Chapter 2: Introduction to Financial Statement Analysis Flashcards
Generally Accepted Accounting Principles (GAAP)
a common set of rules and a standard format for public companies to use when they prepare their financial reports
Auditor
a neutral third party that corporations are required to hire to check the annual financial statements to ensure they are prepared according to GAAP, and to verify that the information is reliable
Balance Sheet
- a list of a firm’s assets and liabilities that provides a snapshot of the firm’s financial position at a given point in time
- in IFRS it is referred to as the Statement of Financial Position
Assets
the cash, inventory, property, plant and equipment, and other investments a company has made
Current Assets
cash or assets that could be converted into cash within one year
ex. marketable securities, accounts receivable, inventories, and pre-paid expenses (rent and insurance)
Marketable Securities
short-term, low-risk investments that can be easily sold and converted to cash
ex. money market investments, like government debt that mature within a year
Long-term Assets
plant, and equipment, as well as property not used in business operations, start-up costs in connection with a new business, investments in long-term securities, and property held for sale
Depreciation
- a yearly deduction a firm makes from the value of its fixed assets (other than land) over time according to a depreciation schedule that depends on an asset’s lifespan
- allocates the cost of a large amount overtime
- in income statement
- tangible
- tax shield
- straight line deprecation
- declining depreciation is a rate (%) (ex. CCA rate)
Accumulated Depreciation
the cumulative depreciation of an asset up to a given point in its life; equal to last period’s accumulated depreciation plus the current period’s depreciation expense
Book Value
the acquisition cost of an asset less its accumulated depreciation
Goodwill
the difference between the price paid for a company and the book value assigned to its assets
Liabilities
a firm’s obligations to its creditors
Current Liabilities
liabilities that will be satisfied within one year
ex. accounts payable, notes payable, short-term debt, current maturities of long-term debt, salary or taxes owed, and deferred or unearned revenue
Short-term Debt
debt with a maturity of less than one year
Long-term Debt
any loan or debt obligation with a maturity of more than a year
Capital Lease
- a long-term lease contract that obligates the firm to make regular lease payments in exchange for use of an asset
- allows a firm to gain use of an asset by leasing it from the asset’s owner
ex. leasing a building to serve as its corporate headquarters
Future Income Tax
an account that shows taxes that have been recognized on the firm’s financial statements but are not yet charged according to tax law
Shareholders’ Equity
- the difference between the firm’s assets and liabilities
- an accounting measure of the firm’s net worth
Book Value of Equity
- the difference between the book value of a firm’s assets and its liabilities
- aka shareholders’ equity, it represents the net worth of a firm from an accounting perspective
Market Capitalization
- the total market value of equity
- equals the market price per share times the number of shares
Enterprise Value
- the total market value of a firm’s equity and debt, less the value of its cash and marketable securities
- measures the value of the firm’s underlying business
Income Statement
- a list of a firm’s revenues and expenses over a period of time
- aka statement of earnings, statement of operations, or profit and loss statement
- net income or earnings is the “bottom” line of the income statement
Earnings Calculations of Income Statements
- Cost of Goods Sold/Cost of Sales
- Gross Profit
- Operating Expenses
- Earnings Before Interest and Taxes
- Earnings Before Taxes and Net Income
Gross Profit
the difference between net sales revenue and the cost of goods sold
Operating Expenses
expenses from the ordinary course of running the business that are not directly related to producing the goods or services being sold
ex. administrative expenses and overhead, salaries, marketing costs, and research and development ( R&D) expense
Amortization
- a charge that captures the change in value of acquired assets
- not an actual cash expense like depreciation
Operating Income
a firm’s gross profit less its operating expenses
Earnings Before Interest and Taxes (EBIT)
other sources of income or expenses that arise from activities that are not the central part of a company’s business
ex. cash flows
Earnings Before Taxes and Net Income
amount deducted from interest paid on outstanding debt to compute Global’s earnings and corporate taxes to determine the firm’s net income
Earnings Per Share (EPS)
