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Financial Managment > Chapter 3: Analysis of Financial Statements > Flashcards

Chapter 3: Analysis of Financial Statements Flashcards

1
Q

EBITDA

A

Earnings before interest, taxes, depreciation and amortization

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2
Q

intrinsic value of a firm

A

expected future free cash flows discounted at the weighted average cost of capital

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3
Q

Free Cash flow

A

FCF

= net operating profit after taxes - required investments of operating capital

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4
Q

Weighted average cost of capital

A

WACC

cost of debit and equity
- determined by:
market interest rates
market risk aversion
firm’s debt/equity mix
firm’s business risk

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5
Q

Components of financial statement analysis

A
  • comparing a firm’s performance against that of other firms in the same industry
  • evaluating trends in the firm’s financial position over time
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6
Q

users of financial analysis

A

managers
potential lenders
stockholders (potential stockholders)

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7
Q

Steps of financial analysis

A
  • Gather data
  • examine the statement of cash flows
  • calculate and examine return on invested capital and free cash flow
  • ratio analysis
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8
Q

Items of interest from statement of cash flows

A
  • trends in net cash flow from operations over time
  • large investment acquisitions
  • financing section shows issuing debt or buying back stock (raising capital from investors or returning it to them)
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9
Q

NOPAT

A

Net operating profit after taxes

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10
Q

First measures calculated

A

Net Operating Profit after Taxes & total net operating capital

used to calculate
- operating profitability ratio
- capital requirement ratio
- return on invested capital
- free cash flow

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11
Q

Return on invested capital

A

ROIC

NOPAT/ total net operating capital

measure of firm’s overall performance

ROIC > WACC: company usually adding value
ROIC < WACC: usually means problems

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12
Q

Operating profitability ratio

A

OP

NOPAT / Sales

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13
Q

Capital Requirement ration

A

CR

= Total net operating capital/ sales

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14
Q

Profitability ratios

A

show the combined effects of liquidity, asset management, and debt on operating and financial results

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15
Q

Net profit margin

A

(aka profit margin on sales or profit margin)

show profit per dollar of sales

= Net income available to common stockholders / sales

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16
Q

Operating profit margin

A

= EBIT / Sales

shows how a company is performing with respect to operations before impact of interest expenses

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17
Q

Gross profit margin

A

a way to look at the components of operating costs

= (sales - cost of good sold including depreciation) / sales

identifies the gross profit per dollar of sales before other expenses deducted

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18
Q

Basic Earning Power ratio

A

BEP

= EBIT/ total assets
(EBIT = earnings before interest and taxes)

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19
Q

Return on total assets

A

ROA (or return on assets)

= (net income available to common stockholders) / total assets

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20
Q

Return on common equity

A

ROE (return on equity)

= (net income available to common stockholders)/ common equity

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21
Q

Asset management ratios

A

measure how effectively a firm manages its assets

(aka efficiency ratios)

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22
Q

Total assets turnover ratio

A

measures dollars in sales that are generated for each dollar tied up in assets

= sales/ total assets

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23
Q

Fixed assets turnover ratio

A

measures how effectively the firm uses its plant and equipment

= sales / net fixed assets

(can be influenced by inflation as fixed assets are reported at historical cost rather than replacement cost = older equipment yields higher ratio)

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24
Q

Days sales outstanding

A

DSO
aka average collection period (ACP)

= accounts receivable/ average daily sales

average length of time firm must wait after making a sale before receiving cash

(high accounts receivable can cause high levels of net operating working capital)

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25
Q

Inventory turnover ratio

A

= cost of goods sold (including depreciation) / inventories

depreciation included because virtually all depreciation associated with producing products?

(some sources define it as sales/ inventories)

26
Q

Inventory turnover ratio

A

= cost of goods sold (including depreciation) / inventories

depreciation included because virtually all depreciation associated with producing products?

(some sources define it as sales/ inventories)

Number of times inventory is sold out and restocked (“turned over”) each year

low may mean holding too much inventory

27
Q

Liquidity Ratios

A

Ratios that show the relationship of a firm’s cash and other current assets to its current liabilities

(firm’s short term ability to pay obligations)

28
Q

Current ratio

A

= current assets / current liabilities

relevance of this ratio depends on perspective
creditors: high current ratio = current assets available to cover liabilities
Shareholders: high current ratio may mean too much money tied up in nonproductive assets

flag if wildly different from industry average

29
Q

Quick ratio

A

aka acid test ratio

= (current assets - inventories) / current liabilities
or
= (cash + short term investments+ net accounts receivable)/ current liabilities

measurement of firm’s ability to pay off short-term obligations without relying on the sale of inventories

if below 1 would have to sell inventory to pay off current liabilities if they were all called

30
Q

liquid asset

A

one that trades in an active market. Can be converted quickly to cash at the going price

31
Q

Financial leverage

A

ratio of total assets to common equity

the extent to which a firm uses debt financing

shows the factor by which ROA is scaled up to determine ROE

is the magnifying effect that debt has on ROE and shareholder risk

32
Q

implications of firm’s financial leverage

A
  • financing part of a firm with debt means shareholders can control a firm with smaller equity investments
  • shareholders returns magnified if assets generate higher pre-tax return than the interest rate on debt (conversely losses magnified if pre-tax ROA is below interest rate)
  • if a company has high leverage a small decline in performance may cause the firm’s value to fall below it’s total debt

ergo creditor’s position riskier as leverage increases

33
Q

Debt management ratios

A

aka leverage ratios

show:
- a firm’s use of debt relative to equity
- it’s ability to pay interest in principle

help judge likelihood of defaulting on deby

34
Q

debt-to-assets ratio

A

aka debt ratio

= total debt/ total assets

percentage of funds provided by investors other than preferred or commDeon shareholders

