Financial Analysis Techniques

Question 1

Ratio Analysis

Answer 1

Express relationships among data that can be used for internal comparison across firms

Question 2

Limitations of Ratios

Answer 2

• Financial ratios are not useful when viewed in isolation
• Comparisons with other companies can be difficult when companies use different accounting methods
• When companies operate in multiple industries, it is difficult to find a ratio that is comparable between industries
• Conclusions cannot be made using a single ratio
• Determining the target value of comparison for a ratio is difficult

Question 3

Common size statements

Answer 3

normalize balance sheets and income statements and allow the analyst to more easily compare performance across firms and for a single firm over time.

• vertical - expresses all BS accounts as a percentage of total assets
• horizontal - expresses all IS items as a percentage of sales.

Question 4

Vertical common-size income statement ratios

Answer 4

Income statement account / sales

Question 5

Horizontal common-size balance sheet ratios

Answer 5

balance sheet account / total assets

Question 6

Activity Ratios

Answer 6

Asset utilization or turnover ratios. They give indications of how well a firm utilizes various assets such as inventory and fixed assets

Question 7

Liquidity ratios

Answer 7

Look at the ability to pay ST obligations as they come due

Question 8

Solvency ratios

Answer 8

gives the analyst information on the firm’s financial leverage and ability to meet its longer-term obligations.

Question 9

Profitability ratios

Answer 9

provide information on how well a company generates operating profits and net profits from its sales.

Question 10

Valuation ratios

Answer 10

Compare the relative valuation of companies,

i.e. sales per share, earnings per share, and price to cash flow.

Question 11

Receivables Turnover

Answer 11

= annual sales / average receivables

Question 12

Days of sales outstanding

Answer 12

=365 / receivables turnover

Question 13

Inventory Turnover

Answer 13

= COGS / Average Inventory

Question 14

Days of Inventory on Hand

Answer 14

=365 / inventory turnover

Question 15

Payables Turnover

Answer 15

=Purchases / average trade payables

Question 16

Number of Days Payable

Answer 16

365 / payables turnover ratio

Question 17

Total Asset Turnover

Answer 17

= revenue / average total assets

Question 18

Fixed Asset Turnover

Answer 18

= revenue / average net fixed assets

Question 19

Working Capital Turnover

Answer 19

=revenue / average working capital

• working capital = current assets -current liabilities
  How the firm is using working capital in terms of dollars of sales per dollar of working capital.

Question 20

Current Ratio

Answer 20

= Current Assets / Current Liabilities

Question 21

Quick Ratio

Answer 21

= (Cash + marketable securities + receivables) / current liabilities

• Does not include inventories and other assets that are not as liquid

Question 22

Cash Ratio

Answer 22

=(Cash + marketable securities) / current liabilities

Question 23

Defensive Interval ratio

Answer 23

• indicates the number of days of average cash expenditures the firm could pay with its current liquid assets.
  = (cash + marketable securities + receivables) / average daily expenses

– here expenses are SG&A, COGS, and R&D

Question 24

Cash Conversion Cycle

Answer 24

The length of time it takes to turn the firm’s cash investment in inventory back into cash.

= days of sales outstanding + days of inventory on hand - number of days payable

Question 25

Debt-to-equity ratio

Answer 25

= total debt / total shareholders' equity

Question 26

Debt-to-Capital ratio

Answer 26

= total debt / (total debt + total shareholders' equity)

Question 27

Debt-to-assets

Answer 27

= total debt / total assets

Question 28

Financial Leverage

Answer 28

= average total assets / average total equity

Question 29

Interest Coverage

Answer 29

= EBIT / interest payments

Question 30

Fixed Charge Coverage

Answer 30

= (EBIT + lease payments) / (interest payments + lease payments)

Question 31

Net Profit Margin

Answer 31

= net income / revenue

Question 32

Gross Profits

Answer 32

= net sales - COGS

Question 33

Operating Profits

Answer 33

EBIT

Question 34

Net Income

Answer 34

Earnings after Taxes (EAT), but before dividends

Question 35

Total Capital

Answer 35

LT debt + ST debt + Common and preferred equity

Question 36

Total Capital

Answer 36

Total Assets

Question 37

Gross Profit Margin

Answer 37

Gross Profit / Revenue

Question 38

Operating Profit Margin

Answer 38

Operating Income / Revenue OR EBIT / Revenue

Question 39

Pretax Margin

Answer 39

= EBT / Revenue

Question 40

Return on Assets (ROA)

Answer 40

= net income / average total assets | = (net income + interest expense(1 - tax rate))/ average total assets

Question 41

Operating Return on Assets

Answer 41

Operating Income / average total assets

Question 42

Return of Total Capital (ROTC)

Answer 42

= EBIT / average total capital

Question 43

Return on Equity (ROE)

Answer 43

Net income / average total equity

Question 44

Return on Common Equity

Answer 44

= (net income - preferred dividends) / average common equity | = net income available to common / average common equity

Question 45

DuPont system of analysis

Answer 45

ROE = (Net income / Revenue)(Revenue/Avg. Total Assets)( Average Total Assets/Equity) = Net Profit Margin * Asset Turnover * Leverage Ratio - A way to decompose ROE, and see what is changes are driving change in ROE

Question 46

Extended DuPont Analysis System

Answer 46

ROE = (net income / EBT) (EBT/EBIT)(EBIT/Revenue)(revenue/avg. assets)(average assets / average equity) = (tax burden)(interest burden)(EBIT margin)(asset turnover)(financial leverage)

Question 47

Sustainable growth rate (g)

Answer 47

= RR * ROE ``` RR = retention rate ROE = Return on Equity ```

Question 48

Retention Rate (RR)

Answer 48

= (net income available to common - dividends declared)/(net income available to common) = 1 - dividend payout ratio

Question 49

Dividend Payout Ratio

Answer 49

= dividends declared / net income available to common