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Prelims - Financial Reporting > 6 Financial Statement Analysis > Flashcards

6 Financial Statement Analysis Flashcards

1
Q

Who are accounting information users?

(7)

A

Investors/owners, lenders, suppliers, customers, employees, government, public.

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2
Q

What is meant by gearing?

A

The relationship, or ratio, of a company’s debt-to-equity (D/E).

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3
Q

What are 4 sources of finance?

A
  • Share issue
    • Issuing rights to existing shareholders
    • Issue shares on a different capital market
  • Loans
    • Financial institutions
    • Public markets
  • Bonds
    • Issue debt directly to the capital market
  • Leasing
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4
Q

What is trend analysis?

A

AKA horizontal analysis.

It compares the performance of a firm with its own performance a year before, by selecting a base year and often using a 5 year+ time frame.

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5
Q

What is common size analysis?

A

AKA vertical analysis.

It compares the performance of a firm with that of other firms (of similar size/nature).

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6
Q

Common size analysis and comprehensive income statements

A

The items in the statement of comprehensive income expressed as a percentage of revenue.

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7
Q

Common size analysis and consolidated balance sheets

A

The items in the statement of financial position expressed as a percentage of total assets.

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8
Q

What is ratio analysis?

A

The relationship between two or more figures within the same set of financial statements.

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9
Q

3 modes of ratio analysis

A

Ratios from past years

Ratios of other businesses in the same industry

Specified standard ratios

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10
Q

What type of ratios are used to asses performance?

A
  • Profitability ratios
  • Asset utilisation ratios
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11
Q

What types of ratios are used for assessing financial leverage?

A
  • Short-term liquidity ratios
  • Long-term liquidity ratios
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12
Q

Equation for gross profit margin

A

Gross profit margin = gross profit / revenue

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13
Q

Equation for net profit margin

A

Net profit margin = profit after tax / revenue

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14
Q

Equation for net operating profit margin

A

Net operating profit margin = profit before interest and tax / revenue

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15
Q

Equation for return on equity (ROE)

A

Return on equity = profit after tax / equity

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16
Q

Equation for return on assets (ROA)

A

Return on assets = profite before interest and tax / total assets

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17
Q

Equation for return on capital employed (ROCE)

A

Return on capital employed (ROCE) = profit before interest and tax / (equity + long-term debt)

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18
Q

Equation for earnings per share (EPS)

A

Earnings per share = profit after tax / number of shares outstanding

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19
Q

What is meant by diluted EPS?

A

Where a company has certain types of financial instruments - share options, share warrant, convertible securities which entitle their holder to acquire ordinary shares at some future date.

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20
Q

What is meant by inventory turnover?

A

The average length of time from purchase to sale.

(Average of opening and closing invesntories if available, or just closing inventories.)

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21
Q

Inventory turnover equation

A

Inventory turnover = cost of goods sold / inventories

22
Q

Inventory turnover equation in days

A

Inventory turnover (in days) = (Inventories / cost of good sold) x 365

23
Q

What is meant be trade receivables?

A

Average length of time the business takes to collect cash from credit customers.

(average of opening and closing receivables can be used)

24
Q

Trade recievables equation

A

Trade recievable = sales / receivables

25
Q

Trade receivables equation in days

A

Trade receivables (in days) = (receivables / sales) x 365

26
Q

What is meant by trade payables?

A

Average length of time the business takes to pay suppliers.

(Cost of sales can be used if purchases is not given, provided opening and closing inventories are similar)

27
Q

Trade payables turnover equation

A

Trade payables turnover = purchases / trade payables

28
Q

Trade payables turnover equation in days

A

Trade payables turnover (in days) = (trade payables / purchases) x 365

29
Q

What is the working capital cycle?

A

The time it takes to convert net current assets and current liabilities (e.g. bought stock) into cash.

30
Q

Working capital cycle equation

A

Working capital cycle = inventory days + receivable days - payable days

31
Q

What are short-term liquity ratios?

Examples?

A

The company’s ability to generate cash to meet short-term obligation, essentially working capital needs and immediate debt repayment needs.

Current ratio and quick ratio.

32
Q

Current ratio equation

A

Current ratio = current assets / current liabilities

33
Q

Quick ratio equation

A

Quick ratio (or Acid test) = (current assets - inventories) / current liabilities.

34
Q

What are long-term solvency ratios?

Examples?

A

The company’s ability to generate cash internally or from external resources in order to meet long-term financial obligations.

E.g. Gearing, interest cover, dividend cover.

35
Q

Gearing equation

A

Gearing = debt / equity or debt / (debt + equity)

36
Q

Interest cover equation

A

Interest cover = profit before interest and tax / net interest charges

37
Q

Dividend cover equation

A

Dividend cover = earngings per share / dividend per share

38
Q

DuPont model: ROE as a function of two others.

A

ROE = ROA x Gearing

39
Q

DePont Model: ROE as a function of three drivers

A

ROE = Net profit margin x asset turnover x equity multiplier

40
Q

What do each of the drivers of ROE indicate?

A

Net profit margin indicates much the company is able to keep as profits for each unit of revenue it makes.

Asset turnover indicates how much revenue the company is able to generate for each unit of its assets.

Equity multiplier is a measure of financial leverage of the company.

41
Q

6 limitations of ratio analysis

A
  1. Retrospective nature
  2. Impact of inflation on financial data
  3. Is statement of financial position a reflection of the business’s “normal” position?
  4. Business-to-business comparisons - different accounting policies will be used
  5. Combined operations of large MNCs
  6. Do not place too much reliance on “norms”
42
Q

What is cash flow analysis?

A

By looking at cash flow we examines operating activities, investment management and financial risks.

43
Q

Cash flow from operation allows us to analyse… (3)

A

Growth strategy, industry characteristics, credit policies

44
Q

Cash flows related to long-term investments allow us to analyse… (2)

A

Long-term growth opportunities, internal/external financing

45
Q

Free cash flow available to debt and equity holders indicates…

A

Ability to meet interest payments and principals payments, financial risk

46
Q

Free cash flow available to equity holders indicates…

A

Ability to sustain the dividend policy, potential agency problems, etc.

47
Q

5 analytical concepts we are considering

A
  • Business environment and corporate strategy.
  • Earnings management and incentives.
  • Accounting discretion of top management.
  • Entity analysis.
  • Quality of disclosure.
48
Q

What do we mean by examining ‘earnings management and incentives’?

A

The external and internal contracts governing a firm.

49
Q

What do we mean by examining ‘accounting discretion of top management’?

(6)

A
  • Accounting standards
  • Institutional characteristics
  • Company characteristics
  • Board characteristics
  • Audit quality
  • Methods of accounting numbers management
50
Q

What is meant by ‘entity analysis’?

A

Analysing the relationships of the company with other companies.

51
Q

What is meant by examining ‘quality of disclosure’?

A

The accounting methods and accounting estimates.

Prelims - Financial Reporting (7 decks)

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