Book 3_FinAn_Reading-39_FINANCIAL-ANALYSIS-TECHNIQUES

Question 1

The use of Ratios

Answer 1

• 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.

Question 2

Vertical common-size data

Answer 2

stated as a percentage of sales for income statements, or as a percentage of total assets for balance sheets

Question 3

Horizontal common-size data

Answer 3

present each item as a percentage of its value in a base year.

Question 4

Limitations of Ratio analysis

Answer 4

• 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.

Question 5

Activity ratios

Answer 5

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

Question 6

Liquidity ratios

Answer 6

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

Question 7

• the defensive interval;

Answer 7

= (Cash + marketable securities + receivables)/average daily expenditures

Question 8

Solvency ratios

Answer 8

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

Question 9

debt-to-capital

Answer 9

Total debt/(total debt + equity)

Question 10

Financial leverage

Answer 10

= Average total assets/Average total equity

Question 11

Fixed charge coverage ratio

Answer 11

= (EBIT + lease)/(interest payment + lease)

Question 12

Profitability ratios

Answer 12

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

Question 13

payables turnover

Answer 13

• Payables turnover = purchases/average payable balance
• Purchase = ending + cogs - beginning

Question 14

2-stage decomposition of ROE

Answer 14

ROE = ROA x leverage

Question 15

Original DuPont equation (3-stage decomposition)

Answer 15

ROE = net profit margin x asset turnover x leverage

Question 16

Extended DuPont equation (5-stage decomposition):

Answer 16

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

Question 17

The skill of an analyst

Answer 17

• identifying ratios that relate to the industry being analyzed
• and the performance, position, and flexibility of the firm, both currently and in the future.

Question 18

Financial institutions

Answer 18

have to comply with capital adequacy directives designed to prevent insolvency and contagion

Question 19

Ratio analysis

Answer 19

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.

Question 20

Regression analysis

Answer 20

identify relationships between variables
used for forecasting

Question 21

Balance sheet amount in ratio

Answer 21

The average of the beginning and ending amount

Question 22

coefficient of variation for a variable

Answer 22

is its standard deviation divided by its expected value.