a firm’s net income divided by the total number of shares outstanding
Stock Options
a form of compensation a firm gives to its employees that gives them the right to buy a certain number of shares of stock by a specific date at a specific price
Convertible Bonds
corporate bonds with a provision that gives the bondholder an option to convert each bond owned into a fixed number of shares of common stock
Dilution
- an increase in the total number of shares that will divide a fixed amount of earnings
- often occurs when stock options are exercised or convertible bonds are converted
Diluted EPS
a firm’s disclosure of its potential for dilution from options it has awarded which shows the earnings per share the company would have if the stock options were exercised
Statement of Cash Flows
- an accounting statement that shows how a firm has used the cash it earned during a set period
- net income typically does NOT equal the amount of cash the firm has earned
- non-cash expenses
- depreciation and amortization
- uses of cash not on the income statement
- investment in property, plant, and equipment
Capital Expenditures
purchases of new property, plant, and equipment
Retained Earnings
- the difference between a firm’s net income and the amount it spends on dividends
- = net Income - dividends
Management Discussion and Analysis (MD&A)
a preface to the financial statements in which a company’s management discusses the recent year (or quarter), providing a background on the company and any significant events that may have occurred
Off-balance-sheet Transactions
transactions or arrangements that can have a material impact on a firm’s future performance yet do not appear on the balance sheet
Statement of Shareholders’ Equity
an accounting statement that breaks down the shareholders’ equity computed on the balance sheet into the amount that came from issuing new shares versus retained earnings
Statement of Comprehensive Income
statement showing the total income and expenses for a period by combining net income (or profit) from the income statement with information not reported on the income statement, such as gains and losses that affect equity through reserve or other accounts
Quick Ratio
- the ratio of current assets other than inventory to current liabilities
- = cash / current liabilities
Accounts Receivable Days
- number of days’ worth of sales accounts receivable represents
- = accounts receivable / avg daily sales
Accounts Payable Days
- an expression of a firm’s accounts payable in terms of the number of days’ worth of cost of goods sold that the accounts payable represents
- = accounts payable / avg daily cost of sales
Inventory Days
an expression of a firm’s inventory in terms of the number of days’ worth or cost of goods sold that the inventory represents
Inventory Turnover
- the ratio of the annual cost of sales to inventory
- a measure of how efficiently a firm is managing its inventory
- = annual cost of sales / inventory
Accounts Receivable Turnover
- the ratio of annual sales to accounts receivable
- measures of how efficiently the firm is managing accounts receivable
Accounts Payable Turnover
- the ratio of annual cost of sales to accounts payable
- measures of how quickly the firm is paying its suppliers
Interest Coverage Ratio
- an assessment by lenders of a firm’s leverage
- common ratios consider operating income, EBIT, or EBITDA as a multiple of the firm’s interest expense
EBITDA
- a computation of a firm’s earnings before interest, taxes, depreciation, and amortization are deducted
- = EBIT + Depreciation and Amortization (or interest coverage ratio)
Leverage
the amount of debt held in a portfolio or issued by a firm
Debt–Equity Ratio
- the ratio of a firm’s total amount of short and long-term debt (including current maturities) to the value of its equity, which may be calculated based on market or book values
- = total debt / total equity
Return On Equity (ROE)
the ratio of a firm’s net income to the book value of its equity
Return On Assets (ROA)
the ratio of net income to the total book value of the firm’s assets
Sarbanes-Oxley Act (SOX)
a 2002 U.S. Congressional act intended to improve the accuracy of information given to both boards and to shareholders
Statement of Cash Flows
- operating activity
- investment activity
- financing activity
Operating Activity
adjusts net income by all non-cash items related to operating activities and changes in net working capital
Investing Activity
- capital expenditures
- buying or selling marketable securities
Financing Activity
- changes in borrowings
- payment of dividends
- retained earnings for the period
Cash Flow from Assets
- = CF from operating activities + CF from
investing activities
Profits Include…
non cash items:
* depreciation
* does not expense a new capital expenditure
* profits are calculated using the accrual method of accounting
