Ch 7 - Balance Sheet Analysis Flashcards
What are loan covenants? What happens if it’s violated?
the terms and conditions of a loan that require the borrower to meet certain requirements established by the lender
If a borrower violates a loan covenant, the lender can legally enforce specific actions, depending on the loan contract, which can also vary widely
What does the Return on Assets (ROA) ratio indicate? What is it expressed as? What is the ideal output?
- Indicates how effective a company’s assets—invested by both shareholders and creditors—are in generating net income.
- Expressed as a percentage (%)
- to determine whether a company is managing its assets effectively requires knowledge of that company’s industry and comparison against the company’s competitors
To whom is the analysis of an ROA useful for?
- To management
- Also a useful metric for lenders (i.e., banks) to understand how effective management is in using borrowed money to invest in business assets and generate a return.
What does the Return on Equity (ROE) ratio indicate? What is the ideal output?
- ROE is a performance measure that tells us how good a company is at turning cash from investors into profit.
- Expressed as a percentage (%)
- Higher ROE means the more effectively the company generates a return on shareholders’ investment.
- However, not very informative by itself. Instead, ROE should be compared with historical performance and/or ROE of a company’s competitors to understand how the company is performing relative to its peers.
To whom is the analysis of an ROE ratio useful for?
- Shareholders who invest in the company’s shares with an expectation that the company will use this cash to make a profit, which will increase the value of the shareholder’s investment (i.e., the company’s share price).
What does the Asset Turnover ratio indicate? What is it expressed as? What is the ideal output?
- Asset Turnover indicates how well a company is managing its assets but it is in the context of generating sales (RATHER THAN NET INCOME)
- Is expressed as a decimal
- Companies with high asset turnover ratios tend to be considered productive but, productivity is relative. It’s important to consider what the industry average is, as well as how other competitors are performing
How do you conduct a vertical analysis for a Statement of Financial Position?
Divide EVERY line item to TOTAL ASSETS
What is the formula for ending inventory?
Beg + Purchases - Cogs = Ending
How is i/s related to b/s?
Net income flows into retained earnings.
