Chapter 3: Financial Statements and Ratio Analysis Flashcards
The statement of comprehensive income
provides a financial
summary of a company’s operating results during a specified
period.
- prepared annually for reporting purposes
- computed monthly by management
- quarterly for
tax purposes.
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The Statement of Financial Position
presents a summary of a firm’s
financial position at a given point in time
Assets
what the firm owns
Liabilities
what the firm has borrowed.
Equity
the owners’
investment
The Statement of Changes in Equity
- reconciles the net income
earned during a financial year and any cash dividends paid. - The change in retained earnings is between the start and end of
that year. - includes total amounts attributable to owners and non-
controlling interests
The Statement of Cash flows
- provide a summary of cash flows over
the period of concern, typically the year just ended. - provides insight in the company’s
investment, financing and operating activities - ties together
the statement of comprehensive income and previous and current
statement of financial positions.
ratio analysis
Involves methods of calculating
and interpreting financial
ratios to analyze and monitor
the firm’s performance.
cross-sectional analysis
Comparison of different firms’
financial ratios at the same
point in time; involves
comparing the firm’s ratios
to those of other firms in its
industry or to industry
averages.
benchmarking
A type of cross-sectional
analysis in which the firm’s
ratio values are compared to
those of a key competitor or
group of competitors that it
wishes to emulate.
time-series analysis
Evaluation of the firm’s
financial performance over
time using financial ratio
analysis
liquidity
A firm’s ability to satisfy its
short-term obligations as they
come due.
current ratio
A measure of liquidity
calculated by dividing the
firm’s current assets by its
current liabilities
Current ratio = Current assets/Current liabilities
quick (acid-test) ratio
A measure of liquidity
calculated by dividing the
firm’s current assets minus
inventory by its current
liabilities
Quick ratio = (Current assets- Inventory) / Current liabilities
activity ratios
Measure the speed with which
various accounts are converted
into sales or cash—inflows or
outflows
inventory turnover
Measures the activity, or
liquidity, of a firm’s inventory
Inventory turnover = Cost of goods sold / Inventory
average collection period
The average amount of time
needed to collect accounts
receivable
Average collection period = Accounts receivable / Average sales per day
= Accounts receivable / Annual sales / 365
average age of inventory
Average number of days’ sales
in inventory.
average payment period
The average amount of time
needed to pay accounts
payable.
Average payment period = Accounts payable / Average purchases per day
= Accounts payable / Annual purchases / 365
total asset turnover
Indicates the efficiency with
which the firm uses its assets to
generate sales.
Total asset turnover = Sales / Total asset
financial leverage
The magnification of risk and
return through the use of fixed
cost financing, such as debt
and preferred stock.
ability to service debts
The ability of a firm to make
the payments required on a
scheduled basis over the life of
a debt
degree of indebtedness
Measures the amount of debt
relative to other significant
balance sheet amounts.
coverage ratios
Ratios that measure the firm’s
ability to pay certain fixed
charges.
debt ratio
Measures the proportion of
total assets financed by the
firm’s creditors
Debt ratio = Total liabilities / Total assets
times interest earned ratio
Measures the firm’s ability to
make contractual interest
payments; sometimes called the
interest coverage ratio.
Times interest earned ratio = Earnings before interest and taxes / taxes
fixed-payment coverage
ratio
Measures the firm’s ability to
meet all fixed-payment
obligations.
Fixed
payment
coverage
ratio
=
( Earnings before interest and taxes + Lease payments) / (Interest + Lease payments)
+ {(Principal payments + Preferred stock dividends) x [1/(1- T)]}
net profit margin
Measures the percentage of
each sales dollar remaining
after all costs and expenses,
including interest, taxes, and
preferred stock dividends, have
been deducted
Net profit margin = Earnings available for common stockholders / Sales
operating profit margin
Measures the percentage of
each sales dollar remaining
after all costs and expenses
other than interest, taxes, and
preferred stock dividends are
deducted; the “pure profits”
earned on each sales dollar.
Operating profit margin = Operating profits / Sales
earnings per share (EPS)
represents the
number of dollars earned during the period on behalf of each outstanding share
of common stock
Earnings per share = Earnings available for common stockholders / Number of shares of common stock outstanding
market ratios
Relate a firm’s market value, as
measured by its current share
price, to certain accounting
values.
price/earnings (P/E) ratio
Measures the amount that
investors are willing to pay
for each dollar of a firm’s
earnings; the higher the P/E
ratio, the greater the investor
confidence
P/E ratio = Market price per share of common stock , Earnings per share
DuPont system of analysis
System used to dissect the
firm’s financial statements and
to assess its financial condition.
gross profit margin
Measures the percentage of
each sales dollar remaining
after the firm has paid for its
goods
Gross profit margin = Sales- Cost of goods sold / Sales
= Gross profits / Sales
return on common equity
(ROE)
Measures the return earned on
the common stockholders’
investment in the firm.
ROE = Earnings available for common stockholders / Common stock equity
return on total assets (ROA)
Measures the overall
effectiveness of management
in generating profits with its
available assets; also called the
return on investment (ROI).
ROA = Earnings available for common stockholders / Total assets
market/book (M/B) ratio
Provides an assessment of
how investors view the firm’s
performance. Firms expected
to earn high returns relative to
their risk typically sell at higher
M/B multiples.
Book value per share
of common stock
=
Common stock equity / Number of shares of common stock outstanding
