FINANCIAL STATEMENT ANALYSIS

These flashcards cover key concepts related to financial statement analysis, including definitions, measures, and financial ratios essential for managerial accounting.

What is the LIFO method used for in Company 1?

To value inventory.

What does the average cost method do in Company 2?

Values inventory.

What should managers look beyond when analyzing ratios?

Technology changes, industry trends, changes within the company, consumer tastes, economic factors.

What are the two forms of financial statements managers should prepare and interpret?

Comparative and common-size form.

What enhances the meaning of numbers in financial statements?

Drawing comparisons using dollar and percentage changes, common-size statements, and ratios.

What type of analysis shows changes in financial data in both dollar and percentage form?

Horizontal analysis (or trend analysis).

When calculating dollar change, what is the formula used?

Current Year Figure - Base Year Figure.

How do you calculate percentage change?

(Dollar Change / Base Year Figure) × 100%.

What does a trend analysis use to express financial data over time?

Base year percentages (the base year equals 100 percent).

In common-size statements, how are balance sheet items expressed?

As a percentage of total assets.

How are income statement items usually expressed in common-size statements?

As a percentage of sales.

What does the current ratio measure?

A company’s short-term debt paying ability.

What are quick assets in the context of the acid-test ratio?

Cash, marketable securities, accounts receivable, and current notes receivable.

What does the accounts receivable turnover ratio measure?

How many times a company converts its receivables into cash each year.

What is the operating cycle?

The elapsed time from when inventory is received from suppliers to when cash is received from customers.

What information does the times interest earned ratio provide?

A company’s ability to provide protection for its long-term creditors.

What does the debt-to-equity ratio indicate?

The relative proportions of debt to equity on a company’s balance sheet.

What is the purpose of the return on equity ratio?

To indicate how well the company uses the owners’ investments to earn income.

What does the DuPont formula help to compute?

Return on equity.

What is a negative financial leverage?

When the fixed return to creditors and preferred stockholders is greater than the return on total assets.

What does earnings per share indicate?

How much income was earned for each share of common stock outstanding.

What does the price-earnings ratio reflect about investors?

Their willingness to pay a premium for a company's stock due to optimistic growth prospects.

What is the dividend payout ratio?

The portion of current earnings being paid out in dividends.

What does book value per share measure?

The amount that would be distributed to common stockholders if all assets were sold after all creditors were paid.

What is the primary purpose of financial statement analysis?

To provide information about a company's past performance and current financial position to help users make informed economic decisions.

What is "Benchmarking" in financial analysis?

The process of comparing a company's financial ratios and performance metrics against industry standards or direct competitors.

What is the concept of "Vertical Analysis"?

A technique that expresses each item in a financial statement as a percentage of a base amount, such as total assets or net sales, within the same period.

What does "Working Capital" represent?

The difference between current assets and current liabilities ($\text{Working Capital} = ext{Current Assets} - ext{Current Liabilities}$), representing the operating liquidity available to a business.

What is the conceptual definition of "Financial Leverage"?

The use of borrowed money (debt) to finance the purchase of assets with the expectation that the income generated will exceed the cost of borrowing.

What is the main difference between liquidity and solvency?

Liquidity refers to a company's ability to meet short-term obligations, while solvency refers to its ability to meet long-term obligations and sustain operations indefinitely.

Why is the "Quality of Earnings" a key concept for analysts?

It helps determine if reported net income is attributable to core operating activities rather than one-time gains or aggressive accounting choices.

What is an "Index Trend" in historical analysis?

A variation of horizontal analysis where a base year is set to $100\%$ and all subsequent years' data are expressed as a percentage relative to that base year.

What does the "Inventory Turnover Ratio" conceptually indicate?

It measures how efficiently a company manages its stock by showing how many times inventory is sold and replaced during a specific period.

What is a major conceptual limitation of using historical financial statements for future predictions?

They reflect past events and costs, which may not account for future economic shifts, inflation, or changes in the competitive landscape.