Financial statements

0.0(0)
learnLearn
examPractice Test
spaced repetitionSpaced Repetition
heart puzzleMatch
flashcardsFlashcards
Card Sorting

1/121

flashcard set

Earn XP

Description and Tags

Study Analytics
Name
Mastery
Learn
Test
Matching
Spaced

No study sessions yet.

122 Terms

1
New cards

Cash is King

Phrase emphasizing the critical importance of cash flow in business operations

2
New cards

Importance of cash

  • Covers expenses

  • pays off debts

  • supports during economic downturns

3
New cards

Cash flow management

  • monitoring inflows and outflows

  • forecasting cash needs

  • maintaining adequate reserves

4
New cards

Why cash matters

  • smooth functioning of business

  • sustainability and growth

  • ability to withstand unforeseen circumstances

5
New cards

Working capital management

the process of managing a company’s short-term assets and liabilities to ensure efficient operations and liquidity

6
New cards

Components of working capital

  • current assets e.g., cash, inventory, accounts receivables

  • current liabilities e.g., accounts payable, short-term debt

7
New cards

Objective of working capital management

To optimize the balance between liquidity and profitability by ensuring that the company has enough short-term assets to cover short-term liabilities without excessive idle funds.

8
New cards

Strategies for working capital management

  • inventory management

  • Accounts receivable management

  • Accounts payable management

  • Cash flow forecasting

9
New cards

Benefits of effective working capital management

  • improved cash flow

  • Enhanced liquidity

  • Reduced financing costs

  • Better ability to seize opportunities and withstand financial shocks

10
New cards

Positive net working capital

company has enough short term assets to cover its short term liabilities

11
New cards

Negative working capital

potential liquidity issues

12
New cards

Investment : Company takes large new attractive new investment projects

  • finance : company needs to raise finance

  • Dividends : Cuts may be needed to increase internal financing if external sources not available

13
New cards

Dividends : company decides to pay higher level of dividends

  • finance : lower levels of retained earning available for investment have to find external sources

  • investment : if finance not available may have to postpone future investments projects

14
New cards

Finance : company finances itself using ,more expensive sources resulting high cost of capital

  • investment : the number of attractive projects to the company decreases

  • dividends : company’s ability to pay dividends in the future will be adversely affected

15
New cards

(EMH) Weak Form Efficiency

A form of the Efficient Market Hypothesis (EMH) suggesting that all past market prices and trading data are fully reflected in stock prices.

16
New cards

(EMH) Key Points of EMH

  • Investors cannot consistently achieve above-average returns by analyzing past stock prices.

  • Technical analysis, based on historical price movements, is not effective in predicting future prices

  • Weak form efficiency implies that neither fundamental nor technical analysis alone can provide an advantage in stock selection.

17
New cards

Implications of Weak form of efficiency

  • Investors cannot gain an edge through historical price analysis alone.

  • The random walk theory suggests that stock prices follow a random pattern, making short-term prediction difficult.

  • Efficient markets quickly incorporate new information into stock prices, making it challenging to outperform the market consistently

18
New cards

Criticism of Weak form efficiency

  • Critics argue that anomalies and market inefficiencies exist, challenging the idea of weak form efficiency.

  • Behavioral finance theories suggest that investor sentiment and irrational behavior can influence stock prices, contradicting the notion of fully reflecting all past information

19
New cards

Application of Weak form efficiency

  • investors may focus on other forms of analysis such as fundamental analysis to identify undervalued or overvalued stocks

  • Passive investing strategies, such as index funds, align with weak form efficiency by accepting market prices as fair and efficient.

  • Market participants may still seek informational advantages through research, despite the limitations of historical price data.

20
New cards

Weak form of Efficiency presented as

Pt = Pt-1 +

21
New cards

Semi-Strong Efficiency

A form of the Efficient Market Hypothesis (EMH) suggesting that all publicly available information is fully reflected in stock prices.

