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CFI > Financial analysis fundamentals > Flashcards

Financial analysis fundamentals Flashcards

1
Q

What are the three ratios that drive ROE?

A

Net profit margin, total asset turnover ratio, and financial leverage

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2
Q

What is the formula for ROE?

A

ROE = Net income / Shareholders equity

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3
Q

What is the formula for net profit margin?

A

Net profit margin = Net income / sales

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4
Q

What is the formula for total asset turnover?

A

Asset turnover = Sales / Assets

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5
Q

What is the formula for financial leverage (in the context of the 3 ratios driving ROE)?

A

Financial leverage = Assets / Equity

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6
Q

What are the 3 major profitability ratios from the income statement?

A

Gross profit margin, operating profit margin (or EBIT), and net profit margin

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7
Q

What is the conceptual difference between gross profit margin and operating profit margin?

A

Gross profit margin includes direct costs only; operating includes direct + indirect

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8
Q

What are the 3 major indirect costs?

A

R&D, marketing, SG&A

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9
Q

Is depreciation/amortization a direct cost, an indirect cost, or both?

A

Can be both

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10
Q

What is the formula for gross profit margin?

A

Gross profit / Revenue

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11
Q

What is the formula for operating profit margin?

A

Operating profit margin = EBIT / Revenue

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12
Q

What is the formula for net profit margin?

A

Net profit margin = Net income / Revenue

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13
Q

What is the formula for the tax ratio?

A

Tax ratio = tax expense / Pre-tax income

Pretax income is also known as EBT (EBIT with interest added back in)

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14
Q

What is the most common formula for interest coverage ratio? How is it sometimes modified?

A

Interest coverage ratio = EBIT / interest expense

It may be modified to EBITDA / interest expense

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15
Q

What is the consequence of using EBITDA rather than EBIT in the interest coverage ratio?

A

It makes the ratio more aggressive (i.e., appears more solvent). EBITDA exceeds DA because it is higher on the income state/hasn’t subtracted DA expenses, which means higher numerator, which means higher ratio, which means the company looks more solvent

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16
Q

What is the formula for the current ratio?

A

Current ratio = Current assets / current liabilities

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17
Q

What is included in current assets? What modifications need to be made?

A

Current assets include cash, accounts receivable, inventory, and prepaid expenses.

Some of these need to be discounted.

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18
Q

What are examples of common prepaid expenses?

A

Insurance policies, subscriptions paid for, and any other expense paid in advance of when work is completed

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19
Q

What two interpretations can you make from a high current ratio (one good, one bad)?

A

Good - strong liquidity position

Bad - potentially underutilizing assets. Rather than sitting idle, they could be reinvested into noncurrent assets or (if cash) distributed to shareholders

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20
Q

What is the formula for the quick ratio and what is it colloquially known as?

A

Colloquially called the acid test.

Quick ratio = (Current assets - inventory) / Current liabilities

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21
Q

Distinguish the current ratio from the quick ratio

A

The quick ratio excludes inventory from current assets, decreasing the numerator and thus making it a more conservative figure

22
Q

What are the rules of thumb for good current and quick ratios, respectively?

A

Current ratio - 2:1, subject to industry difference (as high as 3:1 or 4:1)

Quick ratio - 1:1

Both should consider industry norms

23
Q

What are the 3 main working capital efficiency ratios and their counterparts?

A

The main ones are the turnover ratios:
Inventory turnover ratio
Accounts receivable turnover ratio
Accounts payable turnover ratio

Their counterparts are the “days” ratios

24
Q

How are the 3 working capital efficiency ratios calculated?

How to convert them to their days ratios?

A

Inventory turnover ratio = COGS / Inventory
Receivable turnover ratio = Sales / Receivables
Payable turnover ratio = COGS / Payables

To convert to days, flip numerator and denominator, and multiply new numerator by 365

25
Q

What do the 3 main working capital efficiency ratios have in common in terms of data source?

A

They divide an income statement item by a balance sheet item

The reverse is true (for each) for their days ratios

26
Q

1) What is the funding gap formula?

2) Is it better to be higher or lower?

A

1) Funding gap = Inventory days - payable days + receivable days
2) Lower is better

27
Q

What are the first 3 steps of constructing a cash flow statement?

A

1) Take net income
2) Add back in noncash expenses (such as depreciation, stock-based compensation, and impairment charges)
3) Adjust for changes in working capital

28
Q

In constructing a cash flow statement, why are noncash expenses added back?

A

Because they were deducted to reach net income in the P&L

29
Q

What is the formula for free cash flow?

