financial analysis

Question 1

Ratio analysis

Answer 1

Analysis used to evaluate financial statements

Question 2

Liquidity ratios

Answer 2

Show the ability of a firm to meet its short-term obligations (1 year)
The types are:
current ratio
quick ratio
cash ratio
working capital

Question 3

Asset management ratios

Answer 3

How efficiently a firm manages its assets.
The types are:
Accounts Receivable Turnover
Days Sales Receivables (collection period)
Inventory Turnover
Days sales outstanding 
fixed asset turnover
Total asset turnover

Question 4

Debt management ratios

Answer 4

How the firm has financed its assets as well as the ability to repay long-term debt. 
The types are:
Debt ratio
Times interest earned
Debt-to-equity
y

Question 5

Profitability ratios

Answer 5

How profitably the firm is operating and utilizing its assets. 
The types are:
Return on assets (roa)
return on equity (roe)
operating margin 
return on common equity

Question 6

Enterprise value

Answer 6

Measures the entire economic/value of a firm. More specifically, it is the takeover price that an investor would pay if he were to acquire the company.
Market capitalization + Total Debt + Preferred Stock - Cash

Question 7

Market value ratios

Answer 7

are used to analyze a stock price and give us an idea what investors think about the firm and its future prospects. 
The types are: 
earnings per share (EPS)
price to earnings  p/e
price to book
ptice to sale
dividend yield

Question 8

current ratio

Answer 8

ratio used to check whether a company will be able to meet its short-term obligations.
current assets/current liabilities.
Creditors use this ratio in determining whether or nor to make a short-term loan.
The industry average is 4.2, it is interpreted as: for every dollar in liabilities you have 4.2 dollars in assets.

Question 9

Quick (acid test) ratio

Answer 9

Measures the liquidity of a business, or the ability of said company to come up with cash in a matter of hours or days. That is why it excludes inventory from the calculations. (current assets - inventories =quick assets) What is left are assets that can be converted to cash immediately. Inventory is not really a liquid asset, except in some industries.
current assets - inventory / current liabilities.

Question 10

How do you interpret the quick ratio result?

Answer 10

If the result is 1.2, it means for every dollar in liabilities 1.2 are available in quick assets.

Question 11

Financial statements are used most of the time by creditors and tax collectors, nor for managers and stock analysts. Therefore, corporate decision makers and security analysts often modify information to meet their needs. The most important modification is the free cash flow which is….

Answer 11

The amount of cash that could be withdrawn from a firm without harming its ability to operate and to produce future cash flows, in other words, how much money the firm distributes to investors.

[EBIT(1 -T) + Depreciation and amortization] - [Capital expenditures + change in net operating working capital]

Question 12

[EBIT(1-T) + Depreciation and Amortization]

Answer 12

Represents the amount of cash that the firm generated from its current operations.

Question 13

EBIT(1-T)

Answer 13

Often referred as NOPAT, it means the profit a company would generate if it had no debt and only operating assets.

Question 14

[Capital expenditures + change in net operating working capital]

Answer 14

Indicates the amount of cash that the company is investing in its fixed assets and operating working capital in order to sustain its ongoing operations.

Question 15

Net operating working capital

Answer 15

current assets - non-interest bearing current liabilities (current liabilities - notes payable).

Question 16

Market value added

Answer 16

Performance measures invented by financial analysts to reflect market values which is the difference between market value of equity and the book value

Question 17

Why do capital expenditures increase assets (PP&E), while other cash outflows, like paying salary, taxes, etc., do not create any asset, and instead instantly create an expense on the income statement that reduces equity via retained earnings?

Answer 17

Capital expenditures are capitalized because of the timing of their estimated benefits – the lemonade stand will benefit the firm for many years. The employees’ work, on the other hand, benefits the period in which the wages are generated only and should be expensed then. This is what differentiates an asset from an expense.

Question 18

Is it possible for a company to show positive cash flows but be in grave trouble?

Answer 18

Yes, lack of revenue in current and future operations and not being able to borrow debt and delaying current debt

Question 19

How is it possible for a company to show positive net income but go bankrupt?

Answer 19

By lending money to borrowers unlikely to pay and borrowing more money without having any way to pay it. So, by a lower working capital

Question 20

How is the income statement linked to the balance sheet?

Answer 20

Net income goes directly to retained earnings.

Question 21

Working capital

Answer 21

Measure used to know the financial condition of a company, short-term. It basically tells if the company will be able to meet its short-term liabilities with its short-term resources (assets). Current assets - current liabilities

Question 22

A higher working capital means…

Answer 22

the less strained the company is financially

Question 23

Types of financial ratios

Answer 23

• Liquidity
• Debt
• Profitability
• Asset Management
• Market value
• Solvency

Question 24

Accounts Receivable Turnover

Answer 24

ratio that measures how many times a business can turn its accounts receivable into cash during a period. In other words, the accounts receivable turnover ratio measures how many times a business can collect its average accounts receivable during the year.
net credit sales / average accounts receivable.
The faster it can collect its receivables the more turns of its receivables, the better.

