. Stock Dividends
3. Operating Income (EBIT)
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Sustainable Growth Rate (SGR) - Maximum rate a company can grow at using its own revenue
= ROE x (1 - Dividend Payout Ratio)
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Gain on Sale of Asset
= MV - BV
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Total Estimated Profit
= Contract Price - Total Est. Cost
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Degree of Completion
= Cost to date / Est. Total Cost
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Profit Realized
= Degree of Completion x Expected Total Profit
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Net Income (from disposal)
= Loss fr. DIsposal + Operating Loss fr. Disposal of Segment + After tax Income fr. Cont. Operations
*net of tax
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Revenue is recognized to show the transfer of promised goods/services to the cutomer in an amount that reflects the consideration the company expects to be entitled for the transfers. Revenue = amt. of consideration. 5 steps to recognize revenue:
1. Identify contract/s with customer
2. Indentify contract's performance obligation
3. Determine transaction price
4. Allocate the transaction price to the performance obligation/s in the contract
5. Recognize revenue as the performance obligation is satisfied
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What triggers the recognition of revenue?
Transfer of control
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Stock Options:
only increase the weighted average common shares outstanding amount.
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Stock Warrants:
only increase the weighted average common shares outstanding amount.
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Convertible Bonds:
ncrease the weighted average common shares outstanding amount. In addition, increase the net income (numerator) by the amount of the after-tax interest saved.
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Convertible Preferred Stock:
increase the weighted average common shares outstanding amount. In addition, preferred dividends are no longer subtracted from net income.
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Refers to the returns to shareholders
Yields
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Earnings Yield
= EPS ÷ Market Price per Share
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Dividend Yield
= Annual Dividend per Share ÷ Market Price per Share
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Dividend Payout Ratio
= Common Dividends ÷ Earnings Available to Common Shareholders
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Shareholder return
= (Ending stock price − Beginning stock price + Annual dividend per share) ÷ Beginning stock price
100
Four Limitations of Ratio Analysis:
1. It is not enough to calculate one ratio and make a determination about the financial health of the firm. Multiple calculations must be made and analyzed to come to any valid determination.
2. It is also important to compare the results to prior year's, industry averages, and competitors
3. Caution needs to be used when comparing one firm with another. The two firms must be in the same industry or the comparisons can be misleading.
4. Focus on knowing how the amounts were derived in order to make valid comparisons
101
Ratio analysis is a great way to compare businesses of different sizes. But, their usefulness is limited as seen in these examples:
1. Choice of inventory valuation method
2. Composition of current assets.
3. Choice of depreciation method.
4. Earnings per share.
5. Return on assets.
102
The SEC website has the _________, which contains all of the company's filings, and can be found at http://www.sec.gov/edgar.shtml.
Edgar database
103
There are other financial websites available that provide free information or are accessed through paid subscriptions. The following are a few examples:
1. CNN Money at http://money.cnn.com/data/markets.
2. Google Finance at http://www.google.com/finance.
3. Yahoo! Finance at www.finance.yahoo.com.
4. The Wall Street Journal has information available for free, with much more information available with a paid subscription, at www.wsj.com.
5. Financial Times has information available for free, with much more information available with a paid subscription, at www.ft.com.
6. Bloomberg has information available for free, with much more information available with a paid subscription, at www.bloomberg.com.
7. Reuters has information available for free, with much more information available with a paid subscription, at www.reuters.com.
8. Morningstar offers only a paid subscription service at www.morningstar.com.
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Business managers use _________ to compare the returns generated on one investment with other potential investments.
return ratios
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ROA - Dupont
= (Net Income ÷ Sales) × (Sales ÷ Average Total Assets)
= Net Profit Margin × Total Asset Turnover
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ROE - Dupont
= (Net Income ÷ Average Total Assets) × (Average Total Assets ÷ Average Equity)
= ROA x Financial Leverage
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Assets can be defined as:
1. Average total assets for a two-year time period.
2. Total assets for a specific time period.
3. Operating assets, meaning property, plant and equipment. These are the assets used to generate income.
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Equity can be defined as:
1. Average common stockholders' equity for a two-year time period.
2. Common stockholders' equity for a specific time period.
3. Total stockholders' equity that includes both preferred and common stockholders' equity.
109
Income or the return can be defined as:
1. Net income.
2. Net income minus preferred stock dividends.
3. Operating income is used to remove income taxes, other gains and losses, and the impact of interest expense on loans outstanding.
110
Sustainable growth rate (SGR). The SGR is the maximum rate a firm can grow at using its own revenue. Said another way, it is how much a firm can grow without having to borrow money for this growth.
= ROE × (1 − Dividend Payout Ratio)
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Assumptions of SGR:
1. The firm will maintain its target capital structure: debt and equity.
2. The dividend payout ratio remains the same.
3. The firm will maintain or increase its revenues
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Revenue is recognized to show the transfer(s) of promised goods or services to the customer in an amount that reflects the consideration the company expects to be entitled to for the transfer(s). This means that revenue is equal to the amount of consideration. There are five steps to be followed:
1. Identify the contract(s) with the customer
2. Identify the contract's performance obligation(s)
3. Determine the transaction price
4. Allocate the transaction price to the performance obligation(s) in the contract
5. Recognize revenue as the performance obligation is satisfied
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It is the___________of the promised goods or services to the customer that triggers the recognition of revenue.
transfer of control
114
What are the four factors that need to be considered when measuring income?
1. Estimates
2. Accounting Methods
3. Disclosure
4. Different Needs of Users
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The following must be met for revenue to be recognized:
1. The firm has a present right to payment for the asset.
2. The customer has legal title to the asset or the service has been provided.
3. The firm has transferred physical possession of the asset.
4. The customer has the significant risks and reward of ownership of the asset.
5. The customer has accepted the asset.
