401 - Exam 1 Flashcards
- Operating/working capital cycle
company’s operations and finances are integrally connected
movement of cash to inventory - to AR - and back to cash - cash conversion cycle
timing VERY imp.
–bc company can be profitable but if ex. gives customers long time to pay - loses control of AR and need cash quicker to pay off liabilities = or if it makes more inventory than it sells
insolvent - when comp. has insufficient cash to pay its maturing obligations
Fin. Statents
BS - SNAPSHOT - shows company health over period
–income stmt. shows changes in owners equity by breaking down revenues and expenses (Explains changes in equity)
CFS - focuses on solvent - having enough cash to pay bills - looks at company’s changes in cash
- -Cash provided or consumed by operating (CFO)
- -cash from investing activities (CFI)
- -cash from financing (CFF)
Current A & L - listed in DECREASING LIQUIDITY - current if converted to cash within one year
Earnings (NI)
measures the extent to which net sales generated during accounting period exceeded expenses incurred in producing the sales
- -earnings or profits
- -to measure earnings need to 1. identify rev. for the period and 2. match corresponding costs to revenues
- -rev. accounted for when sale generated…not when cash is received (time lag on incoming cash)
- -EX. if revenue was $5,020M and AR increased by 102M we assume taht cash received was (5020 - 102) $4,918M and still haven’t collected $102M
EBIT vs. EBITDA
EBIT - measure of business’s income before divided among creditors, owners and taxman - used interchangeably with operating income
EBITDA - used in some industries, like broadcasting, where depreciation charges may overstate true economic deprecation
sources and uses statement
- take 2 balane sheets together and note all changes in accounts that occurred over the period
- segregate changes into those that generated cash and those tha consumed cash
generates cash in 2 ways: REDUCING an asset or INC a liability
- -sale of equipment, liquidation of inventory, reduction of AR = source of cash
- -inc. in bank loan and sale of comon stock are sourse of cash
USES cash
- -inc. asset account or reduce liability account
- -add to inventories or AR, building plant - also repay loans so reduction in AP and operatingl osses all use cash
Total uses = total sources
CFS
expands and rearranges the sources and uses stmt.
- CFO
- -rearrange fin. stmts. to eliminate effectsof accrual acc. on NI
- -add all noncash charges (D and A( back to NI (bc no change in CF)
- -then add changes in current assets and liabilities
- -shows firm solvency bc shows extent to which oeprations are generating or consuming cash
ROE
Earnings per $1 of invested capital
profit margin (NI/S) = How much $ in earnings is squeezed out of every 1$ in sales
asset turnover (S/A) - sales generated from each 1$ in assets - mgmt. efficiency - using resources req. to support sales
leverage (A/E) - amt. of equity used to finance assets
- Profit margin
measures fraction of each dollar of sales that goes through income stmt. to profits
- -imp. bc it shows operating managers company’s pricing strategy and its ability to control operating costs
- -“WHAT PERCENT OF SALES DO YOU GET TO KEEP”
usually varies inversely with AT (comp. with high profit margin tend to have lower asset turnover) - because offer a high value to customers to can demad a high profit margin…but to meet that demand themselves req. a lot of assets
–but Target and grocery stores have opposite - low profit margin bc add little value to product, just supply it, sell for cash and make customer leave with it - so low PM but high AT (so look at them together with ROA)
ROA
NI/A –> PM * AT
basic measure of efficiency - shows how comapny allocates and manages its resources
–measures prodit as a % of money procided by owners and creditors…not just owners
JPM and Google have high ROA by high PM and low AT – but Target and Amazon have high ROA by low PM and high AT
Gross margin
Gross profit / sales
- helps distinguish btwn variable and fixed costs
- -variable - change as sales vary
- -so most of COGS is variable costs
Gross margin - 55.6% means that 55.6% of sales dollars are available to pay for FIXED COSTS and profits – the other 44% is tied up in variable costs
also used to find breakeven point - if estimate fixed costs were 1,968M…and know that 56 cents of each sales dollar are available for fixed costs…then 1,968.,56 = 3,514M to breakeven
–so if sales are below 3,514M, comp. loses money and when above they have a real profit
- Asse turnover
Financial performance improves as asset turnover rises
- -measures sales generated per dollar of assets
- -HOW EFFICIENTLY/EFFECTIVELY ARE MY ASSETS GENERATING SALES
=.99 - means company generated 99 cents of sales for each dollar invested in assets
imp. to remember that if sales decline, a company’s investment in AR and inv. should fall too (use of cash) which frees up cash to be used elsewhere
when current assets are rising…loans will need to be taken to pay for them - and that during a downswing when current assets are falling…it willprovide cash to repay loans
control ratios - measuring the asset turnover for each individual asset on the balance sheet and comparing
ex. AR control ratio rising? - 1. bc sales have grown so AR grew or 2. bc mgmt. has slacked at collection efforts (then can realize where need to improve)
inventory turnover
COGS / ending inventory
=5.8 times - means that inventory turned over 5.8 times per year
—or can do 365 / 5.8 = 63 days – DAYS INVENTORY OUTSTANDING - shows that the inventory sits abuot 63 days before being sod
the collection period
AR / credit sales per day = 96
= has an everage of 96 days worth of credit sales tied up in AR
–or say that the average time lag btwn sale and recept of cash from sale is 96 days
CAREFUL WITH SEASONAL SALES - best way is to do credit sales per day based on prior 60-90 days
days sales in cash
cash and securities / sales per day
=92.3 means has 93.2 days worth of sales in cash and securities
–if too low, dangerous bc illiquid - but if too high, shareholders could be disappointed bc assets are not being put to more productive and profitable uses
Payables period
AP / credit purchases per day = (amt / (amt/365))
- -control ratio for liability
- -should use credit purchases but bc infrequently recorded just do COGS
- -diff. than COGS bc a lot of manufacturers add labor to COGS so it is larger than the credit purchases would be
52.4 - (but if used COGS) it is overstated so means that company’s suppliers are waiting a lot longer than 52.4 to receive pmt.
