B3-M5 Financial statement analysis

Question 1

What is a profitability Ratio? And what are the common types of Profitability ratios?

Answer 1

Profitability ratios is a measure of Success or failure of an enterprise given a time period

Examples:
GPM ratio, PM ratio, RoSales, RoAssets, RoEquity, Operating CF ratio

Question 2

Profit Margin Ratio Formula

Operating Proft margin ratio formula

Answer 2

PM Ratio = Net income / Sales (net)

OPM Ratio = EBIT / Sales Net

Question 3

Return on Sales formula

Answer 3

RoS = EBIT / Sales (net)

Question 4

Return on Assets formula

Answer 4

Normal Formula:
Net income / Ave. Total assets

Dupont ROA formula:
RoA = [NI / Sales (net)] x [Sales (net) / Average Total Assets]
or simply…
RoA = Profit Margin ratio x Asset Turn over

Question 5

Return on Equity Formula

Answer 5

RoE = Net income / Average Total Equity

Question 6

Operating cash flow ratio formula

Answer 6

What is it? Measures how much cash a company has generated from operating activities to cover Current liabilities

Formula: Operating cash flows / Current liabilities

Question 7

What are liquidity ratios? Provide examples

Answer 7

Liquidity ratios are measures of a firm’s ST liability to pay maturing obligations

General Rule: Higher is better (implies more liquid)
Examples:
Current ratio, Quick ratio, [Account] Turnover ratio

Question 8

Formula for Current ratio

Answer 8

Current Assets / Current Liabilities

Question 9

Formula for Quick ratio

Answer 9

Quick Ratio = (Cash + ST Marketable securities + Receivables) / Current liabilities

Question 10

AR turnover formula and what it means?

Answer 10

AR TO = Sales (net) / Average AR (net)

Measures # of times AR are collected over an accounting period (typically one year)

Question 11

Days sales in AR formula and what it means?

Answer 11

Tip: Flip AR TO (then add 365 days to the formula)

Day sales in AR = [Ending AR / (Net sales/365)]

What is it for? Measure the # of days the AR sits before collecting – more on efficiency in collecting.
Usually compared with the AR collection policy

Question 12

Inventory Turnover formula and what it means

Answer 12

Measure how quickly inventory is sold

Inv TO = CoGS / Ave. Inventory

Question 13

Days in Inventory formula and what it means?

Answer 13

Tip: Flip Inventory TO (then add 365 days to the formula)

Day sales in Inv = [Ending Inventory / (COGS/365)]

What is it for? Measure the # of days inventory sits before being sold – more on effectiveness of inventory management.

Question 14

AP Turnover formula and what it means?

Answer 14

Measure how quickly payables are paid; Meaning low TO indicates delays in payment

Payable TO = CoGS / Ave. AP

Question 15

Days of Payables Outstanding formula and what it means?

Answer 15

Tip: Flip AP TO (then add 365 days to the formula)

Days Payables Outstanding = [Ending AP / (COGS/365)]

What is it for? Measure the # of days payable sits before being paid – more on effectiveness of company’s attempt to delay payment to creditors (taking advantage of discounts)

Question 16

Cash conversion Cycle - what does it mean? and formula

Answer 16

How many days a company can flip cash, turn it to inventory (or produce) and collect cash after selling such inventory

Cash conversion cycle = days in inventory + Day sales in AR- days of payables outstanding

Question 17

What are solvency ratios? Provide examples

Answer 17

Solvency ratios are measures of security or protection for long term creditors/investors (so formulas usually includes debt and equity accounts) – The higher the better

Ex. Debt-to-equity ratio, Debt ratio

Question 18

Debt to Equity ratio – what does it mean?

Answer 18

The lower the ratio, the lower the risk since this indicates the degree of leverage used

Question 19

Total Debt ratio formula and what it means?

Answer 19

Debt Ratio = Total liabilities / Total Assets

What it means: How much of the assets are financed by creditors

Question 20

Times interest earned formula and what it means

Answer 20

Times interest earned = EBIT / Interest Expense

What it means - reflects ability of a company to cover interest charges

Question 21

Equity multiplier formula

Answer 21

Eq. Multiplier = Total assets / Total Equity

Interpretation: Greater % of debt utilized by the company results in more assets allocated to debt relative to equity