FIN330 Ch3 Quiz

Chapter 3: Using Financial Statements

Financial Statement purpose

primary means of communicating financial information to external and internal stakeholders

Financial Statement Analysis

the process of analyzing a company’s financial statements for decision making purposes

Sources vs Uses of Cash

sources: bring in cash

uses: spending cash

Assets, Liabilities/ Equity with Sources of Cash

Assets: decrease

Liabilities/ Equity: increase

Assets, Liabilities/ Equity with Uses of Cash

Assets: increase

Liabilities/ Equity: decrease

Statement of Cash Flows

firm’s financial statement that summarizes its sources and uses of cash over a specific period ; groups CF changes into 3 groups

Operating, Investing, and Financing Activities

3 Groups in Statement of Cash Flows

Operating, Investing, Finanncing Activities

Why is it hard to directly compare Financial Statements for 2 companies or the same company at different times?

Exchange rates, size, accounting regulations, different industries

Standardized Financial Statements

Used to compare financial statements; converts amounts into percentages

Common-Size Balance Sheet

shows the makeup of a company’s assets and liabilities through the presentation of percentages

Common Size Line Item = Line Item / Total Assets

Common-Size Income Statement

shows what happens to each dollar in sales

= Line Item / Sales

Common-Base Year Statements

present all items relevant to a certain base year amount

purpose: trend analysis

Ratio Analysis

designed to summarize specific aspects of a firm’s financial position and make better comparisons

looks at Firm Performance in 5 areas

Ratio Analysis 5 Areas

Liquidity (ST Solvency), Financial Leverage (LT Solvency), Asset Management (Turnover), Profitability, Market Value

Liquidity (Ratio Analysis)

provides information about firm’s ability to meet ST obligations

Liquidity Ratios

Current Ratio, Quick (Acid-Test) Ratio, Cash Ratio

Current Ratio Formula and Interpretation

Current Ratio = Current Assets / Current Liabilities

• Ability to meet ST liabilities (if able, CR >= 1)

Quick (Acid-Test) Ratio Formula and Interpretation

Quick Ratio = (CA - Inventory) / CL

• Ability to meet ST liabilities with CA excluding inventory (if able, QR >= 1)

Cash Ratio Formula and Interpretation

Cash Ratio = Cash / CL

• Ability to meet ST liabilities with cash on hand (if able, QR >= 1)

Financial Leverage (Ratio Analysis)

LT Solvency; provides information about a firm’s ability to meet LT obligations

Financial Leverage Ratios

Total Debt Ratio, Debt-Equity Ratio, Equity Multiplier, Times Interest Earned (TIE), Cash Coverage Ratio

Total Debt Ratio Formula and Interpretation

TDR = (Total Assets - Total Equity) / Total Assets

• ___ % of assets are being financed through debt.

• Firm has ___ cents in debt for every $ in total assets.

Debt to Equity Ratio Formula and Interpretation

Debt to Equity Ratio = Total Debt / Total Equity

• how much financed by debt vs equity

• Firm has ___ cents in total debt for every dollar of equity

Equity Multiplier Formula and Interpretation

EM = Total Assets / Total Equity

• =1 means 0 debt

• >1 means debt

• >2 means half financed by debt

• >3 over half financed by debt

Times Interest Earned (TIE) Formula and Interpretation

TIE = EBIT / Interest

• Firm’s interest obligations can be covered by current operating income ___ times

Cash Coverage Ratio Formula and Interpretation

CCR = (EBIT + Dep + Amort) / Interest

• Firm’s interest obligations can be covered by current generated cash flows ___ times

Asset Management (Ratio Analysis)

Turnover; provides information about how efficiently a firm uses its assets

Asset Management Ratios

Inventory TO, Days Inv Outstanding, Receivables TO, Days Sales Outstanding, Payables TO, Days Payables Outstanding, Cash Conversion Cycle, Total Asset Turnover

Inventory Turnover Formula and Interpretation

Inv TO = COGS / Inv

• Firm turns its inventory over ___ times/ year

• GOAL: High

Days Inv Outstanding Formula and Interpretation

DIO = (Inv / COGS) *365

• Takes a firm ___ days to turnover (sell) its inventory

• GOAL: Low

Receivables TO Formula and Interpretation

Receivables TO = Sales / AR

• Times/ year firm collects its avg. AR balance

• GOAL: High

Days Receivables Outstanding Formula and Interpretation

DRO = (AR / Sales) * 365

• Amount of days needed to collect avg. AR balance

• GOAL: Low

Payables TO Formula and Interpretation

Payables TO = COGS / AP

• How many times/ year firm pays off avg. AP balance to suppliers

• GOAL: Low

Days Payables Outstanding Formula and Interpretation

DPO = (AP / COGS) * 365

• Amount of days it takes a firm to pay suppliers AP balance

• GOAL: High

Cash Conversion Cycle Formula and Interpretation

CCC = DSO + DIO - DPO

• Takes firm approximately ___ days to convert its investments in inventory and other resources into cash flows from sales

• GOAL: Low

• Can be negative is DPO > DIO + DSO ; likely big companies with market power

Total Asset Turnover Formula and Interpretation

TAT = Sales / Total Assets

• GOAL: High

• Firm produces ___ dollars in sales for every dollar in assets

Profitability (Ratio Analysis)

provides information on how efficiently a firm uses its assets and manages operations by evaluating profits with respect to sales, assets, or owners’ investment

Profitability Ratios

Net Profit Margin, EBITDA Margin, ROA, ROE

Net Profit Margin Formula and Interpretation

PM = Net Income / Sales

• Each $ of sales generates __ dollars in net income to shareholders

EBITDA Margin Formula and Interpretation

EBITDA Margin = EBITDA / Sales

• Each dollar of sales generates __ dollars in operating profit

ROE Formula and Interpretation

ROE = Net Income / Total Equity

• Each dollar in equity generates __ dollars in net income

  • Not true representative of return to investor because it can be manipulated through debt

Market Value Ratio Analysis

relates a firm’s market value (current share price) to certain accounting values

Market Value Ratios

Price Earnings Ratio, Market-to-Book Ratio, Market Capitalization, Enterprise Value, Enterprise Value Multiplies

Price Earnings Ratio Formula and Interpretation

PER = Price per Share / Earnings per Share

• How much the investor is willing to pay for each dollar of a firm’s earnings

Market-to-Book Ratio Formula and Interpretation

MtBR= Market Value per Share / Book Value per Share

• how investors view a firm’s performance (under or over value firm)

Market Capitalization Formula and Interpretation

MC = Price per Share * Shares Outstanding

• measures the total dollar market value of a company's outstanding shares of stock

Enterprise Value Formula and Interpretation

EV = Market Cap - Market Value of Interest Bearing Debt - Cash

• measures company’s total value; how much it would take to buy all outstanding stock & pay off debt

Enterprise Value Multiplies Formula and Interpretation

EVM = Enterprise Value / EBITDA

• value of company’s total business rather than value of equity

DuPont Identity

focus on key metrics of financial performance individually to identify strengths & weaknesses

ROE Decomposition

• Operating Efficiency (Profit Margin Ratio)

• Asset Use Efficiency (Total Asset TO Ratio)

• Financial Leverage (Equity Multiplier)

DuPont Identity Picture

ROE splits: ROA & Financial Leverage

• ROA splits: Profit Margin, Total Asset TO

• Financial Leverage: Financial Leverage (Debt)

Problems with Financial Statement Analysis

• no way to know relevant ratios

• benchmarking difficult for diversified firms

• difference in accounting regulations

• use of varying accounting procedures

• different fiscal years

• extraordinary / 1-time events