FInancial accounting cours 9 Flashcards
Describe financial ratios.
- They are relative values (size effects do not bias them).
- They provide an objective view of a company for external users.
- They allow benchmarking with other companies in the same industry.
- They allow a comparative analysis of the financial evolution of a company from one year to the next.
What are performance ratios?
They measure the profitability of the entity’s operating activities in relation to sales, assets, and equity.
What are activity ratios?
They measure the quality of operational management (profit margins, cost control, etc.)
What are financing ratios?
They evaluate the long-term financial structure, and the use of external financing.
What are liquidity ratios?
They calculate the liquidity generated and the short-term solvency of the company.
Which statement reflects performance?
The statement of Profit or Loss.
Describe the gross profit margin.
- It indicates the proportion of sales that a company retains after covering costs directly related to sales.
- Provides information on pricing strategy and cost of sales control.
- This ratio is directly affected by the selling price and the cost of sales.
What is the formula for the gross profit margin?
Gross profits/Sales (%)
What can gross margin increases will indicate?
- Better inventory control.
- Reduced procurement costs.
- Reduction in the cost of purchasing/manufacturing goods.
- Increase in selling price.
What is the alternate way to find the gross profit?
In the note “cost of inventories expensed in the year”.
What is EBITDA?
Acronym for: Earnings before Interest, Taxes, Depreciation, and Amortization.
What does EBITDA indicate?
It is a performance indicator that is not affected by management choices concerning investment and financing, or by taxation.
What is EBIT?
Earning Before Interest and Taxes.
What does EBIT indicate?
It is a performance indicator that is not affected by financing choices or taxation.
What does the operating margin do?
Provides information on the % of operational profitability taking into account operating costs only.
How do you have an operating margin excluding interest and income tax expenses?
EBIT/sales revenue (%)
How do you have an operating margin excluding interest, income tax, depreciation, and amortization expenses?
EBIT/Sales revenue (%)
Describe the net profit margin.
- It indicates the proportion of sales that turn into profit.
- It shows what each $ of sales generates in net income.
- It shows links can be made to cost management and also to pricing policy.
- This ratio is highly dependent on the sector of activity.
What is the formula for the net profit margin?
Net income/Sales (%)
What is the return on assets (ROA)?
It indicates the company’s ability to generate results (or profits) from all its assets.
What does the ROA represent?
- It represents the return on the company’s resources.
- It represents the net income generated by each dollar of assets.
What is the formula of the ROA?
Net income/Total assets (%)
Describe the ROA in terms of $.
$ of net income generated by each $ invested in resources.
What is asset turnover? ($)
$ of sales generated by each $ invested in resources. It is a volume.
What is the formula for Asset Turnover?
Sales/Total Assets.
What is the Net Profit Margin? ($)
$ of net income generated by each $ of sale. It is the net margin.
What is the formula for the Net Profit Margin?
Net Income/Sales
What does return on assets equal?
Asset turnover*Net Profit Margin= Return on Assets
What is Return on Equity?
- It indicates the return to shareholders on their invested capital.
- It is possible to calculate ratios by type of shareholders (common or preferred).
What is the formula for the ROE?
Net income/shareholders’ equity (%)
Describe the Earnings per share (EPS).
- It allows the user of the financial statement to assess the impact of the company’s results on each outstanding share.
- It measures the portion of net income earned by each common share.
Can the EPS be compared to the industry?
No, because the number of shares outstanding differs from one company to another.
What happens to the EPS if a company ceases some of its activities during the fiscal year?
The EPS must be calculated before and after the discontinued operations.
Is the EPS present in financial statements?
Yes, it is mandatory under IFRS.
What is the formula of the EPS?
(Net income-Dividends on preferred shares)/(Weighted average number of common shares outstanding) ($)
Describe the diluted earnings per share.
- It measures the profit or loss attributable to each share outstanding or that could exist if all holders of dilutive instruments exercise them.
- It is the most pessimistic estimate possible for the registered pension plan.
Give examples of dilution instruments.
Stock options, convertible bonds, warrants, etc.
Give the formula of the diluted earnings per share.
(Net income - Dividends on preferred shares)/(Weighted average number of common shares outstanding + common shares if dilutive instruments were converted) ($)
What is the formula of the P/E ratio?
Share price/Earnings per share (it is a multiple)
Describe the Price-to-earnings ratio.
This ratio makes it possible to measure the performance of a company by the stock market valuation of its shares.
What is the interpretation of the P/E ratio?
How many times of earnings per share an investor is willing to pay for a share or how many years an investor is willing to wait to recover his capital?
