Analyzing Combined Balance Sheet and Income Statement Measures

Question 1

Financial Productivity

Answer 1

Measures and Intstment attractiveness to its owners
Indicates whether owner or others might want to invest more in the company
Tests management’s effectiveness in generating sales volume, establishing prices and controlling expenses and asset leves.

Question 2

ROA

Answer 2

Profit Before or After Tax/Total or Average Assets

Question 3

What does ROA measure

Answer 3

ROA measures management’s effectiveness in using a company’s total resourses to make a profit.
How many pennies of profit were generated from each dollar of assets?

Question 4

Benefits of ROA Analysis

Answer 4

Helps lenders evaluate creditworthiness because it takes into account both the costs and benefits of leveage. A burden on profit as interest expense increases
Pressuere on profitability if asset increase faster than sales
Opportunity for addes revenue and profit if production capacity efficing or value-added expands.

Question 5

ROE

Answer 5

Net Income / Net Worth

Question 6

ROE evaluate?

Answer 6

The attractiveness of an investment to its owners or potential new investors.

Question 7

Limitations of ROE measurements

Answer 7

Can be distorted by tax strategies

Produce misleading indication if the company’s equity has grown or shrunk significantly

Question 8

Other Variations of ROE

Answer 8

Profit Before Taxes / Net Worth
Profit Before Taxes /( x1 Net Worth + XO Net Worth)/2
Profit Before Taxes / Tangible Net Worth

Question 9

How ROA and Leverage Affect ROE

Answer 9

ROE and Leverage can increase ROE in to ways: 1. Improviing profitability or revenues with the same assets.
By increasing leverage at an interest rate that is less than it ROA

Question 10

A High ROE Can Mean

Answer 10

Potentially more risk and less protection for creditors.

Question 11

Net Sales to Total Assets Ratio

Answer 11

Measure total asset turnover. The higher the ratio the better

Question 12

Net Sales to Turnover - Industry FActors

Answer 12

Untilities,financial institutions, and manufactuers have lower net sales assets ratios than most retailers, wholesalers, service companies

Question 13

An abnormally high sales to assets ratio

Answer 13

Means: Company may need additional asset investments
Depreciated assets faster
Have more operating leases
Use an accounting method that understates inventory

Question 14

Net Sales to Net Fixed Assets Ratio

Answer 14

Measure how well a company uses fixed assets such as plant and equipment.

Question 15

High/Low Net Sales to Net Fixed Assets

Answer 15

High: Company has recnetly added assets
Low:Company is experiencing sales decline and may need to divest assets

Question 16

Accounts Receivable Turnover Ratio

Answer 16

Net Sales / Accounts Receivable Represents the average length of time it takes to collect its receivables.

Question 17

Days’ Sales in Receivable

Answer 17

Accouts Receivable x 365/Net Sales

Question 18

Assumption s of AR Measures

Answer 18

Assumes all sales are on credit.

Year-end receivables are comparable to sales throughout the year.

Question 19

Compensating for Seasonality in Days’s Sale in AR

Answer 19

Obtain interim statements
Use averages to calculate ratio
RMA composites use only year-end receivables

Question 20

Quatify Days Sales in Dollar Terms

Answer 20

Net Sales/365 = x Days Sales Outstanding = $ plus or minus cash source or use of funds.

Question 21

Determiing the effect of returns, allowances and charge off.

Answer 21

Use gross receivables rather than net receivable.

Question 22

Inventory Turnover Ratio

Answer 22

COGS/Inventory

Question 23

Days COGS in Inventory

Answer 23

Inventory x 365/COGS Used average COGS for the year

Question 24

Compensationing for Distortion

Answer 24

Use average inventory figures, or compute messure for individual interim periods

Question 25

Accounts Payable Turnover Ratio for Manufactuers

Answer 25

Purchases / Accounts Payable

Question 26

Accounts Payable Turnover Ratio for Resellers

Answer 26

COGS / Accounts Payable

Question 27

Accounts Payable Day Formula

Answer 27

Accounts Payable X 365 / COGS or Purchases

Question 28

Distortions of Accounts Payable

Answer 28

To compensate for distortions use montly or quarterly average acounts payable or calculate the measure individual or montly periods

Question 29

When calculating Accounts Payble Turnover for manufactuers

Answer 29

Always use Purchases not evry thing in COGS! However also use COGS based computation in your analysis of manufactueres.

Question 30

Working Capital Turnover Ratio

Answer 30

Net Sales / Working Capital
Expresses a company’s balance sheet liquidity
Potential cash needs in relation to it net sales for a year.

Question 31

Working Capital acts as an

Answer 31

Liquidity Cushion

Question 32

Too much working capital

Answer 32

Means a company has idle current assets

Question 33

What does a high Working Capital Turnover ratio mean

Answer 33

The higher the turnover , the lower the liquidity cusion. A low turnover means there is a generous liquidity cushion.

Question 34

Low Working Capital Turnover

Answer 34

Could mean that the company could have a company’s cash tied up in idle current assets.
Assets could have uncertain quality

Question 35

Low Working Capital

Answer 35

Excess captial could be sucking up equity or long-term debt.

Question 36

What is the proper amount of working captial

Answer 36

Allows a company to meet its current obligation in a timely manner
Takes full advantage of interest free trade credit
Provides a cushion for unexpected value loss in receivable and inventory
Provides a cushion for unexpected reduction in payment terms
Is comprised of quality assets that will turn to cash as anticipated.

Question 37

Developing a Working Capital Turnover Estimate

Answer 37

How much is in cash and receivables versus inventory
What is the quality of those assets
Compare to when the company was taking trade discounts, collecting it receivables within standard sales terms
Turning its inventory as fast as or faster than the industry’s experience
Possessing as much cash or as a percent of total assets as the industry composite

Question 38

Higher Working Capital Turnover can mean?

Answer 38

Can be a sign of improved current asset efficieny
Higher Working captial turnover can also mean that the company’s liquidity cushion is dropping below an amount that safely covers current obligations

Question 39

Lower working capital turnover can mean

Answer 39

Deteriorated current asset efficiency.