MBA403 Week 2: Analysing Financial Statements

This set of vocabulary flashcards covers financial ratio analysis concepts, formulas, and benchmarks based on the Week 2 lecture materials, including examples from Virgin Australia and Harvey Norman.

Leverage

Refers to the amount of debt a firm uses to finance its assets.

Liquidity

Concerns a business’s ability to meet its short term financial obligations.

Insolvency

When the value of a company’s liabilities exceeds that of its assets.

Ratio Analysis

A method that allows for combining and comparing data from financial statements to gain deeper insights into a business.

Financial Stability Ratios

Ratios used to examine a company’s financial structure and the risks arising from its debt obligations.

Efficiency Ratios

Ratios used to determine if a business is using its assets efficiently to generate sales, cash, and profit.

Profitability Ratios

Ratios used to assess profitability versus sales, assets, and shareholder equity.

Debt Ratio formula

$$\frac{\text{Total Liabilities}}{\text{Total Assets}}$$

Debt Ratio Ideal Range

Generally between $30\%$ and $50\%$, though it varies by industry and economic environment.

Debt to Equity Ratio formula

$\frac{\text{Liabilities}}{\text{Equity}}$ with an ideal range of $40\%-100\%$.

Current Ratio formula

$$\frac{\text{Total Current Assets}}{\text{Total Current Liabilities}}$$

Current Ratio Benchmark

Should be comfortably above $1$, up to a level of $2$. Values below $1$ may represent high-volume, cash-generating businesses like supermarkets.

Quick Ratio formula

$$\frac{\text{Current Assets} - \text{Inventories}}{\text{Liabilities}}$$

Interest Cover Ratio formula

$$\frac{\text{EBIT}}{\text{Interest Expense}}$$

Interest Cover Ratio Benchmarks

Below $1$ indicates inability to meet current interest obligations; $2$ is the minimum acceptable, with above $3$ preferred.

Asset Turnover formula

$$\frac{\text{Sales}}{\text{Total Assets}}$$

Inventory Turnover formula

$$\frac{\text{Inventories}}{\text{Cost of Goods Sold}} \times 365$$

Inventory Turnover Days Interpretation

Indicates how many days it takes to sell inventory; levels above $90$ days are considered relatively high.

Age of Accounts Receivable formula

$$\frac{\text{Accounts Receivable}}{\text{Sales}} \times 365$$

Age of Accounts Receivable Benchmarks

$30$ days is considered acceptable; $45$ days is concerning; and $60$ days is reportable as a 'default'.

Return on Sales formula

$$\frac{\text{EBIT}}{\text{Sales}} \times 100$$

Return on Equity (RoE) formula

$$\frac{\text{Net Profit}}{\text{Equity}} \times 100$$

Return on Investment (RoI) formula

$$\frac{\text{EBIT}}{\text{Total Assets}} \times 100$$

RoI Decomposition

$$\text{Return on Sales} \times \text{Asset Turnover}$$

Horizontal Analysis

Measuring a company’s performance through time using 'time series' data, ideally with at least $3$ observations.

Vertical Analysis

Comparing a company’s performance to an appropriate standard, guideline, or benchmark such as competitors or industry averages.

The 'Big Picture'

External factors influencing financial analysis including revenue trends, competition, regulatory factors, and business strategy.