22
New cards

Key points for semi strong efficiency

  • Market prices adjust rapidly and accurately to new information, making it difficult for investors to consistently outperform the market

  • Fundamental analysis, based on public information like financial statements and economic data, is not sufficient to achieve above-average returns.

  • Semi-strong efficiency implies that even insider information cannot consistently generate abnormal returns, as it is quickly reflected in stock prices upon becoming public.

23
New cards

Implication of semi strong efficiency

  • Investors cannot gain an advantage by analyzing publicly available information alone.

  • Efficient markets lead to fair and unbiased stock prices, reflecting all available information.

  • Active investment strategies, such as stock picking and timing the market based on public news, are generally ineffective in the long term.

24
New cards

Criticism of semi strong efficiency

  • Critics argue that anomalies and inefficiencies exist, challenging the idea of semi-strong efficiency.

  • Behavioral finance theories suggest that investor sentiment and cognitive biases can lead to mispricing, undermining market efficiency.

  • Event studies and empirical evidence occasionally demonstrate delayed or incomplete price adjustments to public information, raising questions about market efficiency.

25
New cards

Application for semi strong efficiency

  • Investors may focus on other forms of analysis, such as technical analysis or sentiment analysis, to complement fundamental analysis in their decision-making process.

  • Passive investing strategies, such as index funds and exchange-traded funds (ETFs), align with semi-strong efficiency by accepting market prices as fair and efficient.

  • Market participants may still seek informational advantages through proprietary research or specialized knowledge, even though public information is quickly reflected in stock prices.

26
New cards

Strong Form Efficiency

A form of the Efficient Market Hypothesis (EMH) suggesting that all information, both public and private, is fully reflected in stock prices.

27
New cards

Key points of strong form of efficiency

  • Market prices adjust rapidly and accurately to all available information, including insider information.

  • Investors cannot consistently achieve above-average returns, even with access to private or insider information.

  • Strong form efficiency implies that no individual or entity can consistently outperform the market, as all information is already reflected in stock prices.

28
New cards

Implications of strong form efficiency

  • Investors cannot gain an advantage through any type of information, whether public or private.

  • Strong form efficiency leads to fair and unbiased stock prices, reflecting all available information, including insider knowledge.

  • Insider trading is considered illegal in many jurisdictions because strong form efficiency suggests that insider information provides no advantage in the market

29
New cards

Criticisms of strong form of efficiency

  • Critics argue that anomalies and inefficiencies exist, challenging the idea of strong form efficiency.

  • Empirical evidence occasionally demonstrates instances where market prices do not fully reflect private or insider information, suggesting potential limitations to strong form efficiency.

  • Behavioral finance theories suggest that cognitive biases and market sentiment can lead to mispricing, undermining the efficiency of stock prices.

30
New cards

Application of strong form of efficiency

  • Investors may focus on passive investment strategies, such as index funds or exchange-traded funds (ETFs), which accept market prices as fair and efficient.

  • Market participants may still seek informational advantages through proprietary research or specialized knowledge, despite the limitations of strong form efficiency.

  • Regulatory bodies monitor and enforce laws against insider trading to maintain confidence in market integrity and fairness.

31
New cards

Abnormal rate of return

A measure used in finance to assess the performance of an investment relative to its expected return, typically adjusted for risk.

32
New cards

Formula abnormal rate of return

Actual Return - Expected Return

33
New cards

Key points of abnormal rate of return

  • Actual return refers to the realized return earned on an investment over a specific period.

  • Expected return represents the anticipated return based on factors such as market conditions, asset characteristics, and risk.

  • A positive abnormal rate of return indicates that the investment outperformed expectations, while a negative abnormal rate of return suggests underperformance.

34
New cards

Interpretation of abnormal rate of return

  • Positive abnormal returns may indicate skilled investment management, superior analysis, or the exploitation of market inefficiencies.

  • Negative abnormal returns may suggest poor investment decisions, unforeseen risks, or market downturns.

