Chapter 2 Vocabulary - Introduction to Financial Statement Analysis

Financial Statements

Accounting reports issued by a firm, quarterly and/or annually, the present/past performance information and a snapshot of the firm’s assets and the financing of those assets

Annual Report (10-K)

The yearly summary of business, accompanying or including financial statements, sent by US public companies to their shareholders

Generally Accepted Accounting Principles (GAAP)

A common set of rules and a standard format for public companies to use when they prepare their financial reports

Auditor

A neutral third party, which corporations are required to hire, that checks a firm’s annual financial statements to ensure they are prepared according to GAAP, and provides evidence to support the reliability of the information

Balance Sheet / Statement of Financial Position

A list of a firm’s assets and liabilities that provides a snapshot of the firm’s financial position at a given point in time

Assets

The cash, inventory, property, plant, and equipment, and other investments a company has made

Current Assets

Cash or assets that can be converted into cash within one year

Marketable Securities

Short-term, low-risk investments that can be easily sold and converted to cash

Accounts Receivable

Amounts owed to a firm by customers who have purchased goods or services on credit

Inventories

A firm’s raw materials as well as its work-in-progress and finished goods

Long-Term Assets

Assets that produce tangible benefits for more than one year

Liabilities

A firm’s obligations to its creditors

Current Liabilities

Liabilities that will be satisfied within one year

Accounts Payable

The amounts owed to creditors for products or services purchased with credit

Notes Payable

Loans that must be repaid in the next year

Stockholders’ Equity

An accounting measure of a firm’s net worth that represents the difference between the firm’s assets and its liabilities

Book Value of Equity

The difference between the book value of a firm’s assets and its liabilities; it represents the net worth of a firm from an accounting perspective

Common Stock and Paid-In Surplus

The amount that stockholders have directly invested in the firm through purchasing stock from the company

Retained Earnings

Profits made by the firm, but retained within the firm and reinvested in assets or held as cash

Depreciation

A yearly deduction a firm makes from the value of its fixed assets (other than land) over time, according to a depreciation schedule that depends on an asset’s life span

Book Value

The acquisition cost of an asset less its accumulated depreciation

Net Working Capital

The difference between a firm’s current assets and current liabilities that represents the capital available in the short term to run the business

Liquidation Value

The value of a firm after its assets are sold and liabilities paid

Market Capitalization

The total market value of equity; equals the market price per share times the number of shares

Market-to-Book Ratio / Price-to-Book (P/B) Ratio

The ratio of a firm’s market (equity) capitalization to the book value of its stockholders’ equity

Value Stocks

Firms with low market-to-book ratios

Growth Stocks

Firms with high market-to-book ratios

Enterprise Value

The total market value of a firm’s equity and debt, less the value of its cash and marketable securities; it measures the value of the firm’s underlying business

Income Statement

A list of a firm’s revenues and expenses over a period of time

Net Income

The last or “bottom” line of a firm’s income statement that is a measure of the firm’s income over a given period of time

Gross Profit

The third line of an income statement that represents the difference between a firm’s sales revenues and its costs

Operating Income

A firm’s gross profit less its operating expenses

Earnings Before Interest and Taxes (EBIT)

A firm’s earnings before interest and taxes are deducted

Earnings Per Share (EPS)

A firm’s net income divided by the total number of shares outstanding

Stock Options

The right to buy a certain number of shares of stock by a specific date at a specific price

Convertible Bonds

Corporate bonds with a provision that gives the bondholder an option to convert each bond owned into a fixed number of shares of common stock

Dilution

An increase in the total number of shares that will divide a fixed amount of earnings

Diluted EPS

The earnings per share a company would have based on the total number of shares including the effects of all stock options and convertible bonds

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)

A computation of a firm’s earnings before interest, taxes, depreciation, and amortization are deducted

Statement of Cash Flows

An accounting statement that shows how a firm has used the cash it earned during a set period

Capital Expenditures

Purchases of new property, plant, and equipment

Payout Ratio

The ratio of a firm’s dividends to its net income

Statement of Stockholders’ Equity

An accounting statement that breaks down the stockholders’ equity computed on the balance sheet into the amount that came from issuing new shares versus retained earnings

Management Discussion and Analysis (MD&A)

A preface to the financial statements in which a company’s management discusses the recent year (or quarter), providing a background on the company and any significant events that may have occurred

Off-Balance Sheet Transactions

Transactions or arrangements that can have a material impact on a firm’s future performance, yet do not appear on the balance sheet

Gross Margin

The ratio of gross profit to revenues (sales), it reflects the ability of the company to sell a product for more than the sum of the direct costs of making it

Operating Margin

The ratio of operating income to revenues, it reveals how much a company has earned from each dollar of sales before deducting interest and taxes

Net Profit Margin

The ratio of net income to revenues, it shows the fraction of each dollar in revenues that is available to equity holders after the firm pays its expenses, plus interest and taxes

Current Ratio

The ratio of current assets to current liabilities

Quick Ratio / “Acid-Test” Ratio

The ratio of current assets other than inventory to current liabilities

Cash Ratio

The ratio of cash to current liabilities

Asset Turnover

The ratio of sales to total assets

Accounts Receivable Days

An expression of a firm’s accounts receivable in terms of the number of days’ worth of sales that the accounts receivable represents

Accounts Payable Days

An expression of a firm’s accounts payable in terms of the number of days’ worth of cost of goods sold that the accounts payable represents

Inventory Days

An expression of a firm’s inventory in terms of the number of days’ worth of cost of goods sold that the inventory represents

Inventory Turnover Ratio

The cost of goods sold divided by either the latest cost of inventory or the average inventory over the year; it shows how efficiently companies turn their inventory into sales

Interest Coverage Ratio / Times Interest Earned (TIE) Ratio

An assessment by lenders of a firm’s leverage, it is equal to a measure of earnings divided by interest

Leverage

The relative amount of debt on a firm’s balance sheet

Debt-Equity Ratio

The ratio of a firm’s total amount of short- and long-term debt (including current maturities) to the value of its equity, which may be calculated based on market or book values

Debt-to-Capital Ratio

The ratio of total debt plus total equity

Net Debt

Debt in excess of a firm’s cash revenues

Debt-to-Enterprise Value Ratio

The ratio of a firm’s net debt to its enterprise value

Equity Multiplier

A measure of leverage equal to total assets divided by total equity

Price-Earnings (P/E) Ratio

The ratio of the market value of equity to the firm’s earnings, or its share price to its earnings per share

PEG Ratio

The ratio of a firm’s P/E to its expected earnings growth rate

Return on Equity (ROE)

The ratio of a firm’s net income to the book value of its equity

Return on Assets (ROA)

The ratio of net income plus interest expense to the total book value of the firm’s assets

Return on Invested Capital (ROIC)

The ratio of the after-tax profit before interest to the book value of invested capital not being held as cash (book equity plus net debt)

DuPont Identity

Expresses return on equity as the product of profit margin, asset turnover, and a measure of leverage

Sarbanes-Oxley Act (SOX)

Legislation passed by Congress in 2002, intended to improve the accuracy of financial information given to both boards and shareholders