Financial Statement Analysis Flashcards
Develop skills in financial statement analysis, reporting standards, income statement, balance sheet, cash flow statement, financial analysis techniques, inventories, long-lived assets, income taxes, and non-current liabilities.
Define:
Credit migration risk
The risk that a bond issuer’s creditworthiness deteriorates leading investors to believe that the risk of default is higher.
aka downgrade risk
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Accounts payable
When a business owes its vendors for goods and services which were purchased but which have not yet been paid.
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Accounts receivable
Amounts that the company is owed for things that have been sold or returned.
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Accounts receivable turnover
Net Credit Sales / Average Accounts Receivable
Measure of how efficient the company is with its AR.
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Accrued expenses
Expenses incurred but not yet paid (at end of an accounting period), this results in a liability. (Some examples would be salaries or rent that have been incurred but not paid by the end of the period).
May also be called accrued liabilities
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Accrued interest
Interest earned but not yet paid.
(Example of an accrued expense)
This is a liability
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Accumulated depreciation
An accounting measure that represents the total depreciation expense recognized on a fixed asset (PPE) over its useful life, up to a specific point in time.
Used to offset the cost of PPE over time.
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Acquisition method
Method of accounting for a business combination- Acquirer is required to measure each identifiable asset and liability at fair value.
Was the result of an attempt by IASB and FASB to support convergence of standards for the accounting of business combinations.
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Amortized cost
The cost of an asset adjusted for amortization and impairment.
Historical (initial) cost, reduced by amortization and impairment.
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Amortization
The process of allocating the cost of intangible long-term assets with a finite useful life to seperate accounting periods.
Spreading the cost over the useul life (different accounting periods).
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Asset utilization ratios
aka efficiency ratios
Ratios which assess how effectively a company uses its assets to generate sales or revenue.
The turnover ratios
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Assets
Resources controlled or owned by an entity from which future economic benefits are expected to flow to the entity.
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Available-for-sale
Debt and equity securities which are neither classified as held-to-maturity or held-for-trading. The holder is willing to sell but not actively planning to sell. Reported at fair value on the balance sheet.
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Balance sheet
statement of financial position
Financial statement presenting current financial position for a company. This requires the disclosure of current resources the company controls (assets) and claims on those resources (liabilities and equity).
This is a snapshot of the financial position at a particular point in time.
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Book value
The net amount for an asset or liability on the balance sheet.
May also refer to the amount by which a company’s assets exceed their liabilities.
aka carrying value or carrying amount
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Carrying amount
The amount at which an asset or liability is valued according to accounting principles.
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Cash conversion cycle
The length of time for a company to convert cash invested in operations to cash received as a result of operations.
days of inventory on hand + days of sales outstanding – number of days of payables
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Cash equivalents
Very liquid short-term investments
<= 90 days until maturity
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Cash flow from operations
Cash earned from operating activities.
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Classified balance sheet
A balance sheet organized into different classficiations (categories) so as to group together the various assets and liabilities based on similar characteristics. (e.g., current and noncurrent)
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Common-size analysis
Restatement of financial statement items in terms of a common denominator or reference item in order to make comparisons more straightforward.
ex. income statement where all items expressed as % of revenue.
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Completed contract
Method of revenue recognition- company does not recognize any revenue until the contract is completed.
often used for long term construction contracts.
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Comprehensive income
=Net Income + Other Comprehensive Income (OCI)
A more comprehensive account of income earned, as it considers items which bypass the income statement (like unrealized +/- on securites available for sale, or foreign currency translation adjustments).
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Contra account
Account used to offset another account.
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Cost of goods sold
COGS
For a period: Beginning inventory - ending inventory + cost of goods acquired or produced
The cost incurred to procure the goods that were sold in the period.
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Current ratio
Current assets / current liabilities.
liquidity ratio
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Current assets
Assets expected to be consumed or converted into cash in one year or less.
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Days in receivables
Estimate of the average number of days it takes to collect on credit accounts.
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Current cost
For assets: amount it would cost to buy or produce the same or an equivalent asset today.
For liabilities: undiscounted amount that would be required to settle the obligation today.
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Current liabilities
Short-term obligations which are expected to be settled in the near future (1 year or less).
ex. accounts payable, accrued liabilities
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Day’s sales outstanding
Estimate of the average number of days it takes to collect on credit accounts.
