Chapter 3 Flashcards
Common Size Financial Statement
A Common Size Financial Statement shows the specific lines of the financial statement as a percentage of a broader statement line.
Common Size Income Statement
PCT of sales
Common Size Balance Sheet
PCT of Total Assets
Liabilities
PCT of Total Liabilities
Use of Common Size Financial Statement
Compare one or more Companies of different sizes
Short Term Solvency
Do they have the cash to pay their bills? Current Ratio, Quick Ratio, Cash Ratio
Long Term Solvency
Will the firm be able to service its debt? Debt to equity Ratio, Cash Coverage Ratio, Times Interest Earned
Asset Management
How efficiently does the firm manage its assets Inventory Turnover, Days’ Sales in Inventory, Receivables Turnover Days’ Sales in Receivables, Payables Turnover, Days’ Cost in Payables
Profitability Ratios
How efficiently does the firm use its assets and manage operation to generate profits
Profit Margin, Return on Assets, Return on Equity
Market Value Ratios
Market Valuation of a company sensible Earnings Per Share, Price to Earnings
Current Ratio
A current ratio somewhat greater than 1.0 suggests the firm can pay its suppliers, other bills, and debt service requirements over the next year
Quick Ratio
Inventory is the hardest Current Asset to convert to cash. A sale has to be made, and the cash collected. Meanwhile, inventory that sits too long can become damaged or turn obsolete. The Quick Ratio backs Inventory out of Current Assets. A ratio of at least 1.0 gives confidence the firm can meet its obligations.
Cash Ratio
Cash is King! Very short-term creditors, who won’t wait for non-cash assets to be converted, would be interested in the Cash Ratio before being willing to lend.
Debt to Equity Ratio
A Debt-Equity ratio higher than 1.0 means the company is using debt funding more than equity funding.
If equity holders are last in line, then holding equity is more risky to the investor than holding debt.
More risk, more return. So equity holders demand more return than bond holders.
Therefore Debt is a cheaper source of financing for a company than equity. (So Debt is tempting.)
But more Debt equals more Risk.
Financial Leverage
Financial Leverage ratios measure Capital Structure, or how much debt the company is using to fund its business, and the level of its risk.
Cash Coverage Ratio
The Cash Coverage Ratio tells how many times a company can pay Interest due before exhausting cash.
Analysts are very interested in EBITDA and the Cash Coverage ratio for startups and fast-growing companies.
(This is because falling levels of cash and cash burn are the leading signs of startup failure.)
Times Interest Earned
However, depreciation is an expense to be taken seriously – depreciated assets need to be replaced – but the issue here is whether or not enough cash is available to service debt – not whether the firm can service debt plus replace capital assets.
For mature firms, analysts are more interested in this ratio than Cash Coverage.
Debt to Equity Ratio
Total Assets-Total Equity/Total Equity
Inventory Turnover
As COGS is only booked as a sale is made, the higher COGS is a multiplier on inventory, the more efficiently inventory is turning into a sale. (Higher is better, unless the firm runs out of inventory, foregoing sales).
Days Sales in Inventory
Recall how slowly the fictional Classen, Inc (Chapter 2 slides) sold off its inventory. It took than more than a year to go through it just once! As long as a firm is not running out of inventory (and foregoing sales), lower is better for this number.
Receivables Turnover
If Inventory Turnover tells us how fast the firm is turning inventory into sales, Receivables Turnover tells us how fast the firm is collecting (turning into cash) those receivables.
Days Sales in Receivables
Once we have Receivables Turnover, we can measure how many days it takes the firm to collect its receivables. (How long is the firm issuing free credit to the people who owe it money! Or how fast is it collecting on these loans so that they can make new loans to buyers!
Payables Turnover
If we assume a firm buys all of its inventory on credit, then Payables Turnover measures many times the firm pays its bills.
Days Costs in Payables
Likewise, we can measure in days how long the firm takes to pay its bills.
Earnings Per Share
Earnings per Share (EPS) measures how much of the firm’s profit each share is entitled to.
Price to Earnings
Measures how much an investor must pay for every dollar of profit the firm has earned.
