Chapter 3: Financial Statements Analysis and Financial Models

Question 1

Common-Size Statements

Answer 1

A way of standardizing financial statements by expressing each item in the balance sheet as a percentage of total assets (balance sheet) or total sales (income statement) instead of total dollars.

Question 2

Financial Ratios

Answer 2

Used to compare and investigate the relationships between different pieces of financial information.

Question 3

Financial Ratio Categories

Answer 3

1. Shot-term solvency, or liquidity ratios
2. Long-term solvency, or financial leverage ratios
3. Asset management, or turnover ratios
4. Profitability ratios
5. Market value ratios

Question 4

Current Ratio

Answer 4

current assets / current liabilities
short-term liquidity ratio
should be at least 1

Question 5

Quick Ratio

Answer 5

(current assets - inventory) / current liabilities

short-term liquidity ratio

Question 6

Cash Ratio

Answer 6

cash / current liabilities

short-term liquidity ratio

Question 7

Total Debt Ratio

Answer 7

(total assets - total equity) / total assets
long-term liquidity ratio
includes all debts of all maturities to all creditors
The result gives the amount of debt for each dollar in assets & the remainder is equity.

Question 8

Times Interest Earned Ratio

Answer 8

EBIT / Interest
long-term liquidity ratio
measures how many times the company can cover its interest obligations

Question 9

Cash Coverage Ratio

Answer 9

(EBIT + depreciation & amortization) / Interest

long-term liquidity ratio

Question 10

Inventory Turnover

Answer 10

COGS / Inventory
turnover ratio
measures the number of times a company sold off their entire inventory during the year
higher ration means more efficiency

Question 11

Days’ Sales in Inventory

Answer 11

365 days / inventory turnover

measures average days inventory sits before being sold

Question 12

Receivables Turnover

Answer 12

sales / accounts receivable
turnover ratio
measures the number of times a company collected outstanding credit & lent the money again during the year

Question 13

Days’ Sales in Receivables

Answer 13

365 days / receivables turnover

measures average days a company collects on their credit sales

Question 14

Total Asset Turnover

Answer 14

sales / total assets
turnover ratio
the result gives the amount of sales generated from each dollar in assets

Question 15

Profit Margin

Answer 15

Net Income / sales
profitability measure
the result gives the amount of net income from every dollar in sales

Question 16

EBITDA Margin

Answer 16

EBITDA / Sales
Profitability measure
before-tax operating cash flow

Question 17

Return on Assets

Answer 17

net income / total assets
profitability measure
measures the amount of profit per dollar in assets

Question 18

Return on Equity

Answer 18

net income / total equity
profitability measure
the result gives the amount of profit for each dollar in equity

Question 19

Earnings per Share

Answer 19

net income / shares outstanding

market value measure

Question 20

Price-Earnings Ratio

Answer 20

price per share / earnings per share
market value measure
measures how much investors are willing to pay per dollar for current earnings
higher number means better prospects for future growth

Question 21

Market-to-Book Ratio

Answer 21

market value per share / book value per share
market value measure
compares the market value of investments to their cost

Question 22

Market Capitalization

Answer 22

price per share x shares outstanding
market value measure
Lets a potential buyer of the company know the minimum amount of money it would cost.

Question 23

Enterprise Value

Answer 23

market capitalization + market value of interest-bearing debt - cash
market value measure
Gives a more complete estimate of how much it would take to buy out a company’s shares and debt

Question 24

DuPont Identity

Answer 24

ROE = profit margin × total asset turnover × equity multiplier
Tells us that ROE is affected by 3 things:
1. Operating efficiency (measured by profit margin)
2. Asset use efficiency (measured by total asset turnover)
3. Financial leverage (measured by the equity multiplier)