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Days of inventory on hand
number of days in the period/inventory turnover in the period
activity ratio
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Debit
Result in an increase of asset and expense accounts or decrease in liability and owners’ equity accounts.
In double entry accouting
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Debt-to-assets ratio
Measures the percentage of total assets financed with debt.
Total debt/total assets.
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Debt-to-capital ratio
Measures the percentage of a company’s capital (debt plus equity) represented by debt.
Total debt / (Total debt + Total shareholders’ equity)
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Debt-to-equity ratio
Measures the amount of debt capital relative to equity capital.
Total debt / Total shareholders’ equity.
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Deductible temporary differences
Temporary discrepancies between the book (financial) and tax (income tax) values of certain assets and liabilities. Deductible temporary differences result in a deferred tax asset (reduction of taxable income in a future period when the balance sheet item is recovered or settled).
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Defensive interval ratio
Estimate of the number of days that an entity could meet cash needs using liquid assets.
liquidity ratio
(cash + short-term marketable investments + receivables) / daily cash expenditures
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Deferred income
aka unearned revenue or deferred revenue
Money that has been collected (recieved in advance) for goods or services that have not yet been delivered.
liability account
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Deferred tax assets
DTA
An excess amount is paid for income taxes relative to accounting profit (taxable income > accounting profit and therefore income tax payable exceeds tax expense).
Expectation is to recover the difference in future periods when tax expense exceeds income tax payable.
paid more taxes than accounting says they should
Asset
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Deferred revenue
Money that has been collected for goods or services which haven’t been delivered
(payment received in advance).
Liability
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Deferred tax liabilities
DTL
When the taxable income is less than the accounting profit and therefore income tax payable is less than tax expense. Expectation is to eliminate the liability in future periods when income tax payable exceeds tax expense.
paid less taxes than accounting says they should
Liability
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Depreciation
When the cost of long-lived tangible assets is allocated to the periods during which the assets are expected to provide economic benefits.
Spreading out the cost of periods of use
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Direct Method
for Cash Flow Statement
CFO presentation format which calculates CFO as operating cash receipts - operating cash disbursements.
Most intuitive method but requires more intensive record keeping/data, as opposed to indirect method which derives CFO using the Income Statement and changes in Balance Sheet items
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Double declining depreciation method
Accelerated depreciation method which depreciates an asset at double the straight-line rate. This rate gets applied to the declining book value of the asset at the beginning of the period.
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Double-entry accounting
Accounting system: every recorded transaction affects at least two accounts.
This keeps the accounting equation (assets = liabilities + owners’ equity) in balance.
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Equity
Residual interest in the assets after liabilities have been settled.
assets - liabilities
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Expenses
Outflows of economic resources or increases in liabilities associated with the creation of revenues.
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Fair value
The amount an asset could be exchanged, or a liability settled, between knowledgeable, willing parties.
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FIFO method
First In, First Out
Inventory method which uses the costs of the earliest items into inventory as the cost of goods sold (to match with revenue earned).
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Financial leverage
The use of fixed financing costs (debt) in attempt to magnify returns on equity.
Financial Leverage Ratio = Total Assets/Total Equity
Analysts want to consider how much financial leverage a company is using.
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Fixed charge coverage
The number of times interest and lease payments are covered by operating income.
(EBIT + lease payments) / (interest payments + lease payments)
Solvency ratio
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Fixed costs
Costs which do not change. Independent from company’s sales.
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Fundamental analysis
Analyzing publicly available information about a company’s financial health and competive environment in an attempt to understand the intrinsic value of the debt or equity of the company.
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Fundamental value
aka intrinsic value
The true value of an asset based on an analysis of its qualitative and quantitative characteristics.
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Goodwill
Intangible asset representing excess paid to acquire companies over the value of the net assets acquired.
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Gross Profit
Revenue - cost of sales
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Gross margin
aka gross profit margin
Gross profit / revenue
gross profit = NI - COGS
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Held for trading
aka trading securities
Financial assets bought with the intent to sell in the near term (< 3 months).
as opposed to available for sale or held to maturity
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Held-to-maturity
Fixed income security which a company intends to hold to maturity.
Presented at original cost +/- amortization of discounts or premiums
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Historical cost
With assets: amount paid to purchase (including costs of acquisition or preparation)
With liabilities: Proceeds received for issuing the liability.
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Income statement
aka Profit and Loss Statement
A financial statement which provides info about a company’s profitability over a period of time.
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Income tax payable
Income tax owed by the company (taxable income).
as opposed to tax expense
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Indirect Method
CFO presentation format which calculates CFO by beginning with net income then adding/subtracting non cash items and changes in working capital to arrive at operating cash flow.
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Installment method
The % of total profit for the sale which is recognized in the period is determined by the % of the total sales price for which the seller has received cash.
Method of revenue recognition
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Intangible assets
Assets which are not tangible (lacking physical substance).
ex. patents and trademarks
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Interest coverage ratio
The extent to which a company’s earnings (or cash flow) covered its interest costs in the period.
EBIT/Interest Payments
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Inventory turnover
COGS / Average Inventory
Activity Ratio
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Just-in-time method
Inventory management method that minimizes inventory stocks.
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LIFO method
**Last In, First Out **
Inventory method which uses the costs of the most recent items into inventory as the cost of goods sold (to match with revenue earned).
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LIFO reserve
The difference between the reported LIFO inventory amount and what the inventory amount would have been if the FIFO method had been used.
FIFO Inventory - LIFO Inventory
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Liabilities
Obligations which will require a future reduction of assets (outflow) in order to settle.
In other words, a creditors’ claims on the resources of a company.
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Liquidation
The selling of a company’s assets in order to settle claims, typically during bankruptcy proceedings.
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Loan-to-value ratio
Property’s purchase price / amount of its mortgage.
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Long-lived assets
Assets that are expected to provide economic benefits in the future.
Over a period greater than one year.
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Market value
Price something can be bought or sold at in an open market.
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Matching principle
Recognizing expenses when the associated revenue is recognized.
Accounting
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Net income
What remains after subtracting all expenses (depreciation, interest, taxes, etc.) from revenue.
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Net book value
The remaining balance of an asset’s purchase cost, after depreciation has been considered.
Liabilities: face value of bond +/- unamortized discount or premium
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Net profit margin
Indicates how much is left after all costs and expenses are deducted from revenue.
Net Income / Revenue
measure of profitability
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Net realizable value
Estimated selling price - the estimated costs incurred to make the sale.
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Net tax rate
The tax rate net of transfer payments.
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Net revenue
Revenue after adjustments (estimated returns or amounts unlikely to be collected).
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Non-current assets
Assets expected to benefit the company over an extended period of time.
More than 1 year
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Notes payable
Liabilities: Amounts owed by a business to creditors as a result of borrowing. Written promise to repay (typically including principal, interest, and date of repayment).
This differs from accounts payable, which is a recording of purchases made from suppliers, on credit, without a formal written promise to repay.
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Non-current liabilities
Long term financial obligations which are not due within the next 12 months.
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Number of days of inventory
Indication of the number of days a company ties up funds in inventory.
Number of days in a period / inventory turnover ratio for the period
Activity ratio
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Number of days of payables
Estimate of the average number of days it takes a company to pay its suppliers
Number of days in a period / payables turnover ratio for the period
Activity Ratio
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Operating activities
Activities that are part of the day-to-day business functioning of an entity (selling goods/services).
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Operating cash flow
Cash provided from operating activities.
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Operating cycle
A measure of the time needed to convert raw materials into cash from a sale.
Days’ sales of inventory + days’ sales outstanding
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Operating lease
Agreement allowing the lessee to use the asset for a period of time.
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Operating efficiency ratios
Measure how efficiently a company performs day-to-day tasks (collection of receivables, management of inventory).
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Operating profit
A company’s profits on its usual business activities before deducting taxes. Also called operating income.
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Operating profit margin
aka operating margin
EBIT / revenue
EBIT = operating income
Profitability ratio
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Other comprehensive income
OCI
Items of comprehensive income which are not reported on the income statement (unrealized +/- on securites available for sale, foreign currency translation adjustments, etc.).
NI + OCI = Total Comprehensive Income
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Owners’ equity
aka shareholders’ equity
Shareholders residual interest in the assets of an entity after deducting the entity’s liabilities.
Assets - Liabilities
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Percentage-of-completion
In each accounting period, a percentage of revenue from the contract is recognized on the income statement, proportional to the percentage of the contract which has been completed at that time.
Revenue recognition method
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Period costs
Costs which cannot be directly matched with the timing of revenues and are therefore expensed in the period which they were incurred.
As opposed to product costs like COGS
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Permanent differences
Differences between tax and financial reporting of revenue which is not expected to be reversed in the future.
