Ratio Analysis Flashcards
(106 cards)
1
Q
Ratio analysis consists of calculating financial performance using five basic types of ratios:
A
profitability, liquidity, activity, debt, and market.
2
Q
Ratio analysis consists of
A
the calculation of ratios from financial statements and is a foundation of financial analysis.
3
Q
A financial ratio, or accounting ratio, shows
A
the relative magnitude of selected numerical values taken from those financial statements.
4
Q
Liquidity:
A
availability of cash over short term: ability to service short-term debt.
5
Q
Ratio:
A
a number representing a comparison between two things.
6
Q
Ratio analysis:
A
the use of quantitative techniques on values taken from an enterprise’s financial statements.
7
Q
Shareholder:
A
one who owns shares of stock.
8
Q
Profitability ratios:
A
measure the firm’s use of its assets and control of its expenses to generate an acceptable rate of return.
9
Q
Liquidity ratios:
A
measure the availability of cash to pay debt.
10
Q
Activity ratios, also called efficiency ratios:
A
measure the effectiveness of a firm’s use of resources, or assets.
11
Q
Debt, or leverage, ratios:
A
measure the firm’s ability to repay long-term debt.
12
Q
arket ratios are concerned with shareholder audiences. They measure:
A
the cost of issuing stock and the relationship between return and the value of an investment in company’s shares.
13
Q
Ratio analysis is:
A
a tool for evaluating financial statements but also relies on the numbers in the reported financial statements being put into order to be used for comparison. With a few exceptions, the majority of the data used in ratio analysis comes from the financial statements.
14
Q
Prior to the calculation of financial ratios, reported financial statements are often:
A
reformulated and adjusted by analysts to make the financial ratios more meaningful as comparisons across time or across companies.
15
Q
Earnings management:
A
a euphemism, such as creative accounting, to refer to fraudulent accounting practices that manipulate reporting of income, assets, or liabilities with the intent to influence interpretations of the income statements.
16
Q
Valuation:
A
the process of estimating the market value of a financial asset or liability.
17
Q
One of the advantages of ratio analysis is that:
A
it allows comparison across companies. However, while ratios can be quite helpful in comparing companies within an industry and even across some similar industries, cross-industry comparisons may not be helpful and should be done with caution.
18
Q
Metric:
A
a measure for something; a means of deriving a quantitative measurement or approximation for otherwise qualitative phenomena.
19
Q
Valuation:
A
the process of estimating the market value of a financial asset or liability.
20
Q
One of the advantages of ratio analysis is that it allows comparison across companies, an activity which is often called:
A
benchmarking.
21
Q
Benchmark:
A
a standard by which something is evaluated or measured.
22
Q
Ratio:
A
a number representing a comparison between two things.
23
Q
Trend analysis is:
A
the practice of collecting information and attempting to spot a pattern or trend in the same metric historically by examining it in tables or charts. Often this trend analysis is used to predict or inform decisions around future events.
24
Q
Trend analysis can be performed in different ways in finance. Fundamental analysis relies on:
A
historical financial statement analysis, often in the form of ratio analysis.
25
Trend analysis using financial ratios can be complicated by changes to companies and accounting over time. For example:
a company may change its business model and begin to operate in a new industry, or it may change the end of its financial year or the way it accounts for inventories.
26
The operating margin equals
operating income divided by revenue.
27
Operating income:
revenue—operating expenses. (Does not include other expenses such as taxes and depreciation).
28
The operating margin (also called the operating profit margin or return on sales) is a
ratio that shines a light on how much money a company is actually making in profit. It is found by dividing operating income by revenue, where operating income is revenue minus operating expenses.
29
Operating margin formula:
The operating margin is found by dividing net operating income by total revenue.
30
However, the operating margin is not a perfect measurement. It does not include things like:
capital investment, which is necessary for the future profitability of the company. Furthermore, the operating margin is simply revenue.
31
Profit margin measures :
the amount of profit a company earns from its sales and is calculated by dividing profit (gross or net) by sales.
32
Profit margin is:
the profit divided by revenue.
33
There are two types of profit margin:
gross profit margin and net profit margin.
34
Net profit:
the gross revenue minus all expenses.
35
Gross profit:
the difference between net sales and the cost of goods sold.
36
The profit margin ratio is broadly:
the ratio of profit to total sales times 100%. The higher the profit margin, the more profit a company earns on each sale.
37
Net Profit Margin:
The percentage of net profit (gross profit minus all other expenses) earned on a company’s sales
38
Gross Profit Margin:
The percentage of gross profit earned on the company’s sales.
39
The return on assets ratio (ROA) measures
how effectively assets are being used for generating profit.
40
ROA is:
net income divided by total assets.
41
The ROA is the product of two common ratios:
profit margin and asset turnover.
42
A higher ROA is better, but there is no metric for a good or bad ROA. An ROA depends on:
the company, the industry and the economic environment.
43
ROA is based on:
the book value of assets, which can be starkly different from the market value of assets.
44
Net income:
gross profit minus operating expenses and taxes.
