Chapter 3: Fundamental Interpretations Made from Financial Statement Data Flashcards
ratio
the relationship between two numbers
trend analysis
evaluation of selected data over time / compares a single observation over several years
rate of return calculation (ROR)
amount of return / amount investment
*time assumed to be 1 year, so if not a year convert it
[return on an investment alternative; the higher the ROR the more profitable the alternative]
interest calculation
principal x rate x time (income or expense from borrowing money)
return on investment (ROI) calculation
net income / average total assets
OR
operation income / average operating assets
return on investment (ROI)
rate of return that management was able to earn on the assets it had available to use during the year (most important measure of profitability)
DuPont Model
ROI = margin X turnover
margin = net income / sales turnover = sales / average total assets
[inversely related]
DuPont Model rationale
profitability from sales (margin) and utilization of assets (turnover) to generate sales revenue were both important factors to be considered when evaluating a company’s overall profitability
margin
[net income / sales] from every dollar of sales revenue, some amount must work its way to net income
turnover
[sales / average total assets] efficiency with which the firm’s assets are used in the revenue-generating process
average ROI based on net income (merchandising and manufacturing)
8-12%
return on equity (ROE) calculation
net income / average stockholder’s equity
average ROI (merchandising and manufacturing)
12-18%
liquidity
a firm’s ability to meet its current obligations and is measured by relating its current assets and current liabilities as reported on the balance sheet [enough cash to pay debt]
3 ways liquidity is measured
1) working capital 2) current ratio 3) acid-test ratio
working capital
current assets - current liabilities (excess of assets over liabilities)
current ratio use
to judge a company’s current bill-paying ability
current ratio calculation
current assets / current liabilities (2.0 considered adequate liquidity)
acid-test (quick) ratio calculation
[cash (including temporary cash investments) + accounts receivable] / current liabilities
(1.0 considered adequate liquidity; more conservative)
acid-test (quick) ratio
provides information about an almost worst-case situation—the firm’s ability to meet its current obligations even if none of the inventory can be sold
interest: principal
amount invested or borrowed
interest: rate
interest rate per year expressed as a percent
interest: time
length of time/years the funds are invested or borrowed
balance sheet equation
assets = liabilities + stockholder equity
