Chapter 12 Flashcards
Canadian Securities Administrators (CSA)
Protect investors and maintain the integrity of the securities market
Accounting Standards Board (AcSB)
Set Generally Accepted Accounting Standards (GAAP).
Canadian Public Accountability Board
Federal agency which oversees Canadian accounting firms (independent
auditors) that perform auditing engagements of public companies.
Corporate Governance Standards (Stock Exchanges)
Along with provincial governments, set overall corporate governance
standards. (The most prominent is the Ontario Securities Commission)
Management
Responsible for the information in the financial statements and disclosures.
Chief Executive Officer (CEO)
highest officer of the company.
Chief Financial Officer (CFO)
highest officer associated with the financial and accounting side of the
business
Accounting Staff
prepare the details of the reports and bear professional responsibility for the
accuracy of the information.
Board of Directors
Responsible for ensuring that processes are in place for maintaining the integrity
of the company’s accounting, financial statement preparation, and financial
reporting.
Board of Directors (Audit Committee)
Is composed of non-management (independent) directors with financial
knowledge and is responsible for hiring the company’s independent auditors.
They also meet separately with the auditors to discuss management’s
compliance with their financial reporting responsibilities.
Independent Auditors
Follow established auditing standards to assess the fairness of the financial
statements and related presentations
Information Intermediaries
Analysis and Advice
- Receive accounting reports and other information about the company from electronic information
services. - Gather information through conversations with company executives and visits to company
facilities and competitors. - Results of their analyses are combined into analysts’ reports.
USERS
- Institutional & Private Investors
- Lenders or Creditors
Institutional Investors
Includes pension, mutual, endowment and other funds that invest on
the behalf of others
Private Investors
Individuals who purchase shares in companies
Lenders or Creditors
Suppliers, banks, commercial credit companies, and other financial institutions
that lend money to companies
THE DISCLOSURE PROCESS – PRESS RELEASES
Press Releases are used to announce quarterly and
annual earnings as soon as the verified figures are
available
ANNUAL REPORTS - Private Held Companies
- Four basic financial statements.
- Related notes.
- Report of independent accountants (auditor’s
opinion) if the statements are audited.
ANNUAL REPORTS - Public Companies
- Non-financial Section
* Includes a letter to the shareholders, a description of
management’s philosophy, products, successes, etc. - Financial Section
* Provincial securities commission regulators set
minimum disclosure standards for the financial
section for public companies.
Quarterly Reports
QUARTERLY REPORTS
- Usually begin with a short letter to shareholders
- Condensed unaudited statement of earnings and
statement of financial position for the quarter. - Often, the statement of cash flows and statement of
changes in shareholders’ equity are omitted. Some
notes to the financial statements also may be
omitted.
What does Investors need to know?
Investors need to know if the company is trying to
earn a high rate of return through product
differentiation or cost differentiation.
FINANCIAL STATEMENT USERS
Management - uses accounting data
to make product pricing
and expansion
decisions.
External Decision makers - use accounting data
for investment, credit,
tax, and public policy
decisions.
THREE TYPES OF FINANCIAL
STATEMENT INFORMATION
- Past
Performance
Net earnings,
sales volume,
cash flows,
return-on-
investment,
EPS.
- Present
Condition
Assets, debt,
inventory,
various ratios.
- Future Performance
Sales and earnings
trends are good
indicators of future
performance.
Financial Statement Analysis based on comparisons
- Time series
analysis
Examines a single
company to identify
trends over time.
- Comparison with similar companies
Provides insights
concerning a
company’s relative
performance
Ratio analysis is used to…
express the proportionate relationship between two
different amounts.
Profitability Ratios
a primary measure of the overall success of a
company. It is necessary for a company’s survival.
- Return on Equity
- Return on Assets
- Gross Profit Percentage
- Net profit margin ratio
- Earnings per share (EPS) ratio
- Quality of earnings ratio
Profitability Ratios - Return on Equity (ROE)
This measure indicates how much income was earned for every
dollar invested by the owners
Net Earnings / Average Shareholders’ Equity
Profitability Ratios - Return on Assets (ROA)
Many analysts consider this ratio as the best overall
measure of a company’s profitability.
Return on Assets
PROFITABILITY RATIOS – FINANCIAL LEVERAGE %
Financial leverage is the advantage or disadvantage that occurs
as the result of earning a return on equity that is different from
the return on assets.
Financial Leverage = Return on Equity - Return on Assets
PROFITABILITY RATIOS – GROSS PROFIT PERCENTAGE
The gross profit percentage (also referred to as the gross profit
margin) reflects gross profit as a percent of sales. If not shown
separately on a company’s statement of earnings, gross profit is
calculated by subtracting cost of sales from net sales.
