Financial Statement Analysis Flashcards
What is solvency?
The ability to meet financial obligations
What is working capital?
Current Assets - Current Liabilities
Measures short-term solvency
What is the current ratio?
Current Assets / Current Liabilities
Measures short-term solvency
What is the quick ratio?
(Cash + Marketable Securities + Net Receivables) / Current Liabilities
Eliminates inventory and prepaid expenses from current assets
- also caled “acid-test ratio”
- measures short-term solvency
What is the defensive-interval ratio?
(Cash + Marketable Securities + Net Receivables) / Avg. Daily Cash Expenditures
Measures # of days company can meet costs of basic operations
What is the debt-to-equity ratio?
Total Liabilities / Total Equity
Measures long-term solvency
What is times interest earned (TIE)?
EBIT / Interest Charges
Measures ability to meet interest payments
-EBIT is used since interest payments are tax-deductible
What is times preferred dividends earned?
Net Income / Annual Preferred Dividend Requirement
Measures ability to pay preferred dividends
What is operational efficiency?
Ability to generate income and to use assets efficiently and effectively
What is total asset turnover?
Total Sales / Avg. Total Assets
Calculates generation of sales per dollar of assets
What is receivables turnover?
Net Credit Sales / Avg. Net Receivables
Calculates efficiency of credit policies and collection
What is days’ sales outstanding?
360 / Receivables Turnover
Calculates avg. number of days to collect receivables
What is inventory turnover?
COGS / Avg. Inv.
What is days’ supply in inventory?
360 / Inventory Turnover
How do you calculate the length of an operating cycle?
Days’ Sales Outstanding + Days’ Supply in Inventory
Measures time from point of sale to cash collection
What is book value per common share?
Common Stockholders’ Equity / # of Common Shares Outstanding
Measures what common stockholders would receive if all assets were sold and creditors paid
How do you calculate common stockholders’ equity?
Total Stockholders’ Equity
- Preferred Stock
- cumulative PS dividends in arrears (even if undeclared)
= Common Stockholders’ Equity
The amount subtracted comprises “Preferred Stockholders’ Equity”
What is book value per preferred share?
Preferred Stockholders’ Equity / # Preferred Shares Outstanding
What is return on total assets?
EBIT / Avg. Total Assets
Measures efficiency with which assets generate earnings
What is Return on Common Stockholders’ Equity?
Net Income - Preferred Dividends
/
Avg. Common Stockholders’ Equity
Measures the leverage of CSE – if Return on CSE is greater than Return on Total Assets, then leverage is positive
What is Return on Stockholders’ Equity?
Net Income / Avg. Stockholders’ Equity
What is Earnings per Share (EPS)?
Net Income - Preferred Dividends
/
Avg. # of Common Shares Outstanding
Measures ability to pay dividends to common stockholders (by measuring profit per share)
What is the price-earnings ratio?
Market Price per Common Share / EPS
Measures whether a stock is cheap or expensive compared to its earnings
What is the dividend payout ratio?
Cash Dividend per Common Share / EPS
Represents the EPS that is distributed to stockholders in dividends (e.g. low ratio probably indicates reinvestment of profits)
What is the yield on common stock?
Dividend per Common Share
/
Market Price per Common Share
Measures cash return on a stock investment
What must be included in financials for companies that trade common stock and potential common stock (e.g. options, warrants)?
Basic EPS and diluted EPS
What is diluted EPS?
The reduction in EPS due to the assumed conversion/exercising of all potential securities into common stock
What is income available to common stockholders (IAC)?
Net Income - Preferred Dividends
Numerator for EPS
How do you calculate preferred dividends earned for cumulative P/S?
Pay attention to the minimum dividends to which preferred stockholders are entitled, use the data for preferred dividends paid, and then spot any “gaps” (where the entitled dividends were not paid)
What are general rules when calculating the weighted average number of shares outstanding?
Multiply shares outstanding at a given point times the percentage of the period it was outstanding (e.g. 4/12 months) to get that component of weighted average
Add up all the components to get the weighted average for the period
If a stock dividend or stock split occurs at any given point, it has to be applied retroactively to the beginning of the period
In the calculation of weighted average shares of common stock outstanding, what happens if a stock dividend or stock split occurs during the period?
It has to be applied retroactively to the beginning of the period
E.g. for a 2-to-1 stock split, multiply all previous components of weighted average by 2
In the calculation of common stock outstanding, how do stock dividends specifically affect the weighted average component?
