ch 3 working with financial statements

Question 1

why do we look at financial statements?

Answer 1

to determine the health of a company

Question 2

sources of cash

Answer 2

activities that bring in cash
when we sell something
- dec in asset account
- inc in liability or equity account

Question 3

uses of cash

Answer 3

activities that involve spending cash
when we buy something
- inc in asset account
- dec in liability or equity account

Question 4

statement of cash flows

Answer 4

stmt that summarizes the sources and uses of cash

Question 5

3 major categories of the stmt of cash flows

Answer 5

operating activity - net income and changes in most current accounts
investment activity - changes in fixed assets
financing activity - changes in notes payable, long-term debt and equity accounts as well as dividends

Question 6

common-size statement

Answer 6

standardizing financial statements as a percentage of total assets and income as a percentages of sales

Question 7

financial ratios

Answer 7

allow for better comparison through time or btw companies

Question 8

things to consider concerning financial ratios

Answer 8

• what aspects of the firm are we attempting to analyze? Generally, the aspects of interest are “fuzzy” and often both abstract and relative
• what info goes into a particular ratio and how does that info relate to the aspect of the firm being analyzed?
• what is the unit of measurement?
• what would a good or bad ratio look like?

Question 9

5 categories of financial ratios

Answer 9

• short-term solvency or liquidity
• long-term solvency or financial leverage
• asset management or turnover
• profitability
• market value

Question 10

short-term solvency or liquidity measures

Answer 10

provide info about a firm’s liquidity
- the firm’s ability to pay its bills over the short run without undue stress

Question 11

short-term solvency or liquidity ratios

Answer 11

current ratio
quick ratio
cash ratio
net working capital
interval measure

Question 12

long-term solvency or financial leverage

Answer 12

address the firm’s long-run ability to meet its obligations
- measure debt, equity, and assets at book values

Question 13

long-term solvency or financial leverage ratios

Answer 13

total debt ratio
debt/equity ratio
equity multiplier
long-term debt ratio
times interest earned
cash coverage ratio

Question 14

asset management or turnover

Answer 14

how efficiently a firm uses its assets to generate sales

Question 15

asset management or turnover ratios

Answer 15

inventory turnover ratio
days’ sales in inventory
receivables turnover
days’ sales in receivables
net working capital turnover
fixed asset turnover
total asset turnover

Question 16

profitability

Answer 16

measure how efficiently the firm uses its assets and how efficiently the firm manages its operations

Question 17

profitability ratios

Answer 17

profit margin
return on assets
return on equity

Question 18

market value

Answer 18

market price per share of stock

Question 19

market value ratios

Answer 19

price-earning ratio
PEG ratio
market-to-book ratio
EV/EBITDA

Question 20

du pont identity

Answer 20

return on equity = profit margin x total asset turnover x equity multiplier

Question 21

what the du pont identity tells us

Answer 21

ROE is affected by three things
1. operating efficiency (profit margin)
2. asset use efficiency (total asset turnover)
3. financial leverage (equity multiplier)

Question 22

internal uses of financial stmts

Answer 22

performance evaluation
planning for the future

Question 23

external uses of financial stmts

Answer 23

potential investors
comparison to competitors
acquiring another firm

Question 24

time-trend analysis

Answer 24

use to see how the firm’s performance is changing through time

Question 25

peer group analysis

Answer 25

compare to similar companies or within industries

Question 26

potential problems with financial stmt analysis

Answer 26

• there is no underlying theory, so there is no way to know which ratios are most relevant
• benchmarking is difficult for diversified firms
• globalization and international competition makes comparison more difficult bc of differences in accounting regulations
• varying accounting procedures
• different fiscal years
• extraordinary events