Financial Statement Analysis

Question 1

What are the four financial statements that all public companies must produce?

Answer 1

BS, IS, Statement of cashflow & Statement of changes in equity

Question 2

What is the role of an auditor?

Answer 2

Its a third party which checks if the financial statements are reliable and prepared according to IFRS/GAAP

Question 3

What is the BS identity?

Answer 3

Assets = Liability + Shareholders equity

Question 4

The book value of a companys assets usually does not equal the market value of those assets. What are reasons for the difference?

Answer 4

Market value is usually higher bc it includes profitability, intangibles and future growth prospects

Question 5

What is a firm’s enterprise value and what does it measure?

Answer 5

The cost to take over the business (market value + debt - cash)

Question 6

What is the difference between a firm’s gross profit and its net income?

Answer 6

Gross profit focuses only on sales/costs that are directly related to the good/service the company sells.

Net income includes all operations of revenue/expenses besides the ones already mentioned and has interest and taxes deducted.

Question 7

What are the diluted earnings per share?

Answer 7

Calculation to figure out the quality of a companys earnings per share (EPS), if all convertible securities are exercised

Question 8

Why does a firm’s net income not correspond to cash generated?

Answer 8

Bc there are non-cash entries listed in the IS (such as depreciation) and certain uses of cash aren’t listed on the IS (for example purchase of PPE)

Question 9

What are the components of the statement of Cashflow?

Answer 9

• Operating activities
• Investment activities
• Financing activities

Question 10

Where do off-balance sheet transactions appear in a firm’s financial statements?

Answer 10

in the MD&A (management discussion & analysis), which is a preface to financial statements providing a background on the company & any significant events

Question 11

What information do the notes to financial statements provide?

Answer 11

Further details such as accounting assumptions, details of stock-based compensation plans for employees, leases, taxes, etc

Question 12

Why is EBITDA used to assess a firm’s ability to meet its interest obligations?

Answer 12

Because depreciation and amortization aren’t actual fash expenses, but would get deducted when computing EBIT

Question 13

What is the difference between a firm’s book debt-equity ratio and it’s market debt-equity ratio?

Answer 13

The market value of equity is easier to interpret bc the book debt ratio might be negative, making the ratio meaningless

Question 14

To compare the valuation of firms with very different leverage, which valuation multiplies would be most appropriate?

Answer 14

Valuation ratios based on the firms enterprise value. For example:

• ratio of enterprise to revenue
• ratio of enterprise to operating income, EBIT or EBITDA

Question 15

What is the DuPont Identity?

Answer 15

A tool to express the ROE (return on equity) in terms of the firms profitability, asset efficiency and leverage to gain a further insight into a firm’s ROE

calculated:
Net profit margin * asset turnover * equity multiplier

Question 16

What information does the cashflow statement provide?

Answer 16

how much cash the company has generated

Question 17

Why is profit different from cash?

Answer 17

• you can’t use profit go pay obligations bc it’s just an accounting term. Profit includes non-cash expenses such as depreciation
• Cash is needed to pay bills. Some uses of cash are not deducted on the IS (f.e. Investment in PPE)

Question 18

What is significant about operating activities?

Answer 18

directly related to the goods & services

Question 19

What is significant about investing activities?

Answer 19

cash outflow - > purchase of assets or money invested in financial instruments

Question 20

What is significant about financing activities? What are their in- & outflows

Answer 20

• debt & equity financing
• inflows are borrowings or sale of shares
• outflows are repayments or dividends

Question 21

Name 3 typical cash inflows!

Answer 21

• Decrease in assets (bc cash hasn’t flown, therefore added back)
• Increase in liabilities (bc cash hasn’t flown yet)
• depreciation and other non-cash charges (added back because it’s non-cash)
• sale of shares

Question 22

Name 3 typical cash outflows!

Answer 22

• Increase in assets (bc we needed to spend cash on inventory for example)
• Decrease in liabilities (repayments)
• dividends paid
• repurchase of shares

Question 23

What is a capital expenditure?

Answer 23

purchase of a new PPE (doesn’t immediately appear as expense in IS and therefore needs to be deducted in the cashflow statement)

Question 24

How can you calculate retained earnings?

Answer 24

Net income - dividends

Question 25

How do you calculate the change in shareholders equity?

Answer 25

Change in share capital + change in retained earnings