Ch6. Financial Statements Analysis Flashcards
The process of providing funds for business activities
Financing
Two types of Financing
Equity - owners or shareholders
Debt - creditors
Calculated by dividing total liabilities by total assets. Also called debt rate representing creditors risk in the bysiness
Financing ratio
Used to evaluate the level of debt relative to another financial metric
Leverage ratio
common leverage ratios is:
- debt-to-equity (d/e) ratio
- equity multiplier
- time interest earned
a measure of the degree to which a company is financing its operations with debt rather
than its own resources.
= total debt ÷ shareholders’ equity
debt-to-equity (D/E) ratio
measures the portion of a company’s assets financed by shareholders’ equity rather than debt
= total assets ÷ shareholders’ equity
equity multiplier
- it is a solvency ratio that indicates its ability to pay its debts.
= EBIT ÷ interest expense
times interest earned
-the Return on Equity (ROE) is
greater than the Return on Assets
(ROA)
ROE = Profit ÷ Shareholders’ Equity
ROA = Profit ÷ Total Assets
Good Financial Leverage
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
INVESTING RATIOS
BASIC FINANCIAL STATEMENTS ANALYSIS
Traditional Methods:
- Horizontal or comparative
- Trend Analysis
- Vertical or common-size
- Financial mix ratio
involves the comparison of two periods (months, or quarters, or years, etc.), two companies, actual and budgets and other bases of analyses.
Horizontal or comparative analysis
- 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.
Trend Analysis
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.
VERTICAL OR COMMON-SIZE ANALYSIS
take into account the interrelationships of the items in each financial statement.
FINANCIAL MIX RATIOS
Financial mix ratio analysis are classified as follows:
Profitability ratios
Growth ratios
Liquidity ratios
Leverage ratios
Determines the portion of sales that went into the company’s earnings.
= Profit ÷ Sales
Profit Margin or Return on Sales
measures the ability to generate return on every asset that are used to operate the business.
= Profit ÷ Assets
Return on Assets (ROA)
measures the amount earned on the owners’ or stockholders investment.
= Profit ÷ Shareholders’ Equity
Return on Equity (ROE)
measured when the company issues two classes of stocks.
= Profit – Preferred Dividends ÷ Ordinary Shareholders’ Equity
Return on Ordinary Equity (ROOE)
measures the amount of net
income earned by each common
share.
= Profit – Preferred Dividends ÷ Average Ordinary Shares
Earnings Per Share (EPS)
Profitability ratios are:
- Profit Margin or Return on Sales
- Return on Assets (ROA)
- Return on Equity (ROE)
- Return on Ordinary Equity (ROOE)
- Earnings Per Share (EPS)
-indicate how fast a company or its business is growing.
GROWTH RATIOS
- compares a stock’s price to its earnings.
= Market price per share ÷ Earnings per share
Price-earnings ratio
- shows how much a company pays out in dividends each year relative to its stock price.
= Dividend per share÷ Market price per share
Dividend yield ratio
-measures the book value of a firm on a per-share basis.
-book value equals a firm’s total assets minus its total liabilities.
Book value per share
GROWTH RATIOS are:
*Price-earnings ratio
*Dividend yield ratio
*Dividend payout ratio
*Book value per share
used to determine a debtor’s ability to pay off current debt obligations without raising external capital.
LIQUIDITY RATIOS
a measure of a company’s ability to pay its current liabilities with its current assets (liquidity).
= CA ÷ CL
Current ratio or WC ratio
- 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
Quick ratio or acid test ratio
are technically the same as quick assets: cash, cash equivalents, marketable securities, current receivables.
defensive assets
= Total defensive assets ÷ Average daily expenditures or daily operating cash flow
Defensive interval ratio
LIQUIDITY RATIOS are:
- Current ratio or working capital
(WC) ratio
*Quick ratio or acid test ratio
*Defensive interval ratio
-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.
FINANCIAL LEVERAGE
Common leverage ratios include:
- debt-to-equity (D/E) ratio
- equity multiplier
- times interest earned
- debt rate (debt ratio)
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.
Gearing ratio
