Ch 3 analyzing Financial Statements Flashcards
What are the 6 ratios to analyze debt?
Preferred Dividend Coverage
(Working)Asset Coverage
Interest Coverage
Debt/Equity Ratio
Percentage of Total Capital Ratios
Cash flow/Debt
What are the 2 ratios to analyze liquidity?
Working Capital Ratio
Quick Ratio (Acid Test)
What are the 7 ratios to analyze profitability?
Gross Profit MargIn
Operating profit margin
Net profit margin
Net return on equity
Net return on investment capital
Pre-tax return on investment capital
Inventory turnover
What are the 6 ratios to analyze value?
Dividend yield (current dividend per share / market price per share). For those investors interested in cash profits.
Equity per preferred share
Equity per common share.
Earnings per common share (net income/# of outstanding common shares). How much did we make and how many shares do we have to split it between.
Percentage of available earnings paid out as preferred and common dividends
Percentage of available earnings paid out as common dividends
Price-earnings ratio (market price per common share/ earnings per common share). How much the public is willing to pay for the companies prospects to earn. High numbers mean the company’s income is expected to grow at a fast rate. For investors interested market price appreciation.
Why do we analyze liquidity?
For a company to remain solvent it must meet it’s current liabilities. Liquidity helps the investor evaluate the ability of a company to turn as seats into cash to meet its short term obligations.
Lack of sufficient working capital and inability to liquidate current assets readily are frequent causes of business failure.
How do you calculate working capital ratio? What type of test is it and what does it mean?
(Test of Liquidity)
Current assets / current liabilities
(Assets that would be liquidated in a year / debts that are due in a year)
2:1 is a good ratio. There are $2 of assets for every dollar owed.
If the ratio consistently exceeds 5:1 the company may have an unnecessary accusation of funds which could indicate sales problems (too much inventory) or financial mismanagement.
How do you calculate the Quick Ratio (Acid Test)? What type of test is it and what does it mean?
Test of liquidity
Current assets - inventory / current liabilities
A more stringent test than the current ratio (working capital ratio test).
Inventory may be difficult to quickly convert to cash so if is removed from current assets.
1:1 is a good ratio but companies with large inventories and a quick inventory turnover can be less than 1.
How do you calculate working asset coverage? What type of test is it and what does it mean?
(Debt analysis)
Total assets - deferred charges - intangible assets - [total current liabilities - (bank advances + current portion of long term debt)] / (short term + long)/$1000
This ratios shows the net TANGIBLE assets per $1000 of total outstanding. It enables the debts holder to measure the protection provided by the companies tangible assets.
Rules of thumb:
Utilities : at least $1500/1000
Industrials : at least $2000/1000
Considered by some to be an academic number but it is a required prospectus number in Ontario
How do you calculate invested capital?
Invested capital = Short term debt + long term debt + par value of preferred shares + stated value if common shares + contributed surplus + retained earnings + foreign exchange adjustment
How do you calculate percentage of total capital ratios? What type of test is it?
(Debt / invested capital) X 100
ie preferred shareholders percentage would be:
750000 / 16559000 X 100 = 4.56%
Invested capital = Short term debt + long term debt + par value of preferred shares + stated value if common shares + contributed surplus + retained earnings + foreign exchange adjustment
What are the rules for Total capital percentages (Capital Structure)
There are no general rules as it varies widely among various industries.
Utilities - total debt outstanding shouldn’t exceed 60% of the total capital
Industrials - total debt outstanding shouldn’t exceed 1/3rd of the total capital.
How do you calculate debt/equity ratio and what kind of test is it?
Test of debt.
Total debt (long and short term) / book value of shareholder equity.
What is the significance and the rules of thumb for debt/ equity ratio.
It pinpoints the relationship of debt to equity and can be a warning sign that a companies borrowing is excessive. The higher the ratio the higher the financial risk.
Utilities - total debt outstanding should not be more than one and a half times the book value of shareholders equity. Should not exceed 1.5.
Industrials - total debt outstanding should not be more than half times the book value of shareholders equity. Should not exceed 0.5.
Why is the cash flow/total debt ratio important?
It gauges the company’s ability to repay the funds that it has borrowed
How do you calculate cash flow / total debt ratio and what are the rules of thumb?
Net earnings (before extraordinary items) - equity income+ minority interest in earnings of subsidiary companies + deferred income taxes + depreciation + any any other deductions not paid in cash e.g. Depletion, amortization etc / total debt outstanding (short and long term)
Utilities - cash flow should be at least 20% of total outstanding debt in each respective year over the past 5 years.
Industries - cash flow should be at least 30% of total outstanding debt in each respective year over the past 5 years.