Book 3_FinAn_Reading-39_FINANCIAL-ANALYSIS-TECHNIQUES Flashcards
The use of Ratios
- Project earnings and future cash flow,
- Evaluate a firm’s flexibility,
- Assess management’s performance,
- Evaluate changes in the firm and industry over time,
- Compare the firm with industry competitors.
Vertical common-size data
stated as a percentage of sales for income statements, or as a percentage of total assets for balance sheets
Horizontal common-size data
present each item as a percentage of its value in a base year.
Limitations of Ratio analysis
- Not useful when viewed in isolation
- require adjustments when different companies use different accounting treatments
- Comparable ratios may be hard to find for companies that operate in multiple industries
- Ratios must be analyzed relative to one another, and determining the range of acceptable values for a ratio can be difficult.
Activity ratios
indicate how well a firm uses its assets
- receivables turnover
- days of sales outstanding,
- inventory turnover,
- days of inventory on hand,
- payables turnover,
- payables payment period,
- turnover ratios for total assets, fixed assets, and working capital
Liquidity ratios
indicate a firm’s ability to meet its short-term obligations
- the current, quick, and cash ratios;
- the defensive interval;
- and the cash conversion cycle
- the defensive interval;
= (Cash + marketable securities + receivables)/average daily expenditures
Solvency ratios
indicate a firm’s ability to meet its long-term obligations.
- debt-to-equity,
- debt-to-capital,
- debt-to-assets,
- financial leverage,
- interest coverage,
- fixed charge coverage ratio
debt-to-capital
Total debt/(total debt + equity)
Financial leverage
= Average total assets/Average total equity
Fixed charge coverage ratio
= (EBIT + lease)/(interest payment + lease)
Profitability ratios
indicate how well a firm generates operating income and net income.
- net, gross, and operating profit margins;
- pretax margin;
- return on assets;
- operating return on assets;
- return on total capital;
- return on total equity;
- and return on common equity
payables turnover
- Payables turnover = purchases/average payable balance
- Purchase = ending + cogs - beginning
2-stage decomposition of ROE
ROE = ROA x leverage
Original DuPont equation (3-stage decomposition)
ROE = net profit margin x asset turnover x leverage
Extended DuPont equation (5-stage decomposition):
ROE = (Net income/EBT) x (EBT/EBIT) x (EBIT/Revenue) x asset turnover x leverage
= Tax burden x interest burden x EBIT margin x asset turnover x leverage
The skill of an analyst
- identifying ratios that relate to the industry being analyzed
- and the performance, position, and flexibility of the firm, both currently and in the future.
Financial institutions
have to comply with capital adequacy directives designed to prevent insolvency and contagion
Ratio analysis
can be used to construct pro forma financial statements based on a forecast of sales growth and assumptions about the relation of changes in key income statement and balance sheet items to growth of sales.
Regression analysis
identify relationships between variables
used for forecasting
Balance sheet amount in ratio
The average of the beginning and ending amount
coefficient of variation for a variable
is its standard deviation divided by its expected value.
