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Financial Statement Analysis Flashcards

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1
Q

What does ratios that were compared to previous year show?

A

Internal trends

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2
Q

What does ratios that were compared to the other firms within the same industry show?

A

External trends

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3
Q

What is ratio analysis?

A

A diagnostic tool that helps to identify problem areas and opportunities within a company

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4
Q

What are some of the most frequently used ratios?

A
  1. Liquidity
  2. Debt management / degree of financial leverage or debt
  3. Profitability
  4. Efficiency
  5. Value
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5
Q

What are liquid assets?

A

Assets that can be converted into cash quickly

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6
Q

What does the liquidity ratio show?

A

Firm’s ability to meet its short term obligations.

Higher the ratio, indicates greater liquidity and lower risk for short term lenders (lower financial risk)

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7
Q

How do you calculate current ratio?

A

Current assets/current liabilities

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8
Q

How do you calculate quick ratio/acid test ratio?

A

(Current assets - inventory)/current liabilities

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9
Q

What does debt ratios show?

A

The extend to which a firm is relying on debts to finance its investment and operations and how well it can manage the debt obligations (repayment of principal and periodic interests)

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10
Q

What are the two leverage ratios under debt management ratios?

A
  1. Debt to equity ratio

2. Debt to assets ratio

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11
Q

What does debt to equity ratio show?

A

The firm’s degree of leverage or its reliance on debt for financing

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12
Q

What does debt to assets ratio show?

A

The company’s reliance on external source to finance its assets

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13
Q

What does the leverage ratios show?

A

The lower the ratio, the more conservative the company, but if the company is not using debt, it may be forgoing investment and growth opportunities

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14
Q

How do you calculate debt to equity ratio?

A

Total debts/total equity

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15
Q

How do you calculate debt to assets ratio?

A

Total debt/total assets

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16
Q

What does interest cover or time interest earned ratio shows?

A

The firm’s ability to cover the fixed interest charges with current earnings

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17
Q

How do you calculate the interest cover or times interest earned ratio?

A

EBIT/annual interest expenses

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18
Q

How do you calculate the cash flow coverage?

A

Net cash flow/annual interest expense

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19
Q

How do you calculate net cash flow?

A

Net income adjusted with non cash items such as depreciation and amortisation

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20
Q

What are some of the profitability ratios?

A
  1. Net profit margin
  2. Return on assets (ROA)
  3. Return on equity (ROE)
  4. Earnings per share (EPS)
  5. Dividends per share (DPS)
  6. Payout ratio
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21
Q

How do you calculate net profit margin?

A

Net profit after tax/sales

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22
Q

How do you calculate return on assets (ROA)?

A

Net profit after tax/total assets

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23
Q

How do you calculate return on equity (ROE)?

A

Net profit after tax/shareholders equity (book value)

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24
Q

How do you calculate earnings per share (EPS)?

A

(Profit after tax - preference dividend)/number of ordinary shares outstanding

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25
Q

How do you calculate payout ratios?

A

Cash dividends/net income

26
Q

What does asset management ratio shows?

A

How well the firm’s assets are managed

27
Q

What are some of the asset management (efficiency) ratios?

A
  1. Inventory turnover
  2. Total assets turnover
  3. Accounts receivable turnover
  4. Average collection period
  5. Days in inventory
28
Q

What does inventory turnover shows?

A

How quickly the inventory is being turnover(sold) to generate sales. A higher ratio shows that the firm is more efficient in managing inventories by minimizing the investment in inventories

29
Q

How do you calculate inventory turnover ratio?

A

Cost of good sold/average inventory

30
Q

What does total assets turnover shows?

A

How much sales the firm is generating for every rand of investment in assets, the higher the ratio the better the firm is performing

31
Q

How do you calculate total assets turnover?

A

Sales/total assets

32
Q

How do you calculate accounts receivable turnover?

A

Annual credit sales/average receivables

33
Q

What does accounts receivable turnover and average collection period show?

A

The firm’s efficiency in collecting cash from its credit sales, while low ratio is good, it could also mean that the firm is very strict with its credit policy which may not attract customers

34
Q

How do you calculate average collection period?

A

Account receivables/(sales/365)

35
Q

What does days in inventory shows?

A

The shelf life, how quickly the product is sold

36
Q

How do you calculate days in inventory?

A

Days in a year (365)/inventory turnover

37
Q

What does value ratio shows?

