finance chapter 3

GAAP

guidelines used to prepare and maintain financial records and reports

financial accounting standards board (FASB)

self-regulatory organization (SRO) that produces and authorizes GAAP

public company accounting oversight board (PCAOB)

SRO established by SOX Act of 2002 to oversee auditors

Form 10-K

audited annual financial statements

annual report

annual stockholders’ meeting report

letter to stockholders

primary communication from management in the annual report

income statement

financial summary of the firm’s operating performance for a given period 

balance sheet

summary of the firm’s financial position at a given point in time

statement of retained earnings

reconciles the net income earned during a given year, and any cash dividends paid, with the change in retained earnings between the start and the end of that year

statement of cash flows

summary of the firms operating, investment, and cash flows, and reconciles them with changed in cash and marketable securities, for a given period

the rule-setting body that authorizes the practice and procedure guidelines used to prepare and maintain financial statements is

a. IFRS

b. FASB

c. PCAOB

d. GAAP

B

ratio analysis

evaluating financial performance on a relative basis

financial ratios

quantitative indicators of a firm’s financial position, wellbeing, or performance

who are the interested parties in financial ratio analysis?

shareholders

creditors

management

analysts

cross sectional analysis

comparison of different firms’ financial ratios at the same point in time

benchmarking

a type of cross-sectional analysis in which the firm’s ratio values are compared with those of a key competitor or with other firms that it wishes to emulate 

time series analysis

evaluation of the firm’s financial performance over time using financial ratio analysis

combines or panel analysis

combines cross-sectional and time-series analysis

Which of the following is not true regarding the use of financial ratios?

a. Cross-sectional analysis compares a firm’s financial ratios to those of other firms.

b. Combined analysis is a combination of cross-sectional and benchmarking analysis.

c. Time-series analysis compares a firm’s financial ratios over time.

d. Benchmarking analysis compares a firm’s ratios to thoseof key competitors.

B

what do liquidity ratios measure?

a firm’s ability to satisfy its short-term obligations as they come due

current ratio

measure of liquidity calculated by dividing firm’s current assets by its current liabilities

quick ratio

measure of liquidity calculated by dividing the firm’s current assets less inventory by its current liabilities

what do activity ratios measure

measure the speed with which various accounts convert into sales or cash

inventory turnover ratio

measures the activity, or liquidity, of a firm’s inventory

= COGS / Inventory

average age of inventory

average number of days’ sales are in inventory

= 365 / inventory turnover ratio

average collection period

the average amount of time needed to collect accounts receivable

= accounts receivable / average sales per day

average sales per day

annual sales / 365

average payment period

the average amount of time needed to pay accounts payable

= accounts payable / average purchases per day

where average purchases per day = annual purchases / 365

total asset turnover 

indicates the efficiency with which the firm uses its assets to generate sales

= sales / total assets

A firm's total asset turnover increased from 0.75 to 0.90. Which of the following is true about the given data?

a. The firm is generating more dollars of sales per dollar of assets now than it was before.

b. The firm is generating fewer dollars of sales per dollar of assets now than it was before.

c. By cutting back on assets, the firm runs the risk of creating problems like inventory stockouts and production delays.

d. The firm's stock price will go up because it is using assets more efficiently.

A

what do debt ratios measure?

measure the firm’s use of debt or financial leverage

financial leverage

the degree to which a firm uses debt financing and the effects of debt financing

debt ratio

total liabilities / total assets

debt to equity ratio

the relative proportion of total liabilities and common stock equity used to finance the firm’s assets

= total liabilities / common stock equity

times interest earned ratio

measures the firm’s ability to make contractual interest payments, sometimes called the interest coverage ratio

= earnings before interest and taxes / interest

fixed payment coverage ratio

measures the firm’s ability to meet all fixed-payment obligations

____ is a term used to describe the magnification of risk and return introduced with fixed-cost financing, such as debt.

a. Financial leverage

b. Operating leverage

c. Fixed-payment coverage

d. Benchmarking

A

what do profitability ratios measure?

measure the firm’s profits with respect to its sales, assets, or the owners’ investment

gross profit margin

the percentage of each sales dollar remaining after the firm has paid for its goods

operating profit margin

the percentage of each sales dollar remaining after deducting all costs and expenses other than interest, taxes, and preferred stock dividends

= operating / sales

net profit margin

the percentage of each sales dollar raining after all costs and expenses including interest, taxes, preferred stock dividends, have been deducted

= earning available for common stockholders / sales

earnings per share

the value of earnings per outstanding share of common stock

= earnings available for common stockholders / number of shares of common stock outstanding

common size income statement

an income statement in which each item is expressed as a percentage of sales

return on total assets (ROA)

measures the return earned on the firm’s total assets, also called the return on investment

= earnings available for common stockholders / total assets

return on equity (ROE)

measures the return earned on the common stockholders’ investment in the firm

= earnings available for common stockholders / common stock equity

what do market ratios measure

relate a firm’s market value, as measured by its current share price, to certain accounting values

price/earning ratio

measures the amount investors are willing to pay for each dollar of a firm’s earnings

market book ratio

compares the market price of a firm’s stock to its book value per share

dupont formula

multiplies the firm’s net profit margin by its total asset turnover to calculate the firm’s return on total assets (ROA)

modified Dupont formula

relates the firm’s return on total assets (ROA) to its return on equity (ROE) using the financial leverage multiplier (FLM)

financial leverage multiplier (FLM)

total assets / common stock equity

The DuPont system merges the income statement and balance sheet into two summary measures of profitability, ________.

a. net profit margin and return on total assets

b. financial leverage multiplier and return on equity

c. return on total assets and return on common equity

d. net profit margin and total asset turnover

C