Chapter 2: Financial Statement Analysis Flashcards
Horizontal and Vertical Statement Analysis
What are the components of a vertical analysis?
- Vertical analysis is based on a single year
- It is used to compare various industries with similar financial reporting
- A type of verticial analysis is the common-size financial statements
Horizontal and Vertical Statement Analysis
How is the common-size financial statement calculated?
- The common-size financial statement is based on a percentage, rather than the amount
- The base amount to determine common-size income statement is Sales
- The base amount to determine common-size balance sheet are total assets
Horizontal and Vertical Statement Analysis
What is horizontal analysis?
- Horizontal analysis is used to compare two periods (i.e. previous year and current year)
- The calculation is (Current Year - Base Year)/Base Year
- The base year for horizontal analysis is the demoninator when calculating the change in percentage
Liquidity Ratios
What is the cash ratio calculation?
(Cash + Securities) / Current Liabilities
Liquidity Ratios
What is not included when calculating quick assets?
- Inventory
- Pre-paid Expenses
Activity Ratios
What is the Asset Turnover Calculation?
Sales / Average Total Assets
- The asset turnover ratio is used to determine a firm’s ability to generate sales from its assets
- A high turnover indicates more resources are being used to generate sales
- A high asset turnover may indicate that the company is undercapitalized
- The company cannot afford to buy enough fixed assets or use its fixed assets efficiently
Activity Ratios
What is the Cash Conversion Cycle?
A/R Turnover in Days + Inventory Turnover in Days - A/P Turnover in Days
Activity Ratios
What is the calculation to determine COGS when only the Sales and Gross Profit Percentage are provided?
Sales x (1 - Gross Profit %)
Activity Ratios
What is the Fixed Asset Turnover Calculation?
Sales / Average Net Fixed Assets
- The calculation is used to determine the firm’s ability to generate sales using fixed assets
Activity Ratios
What is the Accounts Payable Turnover Calculation?
Purchases / Average Accounts Payable
- If purchases cannot be calculated, use Cost of Goods Sold
- A high A/P turnover means that it is taking less time to pay suppliers and cash discounts are being applied
Activity Ratios
What is the Accounts Payable Turnover in Days Calculation?
(# of Days in Year) / Accounts Payble Turnover
OR
Ending Accounts Payable / (Purchases/# of days in year)
Solvency Ratios and Leverage
What is the purpose for solvency ratios?
Solvency ratios are used to measure the company’s ability to pay noncurrent debt when it becomes due and still be able to be in business
Solvency Ratios and Leverage
What ratios are used to determine solvency?
- Debt Ratio
- Debt to Equity Ratio
- Times Interest Earned Ratio
Solvency Ratios and Leverage
What is the purpose of the Debt to Equity Ratio?
- How much equity can absorb the debt
- The lower the ratio, the safer it is for creditors
Solvency Ratios and Leverage
What is the purpose of the Times Interest Earned Ratio?
- It determines how much operating profit can decline before the interest on debt obligations can be met
- A higher ratio shows that the company can pay off the debt with its current income
Solvency Ratios and Leverage
What is the calculation to determine the degree of financial leverage?
Calculation: % of change in EPS / % of Change in Operating Income
- Financial leverage shows how much debt, which are all fixed costs, are used in a company’s structure
- The higher the leverage, the more risk and the more reward
Solvency Ratios and Leverage
What is What is the calculation to determine the degree of operating leverage?
% Change in Operating Income / % Change in Sales
- Operating leverage is based on how much sales change the operating income
- If there are more fixed costs (i.e. salaries) than variable costs (i.e. commissions), then there will be a greater risk
- If sales are increasing, then a high degree of leverage would be beneficial since income will cover the fixed costs
- If sales are decreasing, a high degree of leverage would create a higher risk since there may not be enought income to cover the fixed costs
Returns and Profitability
What is the calculation to determine return on assets?
- Net Income / Average Total Assets
OR - Profit Margin / Asset Turnover
OR - Return on Equity x (1-Debt Ratio)
Returns and Profitability
What is the calculation to determine return on sales?
- Operating income / Net Sales
- Operating income can be calculated in two different ways
Sale price per Unit x Quantity x Target Rate of Return = (Sell Unit x # of Units) - (Variable Costs x # of Units) - (Total Fixed Costs)
Returns and Profitability
What is the calculation for Return on Equity based on the Dupont Analysis?
Net Profit x Asset Turnover x Equity Equalizer
Net Income = (Net Income/ Sales)
Asset Turnover = (Credit Sales / Avg. A/R)
Equity Equalizer (aka Financial Leverage) = (Total Assets / Total Equity)
Returns and Profitability
What is the calculation for Return on Equity based on the Extended Dupont Analysis?
Tax Burden x Interest Burden x Operating Income x Asset Turnover x Equity Equalizer
The Net Income Calculation is replaced by:
Tax Burden = Net Income / Pre-Tax Income (EBT)
Interest Burden = Pre-Tax Income (EBT) / Interest Expenses
Operating Income = EBIT / Sales
Investor and Market Ratios
What is the calculation to determine Price-per-Earnings Ratio?
Market Share Price / EPS
- EPS = (Net Income - P/S Dividend) / Average Common Shares Outstanding
- How much will I need to invest in order to receive $1 of the company’s earnings?
- A higher P/E ratio may indicate to investors that a higher earnings growth is expected
Investor and Market Ratios
What is the calcuation to determine dividend yield?
Dividends per Common Stock / Common Stock Market Price
- How much will I earn from an investment based solely on the dividend payments?
- Companies that are mature and not growing quickly will have a high dividend yield
- Companies that are new and just starting will have a lower dividend yield
Investor and Market Ratios
What is the calculation to determine Dividend Payout Ratio?
Total Dividends / Net Income or Dividends/EPS
- Investors use this ratio to determine if dividends that were paid are appropriate and within reason
- A higher payout ratio means share prices are unlikely to appreciate rapidly