fixed asset turnover
Sales / Net PP&E
- -for companies or industries with large investments in long assets to produce goods - called capital intensive and have lots of fixed assets
- -auto manufacturers and airlines
capital intensity - called operating leverage - concern to creditors specifically bc they want to see basic business risks faced by firm
fixed-asset turnover is. a measure of capital intensity - low turnover means high intensity
5020 / 267 = 18.8 times
Days operating and cash conversion cycle
when comp. begins production cycle, uses cash to purchase inventory - when comp. sells the item, inventory turns into cash after customer pays and the AR is collected
operating cycle = days inventory outstanding + collection period
- -(sum of the # of days cash is tied up in inventory + the # of days it takes customers to pay)
- -in ex. = 63 + 96 = operating cycle of 159 days
- -cash is tied up btwn when it aquires inventory and when its customer pays for about 159 dayss on average
cash conversion cycle (CCC) = operating cycle - payable period
= days inventory outstanding + collection period - payables period
(TIMELINE IN NOTES)
- Financial leverage
firms with predictable and stable CFS can better face leverage risks vs. firms with market uncertainty who should have less leverage
–banks usually have diversified portfolios of readily salable, liquid asses can also use more financial leverage than typical businesses
inversely related with ROA - companies with Low ROA use more debt financing and high ROA use less
debt to assets/ equity ratios
L/A = 63.4%
- -financial lev. used to cmopare book value of liaibilities to book value of its assets
- -says money to pay for 63.4% of the assets comes from creditors
L/E = 173.5%
–means creditors supply $1.73 to every 1$ in shareholder equity
coverage ratios - times interest earned and times burden covered
times interest earned
= EBIT / interest expense = 807/97 = 8.3 times
–MEANS the company earned its interest obligation 8.3 times over in 2016 - EBIT was 8.3x as large as its interest
–assumes that the company will roll over its LTD as they mature (bc still have obligations and didn’t pay entire principal)
times burden covered
= EBIT / (interest + (principal repayment / 1-taxrate))
–includes debt principal repayments as well as interest - have to express principal as a before-tax comparable to interest and EBIT (bc they are before tax and numerator and denominator must be consistent)
–principal repayments are NOT a tax deductable expense (unlike interest)
–assumes they will pay principal to zero
both ratios compare income available for debt service in the numerator of some measure of annual financial obligation
–income available is EBIT - earnings of company that can be used to make interest pmts.
market value leverage ratios
market value of debt / mkt. value of equity = 33.3%
= (mkt. value debt / (# shares*price per share))
mkt. value of debt / mkt. value of assets = 25%
= (mkt. value of debt / (mkt. value of D + E))
mkt. values indicate the true worth of creditors and owners stakes in the business
- -mkt. values are based on investors expectations about FCFs
compares today’s value of expected future income to today’s value of future financial burdens
–good to startups bc may have BAD coverage ratios but creditors will still lend to them bc they believe FCF will be sufficient to service the debt
liquidity ratios
current ratio
- -current assets / current liabilities = 2 times
- -compares assets that will turn to cash within a year to liabilities that must be paid in a year
- -if current ratio is low the company lacks liquidity - it cannot reduce its current assets for cash to meet maturing obligations - must rely on operating income and outside financing
ACID TEST
= Current assets - inventory / current liabilities = 1.8 times
–or quick ratio - inventory subtracted bc freq. illiquid
good but not perfect for 2 reasons
- rolling over obligatiosn - AP invovles almost no insolvency risk if the company is proitable they will be able to roll over at maturity
- cash generated from liquidating current assets cannot be used to reduce liabilities if the comp. intends to grow - it must be plowed back in to teh business to support cont. operations
why ROE suffers as evidence of improved performance?
- TIMING problem
- -ROE looks backwards and focuses on a single year - a little skewed estimate
- -ex. heavy startup costs will bring down an ROE
- -ROE is based on one year of data so it fails to capture the impact of multiperiod decisions - RISK problem
- -says nothing about the risks company had to generate to get it
- -leverage makes ROE high but makes the company an uncertain enterprise - VALUE problem
- -ROE measures return on shareholder’s investment but uses Book value of equity, not market value
- -so ROE is a good maeasure of mgmt.s financial performance..it is not synonymous with high returns on investment to shareholders