When item reduces income for accounting purposes but never for taxes
Result in a difference between effective tax rate and statutory tax rate… do not result in a deferred tax asset or liability (because not expected to reverse).
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Prepaid expense
Operating expense which has been paid in advance of when it is due.
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Price to book value
Price per share / book value per share
Valuation Ratio
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Price to earnings ratio
Price per share / Earnings per share
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Price to cash flow
Price per share / cash flow per share
Valuation ratio
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Price to sales
Price per share / sales per share
Valuation ratio
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Profitability ratios
Used to measure a company’s ability to generate profitable sales from its resources (assets).
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Property, plant, and equipment
PP&E
Tangible assets used for more than one period to produce or supply goods/services, or for administrative purposes.
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Quick assets
Assets which can be readily converted to cash.
ex. cash, short-term marketable investments, receivables
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Quick ratio
Indicates a company’s ability to satisfy current liabilities with its most liquid assets.
(cash + short-term investments + receivables) / current liabilities.
Liquidity Ratio
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Residual claim
The owners’ remaining claim on the company’s assets after the liabilities are settled.
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Return on assets
ROA
Indicates a company’s net profit per dollar invested in total assets.
NI / Average Total Assets
Profitability ratio
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Return on sales
How much of each dollar of revenues is left after all costs and expenses.
NI / Revenue
Profitability Ratio
Same as net profit margin*
this is according to CFA, but in practice Return on Sales is often treated at Operating Profit / Revenue
Operating profit = EBIT
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Return on equity
ROE
Net income / average shareholders’ equity
Profitability Ratio
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Return on total capital
EBIT / debt + equity
Profitability ratio
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Revaluation model
Valuing long-lived assets at fair value, instead of cost - accumulated depreciation.
Any +/- from the revaluation is reported on the income statement and/or through equity under revaluation surplus.
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Revenue
The amount received for the delivery of goods/services within the ordinary operations of a business.
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Solvency
How well a company is able to fulfill its long-term obligations.
Solvency ratios are often used to discern this
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Statement of cash flows
Summarizes the company’s cash inflows and outflows and distinguishes beteen cashflows related to operating, investing, and financing activities.
Reconciles beginning-of-period and end-of-period cash balances on the balance sheet.
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Statement of changes in equity
aka statement of owners equity and statement of retained earnings
Provides insight into the factors affecting shareholders’ equity, and the relationship between income earned (on the income statement) and retained earnings on the balance sheet.
Reconciles beginning of period and end of period values for shareholders’ equity on the balance sheet.
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Straight-line method
Depreciation method which evenly
allocates cost of a long-lived asset (minus residual value) over the useful life of the asset.
As opposed to double declining method.
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Sustainable growth rate
The growth rate for earnings and dividends which can be sustained given a certain level of ROE.
(keeping capital structure constant)
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Tax expense
Income tax payable + changes in deferred tax assets or liabilities.
Essentially income tax payable if determined based on accounting profit instead of taxable income.
Discrepancies between statutory tax treatment and accounting treatment for different items results in a difference between tax payable and tax expense.
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Temporary differences
for taxes
When accounting principals result in a transaction (impacting income) being treated differently than it is under statutory tax rules. The key is that both recognize the transaction, but with different timing. This means that these differences are expected to be rectified in time.
This often results due to accrual accounting principals or different rules around recognizing depreciation/amortization.
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Tax loss carry forward
Taxable loss in the current period which may be used to reduce future taxable income.
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Taxable income
Portion of an entity’s income subject to income taxes (based on tax laws of its jurisdiction).
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Total invested capital
MV of common equity + BV of preferred equity + face value of debt
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Treasury stock method
Specifies what EPS would have been if the options and warrants had been exercised and the company had used the proceeds to repurchase common stock.
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Accrued Revenue
aka unbilled revenue
Revenue earned but not yet billed to customers (at the end of accounting period).
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Units-of-production method
Depreciation method which allocates the cost of a long-lived asset based on usage (how many units were produced) during the period.
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Valuation ratios
Provide insights into how the market values a company’s stock or its assets compared to various financial metrics.
Attempts to quantify an asset or flow (e.g., earnings) relative to the price associated with a specified claim (e.g., price per share or ownership of the enterprise).
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Weighted average cost method
Inventory accounting method: average total cost of available inventory / total units available for sale.
