Chapter 3 - GAAP Financial Statement Analysis Flashcards
The use of common-size statements to highlight basic relationships among items within a single set of financial statements.
Vertical analysis
An analysis that identifies patterns in losses and then projects these patterns into the future. Also a comparison of financial statement data across two or more periods.
Trend analysis
A financial analysis tool used to study the financial condition of an account; two or more data items from accounting records of a company are related to one another and the result is compared to the results for prior accounting periods or for similar businesses.
Ratio analysis
A financial statement in which amounts are reported as a percentage of a base figure.
Common-size statement
What are the four broad categories of financial ratios?
Efficiency, Liquidity, Leverage and Profitability
Name the three turnover ratios used to evaluate efficiency
Accounts Receivable Ratio, Asset Turnover Ratio, and Inventory Turnover Ratio
An efficiency ratio that indicates how quickly a business collects the amounts owed by its customers
Accounts Receivable Turnover Ratio = credit sales / accounts receivable
A measure of the number if days it takes, on average, for a company to collect its accounts receivable
Days sales outstanding = 365 / accounts receivable turnover ratio
An efficiency ratio that measures the use of assets to generate sales
Asset Turnover = Sales / Total Assets
Resources that can not be expected to be sold or consumed within the business’s normal operating cycle and that are usually considered to be long lived
Fixed Assets
An efficiency ratio that indicates how quickly inventory is sold, generating either cash (from cash sales) or accounts receivable (from credit sales)
Inventory Turnover Ratio = Cost of Goods Sold / Inventory
Indicates how well a company is performing and generating income
Efficiency Ratios
Refers to a company’s ability to convert assets to cash in order to satisfy obligations
Liquidity
A company’s current assets less current liabilities is its…
Working capital
The three main formulas or ratios used to measure liquidity
Working Capital, Current Ratio, Acid Test (Quick) Ratio
A liquidity ratio that indicates a company’s ability to meet its short-term financial obligations
Current Ratio = Current Assets / Current Liabilities
A liquidity ratio that provides a measure of a company’s ability to meet its current obligations if it can’t sell its inventory
Acid-test ratio (Quick Ratio) = (cash + marketable securities + accounts receivable) / current liabilities
A measure of the extent to which a company has borrowed money
Leverage
A leverage ratio that measures the extent to which a company is financed using borrowings rather than its own funds (owners’ equity)
Debt-to-equity Ratio = Long-term debt / shareholders’ equity
Can also = total liabilities / shareholders’ equity depending on industry
A leverage ratio that shows the extent to which a company’s assets are financed by debt
Debt-to-assets Ratio (or Debt Ratio) = total liabilities / total assets
A profitability ratio that measures the percentage of sales remaining after deducting all expenses that indicates how effective an insurer is at cost control
Net Profit Margin = Net income (after taxes) / sales
Gross profit / Sales is also sometimes used
A profitability ratio that shows how well a company has used its resources
Return On Assets (ROA) = net income / total assets
Some use the average of all assets at the end of a period as denominator
A profitability ratio that shows the rate of return that shareholders are earning on their equity in the company’s assets
Return On Equity (ROE) = net income / shareholders’ equity
Some use average of shareholder’s equity over a certain period as denominator
An analysis of ROA and ROE by breaking them down into their component ratios
DuPont Identity
ROA can be broken down into two component ratios. What are they?
- Net Profit Margin = net income / sales
Multiplied By - Asset Turnover Ratio = sales / total assets
ROE can be broken down into two component ratios. What are they?
- ROA = Net profit margin x asset turnover ratio
Multiplied By - Equity Multiplier = total assets / equity
Accounts receivable turnover ratio
Credit sales divided by accounts receivable.
Day sales outstanding
365/accounts receivable turnover ratio.
Asset turnover ratio
Sales/total assets
Inventory turnover ratio
Cost of goods sold/inventory
Working capital
Current assets - current liabilities
Current ratio
Current assets/current liabilities
Acid test ratio or quick ratio
(Cash + marketable securities + accounts receivable) / current liabilities
Debt to equity ratio
Long term debt / shareholder’s equity
Debt to assets ratio
Total liabilities divided by total assets
Equity multiplier
Total assets divided by shareholders equity
Net profit margin
Net income divided by sales
Return on assets
Net income divided by total assets
Return on equity
Net income divided by shareholders equity
Du Pont identity – return on equity
A profitability ratio
(Net income / by sales)
X (sales/Total assets)
X (Total assets/Shareholders equity)
