28. FRA - Financial Analysis Techniques Flashcards
LOS 28.a: Describe tools and techniques used in financial analysis, including their uses and limitations
Ratios express realtionships between financial accounts , by expressing one quantitiy in terms of another.
Ratios are an indicator of some aspect of a companys performance but not why it happened.
LOS 28.a: Describe tools and techniques used in financial analysis, including their uses and limitations - Uses of Ratios
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 28.a: Describe tools and techniques used in financial analysis, including their uses and limitations
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 28.a: Describe tools and techniques used in financial analysis, including their uses and limitations
Cross Sectional Analysis compares a specific metric for one company with the same metric for another company.
LOS 28.a: Describe tools and techniques used in financial analysis, including their uses and limitations
Graphs provide a visual aid in comparing performance and financial structure over time.
Regression Analysis can help identify a relationship or trend between variables.
LOS 28.a: Describe tools and techniques used in financial analysis, including their uses and limitations
Common Size Analysis involves expressing financial data to in relation to a single financial statement item or base.
LOS 28b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Activity ratios measure how efficiently a company performs day to day tasks, such as collection of receivables and management of inventory.
Also known as asset utilisation ratios and operating efficiency ratios.
LOS 28b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
LOS 28b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Liquidity Ratios assess a company’s ability to meet its short term obligations - how quickly it can turn assets into cash.
LOS 28b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Activity ratios measure how efficiently a company performs day to day tasks, such as collection of receivables and management of inventory.
Also known as asset utilisation ratios and operating efficiency ratios.
LOS 28b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Coverage Ratios asses the company’s ability to meet its debt repayments.
LOS 28b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Valuation ratios measure the quantity of an asset or flow (e.g earnings) associated with ownership of a specified claim
(e.g a share or ownership of the enterprise)
LOS 28b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
The ability to generate profit on capital invested is a key determinant of a companys overall value.
Profitability reflects a companys competivie position in the market, and by the extension the quality of the its management.
Earnings are located on the income statement. Earnings can be distributed to shareholders or reinvested in the company.
LOS 28b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Interpretation of Profitability Ratios
Return on Investment
How are returns measured?
ROA - return earned on total assets
Return on Total Capital - return on all capital (debt & equity)
ROE - Return on equity (minority, pref and common equity)
Returns can be measure pre or post deduction for return to debt - ie interest expense for returns to total assets/ capital EBIT may be a better measure.
Net income measures the return to equity holders.
LOS 28b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Interpretation of Profitability Ratios
Return on Sales
Gross Profit - resources available to over operating expenses
Operating Profit - gross profit less opex - higher ratio to gross margin indicates control over opex
Pretax Margin - operation profit less interest - considers effects of leverage
Net Profit Margin - revenue minus all expenses
GOPN - Golf Open
LOS 28b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
How are the different types of profitability ratios calculated?
Return on Investment
Return on Sales profitability ratios meaure income relative to assets, equity, or total capital employed.
LOS 28b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
How are the different types of profitability ratios calculated?
Return on Sales
Return on Sales profitability ratios express various subtotals on the income statement (e.g gross profit, operating profit, net profit) as a percentage of revenue.
LOS 28b: Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Solvency refers to a companys ability to fufill its long term debt obligations.
Solvency ratios provide information regarding the amount of leverage in the capital structure.
Imoportant for assessing the risk return characteristics of the business.
LOS 28c: Describe the relationships among ratios and evaluate a company using ratio analysis.
Ratios can be combined and evaluated as a group to better understand how they fit together and how efficiency and leverage are tied to profitability.
LOS 28.d: Demonstrate the application of Dupont analysis of return on equity, and calculate and interpret the effects of changes on its components.
The dupont analysis isolates different aspects of the companys performance and allows the analyst to evaluate how these different aspects of perforance affected the companys overall profitability , as meaured by ROE.
LOS 28.d: Demonstrate the application of Dupont analysis of return on equity, and calculate and interpret the effects of changes on its components.
1. Decomposing ROE
ROE = Net income/ average shareholders equity
ROE = ROA * Financial Leverage
ROE = Net Profit Margin * Total Asset Turnover * Leverage
2.Decompose Net Profit Margin
Tax burden (Net Income/ EBT)
Interest Burden = EBT/EBIT
EBIT Margin = EBIT/ Revenue
LOS 28.e: Calculate and interpret ratios used in equity analysis, credit analysis and segment analysis.
Interperating Earnings Per Share
Interperating Earnings Per Share
LOS 28.e: Calculate and interpret ratios used in equity analysis, credit analysis and segment analysis.
Valuation Ratios
Price to Earnings Ratio = Price per share/ Earnings per share
Price to Cash Flow = alternative to P/E - particulary if earnings quality is an issue.
Price to Sales = no positive income
Price to Book Value = express judgement on required rate of return and its actual rate of return.
LOS 28.f: Describe how ratio analysis and other techniques can be used to model and forecast earnings.
Dividend Related Quantities
Dividend Payout Ratio = % of earnings that the company pays out as dividends.
Retention Rate = % of earnings remaining after the compay pays out dividends =(1 - divident payout)
Sustainable Growth Rate = function of profitability (ROE) and its ability to finance itself from internally generated funds (retention rate)