45
The return on assets ratio (ROA) is found by:
dividing net income by total assets.
46
ROA does have some drawbacks.
First, it gives no indication of how the assets were financed. A company could have a high ROA, but still be in financial straits because all the assets were paid for through leveraging. Second, the total assets are based on the carrying value of the assets, not the market value. If there is a large discrepancy between the carrying and market value of the assets, the ratio could provide misleading numbers. Finally, there is no metric to find a good or bad ROA. Companies that operate in capital intensive industries will tend to have lower ROAs than those who do not. The ROA is entirely contextual to the company, the industry and the economic environment.
47
Return on equity (ROE) measures
how effective a company is at using its equity to generate income and is calculated by dividing net profit by total equity.
48
ROE is:
net income divided by total shareholders' equity.
49
ROE is also:
the product of return on assets (ROA) and financial leverage.
50
ROE shows:
how well a company uses investment funds to generate earnings growth. There is no standard for a good or bad ROE, but a higher ROE is better.
51
Equity:
ownership, especially in terms of net monetary value, of a business.
52
Return on equity (ROE) is:
a financial ratio that measures how good a company is at generating profit.
53
Return on Equity:
The return on equity is a ratio of net income to equity. It is a measure of how effective the equity is at generating income.
54
Current ratio is:
a financial ratio that measures whether or not a firm has enough resources to pay its debts over the next 12 months.
55
The liquidity ratio:
expresses a company's ability to repay short-term creditors out of its total cash. The liquidity ratio is the result of dividing the total cash by short-term borrowings.
56
The current ratio is:
a financial ratio that measures whether or not a firm has enough resources to pay its debts over the next 12 months.
57
Current ratio =
current assets / current liabilities.
58
Acceptable current ratios vary from industry to industry and are generally between
1.5 and 3 for healthy businesses.
59
Working capital management:
decisions related to working capital and short-term financing are referred to as working capital management. These involve managing the relationship between a firm's short-term assets and its short-term liabilities.
60
Current ratio:
current assets divided by current liabilities.
61
Liquidity ratio expresses:
a company's ability to repay short-term creditors out of its total cash. The liquidity ratio is the result of dividing the total cash by short-term borrowings. It shows the number of times short-term liabilities are covered by cash. If the value is greater than 1.00, it means it is fully covered.
62
Liquidity ratio may refer to:
Reserve requirement – a bank regulation that sets the minimum reserves each bank must hold.
63
Liquidity ratio may refer to:
Acid Test – a ratio used to determine the liquidity of a business entity.
64
The current ratio is:
a financial ratio that measures whether or not a firm has enough resources to pay its debts over the next 12 months. It compares a firm's current assets to its current liabilities.
65
Current asset is
an asset on the balance sheet that can either be converted to cash or used to pay current liabilities within 12 months. Typical current assets include cash, cash equivalents, short-term investments, accounts receivable, inventory, and the portion of prepaid expenses that will be paid within a year.
66
The Acid Test or Quick Ratio measures:
the ability of a company to use its assets to retire its current liabilities immediately.
67
Quick Ratio =
(Cash and cash equivalent + Marketable securities + Accounts receivable) / Current liabilities.
68
Acid Test Ratio =
(Current assets – Inventory) / Current liabilities.
69
Ideally, the acid test ratio should be:
1:1 or higher, however this varies widely by industry. In general, the higher the ratio, the greater the company's liquidity.
70
Treasury bills:
treasury bills (or T-Bills) mature in one year or less. Like zero-coupon bonds, they do not pay interest prior to maturity; instead they are sold at a discount of the par value to create a positive yield to maturity.
71
In finance, the acid-test (also known as quick ratio or liquid ratio) measures
the ability of a company to use its near cash or quick assets to extinguish or retire its current liabilities immediately.
72
Quick assets include
those current assets that presumably can be quickly converted to cash at close to their book values. A company with a Quick Ratio of less than 1 cannot pay back its current liabilities.
73
Acid test often refers to
Cash ratio instead of Quick ratio: Acid Test Ratio=(Current assets–Inventory)Current liabilities
74
The acid test ratio should be:
1:1 or higher, however this varies widely by industry. The higher the ratio, the greater the company's liquidity will be (better able to meet current obligations using liquid assets).
75
The debt ratio measures
the firm's ability to repay long-term debt by indicating the percentage of a company's assets that are provided via debt.
76
The higher the ratio
the greater risk will be associated with the firm's operation
77
The debt ratio is expressed as
total debt / total assets
78
Goodwill:
Goodwill is an accounting concept meaning the value of an asset owned that is intangible but has a quantifiable "prudent value" in a business for example a reputation the firm enjoyed with its clients.
79
Debt to total assets ratio:
after-tax income divided by liabilities.
80
Financial ratios are categorized according to the financial aspect of the business which the ratio measures. Financial ratios allow for comparisons:
between companies
between industries
between different time periods for one company
between a single company and its industry average
81
Debt ratios measure
the firm's ability to repay long-term debt. It is a financial ratio that indicates the percentage of a company's assets that are provided via debt. It is the ratio of total debt (the sum of current liabilities and long-term liabilities) and total assets (the sum of current assets, fixed assets, and other assets such as 'goodwill').
