Chapter 3: Working with Financial Statements Flashcards
Sources of Cash
a firm’s activities that generate cash
○ A decrease in an asset account or an increase in a liability (or equity) account is a source
Uses of cash
a firm’s activities in which cash is spent.
○ An increase in an asset account or a decrease in a liability or equity account is a use.
Statement of Cash Flows
A firm’s financial statement that summarizes its sources and uses of cash over a specified period of time.
Common-size statements
§ A standardized financial statement presenting all items in percentage terms. Statement of financial position is shown as a percentage of assets and income statements as a percentage of sales
§ Tells use what happens to each dollar in sales
Can be used for statement of cash flow with each item being expressed as a percentage of total sources or total uses. The results an then be interpreted as the percentage of total sources of cash supplied or as the percentage of total uses of cash for a particular item.
Common-Base Year Financial Statements – Trend Analysis
A standardized financial statement presenting all items relative to a certain base-year amount
Financial ratios–>
relationships determined from a firm’s financial information and used for comparison purposes.
Financial ratio’s are grouped in the following categories
Short-term solvency or liquidity ratios
Long-term solvency or financial leverage rations
Asset management or turnover ratios
Profitability ratios
Market value ratios
Short-term solvency or liquidity ratios
Current Ratio Quick Ratio Cash ratio Net working capital to total assets Interval measure
Current Ratio
Current Assets/Current Liabilities
Quick Ratio
= current assets-inventory/Current liabilities
® Inventory is not very liquid (most often the least liquid), means short-term trouble (over produced or overbought
Cash ratio
= (cash+ cash equivalents)/ current liabilities
Net working capital to total assets
= net working capital/total assets
Interval measure
= current assets/average daily operating costs
Long-term solvency or financial leverage rations
-Intended to address the form’s long-run ability to meet its obligations (financial leverage)
Total debt ratio Debt/equity ratio Equity multiplier Long-term debt ratio Times interest earned (TIE) Cash coverage ratio
Total debt ratio
= (total assets-total equity)/total assets
® Takes into account al debts of all maturities to all creditors
Debt/equity ratio
= total debt/total equity
Equity multiplier
= total assets/total equity
Long-term debt ratio
= long-term debt/ long term debt + equity
Times interest earned (TIE)
= EBIT/interest
Measures long term solvency
Cash coverage ratio
= (EBIT+ Depreciation)/Interest
Asset management or turnover ratios
Intended to describe how efficiently or intensively a firm uses its assets to generate sales
Inventory turnover Days' sales in inventory Receivables turnover Days' sales in receivables NWC turnover Fixed asset turnover Total asset turnover
Inventory turnover
= cost of goods sold/inventory
® If we know how many times inventory was turned over we can use the next formula to see how long it took us to turn it over
Days’ sales in inventory
= 365 days/inventory turnover
Receivables turnover
= sales/accounts receivable
How fast we collect , we can then covert it into days using the next ratio
Days’ sales in receivables
= 365 days/receivables turnover
NWC turnover
= sales/NWC
® Measures how much work we get out of our working capital
Fixed asset turnover
= sales/net fixed assets
For every dollar we have in fixed assets we generate x amount of sales
Total asset turnover
= sales/total assets
® For every dollar in assets we generate x amount of sales
Profitability ratios
Intended to measure how efficiently the firm uses its assets and how efficiently the firm manages its operations
Profit margin
Return on assets
Return on equity
Profit margin
= net income/sales
Generation of profit for every dollar of sales
Return on assets
= net income/total assets
Measure of profit per dollar of assets
Return on equity
= net income/total equity
How shareholders fared during the year
Market value ratios
- Earnings per share (EPS)
- Price earnings ratio
- PEG Ratio
- Market to book ratio
- Enterprise value/earnings before interest, tax, depreciations, and amortization (EV/EBITDA multiple
-Earnings per share (EPS)
)= net income/shares outstanding
-Price earnings ratio
= prices per share/earnings per share
® How much the company sells that share times the earning of that share
-PEG Ratio
= P/E ratio/ expected future earnings growth rate*100
-Market to book ratio
=market value per share/book value per share
® Book value is total equity/number of shares outstanding
-Enterprise value/earnings before interest, tax, depreciations, and amortization (EV/EBITDA
= (Market value of equity + market value of interest bearing debt-Cash(and cash equivalents)/ EBITDA
Du Pont Identity–>
Popular Expression breaking ROE into three parts: Profit margin, total asset turnover, and financial leverage
Du Pont Identity-Tells us that ROE is affect by three things
- Operating efficiency (measure by profit margin)
2. Asset use efficiency (measured by asset turnover
3. Financial leverage (measured by equity multiplier
Weakness in either operating or asset use efficiency shows up in a diminished return on assets, which translates to a lower ROE
Why Evaluate Financial Statements ?
- Internal uses
○ Performance evaluations
○ Comparisons of divisions through performance
○ Explore the next chapter for the future- External uses
○ Potential creditors and investors
○ If you need a loan you may have to submit a form
○ Ratio analysis to see how competition is doing
○ Thinking about acquiring another firm.
- External uses
Choosing a Benchmark
-How to we choose a benchmark or standard of comparison
- Time trend analysis
○ Use of history (look on past financial statements- Peer Group analysis - identify firms that are similar in the sense that they compete in the same markets., have similar assets, and operate in similar ways