A

The embedded value in stocks and are used by investors as screening device before making investments

38
Q

What are some of the value ratios?

A
  1. Price earning (PE) ratio

2. Dividend yield

39
Q

What does PE ratio shows?

A

Vale of the share. High PE ratio may mean that it is overpriced, when the market is bullish(optimistic) PE tends to be high, a low PE ratio may show that the company has a poor track record or underpriced, further investigation is required.

40
Q

How do you calculate PE ratio?

A

Market price per share/after tax earnings per share

41
Q

How do you calculate dividends yield?

A

Dividends per share/market price per share

42
Q

List the uses of ratio analysis.

A
  1. To evaluate performance, compared to previous years and to competitors and the industry
  2. To set benchmarks or standards for performance
  3. To highlight areas that need to be improved, or areas that offer the most promising future potential
  4. To enable external parties, such as investors or lenders, to assess the the credit worthiness and profitability of the firm
43
Q

What are some limitations of ratio analysis?

A
  1. There is considerable subjectivity involved, as there is no correct number for various ratios. Further it is hard to reach a definite conclusion when some of the ratio are favorable and some are unfavorable
  2. Ratios may not be strictly comparable for different firms due to variety of factors such as different accounting policies and year ends. Furthermore, if a firm is engaged in diverse product lines, it may be difficult to identify the industry category to which the firm belongs. Also, just because a specific ratio is better than the average, does not necessarily mean that the company is doing well, it is quite possible that the rest of the industry is doing poorly
  3. Ratios are based on financial statements that reflect the past not the future. Unless the ratios are stable, it may be difficult to make reasonable projections about future trends. Furthermore financial statements such as the balance sheet indicates the picture at one point in time and thus may not be representative of longer periods
  4. Financial statements provide an assessment of cost and not value
  5. Financial statements do not include all items
  6. Accounting standards and practice vary among countries, and thus hamper meaningful global comparisons
44
Q

What does financial statement analysis involves?

A

It involves analyzing the firm’s financial statements to extract information that can be used to facilitate decision making

45
Q

The performance of a firm can be assessed by computing key ratios and analyzing the following…

A
  1. How is the firm performing relative to the industry?
  2. How is the firm performing relative to the leading firms in their industry?
  3. How does the current year performance compared to the previous years?
  4. What are the variables driving the key ratios?
  5. What are the linkages among the ratios?
  6. What do the ratios reveal about the future prospects of the firms or various stakeholders
46
Q

How do you calculate the net worth of a firm?

A

Total assets - total liabilities - preference shares = net worth

47
Q

How do you calculate book value per share?

A

Net worth/number of ordinary shares

48
Q

What does assets to equity ratio shows?

A

This shows firm’s reliance on external debt for financing (or the degree of leverage). Any number above 100% shows that the company relies on external debt for financing some of its assets. If the number equals 100%, it implies that the assets are fully financed by the shareholders.

49
Q

How do you calculate assets to equity ratio?

A

Total assets/shareholders equity

50
Q

How do you calculate the sales growth rate?

A

Sales Growth Rate = {(Current year sales – last year sales)/last year sales}*100

51
Q

How do you calculate expenses analysis?

A

Various expenses/sales

52
Q

How do you calculate gross margin sales ratio?

A

Gross profit/total sales

53
Q

How do you calculate Return on Sales (ROS) or net profit ratio?

A

Net Income/Net Sales

54
Q

How do you calculate return on investments?

A

Return on Investment (ROI) = Net Income/Total Assets

55
Q

How do you calculate retention ratio?

A

Retention ratio = Retained Earnings/Net Income

56
Q

How do you calculate sustainable growth rate?

A

Sustainable growth rate (SGR) = ROE * Retention Ratio

57
Q

How does the management improve the ROE?

A

They need to improve profitability, efficiently use the assets, and optimize the use of debt in their capital structure

58
Q

What does sustainable growth rate shows?

A

SGR shows how much the company will grow in the future if some of the key ratios remain the same as in previous years

59
Q

How do you calculate accounts payable turnover?

A

Purchases/accounts payable

60
Q

How do you calculate days accounts payable outstanding?

A

(Accounts payable/cost of sales)*365

61
Q

How do you calculate financing period?

A

Financing Period = Average Collection period + days in inventory – days AP outstanding

Finance (12 decks)

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