Chapter 5 Financial Analysis

Question 1

_____ and _____ drive firm value

Answer 1

PROFITABILITY and GROWTH

Question 2

What are the 4 levers managers can employ to achieve growth and profit targets?

Answer 2

Operating management
Investment management
Financing strategy
Dividend policy

Question 3

What kind of analysis is used to evaluate the firms effectiveness in the following?

Operating management
Investment management
Financing strategy
Dividend policy

Answer 3

Ratio analysis

Question 4

What are some of the comparison benchmarks used when evaluating ratios?

Answer 4

Ratios over time from prior periods (time series)

Ratios of other firms in the industry (cross-sectional)

Some absolute benchmark

Question 5

Effective ratio analysis must attempt to relate underlying ____ factors to the ______ numbers

Answer 5

business factors

financial numbers

Question 6

Return on _______ is a comprehensive performance indicator because it shows how well managers are employing the funds invested by the firm’s shareholders to generate returns.

(essentially, how well the company is using shareholders’ investment in the firm)

Answer 6

Equity

Question 7

Return on _______ signifies how good the company is in generating returns on the investment it received from its shareholders

(essentially, how well the company is using shareholders’ investment in the firm)

Answer 7

Equity

Question 8

true or false

To understand the extent to which the company’s return on invested capital results from its operating versus its non-operating activities we examine by DECOMPOSING the ROE.

Answer 8

true

Question 9

(traditional approach) ROE can be decomposed into

ROE = RO___ X ______ Leverage

Answer 9

Return on Assets

Financial Leverage

Question 10

RO___ tells you how much profit a company is able to generate for each dollar of assets invested

Answer 10

assets

Question 11

______ leverage indicates how much assets the firm is able to deploy for each dollar invested by its shareholders

Answer 11

Financial

Question 12

Identify the limitations of the traditional approach to decomposing a firm’s ROE.

Answer 12

The denominator includes the assets claimed by all providers of capital to the firm, but the numerator includes only the earnings available to equity holders.

The assets themselves include both operating assets and financial assets such as cash and short-term investments.

Net income includes income from operating activities as well as interest income and expense, which are consequences of financing decisions. Often it is useful to distinguish between these two drivers
of performance.

Financial leverage ratio used above does not recognize the fact that a firm’s cash and short-term investments are in essence “negative debt” because they can be used to pay down the debt on the company’s balance sheet.

Question 13

What are the 2 primary tools in financial analysis?

Answer 13

Ratio analysis

Cash flow analysis

Question 14

_____ ANALYSIS assesses how various line items in financial statements relate to each other and to measure relative performance.

Answer 14

RATIO

Question 15

____ _____ ANALYSIS evaluates liquidity and the management of operating, investing, and financing activities.

Answer 15

CASH FLOW

Question 16

a firm’s performance metrics are impacted by what 2 things?

1) ______ decisions: Product differentiation, pricing, customer credit…
2) ________execution: Cost control, reviews of existing stores, location of new stores…

Answer 16

Strategic

Management

Question 17

TRUE OR FALSE:

Regarding Cash Flow Analysis, all ratios using income statement numbers are based on accrual basis accounting.

Answer 17

TRUE

Question 18

Cash flow analysis can provide further insights into ______, ________, and _____ activities.
Since 1988, all U.S. companies are required to include a statement of cash flows in their financial statements.

Answer 18

OPERATING

INVESTING

FINANCIING

Question 19

Differences in reporting cash flow information allow for variation across firms that complicate comparisons.
Analysts can make adjustments to arrive at _____ cash flows, a commonly used metric for financial analysis.

Answer 19

FREE

Question 20

When decomposing net profit margins, common-sized income statements facilitate comparisons of key line items across time and different firms.
Additionally, the following ratios are also helpful:
_____profit margin
______ margin
____ margin
Recurring ___ margin

Answer 20

Gross Profit Margin
EBITDA margin
NOPAT margin
Recurrent NOPAT

Question 21

____ _____ margin = (Sales −Cost of sales)/Sales

Measures the profitability of sales, less direct costs of sales

Answer 21

gross profit margin

Question 22

A detailed analysis of _____ turnover allows the analyst to evaluate the effectiveness of a firm’s investment management.

Two primary areas of investment management

1) ____ ______ management
2) Management of _____-______ assets

Answer 22

ASSET

WORKING CAPITAL

LONG-TERM ASSETS

Question 23

______ capital is the difference between operating assets (≈current assets) and operating liabilities (≈current liabilities).

Answer 23

WORKING CAPITAL

Question 24

From working capital management perspective:

Lower Days’ Receivables is \_\_\_\_\_
Higher A/R Turnover is \_\_\_\_\_
Lower Days’ Inventory is \_\_\_\_\_\_
Higher Inventory Turnover is \_\_\_\_\_\_
Higher Days’ Payables is \_\_\_\_\_\_
Lower A/P Turnover is \_\_\_\_\_

Answer 24

better

Question 25

Cash Conversion Cycle which measures the length of time, in days, it takes for a company to convert resource inputs into cash flows.

Shorter CCC is ____ and can be negative

Answer 25

better

Question 26

Liquidity analysis relates to evaluating current liabilities Which of the following ratios to help evaluate liquidity?

Current ratio
Quick ratio
Cash ratio
Operating cash flow ratio
Gross profit margin
EBITDA margin
NOPAT margin
Recurring NOPAT margin

Answer 26

Current ratio
Quick ratio
Cash ratio
Operating cash flow ratio

The remaining relate to ratios used to decompose net profit margins.