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Training The Street > Financial Statement Analysis & Accounting Ratios > Flashcards

Financial Statement Analysis & Accounting Ratios Flashcards

1
Q

Why is financial statement analysis absolutely necessary?

A

A company’s reported financial statements may not accurately represent the actual performance of the business.

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2
Q

What is a nonrecurring item?

A

A nonrecurring item refers to an entry that is infrequent or unusual that appears on a company’s financial statements.

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3
Q

How are non-recurring items dealt with in financial statement analysis?

A

Adjustments are made to remove non-recurring items so as to not distort the ability to analyze the business’ operating performance.

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4
Q

What are some examples of non-recurring items?

A
  • product recalls
  • litigation settlements
  • restructuring
  • company sells a business
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5
Q

What is the purpose of the income statement?

A

Summarizes the revenue and expenses for a period of time - reports the profit performance of the business.

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6
Q

Which of the “Big 3” financial statements are used to analyze profitibility?

A

the Income Statement

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7
Q

What is the purpose of the Cash Flow statement?

A

Reports the sources of a business’ cash inflows and outflows between two balance sheet dates.

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8
Q

What is the purpose of the balance sheet?

A

Reports the balance of assets, liabilities and equity at a PRECISE moment in time.

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9
Q

Since we have the income statement, why do we need the statement of cash flows?

A

Revenue does not record cash flow, because revenue is recognized as it is received (as opposed to being recorded when cash changes hand).

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10
Q

Is depreciation a cash inflow or cash outflow?

A

Neither! It is not a cash flow and must be removed from the cash flow statement.

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11
Q

How do we complete a financial statement analysis?

A
  1. Identify risks within the business and industry (SWOT analysis)
  2. Identify financial risks

(can company generate enough cash flow to meet financial obligations)

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12
Q

What is a SWOT analysis?

A

An analysis of the company’s:

  • Strengths
  • Weaknesses
  • Opportunities
  • Threats
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13
Q

What is the key reason income statments and cash flow statements do not reflect the same change in cash?

A

Revenue is recognized when it is earned.

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14
Q

What is the accounting matching principle?

A

Revenues are matched with expenses.

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15
Q

What is the normalization process?

A

The process of removing non-recurring items

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16
Q

What are the major line items on the income statement?

A

Income Statement

Total Revenues

- Cost of Goods Sold (COGS)

Gross Profit

-SG&A

-Depreciation/Amortization

Operating Profit

  • Interest expense

- Interest (income)

Pre-tax Income

- Income taxes

Net Income

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17
Q

What is included in Cost of Goods Sold?

A
  • Cost of good sold
  • direct costs
  • shipping costs
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18
Q

What is included in SG&A?

A

SG&A = Overhead

  • Sales
  • General
  • Admin
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19
Q

What is interest income?

A

Income from interest on a company’s cash

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20
Q

What is interest expense?

A

expense due to use of debt

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21
Q

Which investors have access to a company’s revenue?

  • Debt holders
  • Common stock holders
  • Preferred stock holders
A

All of the above.

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22
Q

Which investors have access to a company’s operating income?

  • Debt holders
  • Common stock holders
  • Preferred stock holders
A

All of the above

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23
Q

Which investors have access to a company’s net income?

  • Debt holders
  • Common stock holders
  • Preferred stock holders
A
  • Common stock holders
  • Preferred stock holders
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24
Q

What are some sources of revenue growth?

A
  • Organic Growth
  • Acquisitions
  • Market Share gains
  • Sector Growth
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25
Q

What is the growth formula?

A

Final - Initial

Initial

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26
Q

What does profitibility measure?

A

Measures management’s ability to maximize revenues and control expenses

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27
Q

What are margins?

A

A means of measuring profitability in which a financial statistic is divided by sales(revenue).

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28
Q
  1. How do you calculate gross margin?
  2. What does it mean?
A
  1. Gross Profit / Sales
  2. The amount of gross profit a company earns per $1.00 of sales.
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29
Q

What are returns?

A

A means of calculating profitability as a function of a business input.