35
Q

Debt-to-equity ratio

A

= total debt / total common equity

(amount of debt for every dollar of equity)

36
Q

market value of equity

A

= stock price x number of shares

37
Q

market debt ratio

A

= total debt / (Total debt + market value of equity)

38
Q

liabilities to assets ratio

A

shows the extent to which a firm’s assets are NOT supported by equity

= total liabilities / total assets

39
Q

Equity multiplier

A

a set of rations that measure how effectively a firm is managing it’s assets (also asset management ratios)

= return on equity / return on assets

= (net income/ common equity) / (net income/ total asset)

the factor by which ROA is mulitipled to determine ROE

= 1/(1- liabilities-to-assets ratio)

40
Q

Times interest earned ratio

A

TIE ratio aka interest coverage ratio

= EBIT / interest expense

measures extent to which operating income can decline before the firm is unable to meet its annual interest costs

uses EBIT because interest is paid with pre-tax dollars.

41
Q

shortcomings of the TIE ratio

A
  • interest not the only fixed financial charge. need to pay down debt/ lease payments
  • EBIT is not all cash flow available to service debt (esp. if firm has high non-cash expenses)
42
Q

EBITDA coverage ratio

A

Takes all “cash” earnings into account and all financial charges

= (EBITDA + lease payments) / (Interest + principal payments + lease payments)

must add back in lease payments because it has already been removed from EBITDA but is part of financial charges

of most use to relatively short-term lenders (period where depreciation-generated funds can be used to service debt instead of going back into the plant and equiptment

43
Q

sinking fund

A

required annual payment designed to reduce the balance of a bond or preferred stock issue

44
Q

Market value ratios

A

relate a company’s stock price to it’s earnings, cash flow, and book value per share.

measure the value of a company’s stock relative to another company

45
Q

Price/Earnings ratio

A

P/E ratio
shows how much investors are willing to pay per dollar of reported profits

= price per share / earnings per share

compare to industry numbers

higher for firms with strong growth prospects

46
Q

Price/Free cash flow ratio

A

P/FCP

= price per share / free cash flow per share

pertinent because stock price depends on a company’s ability to generate free cash flow)

47
Q

Price/EBITDA ratio

A

= price / EBITDA

measure of operating performance that removes non-operating items (income/ taxes)

48
Q

Market/ book ratio

A

M/B ratio

indicator of how investors regard the company

= market price per share / book value per share

(aka market value of equity / total common equity reported in FS)

Market value: forward looking (expectations of future cash flows)
Book value: past looking (historical investments/ earnings)

49
Q

Book value per share

A

= Total common equity / shares outstanding

50
Q

Market capitalization

A

aka Market cap

total market value of equity in a company

= price per share x total number of shares

51
Q

Trend analysis

A

Examination of a single ratio over time

(can be compared against the trend in the industry on average)

52
Q

Common size analysis

A

all income statement items are divided by sales and all balance sheet items are divided by total assets

thus a common size income statement shows each item as a percentage of sales and a common size balance sheet shows each item as a percentage of total assets

facilitates comparisons of financial statements over time and across companies

53
Q

Percentage change analysis

A

calculates growth rates for all income statement items and all balance sheet accounts relative to a base year

54
Q

DuPont equation

A

a formula showing that the rate of return on equity can be found as the profit margin multiplied by the product of total assets turnover and the equity multiplier

ROE = PM * total asset turnover * equity multiplier

helps show how managerial actions affecting profitability, asset efficiency and financial leverage interact to determine return on equity

55
Q

Extended dupont equation

A

ROE = (net income / sales) * (sales/ total assets) * (Total assets / common equity)

(Same as ROE = Profit margin * total assets turnover * equity multiplier)

56
Q

ROE in terms of asset profitability and leverage

A

ROE = (net income/ total assets) x (total assets / common equity) = ROA * equity multipler

57
Q

Benchmarking

A

When a firm compares its rations to other leading (benchmark) companies in the same industry

58
Q

Potential problems with ratio analysis

A
  • industry averages are only somewhat meaningful to large firms that operate different divisions in different industries
  • goals for high-level performance better set against industry leaders than average ratios
  • inflation may distort firm’s balance sheets (historical cost vs replacement value)
  • distortion from seasonal effects (when balance sheet inventory closes), minimized by using monthly averages for inventory calculations
  • “window dressing” by firms
  • distortion from different choices of accounting methods
59
Q

Window dressing techniques

A

techniques employed by firms to make their financial statements look better than they really are

  • manipulation of timing for assets and liabilities
60
Q

qualitative questions for financial analysis

A
  • to what extent are the company’s revenues tied to one key customer or key product?
  • to what extent does the company rely on a single supplier?
  • what percentage of the company’s business is generated overseas?
  • what are the probable actions of current competitors and the likelihood of additional new competitors?
  • do the company’s future prospects depend critically on the success of products currently in the pipeline or existing products?
  • how do the legal and regulatory environments affect the company?

Financial Managment (11 decks)

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