Question 25

Inventory turnover

Answer 25

This financial ratio tells an investor how many times a business turns its inventory over a period of time. It allows you to see if a company has too many of its assets tied up in inventory and is heading for financial trouble
Sales/Average Inventory

Question 26

Total asset turnover

Answer 26

Measures turnover of all assets.
Sales / average total assets
the higher a company’s asset turnover, the lower its profit margins tend to be (and visa versa). This is because many businesses adopt a low-margin, high-volume approach that can result in rapid growth and economies of scale.

Question 27

Discounted cash flow

Answer 27

A valuation method used to estimate the attractiveness of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one.
Calculated as : DCF: CF1/(1+R) +CF2/(1+R)^2+…CFN/(1+R)^N

Question 28

What financial statement is not used to analyze a bank financials?

Answer 28

The cash flow statement, Because, in the case of a bank, cash is stock in trade, meaning it is just a medium to get the assets that make money, so cash cannot be counted.

Question 29

Statement of cash flows

Answer 29

Accounting report that shows how much cash a firm is generating. It shows how items that affect the balance sheet and income statement affect the firm’s cash flows

Question 30

ex-dividend date

Answer 30

A classification of trading shares when a declared dividend belongs to the seller rather than the buyer. A stock will be given ex-dividend status if a person has been confirmed by the company to receive the dividend payment.
A stock trades ex-dividend on or after the ex-dividend date (ex-date). At this point, the person who owns the security on the ex-dividend date will be awarded the payment, regardless of who currently holds the stock. After the ex-date has been declared, the stock will usually drop in price by the amount of the expected dividend.

Question 31

Formula for recognizing whether the stock is in a bullish or a bearish trend?

Answer 31

• Yahoo Finance
• Select company
• Select 3 month chart
• Add 200 days moving average

Question 32

Net present value

Answer 32

The value of a project, or the present value of a project’s free cash flows discounted at the cost of capital. The larger the NPV, the more value it adds; and added value means higher stock price.

Question 33

Summary for NPV independent and mutually exclusive projects

Answer 33

• Independent projects: If NPV exceeds zero, accept the project.
• Mutually exclusive projects: Accept the project with the highest positive NPV, if no project has positive NPV, reject them all.

Question 34

IRR

Answer 34

Is the internal rate of return, it is an estimation of a project’s rate of return. It forces a project NPV to equal zero.

Question 35

When IRR is used to rank projects, the decision rules are:

Answer 35

Independent projects. If IRR exceeds project’s WACC, accept the project. If IRR is less than WACC, reject it.
Mutually exclusive projects: Accept the project with the highest IRR, provided that IRR is greater than WACC. Reject all projects if the best IRR does not exceed WACC.

Question 36

Capital budgeting

Answer 36

Process of analyzing projects and deciding which ones to include in the capital budget

Question 37

Companies use the following types of capital budgeting to accept or reject projects:

Answer 37

NPV
IRR
MIRR
Payback
Discounted Payback

Question 38

Why is NPV the best method?

Answer 38

It addresses the central goal of financial management, maximizing shareholder wealth.

Question 39

net profit margin

Answer 39

The net profit margin tells you how much money a company makes for every $1 in revenue. Companies with higher net profit margins can often offer better benefits, heftier bonuses, and fatter dividends.

Question 40

The NPV calculation is based on the assumption that cash flows can be reinvested at __________, whereas IRR calculations is based on the assumption that cash flows can be reinvested at__________

Answer 40

WACC, IRR

Question 41

Why do you include the 200 day moving average?

Answer 41

It’s used to know whether a stock is in a bullish or a bearish trend, if it is trading above the 200 day moving average, it is in a bullish trend.

Question 42

leverage is

Answer 42

the use of debt

Question 43

present value

Answer 43

the value today of future cash flows: (how much money you need now to achieve x amount in the future).

Question 44

modified internal rate of return

Answer 44

Similar to the IRR except that it is based on the assumption that cash flows are reinvested at WACC.
The discount rate at which the present value of a project’s cost is equal to the present value of its terminal value, where the terminal value is found as the sum of future values of the cash inflows, compounded at the firm’s cost of capital.

Question 45

The IRR supposedly provides the expected rate of return; the problem is that the IRR is based on the assumption that the project’s cash flows can be reinvested at IRR. This assumption is incorrect, and this causes the IRR to overstate the project’s true return. Is there something better that regular IRR? Yes, and it is

Answer 45

modified internal rate of return MIRR

Question 46

How does a comparable company analysis work?

