Chapter 17: Analysis of Financial Statements Flashcards
What are the building blocks of financial statement analysis?
Liquidity/efficiency, Solvency, Profitability, and Market Prospects?
What does liquidity and efficiency mean?
Ability to meet short-term obligations and to efficiently generate revenues.
What does solvency mean?
Ability to generate future revenues and meet long-term obligations.
What does profitability mean?
Ability to provide financial rewards sufficient to attract and retain financing.
What does market prospects mean?
Ability to generate positive market expectations.
What does a ratio express?
A mathematical relation between two quantities.
How can a ratio be expressed
As a percent, rate, or proportion.
How do you express a change in an account balance from $100 to $250?
(1) 150% increase, (2) 2.5 times, or (3) 2.5 to 1 or 2.5.1).
How is a ratio interpreted?
A ratio must refer to an economically important relation. For example, a direct and crucial relation exists between an item’s sales price and its cost. Accordingly, the ratio of cost of goods sold to sales is meaningful. In contrast, no obvious relation exists between freight costs and the balance of long-term investments.
What does Liquidity mean?
Refers to the availability of resources to meet short-term cash requirements.
How is Liquidity affected?
By the timing of cash inflows and outflows along with prospects for future performance. Analysis liquidity is aimed at a company’s funding requirements.
What does Efficiency mean?
Refers to how productive a company is in using its assets.
How is Efficiency measured?
By how much revenue is generated from a certain level of assets.
What is working capital (net working capital?
Current assets-current Liabilities
Why does a company need adequate working capital?
To meet current debts, to carry sufficient inventories, and to take advantage of cash discounts.
What happens if a company does not have working capital?
A company is less likely to meet current obligations or to continue operating.
How is working capital evaluated?
By not only looking at current liabilities - current assets, but also at their ratio.
How do you solve for the current ratio?
Current assets/current liabilities
What are quick assets?
Cash, short-term investments, and current receivables. (most liquid types of current assets)
What does the acid-test (quick ratio) ratio mean?
Reflects on a company’s short-term liquidity.
What is the acid-test ratio formula?
Cash + Short-term investments + Current receivables/ Current liabilities
What does accounts receivable turnover mean?
By measuring how frequently a company converts its receivables into cash.
What is the accounts receivable turnover formula?
Nets sales/average accounts receivable, net
Short-term receivables from customers are often included in the denominator along with accounts receivable.
How is accounts receivable turnover more precise?
If credit sales are used for the numerator, but external users generally use net sales (or net revenues) because information about credit sales is typically not reported. It provides insight into how frequently a company collects its accounts.
What is the Days’ sales uncollected formula?
Accounts receivable, net/net sales x365
What are the most used general purpose financial statements?
Income statement, balance, statement of stockholders’ equity (or statement of retained earnings), statement of cash flows, and notes to these statements.
What is financial reporting?
Refers to the communication of financial information useful for making investment, credit, and other business decisions.
What does financial reporting include?
Not only general-purpose financial statements but also information from SEC 10-K or other filings, press releases, shareholders’ meetings, forecasts, management letters, auditors’ reports, and Webcasts.
What is the Days’ sales in inventory formula?
(Ending inventory/COGS)x365
What is the total asset turnover?
Reflects a company’s ability to use its assets to generate sales and is an important of operating efficiency.
What is the total asset turnover formula?
Net sales/average total assets
What is solvency?
A company’s long-run financial viability and its ability to cover long-term obligations.
What affects solvency?
All of a company’s business activities - financing, investing, and operating
What is the most important components of solvency?
The composition of company’s capital structure.
What is capital structure?
Refers to company’s financing sources. It ranges from relatively permanent equity financing to riskier to more temporary short-term financing. Assets represent security for financiers ranging from loans secured by specific assets to the assets available as general security to unsecured creditors.
What is debt-to-equity ratio (measure of solvency)?
Total liabilities/total equity
What is times interest earned?
The amount of income before deductions for interest expense and income taxes is the amount available to pay interest expense.
What is times interest earned formula?
Income before interest expense and income taxes/interest expense
What is profitability (relevant to solvency)?
Refers to a company’s ability to generate an adequate return on invested capital
How is return on invested capital judged
By assessing earnings relative to the level and sources of financing.
How is a company’s operating efficiency and profitability expressed by?
First, is profit margin, which reflects a company’s ability to earn net income from sales.
What the profit margin formula?
Net income/net sales
What is the return on total assets formula?
net income/average total assets
What is the return on common stockholders’ equity?
Measures a company’s success in reaching this goal.
What is the return on common stockholders’ equity formula?
Net income - preferred dividends/ average common stockholders’ equity
What is the price-earnings ratio formula?
market price per common share/earnings per share
What is dividend yield?
Used to compare the dividend-paying performance of different investment alternatives.
What is the dividend yield formula?
Annual cash dividends per share/market price per share
