(27) Financial Analysis Techniques Flashcards
LOS 27. a: Describe tools and techniques used in financial analysis, including their uses and limitations. How can ratios be used?
Ratios can be used to project earnings and future cash flows, evaluate a firm’s flexibility, assess management’s performance, evaluate changes in the firm and industry over time, and compare the firm with industry competitors.
LOS 27. a: Describe tools and techniques used in financial analysis, including their uses and limitations. What is vertical and horizontal common-size data?
Vertical common-size data are stated as a percentage of sales for income statements or as a percentage of total assets for balance sheets. Horizontal common-size data presents each item as a percentage of its value in a base year.
LOS 27. a: Describe tools and techniques used in financial analysis, including their uses and limitations. What are the limitations of ratios?
Ratio analysis has limitations, ratios are not useful when viewed in isolation and require adjustments when different companies use different accounting treatments. Comparable ratios may be hard to find for companies that operate in multiple industries. Ratios must be analyzed relative to one another, and determining the range of acceptable values for a ratio can be difficult.
LOS 27. b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Activity ratios indicate how well a firm uses its assets. They include receivables turnover, days of sales outstanding, inventory turnover, days of inventory on hand, payables turnover, payables payment period, and turnover ratios for total assets, fixed assets, and working capital.
LOS 27. b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Liquidity ratios indicate a firm’s ability to meet its short-term obligations. They include the current, quick, and cash ratios, and defensive interval, and the cash conversion cycle.
LOS 27. b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Solvency ratios indicate a firm’s ability to meet its long-term obligations. They include the debt-to-equity, debt-to-capital, debt-to-assets, financial leverage, interest coverage, and fixed charge coverage ratios.
LOS 27. b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Profitability ratios indicate how well a firm generates operating income and net income. They include net, gross, and operating profit margins, pretax margin, return on assets, operating return on assets, return on total capital, return on total equity, and return on common equity.
LOS 27. b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Valuation ratios are used to compare the relative values of stocks. They include earnings per share and price-to-earnings, price-to-sales, price-to-book value, and price-to-cash-flow ratios.
LOS 27. c: Describe relationships among ratios and evaluate a company using ratio analysis.
An analyst should use an appropriate combination of different ratios to evaluate a company over time and relative to comparable companies. The interpretation of an increase in ROE, for example, may be quite different for a firm that has significantly increased its financial leverage compared to one that has maintained or decreased its financial leverage.
LOS 27. d: Demonstrate the application of DuPont analysis of return on equity and calculate and interpret effects of changes in its components. Basic DuPont equation.
(net profit margin)(total asset turnover)(financial leverage multiplier)
OR
(Net profit margin)(equity turnover) if you cross out assets.
LOS 27. d: Demonstrate the application of DuPont analysis of return on equity and calculate and interpret effects of changes in its components. Extended DuPont equation.
(Tax burden)(Interest burden)(EBIT/Revenue)(Asset turnover)(Financial leverage)
Tax burden = (1 – tax rate) = tax retention rate
LOS 27. e: Calculate and interpret ratios used in equity analysis and credit analysis.
Ratios used in equity analysis include price-to-earnings, price-to-cash flow, price-to-sales, and price-to-book value ratios, and basic and diluted earnings per share. Other ratios are relevant to specific industries such as retail and financial services.
LOS 27. e: Calculate and interpret ratios used in equity analysis and credit analysis.
Credit analysis emphasizes interest coverage ratios, return on capital, debt-to-assets ratios, and cash flow to total debt.
LOS 27. f: Explain the requirements for segment reporting and calculate and interpret segment ratios.
A business or geographic segment is a portion of a firm that has risk and return characteristics distinguishable form the rest of the firm and accounts for more than 10% of the firm’s sales or assets.
LOS 27. f: Explain the requirements for segment reporting and calculate and interpret segment ratios.
Firms are required to report some items for significant business and geographic segments. Profitability, leverage, and turnover ratios by segment can give the analyst a better understanding of the performance of the overall business.
LOS 27 (extra): Calculate sustainable growth rate