Gross Profit % = Gross Profit / Net Sales
PROFITABILITY RATIOS – NET PROFIT MARGIN RATIO
The net profit margin ratio measures the percentage of each sales
dollar, on average, that represents net earnings.
Net Profit Margin Ratio = Net Earnings / Net Sales
PROFITABILITY RATIOS – EARNINGS PER SHARE
(EPS)
Earnings per share is probably the single most widely watched financial ratio. The
average number of shares based on the number of shares at the beginning and end of
the year.
EPS = Net Earnings available to common shareholders / Average number of common shares outstanding
PROFITABILITY RATIOS – QUALITY OF EARNINGS
RATIO
Most financial analysts are concerned about the quality of a
company’s earnings because the use of some accounting
procedures can result in higher earnings reports. A ratio higher
than 1 indicates high-quality earnings.
Quality of Earnings Ratio = Cash flows from op. activities / Net Earnings
ASSET TURNOVER RATIOS
Asset turnover ratios focus on capturing how efficiently a company uses its assets.
ASSET TURNOVER RATIOS – TOTAL ASSET TURNOVER
RATIO
The total asset turnover ratio captures how well a company uses its
assets to generate revenue. The ratio is calculated as follows
Total Asset Turnover = Net Sales / Average Total Assets
ASSET TURNOVER RATIOS – FIXED ASSET TURNOVER
RATIO
This ratio measures a company’s ability to generate sales
given an investment in fixed assets.
Fixed Asset Turnover Ratio = Net Sales / Average Net Fixed Assets
ASSET TURNOVER RATIOS – RECEIVABLES TURNOVER
RATIO
This ratio measures how quickly a company collects
its trade receivables.
Receivables Turnover Ratio = Net Credit Sales / Average Net Accounts Receivable
ASSET TURNOVER RATIOS – INVENTORY TURNOVER
RATIO
This ratio measures how quickly the company sells its inventory.
Investory Turnover Ratio = Cost of Sales / Average Inventory
Operating cycle for most companies involves:
- Acquisition of inventory
- Sale of inventory
- Collection of cash from customers
Liquidity Ratios
Liquidity refers to a company’s ability to meet its short-term obligations. A company’s ability to pay its current liabilities is an important
factor in evaluating its short-term financial strength.
Liquidity Ratios
- the current ratio
- the quick ratio
- the cash ratio
LIQUIDITY RATIOS – CURRENT RATIO
The current ratio measures the relationship between the current
assets and current liabilities at a specific date.
Current Ratio = Current Assets / Current Liabilities
LIQUIDITY RATIOS – QUICK RATIO
The quick ratio, sometimes referred to as the acid test, is a more stringent test of short-term liquidity than the current ratio. The quick ratio compares quick assets, defined as cash and near–
cash assets, to current liabilities.
Quick Ratio = Quick Assets / Current Liabilities
LIQUIDITY RATIOS – CASH RATIO
This ratio measures the adequacy of available cash.
Cash Ratio = Cash + Cash Equivalents / Current Liabilities
SOLVENCY RATIOS
Solvency refers to a company’s ability to meet its long-term
obligations.
- Times interest earned
- Cash coverage
- Debt-to-Equity ratios
SOLVENCY RATIOS – TIMES INTEREST EARNED
Tests of solvency measure a company’s ability to meet its long-term obligations. This ratio indicates a margin of protection for creditors
Times Interest Earned = Net Earnings + Interest Expense + Income Tax Expense / Interest Expense
SOLVENCY RATIOS – CASH COVERAGE RATIO
This ratio compares the cash generated with the cash
obligations of the period
Cash Coverage Ratio = Cash Flow from Operating Activities Before Interest and Taxes / Interest Paid (from statement of cash flows)
SOLVENCY RATIOS – DEBT-TO-EQUITY RATIO
This ratio measures the amount of liabilities that exists for each $1
invested by the owners.
Debt-to-Equity Ratio = Total Liabilitiies / Shareholder’s equity
MARKET RATIOS
Some ratios, often called market ratios, relate the current
market price per share to the return that accrues to
investors.
MARKET RATIOS – PRICE/EARNINGS (P/E)
RATIO
Market tests relate the current market price of a share to an
indicator of the return that might accrue to the investor.
This ratio measures the relationship between the current market
price of the share and its earnings per share.
P/E Ratio = Current Market Price Per Share / Earnings Per Share
INTERPRETING RATIOS
- Ratios may be interpreted by comparison with ratios of
other companies or with industry average ratios. - Ratios may vary because of the company’s industry
characteristics, nature of operations, size, and
accounting policies.
What is an efficient market?
A securities market in which prices fully reflect available information is called
an efficient market. In an efficient market, a company’s share price reacts
quickly when new, relevant information is released about the company.
In addition to financial ratios, 3 special factors might affect company analysis
- Rapid growth
- Uneconomical expansion
- Subjective factors
