Chapter 14: Financial Statement Analysis

Question 1

financial statement analysis to evaluate a company’s financial health and future
prospects.

Answer 1

Stakeholders

Question 2

Examples of Stakeholders

Answer 2

Stockholders, creditors & Managers

Question 3

analyze a company’s financial statements to estimate its potential for earnings growth, stock price appreciation, making dividend payments, and paying principal and interest on loans.

Answer 3

Stockholders and creditors

Question 4

analysis focuses on the relations
among financial statement accounts at a given point in time.

Answer 4

Vertical analysis

Question 5

A _________ is a vertical analysis in which each financial statement account is expressed
as a percentage.

Answer 5

common-size financial statement

Question 6

In income statements, all items are usually expressed as a percentage of
____________.

Answer 6

sales

Question 7

sales. In balance sheets, all items are usually expressed as a percentage of ______________.

Answer 7

total assets

Question 8

Horizontal analysis can be even more useful when data from a number of years are
used to compute ____________.

Answer 8

trend percentages

Question 9

To compute _________, a base year is selected and the data for all years are stated as a percentage of that base year.

Answer 9

trend percentages

Question 10

involves analyzing financial data
over time, such as computing year-to-year dollar and percentage changes within a set of financial statements.

Answer 10

Horizontal Analysis

Question 11

three analytical techniques
are widely used:

Answer 11

1. Dollar and percentage changes on statements (horizontal analysis).
2. Common-size statements (vertical analysis).
3. Ratios.

Question 12

two limitations of financial statement analysis that managers
should always keep in mind

Answer 12

1. comparing financial data across companies
2. looking beyond ratios when formulating conclusions.

Question 13

refers to how quickly an asset can be converted to cash.

Answer 13

Liquidity

Question 14

________assets can be converted to cash quickly, whereas ________ assets cannot.

Answer 14

Liquid; I-ll liquid

Question 15

The excess of current assets over current liabilities is known as

Answer 15

Working Capital

Question 16

Formula of Working Capital

Answer 16

Working capital = Current assets − Current liabilities

Question 17

What are the 3 Financial Ratios for Assessing Liquidity

Answer 17

1. Working Capital
2. Current Ratio
3. Acid-test ratio

Question 18

A company’s working capital is frequently expressed in ratio form.

Answer 18

Current Ratio

Question 19

is a more rigorous test of a company’s ability to meet its short-term debts than the current ratio.

Answer 19

acid-test (quick) ratio

Question 20

formula of acid-test (quick) ratio

Answer 20

Acid-test ratio =

Cash + Marketable securities + Accounts receivable + Short-term notes receivable _______________________________________

Current liabilities

Question 21

Formula of Current Ratio

Answer 21

Current ratio = Current assets / Current liabilities

Question 22

RATIO ANALYSIS—ASSET MANAGEMENT

Answer 22

1. Accounts Receivable Turnover
   2.

Question 23

The _____________ and average ____________ measure how quickly credit sales are converted into cash.

Answer 23

accounts receivable turnover ; collection period ratios

Question 24

Formula of Accounts Receivable Trunover

Answer 24

Accounts receivable turnover =

Sales on account ______________________________
Average accounts receivable balance

Question 25

The Formula of Average collection period

Answer 25

Average collection period = 365 days ________________________ Accounts receivable turnover

Question 26

______________ measures how many times a company’s inventory has been sold and replaced during the year.

Answer 26

inventory turnover ratio

Question 27

The number of days needed on average to sell the entire inventory

Answer 27

Average Sales Period

Question 28

Formula of Average Sales Period

Answer 28

Average sale period = 365 days ________________ Inventory turnover

Question 29

measures the elapsed time from when inventory is received from suppliers to when cash is received from customers.

Answer 29

Operating Cycle

Question 30

Formula of Operating Cycle

Answer 30

Operating cycle = Average sale period + Average collection period

Question 31

is a ratio that compares total sales to average total assets. It measures how efficiently a company’s assets are being used to generate sales. This ratio expands beyond current assets to include noncurrent assets, such as property, plant, and equipment. It

Answer 31

Total Asset Turnover

Question 32

Formula of Total Asset Turnover

Answer 32

Total asset turnover = Sales _________________ Average total assets

Question 33

refers to borrowing money to acquire assets in an effort to increase sales and profits.

