Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

Finance Skill for Managers > Financial Statement Analysis > Flashcards

Financial Statement Analysis Flashcards

You may prefer our related Brainscape-certified flashcards:
Series 65 flashcards Series 63 flashcards Series 66 flashcards Series 7 Top-off Exam flashcards SIE Exam flashcards CFA flashcards Series 79 Top-Off Exam flashcards
1
Q

Ratios are useful for analyzing and comparing company performance for at least four different reasons:

A
  1. Standardization
  2. Flexibility
  3. Focus
  4. Evaluation
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

The process of completing a financial analysis to compare a firm’s financial performance to that of other similar firms.

A

Benchmarking

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

Comparing a firm’s ratios across time.

A

Trend Analysis

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

Comparing a firm’s financial ratios to other firms’ ratios or industry averages.

A

Cross-sectional Analysis

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

Firms whose performance varies according to the season.

A

Seasonal Firms

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

Which statement below is an example of how ratios are used in the field of finance?

  1. Ratio analysis is performed based on a strict set of rules governed by generally accepted accounting principles.
  2. Ratios are helpful only when comparing companies that are the same size and that use the same operational style.
  3. A firm’s ratios may vary year over year, so they are not helpful for evaluating whether firm goals are met.
  4. A firm’s ratios are compared with those of a benchmark peer group to determine the firm’s relative strength and performance.
A

A firm’s ratios are compared with those of a benchmark peer group to determine the firm’s relative strength and performance.

This is called cross-sectional analysis and is common in financial analysis.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

Why are ratios considered flexible?

Because they are not regulated and can be changed or invented according to a firm’s needs
Because they do not require historical financial data in order to analyze a firm
Because they are based on estimates and thus do not have to be exact
Because there are five ratios that must always be calculated and then reported on public financial statements

A

Because they are not regulated and can be changed or invented according to a firm’s needs

Because financial ratios are an internal management tool, they are not subject to external rules and regulations.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

How might calculating financial ratios help shareholders?

Ratios allow shareholders to participate in management decisions.
Ratios can be used to know what exactly is happening in a firm by answering questions about the firm.
Ratios can be used to determine whether a firm is maximizing shareholder wealth.

A

Ratios can be used to determine whether a firm is maximizing shareholder wealth.

Ratios are used to evaluate managerial actions so shareholders can determine how effectively and profitably managers are using their invested capital.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

What are the five major ctegories of financial ratios?

A
  • Liquidity
  • Activity
  • Leverage
  • Profitability
  • Market
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

The firm Betsy’s Books conducts a financial analysis using ratios to know how it is performing in comparison to other similar firms. What is this process called?

Maximization
Benchmarking
Auditing
Equity valuation

A

Benchmarking

Benchmarking allows management to see how firms differ from one another and evaluate their performance relative to each other.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

{BLANK} measure a firm’s ability to meet short-term obligations.

A

Liquidity ratios

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

{BLANK} measure how well a company uses its assets to generate sales or cash.

A

Activity ratios

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

{BLANK} consider how a firm is financed and how financially risky a firm is.

A

Leverage ratios

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

{BLANK} are used to directly judge how well management is maximizing shareholder wealth.

A

Profitability ratios

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

{BLANK} are used to evaluate the current share prices of a public firm’s stock.

A

Market ratios

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

What type of ratio is used to assess a firm’s ability to meet short-term obligations without raising external capital?

  1. Market ratios
  2. Profitability ratios
  3. Liquidity ratios
  4. Activity ratios
A

Liquidity ratios

Liquidity ratios measure a firm’s ability to meet short-term obligations without raising external capital.

15
Q

Why are several different types of ratios used to analyze a firm?

  1. Because ratios are sometimes inaccurate, and firms have a greater chance of calculating an accurate ratio if they calculate multiple ratios
  2. Because different types of ratios are needed to get information about different parts of a firm
  3. Because other ratios must be calculated before the main ratio can be calculated
  4. Because certain types of ratios become obsolete as a firm innovates
A

Because different types of ratios are needed to get information about different parts of a firm

Using only one type of ratio in a full financial analysis of a firm would not tell you very much information about the firm. It is through the calculation of many ratios that an analyst will be able to see the bigger picture of the firm.

16
Q

What do leverage ratios describe?

  1. How easily a firm can convert assets into cash
  2. What return shareholders will earn on their investment in a firm
  3. How efficiently a firm is using its assets
  4. What proportions of equity and debt a firm uses to finance its assets
A

What proportions of equity and debt a firm uses to finance its assets

This information gives insight into the financial structure of a firm.

17
Q

A firm has paid off its short-term loans more quickly in the past couple of years. What might this trend indicate about the firm’s financial ratios?

Its leverage ratio is decreasing.
Its liquidity ratio is increasing.
Its profitability ratio is decreasing.
Its activity ratio is increasing.

A

Its liquidity ratio is increasing.

Liquidity is a measure of the ability of a firm to convert short-term assets into cash. Paying off short-term loans quickly is an indication that a firm is quite liquid, so the firm’s liquidity ratio would be increasing.

18
Q

What are the two liquidity ratios?