A

Free cash flow = Cash flow from operating activities minus capex

30
Q

What are the 3 main categories to evaluate management on in the cash flow statement?

A

1) Asset management (capital invested in or pulled out of working capital, capex vs. depreciation/amortization)
2) Operational management (direction of change of operating cash flow)
3) Financing strategy (capital structure optimization)

31
Q

What is an analytical balance sheet?

A

A re-cut of the balance sheet to show net assets and capital employed over time

32
Q

How are net assets and capital employed calculated?

A

Net assets = Total assets - current liabilities

Capital employed = (Noncurrent liabilities) + equity + (current portion of long-term debt) + (short term debt or interest bearing liabilities)

33
Q

What are the 2 short-term working capital gap funding options?

A

Overdrafts, operating lines of credit

34
Q

What is the difference between how revolving and term loans are typically used?

A

Revolving typically for working capital, term typically for purchase of fixed assets like PP&E

35
Q

What’s the difference between a warrant attached to a bond and a convert in 1) cash flow to the company and 2) usage by company type?

A

1) Bonds + warrants have either 1 or 2 series of cash flows (first is cash received for bond sale, second is cash received for stock issuance if warrant is exercised). Converts have only 1 cash flow (the bond sale), so less investment from investor, but issuer doesn’t need to make payments on the bond anymore
2) Bonds + warrants more common with private companies

36
Q

1) Is the maturity of a syndicated loan generally short, medium, or long?
2) Is the interest rate of a syndicated loan typically fixed or floating?

A

1) Medium

2) Floating

37
Q

What are standby facilities used for?

A

Extraordinary circumstances, such as backstopping a commercial paper program

38
Q

How do capital leases and operating leases differ in terms of 1) goals, 2) duration, 3) economic risk and reward transfer, 4) accounting treatment?

A

1) Capital leases are typically a way to finance acquisition of an asset without involving an intermediary, while operating leases are to obtain use of an asset until no longer required or useful and then returned
2) Capital leases typically longer-term
3) Capital leases transfer most economic risks and rewards to lessee, operating leases do not
4) Capital leases are recorded as assets offset by a liability obligation; operating leases are not recorded on balance sheet (instead on P&L as an expense)

39
Q

Companies typically need to have one of these two things to tap debt markets

A

History of profitability or pledgeable assets

40
Q

3 properties of common shares

A

No guarantee of dividend, confer voting rights, last to be paid on liquidation

41
Q

What distinguishes preferred shares from common?

A

Entitled to a specified rate of dividend, similar to debt (but no tax deductible like interest)

42
Q

What are the three main benefits of using debt rather than equity for financing?

A

1) Quick and inexpensive (for bank loans) vs. issuing equity
2) Can time loan to match duration of asset
3) Doesn’t dilute equity investors

43
Q

Debt to equity, debt to total capital, and debt to tangible net worth all use which item(s) in their numerator?

A

Interest-bearing liabilities

44
Q

What’s the key item is included in the total liabilities to equity ratio that is excluded in the debt to equity ratio?

A

Total liabilities to equity includes accounts payable

45
Q

What is the most commonly used leverage ratio for financial covenants? Why is it a bit misleading?

A

Debt to EBITDA

It allegedly shows cash available to pay liabilities (or otherwise as a proxy for cash flow), but it’s a P&L item not a cash flow item (and excludes capex and changes in working capital)

46
Q

What are the three secondary profitability ratios in pyramid analysis?

A

Tax impact, capital structure impact, and margin impact

47
Q

How are tax impact, capital structure impact, and margin impact calculated?

A

Tax impact = NI / Pretax profit
Capital structure impact = Pretax profit / EBIT
Margin impact = EBIT / sales

When all are multiplied together, pretax profit and EBIT cancel each other out, leaving net profit margin (NI / sales)

48
Q

What are the two secondary efficiency ratios?

A

PP&E turnover ratio and working capital turnover ratio

49
Q

How are the two secondary efficiency ratios calculated?

A

PP&E turnover ratio = Sales / PP&E

Working capital turnover ratio = Sales / Working capital

50
Q

What are the three secondary leverage ratios?

A

Debt to equity ratio, liabilities to equity ratio, and assets to equity ratio

51
Q

What are the 4 factors that drive ROE (and its components)? What is the notable omission?

A

Revenue, net income, equity, total assets

Debt is the notable omission as it’s not needed to calculate ROE, net profit margin, asset turnover, or financial leverage

CFI (1 decks)

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