Financial Reporting & Analysis - Analysis Techniques Flashcards
Ratio: ROE
Net income / shareholder’s equity
Limitation of ratios (4)
- Comparability across industries,
- Determine whether results of ratio analysis are consistent,
- Need to use judgement and
- Use of alternative accounting methods.
Define: vertical balance sheet analysis
Each item on the balance sheet divided by total assets
Define: horizontal balance sheet analysis
% change in each item from period-to-period
Define: vertical income statement
% of revenue (sometimes % of assets for financial institutions)
Trend analysis techniques (2)
- Set year 1 as an index value and show the next years as a ratio of year one (1 to 1.2 to 1.3 = 30% increase from base year), or
- Show % change from previous year
Define: activity ratios
How effectively company performs day to day tasks like managing inventory, collecting receivables, etc.
Define: liquidity ratios
Ability to meet short-term obligations
Define: solvency ratios
Ability to meet long-term obligations
Define: profitability ratios
Ability to generate profits from current resources (e.g. assets)
Define: valuation ratios
Typically the quantity of assets divided by the flow associated with the ownership of those assets (i.e. price divided by earnings for PE)
Interpreting ratios (2)
- Analyze ratios from a trend and benchmark perspective, understanding why ratios diverge
- Evaluate based on: company goals, industry norms and economic conditions
Ratio: inventory turnover (a)
- Cost of goods sold / average inventory
2. Heart of operations, # of times turned over in a period
Ratio: days of inventory on hand (DOH) (a)
- # of days in period / inventory turnover
2. How long it takes to turnover inventory. Lower is good
Ratio: receivable turnover (a)
- Revenue / average receivables
Ratio: days of sales outstanding (DOS) (a)
- # of days in period / receivables turnover
2. # of days to collect receivables. A high number could indicate poor credit quality standards.
Ratio: payables turnover (a)
- Purchases / average trade payables
2. How many times per year all creditors are paid
Ratio: days of payables (a)
- # of days in period / payables turnover
2. # of days to pay payables. Long time could reflect inability to pay, or taking advantage of credit facilities.
Ratio: working capital turnover (a)
- Revenue / average working capital
2. How efficiently revenue is generated with working capital. 4 = $4 of revenue for $1 working capital
Ratio: fixed asset turnover (a)
- Revenue / average net fixed assets
- Efficiency of fixed assets. New assets (not depreciated yet) will make this # worse. YOY may not be that helpful because fixed assets are not always linear.
Ratio: total asset turnover (a)
- Revenue / average total assets
- Could indicate efficiency, but also strategic decisions like capital vs labor intensity. 1.2 = $1.2 revenue for each $1 of assets.
Define: liquidity ratios
- Measures how quickly assets are turned into cash & ability to meet short-term needs,
- Liquidity achieved through efficient use of assets,
- Larger companies have more avenues for liquidity & thus usually require smaller capital buffers,
- Contingent liabilities should be included (especially for banks) because they will be triggered when overall liquidity decreases.
Ratio: current (L)
Current assets / current liabilities
Ratio: quick (acid) (L)
(Cash + short-term marketable securities + receivables) / current liabilities
Ratio: cash (L)
- (Cash + short-term marketable securities) / current liabilities
- Crisis cash measure
Ratio: defensive interval (L)
- (Cash + short-term marketable securities + receivables) / daily cash expenditure
- Burn rate, i.e. number of days survive
Ratio: cash conversion cycle (L)
- DOH + DSO - # of days of payables
- Measures period of time from when comp invests in working capital until it collets cash.
- Shorter = more liquidity, less financing of inventory and shorter credit collection.
Define: operating leverage
Higher fixed costs & lower variable costs = more operating leverage. As sales increase, margin should increase.
Define: financial leverage
More debt in the capital structure. Leverage can increase returns to shareholder’s but also increase risk of default.
Ratio: debt-to-assets (S)
Total debt / total assets
Ratio: debt-to-capital (S)
Total debt / (total debt + total shareholder’s equity)
Ratio: debt to equity (S)
Total debt / total shareholder’s equity
Ratio: interest coverage (S)
EBIT / interest payments
Ratio: fixed charge coverage
(EBIT + lease payments) / (interest payments + lease payments)
Define: profitability ratios
Ability to generate a profit is key, so this is the focus of most equity analysts
Ratio: gross profit margin (P)
- gross profit / revenue
- % of revenue to cover expenses.
- Higher shows either higher product pricing or lower costs.
Ratio: operating profit margin (P)
- operating income / revenue
2. Change relative to gross profit can indicate ability (inability) to control overhead and operating costs
Ratio: pre-tax margin (P)
EBT / revenue
Ratio: net profit margin (P)
- net income / revenue
2. Net of all expenses. Analysts will generally adjust for non-recurring items to project forward.
Ratio: operating ROA (P)
Operating income / average total assets
Ratio: ROA (P)
- Net income / average total assets
2. Some analysts use other formats to account for interest expenses, etc. Just need to be consistent.
Ratio: return on capital (P)
EBIT / (short-term + long-term debt & equity)
Ratio: ROE (P)
Net income / average total equity
Ratio: Return on common equity (P)
(Net income - preferred dividends) / average common equity
DuPont Analysis (simple)
- ROE = ROA * Leverage
2. As long as company can earn more than cost of leverage, it is a good use of leverage
DuPont Analysis (expanded)
ROE + tax burden interest burden EBIT margin total asset turnover leverage
Steps of equity analysis (5)
- Understanding business & current financial profile,
- Forecasting company performance,
- Selecting appropriate valuation model,
- Converting forecasts to a valuation,
- Making the investment decision
Ratio: P/E (V)
Price per share / earnings per share
Ratio: P/CF (V)
Price per share / cash flow per share
Ratio: P/S (V)
Price per share / sales per share
Ratio: P/BV (V)
Price per share / book value per share
Basic EPS
(Net income - preferred dividends) / weighted average # of ordinary shares outstanding
Ratio: Cash flow per share
Cash flow from operations / weighted average # of outstanding shares
Ratio: EBITDA per share
EBITDA / weighted average # of shares outstanding
Ratio: Dividends per share
Common dividends declared / weighted average # of ordinary shares outstanding
Ratio: Dividend payout
Common share dividends / net income attributable to common stock
Ratio: Retention Rate
(Net income attributable to common stock - common stock dividends) / net income attributable to common stock
Ratio: sustainable growth
Retention rate * ROE
Define: credit risk
Risk of loss caused by debtor’s failure to make a payment
Define: business risks (4)
- Operating environment,
- Industry characteristics,
- Success factors & areas of vulnerability,
- Competitive position (size & diversification)
Define: Segment (IFRS)
- Engages in activities that may create revenue & expenses (even if they don’t yet),
- Whose results are regularly reviewed by senior mgmt,
- Discrete financial information is available
Reporting requirements - segments
- Must report independent data for each segment that represents 10% or more of total segments, and
- Must report up to 75% of total
Ratio: segment margin
Profit or loss / revenue
Ratio: segment turnover
Revenue / assets
Ratio: segment ROA
Profit or loss / assets
Ratio:segment debt ratio
Liabilities / assets
