Chapter 3 Working With Financial Statements Flashcards
What is the equation for a firm’s cash flow from assets?
Cash flow to creditors + Cash flow to owners
What is the statement of cash flows?
A statement depicting the cash sources and cash spending of a firm during a period of time.
What three categories represent possible changes on the statement of cash flows?
Operating activities, financing activities, investment activities
How is interest paid handled differently in accounting?
Interest paid usually goes under financing activities. However in accounting practices it is represented as an expense. And is deducted when net income is computed.
If our net purchase of fixed assets was $149 and we wrote off $276 worth in depreciation, how much cash did we spend on fixed assets?
$149 + $276 = $425
Does standard accounting practice express a change in cash on a per-share basis?
No
What is a common-size statement?
A standardized financial statement presenting all items in percentage terms. The statement of financial position is shown as a percentage of assets, and the income statement is shown as a percentage of sales.
In a common sized statement what is the total change usually set to due to the way the statement is set up
0%
What is a common-base year statement?
A standardized financial statement presenting all items relative to a certain base year amount
If we were using a common base year statement model, answer the following question:
Prufrock’s inventory rose from 393 to 422. If we pick 2019 as our base year how would we find the common size for inventory growth for 2020
2019 = 393
2020 = 422
422/393 = 1.07
All were looking for is the ratio that exhibits the change in a certain metric between whatever periods of time
1.07 implies that inventory grew by 7% from 2019 to 2020
What is combined common size and base year analysis?
By forming common size statements we eliminate the effect of overall growth and then we can apply the trend analysis.
Prufrock’s accounts receivable were 165, 4.9% of total assets in 2019
Prufrock’s accounts receivable were 188, 5.2% of total assets in 2020
Give me a combined common size and base year analysis using this information
Prufrock’s accounts receivable grew by 188/165 = 1.14, 14%.
Whilst
Prufrock’s accounts receivable as a percentage of total assets grew by 5.2/4.9 = 6%
This tells us that 14-6 = 8% is attributable simply to growth in total assets.
Why is it often necessary to standardize financial statements?
To have a basis from which to use certain metrics and to have easy comparability between different firms
Name two types of standardized statements and describe how each is formed?
We got the common-size standardized statement which views all items as a % of total assets
We also have a common-base year standardized statement that views all items as % change based on a certain year that is picked as the base
What are some of the questions to ask ourselves when looking at financial ratios?
- How is it computed? (How are we actually getting the ratio)
- What is it intended to measure, and why might we be interested (what is the actual purpose of this ratio, and how is it useful for us)
- What might a high or low value be telling us and how might these values be misleading
(What are the base measurements we use to determine whether a certain ratio is good or bad and if it is appropriate to use in such a case - How could this measure be improved? (What other measures could I look at or how could I follow this measure further to discern more information)
What are the five categories of financial ratios?
- Short term solvency, Liquidity ratios
- Long term solvency, financial leveraging ratios
- Asset Management and turnover ratios
- Profitability ratios
- Market value ratios
Are the book and market values of assets usually similar?
Yes, and this makes using short term solvency / liquidity ratios very useful in the short term
What is the current ratio?
Current ratio = Current Assets / Current Liabilities
An organization’s measure of liquidity and its ability to cover its current liabilities. A higher ratios implies a better ability to cover liabilities.
However too high of a ratio can also mean inefficient use of cash and other short term assets
If company A has current assets of $1500 and current liabilities of $1000. What is the current ratio of that company and what does it imply?
1.5 and it implies that the company could cover its liabilities 1.5 times over
What is the Quick (Acid-test) ratio?
Quick ratio = Current Assets - Inventory / Current Liabilities
Since inventory is the least liquid asset as well as the one with the most chance of having inaccurate values. We remove it from the current assets pool to get a quick ratio.
When buying inventory using cash how are the current and quick ratios affected?
The current ratio is unaffected whilst the quick ratio gets smaller.
Since current ratio represents all assets while
quick ratio represents current assets - inventory
What is the cash ratio?
Cash ratio = (Cash + Cash equivalents) / Current liabilities
Shows us how much cash we actually have compared to all of our current liabilities