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30
Q
  1. How do you calculate Return on Assets?
  2. What is the value in this metric?
A
  1. Net Income / Total Assets
  2. The ROA figure gives investors an idea of how effective the company is in converting the money it invests into assets into net income.
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31
Q
  1. How do you calculate Return on Equity?
  2. What is the value in this metric?
A
  1. Net Income / Shareholders equity
  2. The ROE figure gives investors an idea of how effective the company is in converting the shareholders invest into the company into net income.
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32
Q
  1. How do you calculate Return on Invested Capital (ROIC)?
  2. What is the value in this metric?
A
  1. Net Income / [Debt + Equity]
  2. The ROIC figure gives investors an idea of how effective the company is at converting money invested into the company into net income.
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33
Q
A
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34
Q

What are some methods of measuring a company’s profitability?

A
  • Margins (Gross Profit Margin)
  • Returns (ROA, ROE, ROIC)
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35
Q

What is EBIT proportional to?

A

EBIT = Operating Income

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36
Q

What does EBIT stand for?

A

Earnings Before Interest and Taxes

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37
Q

What is the purpose of EBIT?

A

Understand the profitability BEFORE the effects of financing and taxes

38
Q

Why is EBIT preferred over Net Income when comparing two companies?

A

The two companies may have (1) different capital structures and (2) different levels of taxation.

39
Q

If you wanted to compare two company’s operating income, which metric would you use?

A

EBIT

40
Q

When people say “the line” what metric serves as “the line”?

A

EBIT

41
Q

What distinction is made for items that are “above the line”?

A

If the income or expense is operating in nature.

42
Q

List some items that would be “above the line”?

A
  • Sales
  • COGS
  • SG&A
  • R&D
43
Q

What distinction is made for items that are “below the line”?

A

Income/Expenses that are not operating in nature

44
Q

List some activities that would be considered “below the line”

A
  • Interest Income
  • Interest Expense
  • Dividend Income
  • Taxes
45
Q

When looking at an income statment, how do we determine which items should be included in EBIT or EBITDA?

A
  1. Must comb through the income statment and identify line items that are operating in nature.
46
Q

True/False:

Net Income = Cash from Operations

A

False!

47
Q

What is the most crucial item for a company?

A

Cash

48
Q

What are the three types of line items on a cash flow statement?

A
  1. Adjustments for non-cash expenses
  2. Cash Inflow (Source of Cash)
  3. Cash Outflow (Usage of Cash)
49
Q

What are the four major sections in a typical cash flow statement?

A
  1. Cash flow from operating activities
  2. Cash flow from investing activities
  3. Cash flow from financing activities
  4. Net change in cash
50
Q

What is the purpose of the cash flow statement?

A
  • To reconcile the changes in cash for the period.
51
Q

What is the starting point for the statement of cash flows?

A

Net Income

52
Q

What line items are seen under “Operating Activities” in the cash flow statement?

A

Operating Activities

Net Income

+ [Adjustments for non-cash expenses]

+ [Adjustment: Depreciation]

+ [Adjustment: Amortizaiton]

+ [Adjustment: Stock-based compensation]

+ [Subtract change in working capital]

Cash flow from operating activities

53
Q

What line items are seen under “Investing Activities” in the cash flow statement?

A

Investing Activities

  • Capital Expenditures (CAPEX)

- Additions to definitite-life intangibles

Cash flow from investing activities

54
Q

What line items are seen under “Financing Activities” in the cash flow statement?

A

Financing Activities

Issuance (repayment) of revolver

Issuance (repayment) of long-term debt

Repurchase of equity

Dividends

Option Proceeds

Cash flow from financing activities

55
Q

How does an increase in accounts receivable impact cash flow?

A

reduces cash flow as your net income goes up, but you haven’t received any cash.

56
Q

How does an increase in accounts payable impact cash flow?

A

Increases cash flow as cash is received but COGS not paid out to supplier yet.

57
Q
A
58
Q

How should we think of “investing activities”?

A

think of it as CAPEX

59
Q

How is CAPEX related to Depreciation?

A

Should be of comparable magnitude.

60
Q

Depreciation Exercise

Click on the image to access the question

A

Click on the image below to see the answer

61
Q

What is amortization?

