Financial Statement Analysis Basics Flashcards
__________ analysis is conducted as a restatement of financial information info in ratio or percent form, used as a comparison.
vertical
__________ analysis examines changes in financial data across time of a single company.
horizontal
When you are said to disaggregate the ROA into two sections, ROA =
(profit margin) * (asset turnover)
The profit margin is conceptually able to tell you the
profit from each dollar of revenue
The asset turnover is conceptually able to tell you the
level of sales generated by each dollar invested in assets
Statements compared in a vertical financial statement analysis are also called…
common-size financial statements
When a ratio includes both an IS item and a BS item, you have to…
average the balance sheet item over multiple periods
In calculating the ROA, you exclude the…
effects of interest payments to creditors + dividends payments to shareholders
ROA can be increased by these two methods:
- targeting higher profit margins
- increasing asset turnover
True or false: ROA focuses on how the company financed the assets.
FALSE
Explain the “Gucci and H&M” analogy when looking at asset turnover versus profit margins.
H&M likely has a high asset turnover and lower profit margins, while Gucci has higher profit margins but lower asset turnover. Both could have the same ROA in theory.
When conducting a horizontal analysis of financial statements, the amount of change for a given year =
(Final - Initial) / (Initial)
or
(Current Year - Prior Year) / (Prior Year)
In vertical analysis, components of the Income Statement are expressed as a percentage of…
net sales
In vertical analysis, components of the Balance Sheet are expressed as a percentage of…
total assets
When a ratio includes an item from the income statement and an item from the balance sheet, you have to
average the balance sheet item over multiple periods
The availability of cash and other near-cash resources to meet near-term obligations is
liability
The current ratio for a company tells you the
amount of current liabilities available for every $1 of current liabilites
The higher the current ratio, the higher a company’s liquidity. This is (better/worse) for the company
better
The quick ratio reflects a company’s ability to
meet its current liabilities without liquidating inventories that could include markdowns
The quick ratio calculation excludes
inventories and prepaid assets
Working capital answers the question:
How many assets are left over after we meet current liabilities?
Positive working capital implies
more expected cash inflows than outflows in the short run
Companies can effectively manage working capital through the following:
- minimizing receivables
- maximizing payables
The operating cash flow to current liabilities (OCFCL) relates…
the net amount of cash from operating activities to the amount of current liabilities
The operating cash flow to current liabilities (OCFCL) is a key indicator of a company’s ability to…
PAY DEBTS
A company’s ability to meet debt obligations is called…
solvency
The debt-to-equity ratio conveys…
how reliant a company is on creditor financing in comparison to equity financing
A higher debt-to-equity ratio means (higher/lower) solvency
lower
Higher debt-to-equity ratio means lower solvency. This poses a (smaller/greater) risk to the company.
greater risk
The times interest earned ratio determines…
how much operating profit is available to pay interest
Lenders prefer the times interest earned ratio to be (high/low)
high, because it implies smaller risk of default
A company’s profit margin measures its ability to…
control the level of expenses relative to sales
A company’s asset turnover measures…
how effectively a company is able to use its assets to generate revenue / sales
Debt increases…
default risk
The return on financial leverage (ROFL) measures…
the amount of ROE that can be attributed to financial leverage
The use of debt and other liabilities to fund assets of the firm, adding risk and volatility to a company, is called…
financial leverage
Operating activities may be restricted by…
debt covenants
Restrictions on operating activities imposed by creditors are called…
debt covenants
This ratio analyzes the relationship between financial performance and the stock price.
the Price-Earnings Ratio (P/E ratio)