  • Abnormal returns are often used to evaluate the effectiveness of investment strategies and to assess the performance of investment managers or financial analysts

35
New cards

Application of abnormal rate of return

  • Investors and analysts use abnormal returns to evaluate the success of investment decisions and to compare the performance of different investment opportunities.

  • Portfolio managers may strive to generate positive abnormal returns by identifying undervalued securities, timing market movements, or employing active trading strategies.

  • Researchers and academics use abnormal returns to study market efficiency, asset pricing models, and the impact of information on investment outcomes

36
New cards

(Excel Functions)

37
New cards

(Excel Functions)

38
New cards

(Excel Functions)

39
New cards
40
New cards

Equity

Assets - Liabilities

41
New cards

DuPont formula (ROE)

knowt flashcard image
42
New cards

DuPont Analysis

Uses the relationship among financial statement accounts to decompose a return into components

43
New cards

Three Factors of DuPont analysis

  • financial leverage : capital structure

  • total asset turnover : measure efficiency

  • net profit margin : profitability

44
New cards

(Profitability) Gross profit margin

Gross Profit / total revenue

45
New cards

(Profitability) Net profit margin

Operating profit (PBIT) / total revenue

46
New cards

(Profitability) post tax profit margin

net profit / total revenue

47
New cards

(Profitability Returns) operating return on asset

operating profit / total assets

48
New cards

(Profitability Returns) ROCE

operating profit / capital employed

49
New cards

(Profitability Returns) Capital employed

total assets - current liabilities

50
New cards

(Profitability Returns) ROA

net profit / total assets

51
New cards

(Profitability Returns) ROE

net profit / equity

52
New cards

(Liquidity) Current ratio

current assets / current liabilities

53
New cards

(Liquidity) quick ratio

current asset - inventory / current liabilities

54
New cards

(Liquidity) cash ratio

cash + short term investments / current liabilities

55
New cards

(Efficiency ratios) inventory turnover period

( Inventory / cost of sales ) X 365

56
New cards

(Efficiency ratios) receivable collection period

( receivable / revenue ) X 365

57
New cards

(Efficiency ratios) payables payment period

( account payable / cost of sales ) X 365

58
New cards

Operating cycle

inventory turnover period + receivable collection period

59
New cards

Cash cycle

operating cycle - payables payment period

60
New cards

( Solvency ) Debt ratio

total debts / total assets

61
New cards

( Solvency ) debt to equity ratio

total debts / total equity

62
New cards

( Solvency ) Gearing

long term debts / capital employed

63
New cards

( Solvency ) financial leverage

total assets / total equity

64
New cards

( Solvency ) interest cover

PBIT / interest

65
New cards

( Earnings ) Earnings per share

Net income / number of ordinary shares

66
New cards

( Earnings ) Book value per share

shareholders equity - preferred shares / number of shares

67
New cards

( Dividends ) dividends per share

dividend paid to shareholders / number of ordinary shares

68
New cards

( Dividends ) dividend payout ratio

dividend paid to shareholders / net income

69
New cards

( Dividends ) Plowback ratio

1 - dividend ratio

70
New cards

(Excel Functions) Future Value

The value of an investment at a specified future date, based on a certain interest rate or rate of return

71
New cards

(Excel Functions) Formula of Future Value

Back: FV = PV × (1 + r)^n

Where: FV = Future Value PV = Present Value r = Interest rate or rate of return n = Number of periods

72
New cards

(Excel Functions) Present Value

The current value of a future sum of money, discounted at a certain interest rate to reflect its current worth

73
New cards

(Excel Functions) Formula for Present value

PV = FV / (1 + r)^n

Where: PV = Present Value FV = Future Value r = Interest rate or discount rate n = Number of periods

74
New cards

(Excel Function) Net Present Value

The difference between the present value of cash inflows and the present value of cash outflows over a period of time, used in capital budgeting to evaluate investment projects.

75
New cards

(Excel Functions) Formula for net present value

NPV = Σ [(Cash inflow / (1 + r)^n) - Cash outflow]

Where: NPV = Net Present Value r = Discount rate n = Number of periods

76
New cards

(Excel Function) payment PMT

The periodic payment made in an annuity or loan, consisting of both principal and interest.