A

Amortization is an accounting technique used to periodically lower the book value of a loan or intangible asset over a set period of time.

62
Q

What metric is used as a proxy for operating cash flow?

A

EBITDA

63
Q

Why shouldn’t EBIT be used as a proxy from operating cash flow?

A

Because EBIT reflects depreciation and amortizaiton which are non-cash expenses.

64
Q

What are some of the weaknesses for using EBITDA as “actual” cash flow?

A

EBITDA doesn’t include:

  • Changes in WC
  • CAPEX
  • Additions to intangibles (such as purchase of software licenses)
  • Interest Expense
  • Tax Expense
  • Debt Paydown
  • Dividends
65
Q

What is the purpose of the balance sheet?

A

provides a snapshot (ending balance) of the company’s financial position

66
Q

What is the typical time frame for when a current asset or current liability will be due?

A

1 year

67
Q

What is the typical time frame for when a long-term (LT) asset or LT liability will be due?

A

Due after 1 year

68
Q

What is an activity ratio?

A

Activity ratios measure the efficiency of a business in turning over its assets

69
Q

What are three important activity ratios?

A
  1. Accounts Receivable Turnover
  2. Inventory Turnover
  3. Accounts Payable Turnover
70
Q

How do you calculate Accounts Receivable Turnover?

A

ART = Sales / AR

71
Q

What does Accounts Receivable Turnover indicate?

A

Indicates how efficient the business is at turning a sale into cash

72
Q

How do you calculate Accounts Receivable Days?

A

ART / Days

73
Q

What does Accounts Receivable Days indicate?

A

The average amount of time it takes before a cash payment is collected.

74
Q
A
75
Q

What does the inventory turnover ratio convey?

A

Inventory turnover is a ratio showing how many times a company has sold and replaced inventory during a given period.

76
Q

How do you calculate inventory turnover ratio?

A

COGS / Inventory

77
Q

What does Accounts Payable Turnover convey?

A

Accounts payable turnover shows how many times a company pays off its accounts payable during a period.

78
Q

How is Accounts Payable Turnover calculated?

A

COGS / AP

79
Q

What are the two common liquidity ratios?

(and how are they calculated)

A
  • Working Capital (CA - CL)
  • Current Ratio (CA / CL)
80
Q

Why is it better for a company to turn over its working capital faster?

A

A quicker turnover ratio means the company is able to quickly convert assets to cash.

81
Q

What is the equation for the Cash Conversion Cycle?

A

CCC = INV Days + AR Days - AP Days

82
Q

What do liquidity ratios indicate?

A

The company’s ability to convert an asset into cash quickly

83
Q

What do Balance Sheet leverage ratios indicate?

A

A leverage ratio is any one of several financial measurements that assesses the ability of a company to meet its financial obligations (debt).

84
Q

What are two common Balance Sheet leverage ratios and how are they calculated?

A
  1. Debt-to-Capital ratio (D/EV)
  2. Net Debt-to-Capital ratio (Debt - Cash / EV)
85
Q

What are two common Cash Flow leverage ratios and how are they calculated?

A
  1. Debt-to-EBIT (Total Debt / EBIT)
  2. Debt-to-EBITDA (Total Debt/EBITDA)
86
Q

What does Debt-to-EBIT (Total Debt / EBIT) convey?

A

How many years of the current level of operating income is required to pay of the entire debt balance.

87
Q

What does Debt-to-EBITDA (Total Debt / EBITDA) convey?

A

How many years of the current level of operating cash flow is required to pay off the entire debt balance.

88
Q

What are coverage ratios?

A

A coverage ratio, broadly, is a metric intended to measure a company’s ability to service its debt and meet its financial obligations, such as interest payments or dividends

89
Q

What are two common coverage ratios and how are they calculated?

A
  1. EBITDA Coverage (EBITDA / Interest Expense)
  2. EBIT Coverage (EBIT/Interest Expense)
90
Q

If a company had a low coverage ratio such as EBITDA Coverage, what would that indicate to stakeholders?

A

A poor ability to pay off debt or dividends.

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