Ch6. Financial Statements Analysis

Question 1

The process of providing funds for business activities

Answer 1

Financing

Question 2

Two types of Financing

Answer 2

Equity - owners or shareholders
Debt - creditors

Question 3

Calculated by dividing total liabilities by total assets. Also called debt rate representing creditors risk in the bysiness

Answer 3

Financing ratio

Question 4

Used to evaluate the level of debt relative to another financial metric

Answer 4

Leverage ratio

Question 5

common leverage ratios is:

Answer 5

• debt-to-equity (d/e) ratio
• equity multiplier
• time interest earned

Question 6

a measure of the degree to which a company is financing its operations with debt rather
than its own resources.
= total debt ÷ shareholders’ equity

Answer 6

debt-to-equity (D/E) ratio

Question 7

measures the portion of a company’s assets financed by shareholders’ equity rather than debt
= total assets ÷ shareholders’ equity

Answer 7

equity multiplier

Question 8

• it is a solvency ratio that indicates its ability to pay its debts.
  = EBIT ÷ interest expense

Answer 8

times interest earned

Question 9

-the Return on Equity (ROE) is
greater than the Return on Assets
(ROA)
ROE = Profit ÷ Shareholders’ Equity
ROA = Profit ÷ Total Assets

Answer 9

Good Financial Leverage

Question 10

are ratios that analysts and investors can use to analyze and make predictions about a company’s financial performance and potential future growth.

several financial ratios track a company’s performance, liquidity, operational efficiency, and profitability

Answer 10

INVESTING RATIOS

Question 11

BASIC FINANCIAL STATEMENTS ANALYSIS
Traditional Methods:

Answer 11

• Horizontal or comparative
• Trend Analysis
• Vertical or common-size
• Financial mix ratio

Question 12

involves the comparison of two periods (months, or quarters, or years, etc.), two companies, actual and budgets and other bases of analyses.

Answer 12

Horizontal or comparative analysis

Question 13

• it is a form of horizontal analysis but the comparison extends beyond two years.
• used to track what happened in the past to provide a pattern of what may happen in the coming years.

Answer 13

Trend Analysis

Question 14

expresses each item within a financial statement as a percent of a base amount; generally the base amounts commonly used is the total assets for the balance sheet and the net sales for the income statement.

• it can be used to compare two periods to analyze the reasons for the changes; or to compare two entities to check their performances; or to budgeted figures to evaluate adherence.

Answer 14

VERTICAL OR COMMON-SIZE ANALYSIS

Question 15

take into account the interrelationships of the items in each financial statement.

Answer 15

FINANCIAL MIX RATIOS

Question 16

Financial mix ratio analysis are classified as follows:

Answer 16

Profitability ratios
Growth ratios
Liquidity ratios
Leverage ratios

Question 17

Determines the portion of sales that went into the company’s earnings.
= Profit ÷ Sales

Answer 17

Profit Margin or Return on Sales

Question 18

measures the ability to generate return on every asset that are used to operate the business.
= Profit ÷ Assets

Answer 18

Return on Assets (ROA)

Question 19

measures the amount earned on the owners’ or stockholders investment.
= Profit ÷ Shareholders’ Equity

Answer 19

Return on Equity (ROE)

Question 20

measured when the company issues two classes of stocks.
= Profit – Preferred Dividends ÷ Ordinary Shareholders’ Equity

Answer 20

Return on Ordinary Equity (ROOE)

Question 21

measures the amount of net
income earned by each common
share.
= Profit – Preferred Dividends ÷ Average Ordinary Shares

Answer 21

Earnings Per Share (EPS)

Question 22

Profitability ratios are:

Answer 22

• Profit Margin or Return on Sales
• Return on Assets (ROA)
• Return on Equity (ROE)
• Return on Ordinary Equity (ROOE)
• Earnings Per Share (EPS)

Question 23

-indicate how fast a company or its business is growing.

Answer 23

GROWTH RATIOS

Question 24

• compares a stock’s price to its earnings.
  = Market price per share ÷ Earnings per share

Answer 24

Price-earnings ratio

Question 25

• shows how much a company pays out in dividends each year relative to its stock price.
  = Dividend per share÷ Market price per share

Answer 25

Dividend yield ratio

Question 26

-measures the book value of a firm on a per-share basis.
-book value equals a firm’s total assets minus its total liabilities.

Answer 26

Book value per share

Question 27

GROWTH RATIOS are:

Answer 27

*Price-earnings ratio
*Dividend yield ratio
*Dividend payout ratio
*Book value per share

Question 28

used to determine a debtor’s ability to pay off current debt obligations without raising external capital.

Answer 28

LIQUIDITY RATIOS

Question 29

a measure of a company’s ability to pay its current liabilities with its current assets (liquidity).
= CA ÷ CL

Answer 29

Current ratio or WC ratio

Question 30

• used to determine a company’s short-term liquidity and ability to cover its current liabilities without selling inventory assets
• it represents a company’s ability to pay current liabilities with assets that can be converted to cash quickly.
  = Cash + Cash Equivalents + Marketable Securities + Current Accounts Receivable ÷ Total Current Liabilities

Answer 30

Quick ratio or acid test ratio

Question 31

are technically the same as quick assets: cash, cash equivalents, marketable securities, current receivables.

Answer 31

defensive assets

Question 32

= Total defensive assets ÷ Average daily expenditures or daily operating cash flow

Answer 32

Defensive interval ratio

Question 33

LIQUIDITY RATIOS are:

Answer 33

• Current ratio or working capital
  (WC) ratio
  *Quick ratio or acid test ratio
  *Defensive interval ratio

Question 34

-the concept of using borrowed capital as a funding source.
-it is often used when businesses invest in themselves for expansions, acquisitions, or other growth methods.

Answer 34

FINANCIAL LEVERAGE

Question 35

Common leverage ratios include:

Answer 35

• debt-to-equity (D/E) ratio
• equity multiplier
• times interest earned
• debt rate (debt ratio)

Question 36

a measure of financial leverage that
demonstrates the degree to which a firm’s operations are funded by equity capital versus debt financing; it compares some form of owner’s equity or capital to debt or funds borrowed by the company.

Answer 36

Gearing ratio