They increase by the % dividend
E.g. 10% stock dividend = multiply weighted avg. component by 1.10
What are the three different kinds of potentially dilutive securities?
Convertible securities – use if-converted method
Options, warrants, etc. – use treasury stock method
Contingently issuable shares
Why are they called potentially dilutive securities?
Because they might be anti-dilutive
How do you determine if securities are anti-dilutive?
Determine their per-share effect – see how much IAC increases when they become common stock, and divide that by the number of shares they turn into
If the per-share effect is greater than the EPS, then they are anti-dilutive
What is the if-converted method?
Assumes that all convertible securities will be converted
Decreases IAC by expenses for those securities, increases shares outstanding
How do convertible securities affect the numerator for EPS?
Income Available to Common Stockholders (IAC) can be increased when the converted securities are:
- convertible bonds, since there aren’t more interest payments
- convertible preferred stock, since there aren’t more preferred dividends
In the if-converted method, how does the removal of interest expense affect IAC?
Net of tax, profit-sharing, bonuses, etc.
- if there is a % profit-sharing, then that % of the income expense would not be available to C/S holders
- similarly if there is a tax effect or bonus
Make sure you deduct these amounts in the proper order, depending on the situation
What is an example of interest expense affecting IAC on the if-converted method?
$40,000 expense, 10% profit-sharing, 40% tax
$40,000 (expense) - $4,000 (increase in profit-sharing upon conversion) = $36,000 (new income, pre-tax) - $14,400 (40% on the new income) = $21,600
IAC would be increased by $21,600
In the if-converted method, how does the removal of P/S dividend payments affect IAC?
Directly – there are no adjustments made, since they are after-tax
What is the treasury stock method?
Assumes that all outstanding options are exercised (if their exercising is profitable) and that the company uses those proceeds to re-purchase treasury stock at the market value
Difference between shares sold and re-purchased = increase to shares outstanding
On the treasury stock method, what are anti-dilutive securities?
All options/warrants that are not “in the money” (i.e. if their exercise price is higher than the market price)
What is the per-share effect for options and warrants?
Always $.00, since they never provide any increase to income
That is, the money from options is already earned when the options are bought; the cash paid in when they are exercised is just to buy shares
What is an example of an option diluting EPS?
10,000 shares, market price = $22, exercise price = $20
$200,000 (proceeds)
/ $22 (market price)
= 9,091 (shares re-purchased by company)
10,000 - 9,091 = 909 incremental shares – added to denominator of diluted EPS
What are the rules governing the first two types of contingently issuable shares?
If the contingency:
- involves a passage of time, include it in diluted EPS
- is a specific event that has not yet been fulfilled, include shares as if it were met
How do you account for a future market price contingency for diluted EPS?
If the contingency depends on the market price at a future date, include all shares that would have been issued if the market price at period-end were the future market price
How do you account for an earnings contingency for diluted EPS?
If shares are issued upon attaining or maintaining certain earnings, then include shares that would be outstanding if the required earnings amount is currently being achieved
Are securities always assessed as anti-dilutive or not in relation to the basic EPS?
No
Add security with smallest per-share effect to basic EPS, and then use that new diluted EPS amount to determine whether the next security is anti-dilutive or not
How often must EPS be presented?
Every period for which an income statement (or summary of earnings) is presented
Where should EPS be reported?
On the face of the income statement – for net income and income from continuing operations
If there are discontinued operations or extraordinary items, EPS for those items need to be present somewhere (can be in notes)
What qualifies as a simple capital structure?
An entity having no dilutive securities
Distinguished from a complex capital structure
What must be reported for a complex capital structure?
Basic and diluted EPS for net income and for income from continuing operations
-needs to be reported on face of the I/S “with equal prominence”
Per-share info needs to be disclosed somewhere for each component of income, including discontinued operations and extraordinary items
If a security is dilutive in calculating diluted EPS for one income component but not another, what happens?
If it is included in diluted EPS for income from continuing operations, then it is included in diluted EPS for everything else
When calculating basic EPS, what should you subtract from net income in the numerator?
Only the preferred dividends that are owed in the year
This can be more or less than the actual amount paid, and you can ignore dividends in arrears
When calculating diluted EPS, for how long are dilutive securities assumed to have been converted?
From the beginning of the earliest period reported, or from the time they were issued – whichever is later
