Financial Analysis Techniques Flashcards
What is a ratio?
It is a mathematical relationship between 2 quantities in terms of a percentage or proportion.
What are the insights that a financial ratio can give?
- It can give microeconomic relationships within the company that are used by analysts to project the company’s earnings and CF.
- It helps with understanding a company’s financial flexibility.
- It helps with the management’s ability.
- It helps to see the changes in the company and industry over time.
- It shows how the company compares to peer companies and the industry overall.
What is the common-size statement?
It allows one to compare a company’s performance with that of other firms and to evaluate its performance over time.
What is a common-size income statement?
It expresses all income statement items as a percentage of revenues.
What is a common-size balance sheet?
It expresses each item as a percentage of total assets. They are prepared to highlight changes in the mix of assets, liabilities, and equity.
What is a cross-sectional analysis?
It compares a specific metric for one company with the same metric for another company or group of companies over a period of time. It is also called a relative analysis.
What are horizontal common-size financial statements?
They show the account based on the dollar values of accounts divided by their base-year values to determine their common-size values.
What tool is used to facilitate comparisons of firm performance and financial structure over time?
Graphs
Why should you use a pie graph?
To illustrate the composition of a total value.
Why should you use a line graph?
To help identify trends and detect changes in direction or magnitude.
Why should you use a stacked common graph?
To illustrate the changes in various items over the period in graphical form.
Why should you use a regression analysis?
To identify relationships between variables over time and assist analysts in making forecasts.
What is the limitation of ratios?
- A same company can be in different industries which makes it hard for comparison.
- One set of ratios might suggest a general problem and another a more specific one for the same issue.
- There is no set range that the ratio must lie within
- There is a latitude in the accounting methods used by a company that changes the financial ratios.
- If a company has different divisions in another country it can be challenging to evaluate ratios because of the different accounting standards.
What is an activity ratio?
It measures how productive a company is in using its assets and how efficiently is performs its everyday operations.
What is a liquidity ratio?
It measures the company’s ability to meet its short-term cash requirements.
What is a solvency ratio?
It measures the company’s ability to meet its long-term debt obligations.
What are profitability ratios?
It measures a company’s ability to generate an adequate return on invested capital.
What are valuation ratios?
It measures the quantity of an asset or flow associated with ownership of a specific claim.
What is inventory turnover?
It evaluates the effectiveness of a company’s inventory management.
- A high inventory turnover ratio relative to industry norms might indicate highly effective management.
- A low inventory turnover relative to the rest of the industry can be an indicator of slow-moving or obsolete inventory.
What is the day of inventory on hand?
It is inversely related to the inventory turnover.
The higher the inventory turnover ratio, the shorter the length of the period that inventory is held on average.
Describe the receivables turnover ratio.
- If the ratio is high, it might indicate that the company’s credit collection procedures are highly efficient. It might also show overly stringent credit or collection policies.
- A low ratio relative to industry averages will raise questions regarding the efficiency of a company’s credit or collection procedures.
- The comparison can be dug deeper by analyzing the company’s sales growth with industry sales.
- An historical comparison can be made to evaluate if a low receivables turnover is the result of credit management issues.
What is the payable turnover ratio? Describe it.
It measures how many times a year the company theoretically pays off all its creditors.
- A high ratio indicates that the company is not making full use of available credit facilities and repaying creditors too soon.
- A low ratio can also result from a company successfully exploiting lenient supplier terms.
What is working capital turnover?
It indicates how efficiently the company generates revenue from its working capital.
The higher the working capital turnover ratio, the higher the operating efficiency is.
What is fixed asset turnover? Describe it.
It measures how efficiently a company generates revenues from its investments in long-lived assets.
- A higher ratio indicates more efficient use of fixed assets in generating revenue.
- A low ratio could be an indicator of operating inefficiency. It can also be the result of a capital-intensive business environment.
- The fixed asset turnover ratio will be lower for a firm whose assets are newer than for a firm whose assets are relatively older.
What is total asset turnover? Describe it.
It measures the company’s overall ability to generate revenues with a given level of assets.
- A high ratio indicates efficiency, while a low ratio can be an indicator of inefficiency or the level of capital intensity of the business.
- It can also identify strategic decisions by management.
What is the liquidity analysis of a company?
It is to evaluate a company’s ability to meet its short-term obligations. Liquidity measures how quickly a company can convert its assets into cash at prices that are close to their fair values.