82
Price to earnings ratio (market price per share / annual earnings per share) is used
as a guide to the relative values of companies.
83
PE/ ratio =
Market price per share / Annual earnings per share
84
The PE/ ratio is a widely used valuation multiple used as:
a guide to the relative values of companies; for example, a higher PE/ ratio means that investors are paying more for each unit of current net income, so the stock is more expensive than one with a lower PE/ ratio.
85
Different types of PE/ include:
trailing PE/ or PE ttm/, trailing PE/ from continued operations, and forward PE/ or PEf/.
86
Time value of money:
the value of money, figuring in a given amount of interest, earned over a given amount of time.
87
Inflation:
an increase in the general level of prices or in the cost of living.
88
In stock trading, the price-to-earnings ratio of a share (also called its PE/, or simply "multiple") is:
the market price of that share divided by the annual earnings per share (EPS).
89
The PE/ ratio is a widely used valuation multiple used as a guide to the relative values of companies; a higher PE/ ratio means
that investors are paying more for each unit of current net income, so the stock is more "expensive" than one with a lower PE/ ratio.
90
Irrational Exuberance
(inflation adjusted price divided by the prior ten-year mean of inflation-adjusted earnings)
91
The vertical axis shows
the geometric average real annual return on investing in the S&P Composite Stock Price Index, reinvesting dividends, and selling twenty years later.
92
The price per share in the numerator is
the market price of a single share of the stock.
93
The price-to-book ratio is
a financial ratio used to compare a company's current market price to its book value.
94
The calculation can be performed in two ways:
1) the company's market capitalization can be divided by the company's total book value from its balance sheet, 2) using per-share values, which is to divide the company's current share price by the book value per share.
95
A higher PB/ratio implies that
investors expect management to create more value from a given set of assets, all else equal.
96
Technically, P/B can be calculated either
including or excluding intangible assets and goodwill.
97
Outstanding shares:
shares outstanding are all the shares of a corporation that have been authorized, issued and purchased by investors and are held by them.
98
The price-to-book ratio, or PB/ ratio, is a
financial ratio used to compare a company's current market price to its book value. The calculation can be performed in two ways, but the result should be the same either way.
99
The second way, using per-share values, is to
divide the company's current share price by the book value per share (i.e., its book value divided by the number of outstanding shares).
100
A higher PB/ ratio implies that
investors expect management to create more value from a given set of assets, all else equal (and/or that the market value of the firm's assets is significantly higher than their accounting value). PB/ ratios do not, however, directly provide any information on the ability of the firm to generate profits or cash for shareholders.
101
Technically, PB/ can be calculated either
including or excluding intangible assets and goodwill. When intangible assets and goodwill are excluded, the ratio is often specified to be "price to tangible book value" or "price to tangible book."
102
A company has $750,000 in cash, $200,000 in marketable securities and $300,000 worth of accounts receivable. Its current assets are worth $1,500,000 and its current liabilities are $1,000,000. What is the company's quick ratio?
Quick ratio = (CA - Inv)/CL. Since we are given all the current assets except for the Inventory, then (CA - Inv) = $750,000 + $200,000 + $300,000 = $1,250,000 and Quick Ratio = $1,250,000/$1,000,000 = 1.25.
103
A company had $5,000,000 in total revenues for its fiscal year. Its expenses for the year were $3,500,000. Its total assets were $12,500,000. What is the company's return on assets for the fiscal year?
ROA = NI/TA. NI = $5,000,000 – $3,500,000 = $1,500,000. Hence, ROA = $1,500,000/$12,500,000 = 0.12.
104
During a fiscal year, a company had $25,000,000 in total sales. It had a cost of goods sold (COGS) of $18,000,000, and $4,000,000 in additional expenses. What is the company's gross profit margin?
Gross Profit Margin = Gross Profit / Sales. Gross Profit = Sales – COGS = $25,000,000 - $18,000,000 = $7,000,000. Hence, GP Margin = $7,000,000/$25,000,000 = 0.28 or 28%.
105
A company has $100,000 in cash, $300,000 in accounts receivable, $50,000 in inventory and a $300,000 office building. Its current liabilities are $250,000.
What is the company's current ratio, and does that ratio show good short-term financial strength?
Current ratio = CA/CL. CA = $100,000 + $300,000 + $50,000 = $450,000. (Note: office building is a Fixed Asset). Current ratio = $450,000/$250,000 = 1.8. The firm has $1.80 in current assets for every $1 it owes in current liability so this reflects good short-term financial strength.
106
A company has $450,000 in cash, $300,000 in marketable securities, and $500,000 worth of inventory. Its current assets are worth $1,750,000 and its current liabilities are $1,250,000. What is the company's acid test ratio?
Acid test ratio = (CA – Inv)/CL = ($1,750,000-$500,000)/$1,250,000 = 1