Answer 46

Find a company with similar characteristics

The entire concept of comparable company analysis is revolving around finding a company that is similar to the one being analyzed. This mostly includes companies in the same industry and sector, but also companies that operate at a similar capacity.

So the first part of the answer is, “find a set of companies in the same industry and area that are close to the same size.”

Step 2: Compare ratios between the company and the peer group

The second part of the answer is this, “Go through annual reports and then create a spreadsheet list ratios such as earnings per share, price-to-earnings, EBITDA, and market cap. Then analyze between the original company and its peers.”

Question 47

Walk me through a discounted cash flow analysis

Answer 47

A discounted cash flow model, or DCF, attempts to value a company based on the present value of its future cash flows, as well as the present value of its terminal value.

The discount rate is determined most commonly by the weighted average cost of capital, or WACC.

Here is how you calculate WACC in a DCF model: Cost of Equity * (% Equity) + Cost of Debt * (% Debt) * (1 – Tax Rate) + Cost of Preferred * (% Preferred).

Here is more detail on discounted cash flow models.

Question 48

payback period

Answer 48

Number of years required to recover the funds invested in a project from its cash flows.

Question 49

The payback period has 3 flaws:

Answer 49

• All dollars received in different years are given the same weight.
• Cash flows beyond the payback year are given no consideration regardless of how large they might be.
• They payback only tells when the initial investment will be recovered.

Question 50

To counter the fact that the payback period gives dollars the same weight analysts developed the discounted payback. The discounted payback is

Answer 50

the length of time required for an investment’s cash flows, discounted at the investment’s cost of capital, to cover its cost.

Question 51

Although the payback methods have faults as ranking criteria, they do provide information about liquidity and risk. So, the shorter the payback, the _________ the project’s liquidity.

Answer 51

Greater

Question 52

price to earnings

Answer 52

One of the most popular and important ratios.
It tells the investor whether a stock is expensive or cheap.
the p/e ratio is the price an investor is paying for $1 of a company’s earnings or profit. In other words, if a company is reporting basic or diluted earnings per share of $2 and the stock is selling for $20 per share, the p/e ratio is 10 ($20 per share divided by $2 earnings per share = 10 p/e).

The P/E is a quick way to look at the valuation of a stock. One way to view it is as how many years it would take for you to recover your investment principal from the earnings a company generates, assuming no change in those earnings. For - See more at: http://wiki.fool.com/P/E_ratio#sthash.rDLV7gib.dpuf
price per share/earnings per share

Question 53

earnings per share

Answer 53

The term earnings per share (EPS) represents the portion of a company’s earnings, net of taxes and preferred stock dividends, that is allocated to each share of common stock. The figure can be calculated simply by dividing net income earned in a given reporting period (usually quarterly or annually) by the total number of shares outstanding during the same term. Because the number of shares outstanding can fluctuate, a weighted average is typically used.
net income - preferred dividends / shares of commo stock outstanding

Question 54

debt-to-equity ratio

Answer 54

A measure of a company’s financial leverage calculated by dividing its total liabilities by stockholders’ equity. It indicates what proportion of equity and debt the company is using to finance its assets.
Total liabilities / shareholder’s equity

Question 55

A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in

Answer 55

volatile earnings as a result of the additional interest expense.

Question 56

ROA

Answer 56

An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company’s annual earnings by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as “return on investment”.
net income/ total assets.

Question 57

Why is the discount rate that causes an NPV to equal zero so important?

Answer 57

The reason is that the IRR is an estimate of the project’s rate of return. If this return exceeds the cost of funds used to finnce the project, the difference will be an additional return that goes to the firm’s stockholders and causes the stock price to ris

Question 58

return on equity (ROE)

Answer 58

Return on equity (ROE) is a measure of profitability that calculates how many dollars of profit a company generates with each dollar of shareholders’ equity. The formula for ROE is:
ROE = Net Income/average Shareholders’ Equity.
ROE is sometimes called “return on net worth.”

Question 59

why is roe important?

Answer 59

ROE is more than a measure of profit; it’s a measure of efficiency. A rising ROE suggests that a company is increasing its ability to generate profit without needing as much capital. It also indicates how well a company’s management is deploying the shareholders’ capital. In other words, the higher the ROE the better. Falling ROE is usually a problem.

However, it is important to note that if the value of the shareholders’ equity goes down, ROE goes up. Thus, write-downs and share buybacks can artificially boost ROE. Likewise, a high level of debt can artificially boost ROE; after all, the more debt a company has, the less shareholders’ equity it has (as a percentage of total assets), and the higher its ROE is.

Some industries tend to have higher returns on equity than others. As a result, comparisons of returns on equity are generally most meaningful among companies within the same industry, and the definition of a “high” or “low” ratio should be made within this context.