Analyzing Combined Balance Sheet and Income Statement Measures Flashcards
Financial Productivity
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.
ROA
Profit Before or After Tax/Total or Average Assets
What does ROA measure
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?
Benefits of ROA Analysis
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.
ROE
Net Income / Net Worth
ROE evaluate?
The attractiveness of an investment to its owners or potential new investors.
Limitations of ROE measurements
Can be distorted by tax strategies
Produce misleading indication if the company’s equity has grown or shrunk significantly
Other Variations of ROE
Profit Before Taxes / Net Worth
Profit Before Taxes /( x1 Net Worth + XO Net Worth)/2
Profit Before Taxes / Tangible Net Worth
How ROA and Leverage Affect ROE
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
A High ROE Can Mean
Potentially more risk and less protection for creditors.
Net Sales to Total Assets Ratio
Measure total asset turnover. The higher the ratio the better
Net Sales to Turnover - Industry FActors
Untilities,financial institutions, and manufactuers have lower net sales assets ratios than most retailers, wholesalers, service companies
An abnormally high sales to assets ratio
Means: Company may need additional asset investments
Depreciated assets faster
Have more operating leases
Use an accounting method that understates inventory
Net Sales to Net Fixed Assets Ratio
Measure how well a company uses fixed assets such as plant and equipment.
High/Low Net Sales to Net Fixed Assets
High: Company has recnetly added assets
Low:Company is experiencing sales decline and may need to divest assets
Accounts Receivable Turnover Ratio
Net Sales / Accounts Receivable Represents the average length of time it takes to collect its receivables.
Days’ Sales in Receivable
Accouts Receivable x 365/Net Sales
Assumption s of AR Measures
Assumes all sales are on credit.
Year-end receivables are comparable to sales throughout the year.
Compensating for Seasonality in Days’s Sale in AR
Obtain interim statements
Use averages to calculate ratio
RMA composites use only year-end receivables
Quatify Days Sales in Dollar Terms
Net Sales/365 = x Days Sales Outstanding = $ plus or minus cash source or use of funds.
Determiing the effect of returns, allowances and charge off.
Use gross receivables rather than net receivable.
Inventory Turnover Ratio
COGS/Inventory
Days COGS in Inventory
Inventory x 365/COGS Used average COGS for the year
Compensationing for Distortion
Use average inventory figures, or compute messure for individual interim periods
Accounts Payable Turnover Ratio for Manufactuers
Purchases / Accounts Payable
Accounts Payable Turnover Ratio for Resellers
COGS / Accounts Payable
Accounts Payable Day Formula
Accounts Payable X 365 / COGS or Purchases
Distortions of Accounts Payable
To compensate for distortions use montly or quarterly average acounts payable or calculate the measure individual or montly periods
When calculating Accounts Payble Turnover for manufactuers
Always use Purchases not evry thing in COGS! However also use COGS based computation in your analysis of manufactueres.
Working Capital Turnover Ratio
Net Sales / Working Capital
Expresses a company’s balance sheet liquidity
Potential cash needs in relation to it net sales for a year.
Working Capital acts as an
Liquidity Cushion
Too much working capital
Means a company has idle current assets
What does a high Working Capital Turnover ratio mean
The higher the turnover , the lower the liquidity cusion. A low turnover means there is a generous liquidity cushion.
Low Working Capital Turnover
Could mean that the company could have a company’s cash tied up in idle current assets.
Assets could have uncertain quality
Low Working Capital
Excess captial could be sucking up equity or long-term debt.
What is the proper amount of working captial
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.
Developing a Working Capital Turnover Estimate
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
Higher Working Capital Turnover can mean?
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
Lower working capital turnover can mean
Deteriorated current asset efficiency.