Answer 33

Financial Leverage

Question 34

If the company’s rate of return on total assets exceeds the rate of return the company pays its creditors, financial leverage is ________.

Answer 34

positive

Question 35

If the rate of return on total assets is less than the rate of return the company pays its creditors, financial leverage is _____________.

Answer 35

negative

Question 36

What are the 3 Debt Management

Answer 36

1. Time interest earned ratio 2. Debt-to-equity ratio 3. Equity multiplier

Question 37

The most common measure of a company’s ability to provide protection to its long-term creditors is the ______________

Answer 37

Time interest earned ratio

Question 38

Formula of Time Interest earned ratio

Answer 38

Times interest earned ratio = Earnings before interest expense and income taxes _________________________________________ Interest Expense

Question 39

is one type of leverage ratio that indicates the relative proportions of debt and equity at one point in time on a company’s balance sheet. As the ___________ increases, it indicates that a company is increasing its financial leverage. In other words, it is relying on a greater proportion of debt rather than equity to fund its assets.

Answer 39

Debt-to-equity Ratio

Question 40

Formula of debt-to-equity ratio

Answer 40

Debt-to-equity ratio = Total liabilities _________________ Stockholders’ equity

Question 41

is another type of leverage ratio that indicates the portion of a company’s assets funded by equity.

Answer 41

Equity Multiplier

Question 42

Formula of Equity Multiplier

Answer 42

Equity multiplier = Average total assets ________________________ Average stockholders’ equity

Question 43

What are the

Answer 43

1. Gross Margin Percentage

Question 44

should be more stable for retailing companies than for other companies because the cost of goods sold in retailing excludes fixed costs.

Answer 44

Gross Margin Percentage

Question 45

Formula of Gross Margin Percentage

Answer 45

Gross margin percentage = Gross margin ___________ Sales

Question 46

The gross margin percentage focuses on only one type of expense (cost of goods sold) and its impact on performance, whereas the __________________ also looks at how selling and administrative expenses, interest expense, and income tax expense have influenced performance.

Answer 46

net profit margin percentage

Question 47

Formula of net profit margin percentage

Answer 47

Net profit margin percentage = Net Income ______________ Sales

Question 48

The return on total assets looks at profits relative to total assets, whereas the _______________ looks at profits relative to the book value of stockholders’ equity.

Answer 48

return on equity

Question 49

Formula of Return of Equity

Answer 49

Return on Equity = Net income ________________________ Average stockholders’ equity

Question 50

It also bears emphasizing that many managers and investors take a more in-depth look at return on equity using principles pioneered by ________________________________

Answer 50

E.I. du Pont de Nemours and Company (better known as DuPont).

Question 51

Formula for DuPont Analysis in Return of Equity

Answer 51

Return on equity = Net profit margin percentage × Total asset turnover × Equity multiplier

Question 52

An investor buys a stock in the hope of realizing a return in the form of either dividends or future increases in the value of the stock. Because earnings form the basis for dividend payments and future increases in the value of shares, investors are interested in a company’s __________.

Answer 52

earnings per share.

Question 53

Formula of earnings per share.

Answer 53

Earnings per share = Net income _______________________________________ Average number of common shares outstanding

Question 54

An index of whether a stock is relatively cheap or rel- atively expensive in relation to current earnings

Answer 54

Price-earnings ratio

Question 55

Formula of Price-earnings ratio

Answer 55

Market price per share ÷ Earnings per share

Question 56

An index showing whether a company pays out most of its earnings in dividends or reinvests the earnings internally

Answer 56

Dividend payout ratio

Question 57

Formula of Dividend payout ratio

Answer 57

Dividends per share ÷ Earnings per share

Question 58

Shows the return in terms of cash dividends being provided by a stock

Answer 58

Dividend yield ratio

Question 59

Formula of Dividend yield ratio

Answer 59

Dividends per share ÷ Market price per share

Question 60

Measures the amount that would be distributed to common stockholders if all assets were sold at their balance sheet carrying amounts and if all creditors were paid off

Answer 60

Book value per share

Question 61

Formula of Book value per share

Answer 61

Total stockholders’ equity ÷ Number of common shares outstanding