Chapter 3 Working with Financial Statements

A set of vocabulary flashcards covering key concepts from Chapter 3: cash flow, standardized statements, ratio analysis, Du Pont identity, benchmarking, and common pitfalls.

Statement of Cash Flows

A financial statement that summarizes the sources and uses of cash, categorized into operating, investing, and financing activities.

Sources of Cash

Cash inflows that occur when selling goods/services, decreases in asset accounts, or increases in liability or equity accounts.

Uses of Cash

Cash outflows that occur when purchasing assets, increases in asset accounts, or decreases in liabilities or equity accounts.

Operating Activity

Cash flow activity that includes net income and changes in most current accounts; part of the Statement of Cash Flows.

Investing Activity

Cash flow activity related to changes in fixed assets and investments.

Financing Activity

Cash flow activity related to changes in notes payable, long-term debt, equity accounts, and dividends.

Standardized Financial Statements

Financial statements converted to percentages to facilitate comparison across firms and over time.

Common-Size Statement of Financial Position

Balance sheet where every account is expressed as a percentage of total assets.

Common-Size Statement of Comprehensive Income

Income statement where every line item is expressed as a percentage of sales.

Why Standardize Financial Statements

To make it easier to compare financial information across firms and growth levels.

Ratios

Financial measures used to compare performance and analyze relationships between figures.

Short-Term Solvency or Liquidity Ratios

Ratios that assess a firm’s ability to meet short-term obligations.

Long-Term Solvency or Financial Leverage Ratios

Ratios that assess a firm’s long-run debt levels and financial leverage.

Asset Management or Turnover Ratios

Ratios that measure how efficiently a firm uses its assets to generate sales.

Profitability Ratios

Ratios that measure a firm’s ability to generate profits relative to sales, assets, or equity.

Market Value Ratios

Ratios that relate market prices to financial metrics (e.g., earnings, book value).

Current Ratio

Current assets divided by current liabilities.

Quick Ratio

(Current assets minus Inventory) divided by Current liabilities.

Cash Ratio

Cash divided by Current liabilities.

Total Debt Ratio

(Total assets minus total equity) divided by Total assets.

Debt/Equity Ratio

Total debt divided by Total equity.

Equity Multiplier

Total assets divided by total equity (equivalently 1 plus Debt/Equity).

Times Interest Earned

EBIT divided by Interest expense.

Cash Coverage

(Earnings Before Interest and Taxes + Depreciation) divided by Interest expense.

Inventory Turnover

Cost of Goods Sold divided by Inventory.

Days’ Sales in Inventory

365 divided by Inventory Turnover.

Receivables Turnover

Sales divided by Accounts Receivable.

Days’ Sales in Receivables

365 divided by Receivables Turnover.

Net Working Capital Turnover

Sales divided by Net Working Capital (Current Assets minus Current Liabilities).

Fixed Asset Turnover

Sales divided by Net Fixed Assets.

Total Asset Turnover

Sales divided by Total Assets.

Profit Margin

Net Income divided by Sales.

Return on Assets (ROA)

Net Income divided by Total Assets.

Return on Equity (ROE)

Net Income divided by Total Equity.

Du Pont Identity

ROE = Profit Margin × Asset Turnover × Equity Multiplier.

Benchmarking

Comparing ratios over time or against peer groups to assess performance.

Time-Trend Analysis

Evaluating how performance changes over time to identify trends.

Peer Group Analysis

Comparing a firm’s performance to similar companies or industry peers.

NAICS Codes

Industry classification codes used to identify peer groups for benchmarking.

Financial Post Datagroup

A data source used for peer and industry comparisons.

Dun & Bradstreet Canada

A source of business data for benchmarking and credit assessments.

Potential Problems in Financial Statement Analysis

Issues such as lack of underlying theory, diversity of firms, accounting differences, different fiscal years, and extraordinary events that complicate comparisons.