A

Current ratio - A liquidity ratio found by current assets divided by current liabilities.

Quick ratio - A liquidity ratios found by current assets less inventory, divided by current liabilities; also called the acid-test ratio.

19
Q

What are the activity ratios?

A
  • accounts receivable turnover (AR turnover) - An activity ratio found by credit sales divided by accounts receivable.
  • average collection period (ACP) - An activity ratio found by the number of days in a year (365) divided by AR turnover.
  • inventory turnover - An activity ratio found by COGS divided by inventory.
  • total asset turnover (TAT) - An activity ratio found by sales divided by total assets.
  • fixed asset turnover (FAT) - An activity ratio found by sales divided by fixed assets.
  • operating income return on investment (OIROI) - An activity ratio found by operating income divided by total assets.
19
Q

What are the leverage ratios?

A
  • debt ratio - A financing ratio found by total liabilities divided by total assets.
  • debt-to-equity ratio - A financing ratios found by total liabilities divided by total equity.
  • times interest earned (TIE) - A financing ratio found by earnings before interest and taxes (EBIT) divided by interest expenses.
20
Q

What are the Profitability ratios?

A
  • return on assets (ROA) - A profitability ratio found by net income divided by total assets.
  • return on equity (ROE) - A profitability ratio found by net income divided by owners’ equity.
  • gross margin - A profitability ratio found by gross profit divided by sales.
  • operating margin - A profitability ratio found by EBIT profit divided by sales.
  • net margin - The percentage of sales remaining after all costs have been deducted from a company’s total sales. Also known as net profit margin; indicates the profit earned by the firm.
21
Q

What are the Market Ratios?

A

Market-to-book ration (M/B ratio) - A market ratio found by market value of equity divided by book value of equity.
Price-to-earnings ratio (P/E ratio) - A market ratio found by price per share divided by earnings per share.

22
Q

What is the main difference between the current ratio and the quick ratio?

  1. The quick ratio includes accounts receivable in current liabilities, and the current ratio does not.
  2. The quick ratio is faster to calculate than the current ratio.
  3. The current ratio includes inventory in current assets, and the quick ratio does not.
  4. The quick ratio is used for smaller companies, and the current ratio is used for larger companies.
A

The current ratio includes inventory in current assets, and the quick ratio does not.

Inventory is the least liquid of all current assets. By not including inventory, the quick ratio is a more stringent test of a firm’s ability to meet short-term obligations.

22
Q

Which type of ratio is a current ratio?

  1. Activity
  2. Solvency
  3. Liquidity
  4. Market
A

Liquidity

A current ratio is a liquidity ratio because it assesses whether a firm can meet short-term obligations.

23
Q

The firm Betsy’s Books has a market-to-book ratio of 1.2. What does this tell you about the firm?

This firm gets an 20% return on investment.
This firm gets a 20% return on its assets.
This firm is expected to grow in the future.
This firm is about to go out of business.

A

This firm is expected to grow in the future.

The market-to-book ratio measures the growth prospects of a company. If the ratio is greater than 1, then the company is expected to grow.

24
Q

What does the net margin measure?

  1. The percent of sales remaining after covering COGS and operating expenses
  2. The percent of revenue remaining after COGS has been taken out of sales
  3. The percent of revenue that is retained as profit for the firm
  4. The percent earned on each dollar invested in the firm
A

The percent of revenue that is retained as profit for the firm

The net margin is net income divided by sales, which tells us how much a firm actually gets to keep after paying all its expenses.

25
Q

{BLANK} is a composition of the profitability, efficiency, and capital structure of a firm.

A

Return on equity

26
Q

ROE = Net Profit Margin x Total Asset Turnover x Leverage Multiplier or {BLANK}

A

ROE = ROA × Leverage Multiplier

27
Q

Which of these measures is a component of return on equity?

  1. Fixed asset turnover
  2. Current ratio
  3. Net margin
  4. Operating margin
A

Net margin

Net margin, total asset turnover, and leverage multiplier are the components of return on equity.

27
Q

How can the DuPont framework help a company assess its return on equity?

It breaks the cash flow of a company into the operating, investing, and financing aspects of the firm to help identify how each contribute to the firm’s profitability.
It compares alternative ways of financing the firm with debt so the company can determine which will provide the highest return on equity.
It provides a cross-sectional analysis of the industry for the firm to be able to compare its return on equity to that of its competitors.
It allows the company to determine how its abilities to generate profits, manage assets, and use financing contribute to the return on equity.

A

It allows the company to determine how its abilities to generate profits, manage assets, and use financing contribute to the return on equity.

The DuPont framework breaks the return on equity into each of these components using the profit margin, total asset turnover, and leverage ratio.

28
Q

Which action increases the return on equity of a firm if all else remains constant?

Increasing equity financing
Decreasing the total asset turnover
Decreasing profitability
Increasing debt financing

A

Increasing debt financing

Increasing debt financing increases the leverage multiplier, which means that the ROE increases.

29
Q

What is a component of the DuPont framework?

Fixed asset turnover
Current ratio
Times interest earned
Return on assets

A

Return on assets

ROE is ROA times leverage multiplier.

Finance Skill for Managers (4 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions