2nd meeting - FS Analysis.pdf

Financial statement analysis

What is the process of evaluating a company's financial health and performance through various tools and techniques?

Intracompany basis

What type of comparison involves analyzing financial data within a single company to detect changes and trends over time?

Industry averages

What type of comparison provides information about a company's relative position within its specific business sector?

Intercompany basis

What type of comparison provides insight into a company's competitive position by comparing it with other firms?

Horizontal analysis

Which tool of financial statement analysis is also known as trend analysis?

Vertical analysis

Which tool of financial statement analysis expresses each item in a statement as a percentage of a base amount?

Ratio analysis

Which tool of analysis uses mathematical relationships between financial statement items to provide clues about underlying conditions?

Determine whether an increase or decrease has taken place

What is the primary purpose of horizontal analysis?

Evaluating a series of data over a period of time

How does horizontal analysis evaluate financial statement data?

Base year amount

In horizontal analysis, what is the amount of the earliest year in a series called?

Current year amount minus base year amount divided by base year amount

What is the formula for computing the percentage change in horizontal analysis?

No percentage change can be computed

In horizontal analysis, what is the result if an item has no value in the base year?

No percentage change can be computed

In horizontal analysis, what occurs if a base year amount is negative and the following year is positive?

Common size analysis

What is the alternative name for vertical analysis?

Total assets

What is always the base amount used in the vertical analysis of a balance sheet?

Net sales

What is always the base amount used in the vertical analysis of an income statement?

Relative size of each category

What does vertical analysis show regarding the different sections of financial statements?

Enables comparison of companies of different sizes

What is a primary benefit of using common size analysis for intercompany comparisons?

Liquidity, solvency, and profitability

What are the three standard classifications of ratios?

Liquidity ratios

Which category of ratios measures the short term ability of an enterprise to pay its maturing obligations?

Solvency ratios

Which category of ratios measures the ability of an enterprise to survive over a long period of time?

Profitability ratios

Which category of ratios measures the income or operating success of an enterprise for a given period?

Current ratio

What ratio is computed by dividing current assets by current liabilities?

Short term debt paying ability

What does the current ratio primarily evaluate?

Composition of the current assets

What important factor does the current ratio fail to take into account?

Slow moving inventory

A satisfactory current ratio might hide the fact that assets are tied up in what?

Acid test ratio

What is another name for the quick ratio?

Cash plus marketable securities plus net receivables divided by current liabilities

What is the formula for the acid test ratio?

Inventory and prepaid expenses

Which two asset types are excluded from the acid test ratio numerator?

Readily salable

Inventory is excluded from the quick ratio because it may not be what?

Transferable

Prepaid expenses are excluded from the quick ratio because they may not be what?

Receivables turnover ratio

Which ratio measures the number of times, on average, receivables are collected during the period?

Net credit sales divided by average net receivables

What is the formula for the receivables turnover ratio?

Liquidity of receivables

What does the receivables turnover ratio specifically measure?

Average collection period

What ratio is computed by dividing 365 days by the receivables turnover ratio?

Effectiveness of credit and collection policies

Analysts use the average collection period to assess what?

Credit term period

The general rule is that the collection period should not greatly exceed what?

Inventory turnover ratio

Which ratio measures the number of times on average the inventory is sold during the period?

Cost of goods sold divided by average inventory

What is the formula for the inventory turnover ratio?

Liquidity of inventory

What is the purpose of the inventory turnover ratio?

Less cash is tied up and lower chance of obsolescence

What does a faster inventory turnover generally indicate?

Running out of inventory

What is a potential downside of a very high inventory turnover?

Average days in inventory

What ratio is computed by dividing 365 days by the inventory turnover ratio?

Long term creditors and stockholders

Who is most interested in a company's solvency ratios?

Face value of the debt at maturity

Long term creditors are interested in a company's ability to pay interest and repay what?

Debt to total assets ratio

Which ratio measures the percentage of the total assets provided by creditors?

Total debt divided by total assets

What is the formula for the debt to total assets ratio?

Degree of leveraging

What does the debt to total assets ratio indicate?

Greater risk of being unable to meet maturing obligations

What does a high debt to total assets ratio signify?

Equity buffer

What is available to creditors if the debt to total assets ratio is low?

Times interest earned ratio

Which ratio indicates a company's ability to meet interest payments as they come due?

Interest coverage

What is another name for the times interest earned ratio?

Income before interest expense and income taxes divided by interest expense

What is the formula for the times interest earned ratio?

Representation of what is available to cover interest

Why does the interest coverage ratio use income before interest and taxes?

Cash debt coverage ratio

Which solvency ratio uses cash from operations instead of accrual income?

Free cash flow

Which measure provides information about a company's ability to pay additional dividends or invest in projects?

Ultimate test of management operating effectiveness

How is profitability frequently used by analysts regarding management?

Return on common stockholders equity

What ratio shows how many dollars of net income were earned for each dollar invested by the owners?

ROE

What is the abbreviation for return on common stockholders equity?

Income available to common stockholders divided by average common stockholders equity

What is the formula for ROE?

Net income minus preferred stock dividends

How is income available to common stockholders calculated?

Return on assets ratio

Which ratio measures the overall profitability of assets in terms of the rate earned on each dollar invested?

ROA

What is the abbreviation for return on assets?

Net income divided by average total assets

What is the formula for the ROA ratio?

ROA and degree of leverage

What two factors directly affect ROE?

Trading on the equity at a gain

What is the term for leveraging when borrowed money earns more than its interest cost?

Use money supplied by nonowners to increase return to owners

What is the simple definition of leverage?

Trade on the equity at a loss

What happens if a company earns less on borrowed funds than it pays in interest?

Profit margin ratio

Which ratio measures the percentage of each dollar of sales that results in income?

Net income divided by net sales

What is the formula for the profit margin ratio?

Profit margin ratio and asset turnover ratio

What two factors directly affect the ROA ratio?

High volume enterprises

Which type of enterprises, like grocery stores, generally have low profit margins?

Low volume enterprises

Which type of enterprises, like jewelry stores, generally have high profit margins?

Asset turnover ratio

Which ratio measures how efficiently a company uses its assets to generate sales?

Net sales divided by average total assets

What is the formula for the asset turnover ratio?

Gross profit rate

Which rate indicates a company's ability to maintain an adequate selling price above its costs?

Gross profit divided by net sales

What is the formula for the gross profit rate?

Becomes more competitive

What typically causes a decline in the gross profit rate within an industry?

Operating expenses to sales ratio

Which ratio measures the costs incurred to support each dollar of sales?

Operating expenses divided by net sales

What is the formula for the operating expenses to sales ratio?

Gross profit rate and operating expenses to sales ratio

What two factors directly influence the profit margin ratio?

Earnings per share

Which measure shows the net income earned on each share of common stock?

EPS

What is the abbreviation for earnings per share?

Income available to common shareholders divided by average number of outstanding common shares

What is the formula for EPS?

Wide variations in the number of shares outstanding

Why are intercompany comparisons of EPS not normally meaningful?

Price earnings ratio

Which ratio measures the relationship between the market price of a share and its earnings per share?

P E ratio

What is the common abbreviation for the price earnings ratio?

Stock price divided by earnings per share

What is the formula for the P E ratio?

Investors assessment of future earnings

What does the P E ratio reflect?

Payout ratio

Which ratio measures the percentage of earnings distributed in the form of cash dividends?

Cash dividends divided by net income

What is the formula for the payout ratio?

Reinvesting most of the net income

Why do high growth companies typically have low payout ratios?

Product of profit margin, asset turnover, and the equity multiplier

How does the DuPont Equation define ROE?

E I DuPont de Nemours and Company

Who initially introduced the disaggregation of ROE for performance evaluation?

Asset management, financial leverage management, and profitability

The DuPont equation shows relationships among which three areas?

Equity multiplier

What is the alternative name for the financial leverage component in the DuPont equation?

Peso of sales

Profit margin is the amount of profit a company earns from each what?

Volume of sales generated from each peso invested in assets

What does asset turnover reflect in the DuPont equation?

Degree to which a company finances assets with debt rather than equity

What does the financial leverage component measure?

Relative riskiness

While leverage increases ROE when performance is positive, what else does it increase?