77
New cards

(Excel Function) Number of Periods (NPER or MPER)

The total number of payment periods in an annuity or loan

78
New cards

Valuing Irredeemable instruments

  • An infinite series of periodic payments of a constant amount, typically representing a stream of income that continues indefinitely

  • Irredeemable instruments, also known as perpetuities, are financial securities that pay a fixed amount of interest indefinitely

79
New cards

Formula for Perpetuity

Perpetuity = Payment / Interest rate

80
New cards

Key points for valuing irredeemable instruments

  • Perpetuities offer fixed interest payments without a maturity date.

  • The present value of a perpetuity is calculated by dividing the payment by the interest rate.

  • Irredeemable instruments are commonly used in certain types of preferred stocks and government securities.

81
New cards

Valuing Fixed Interest Bonds

Fixed interest bonds are debt securities that pay a fixed rate of interest until maturity, at which point the principal is repaid.

82
New cards

(Excel Function) Formula for Present value or Fixed Interest Bond

PV = Σ [(C / (1 + r)^n) + (F / (1 + r)^n)]

Where: PV = Present value C = Periodic interest payment r = Discount rate n = Number of periods F = Face value or principal

83
New cards

Key points for Value of fixed interest bond

  • Fixed interest bonds have a fixed coupon rate and maturity date.

  • The present value of a fixed interest bond is calculated by discounting the future cash flows (interest payments and principal repayment) to their present value.

  • The discount rate used is typically the yield to maturity (YTM), representing the market's required rate of return for the bond.

84
New cards

Bond Concept

A debt instrument issued by governments, municipalities, corporations, or other entities to raise capital, typically consisting of fixed interest payments and a repayment of the principal amount at maturity.

85
New cards

Key Features of Bond concept

  • Fixed interest rate (coupon rate)

  • Maturity date

  • Face value (par value)

  • Issuer (government, corporation, municipality)

  • Credit rating

86
New cards

Coupon Rate

The fixed annual interest rate paid by the bond issuer to the bondholder, expressed as a percentage of the bond's face value

87
New cards

Maturity Date

The date on which the bond issuer repays the principal amount to the bondholder, marking the end of the bond's term

88
New cards

Face Value (Par Value)

The nominal value of the bond, which represents the amount repaid to the bondholder at maturity. It is typically $1,000 for corporate bonds and government bonds

89
New cards

Issuer

The entity that issues the bond to raise capital, such as governments, corporations, municipalities, or government-sponsored enterprises.

90
New cards

Credit Rating

An assessment of the issuer's creditworthiness, indicating the likelihood of timely repayment of interest and principal

91
New cards

Yield

he return earned on a bond, calculated as the annual interest payments divided by the bond's current market price. It represents the bond's effective interest rate

92
New cards

Valuing Convertible Debt

Depends on conversion value Po (1 + g)n R

  • the conversion ratio R

  • the current share price Po

  • share price growth rate g

  • the time to maturity or conversion n

93
New cards

Straight debt

Principle amount + Interest

  • Principal Amount: The initial amount borrowed or the face value of the debt.

  • Interest: The total interest payments over the life of the debt, calculated as Principal×Interest Rate×Time PeriodPrincipal×Interest Rate×Time Period.

94
New cards

Valuing Shares

knowt flashcard image
95
New cards

Gordon Growth model

knowt flashcard image
96
New cards

Straight Line depreciation

Method allocating equal depreciation amounts to each period of an asset's useful life

97
New cards

Useful Life

Period over which an asset is expected to be used, determining the duration of depreciation calculations

98
New cards

Depreciation rate calculation

Convert depreciation percentage to a decimal by dividing by 100

99
New cards

Depreciation Rate Formula

Depreciation Rate = (Depreciation Percentage) / 100

100
New cards

Expense calculation

Multiply depreciation rate by initial cost or book value of the asset