Financial statements

Question 1

financial statements

Answer 1

firm issued accounting reports with last performance information

filed with the SEC (US securities and exchange commission)

10Q - quarterly
10K - annually

must also send an annual report with financial statements to shareholders

Question 2

Generally accepted accounting principles (GAAP)

Answer 2

common set of rules and standard format for public companies to use when they prepare their reports

different countries have their own GAAPs

International financial reporting standards (IFRS) is an international effort to harmonise accounting standards

Question 3

Auditor

Answer 3

Neutral 3rd party that checks a firms financial statements

in reality, auditing firms have their own interests and may be far from neutral

Question 4

Types of financial statements

Answer 4

Balance sheets (stock)

income statement (flows)

statements of cash flows

statement of stockholders equity

Question 5

Stock vs. Flow

Answer 5

a stock is measured at a specific time and represents a quantity existing at that point in time

a flow is measured over an interval of time

Question 6

Balance sheet

Answer 6

snapshot in time of the firms financial position

looks at stocks

Question 7

The balance sheet identity

Answer 7

Equity + total assets - total liabilities

assets = what the company owns 
liabilities = what the company owes

Question 8

Assets

Answer 8

Current assets: cash or asset expected to turn into cash in the next year

Marketable securities (eg gov. debt that matures in a year)

accounts receivable (what customers owe)

inventories

other current assets: eg prepaid expenses

Question 9

Long-term assets

Answer 9

• Net property, plant and equipment

subject to depreciation

• book value = acquisition cost - accumulated depreciation
• Goodwill and intangible assets

subject to amortisation

• other long-term assets e.g investments in long term securities

Question 10

Liabilities

Answer 10

• Current liabilities: due to be paid within the next year
• accounts payable
• short-term debt/notes payable
• current maturities of long-term debt
• other current liabilities (taxes and wages payable)

Question 11

Net working capital

Answer 11

current assets - current liabilities

Question 12

Long-term liabilities

Answer 12

long-term debt
capital leases
deferred taxes

Question 13

Book value of equity

Answer 13

could possibly be negative and many of the firms valuable assets may not be captured on the balance sheet

Question 14

Market value of equity (market capitalisation)

Answer 14

= market price per share x no. of shares outstanding

cannot be negative

Question 15

Market-to-book ration (also price-to-book)

Answer 15

= market value of equity/book value of equity

Question 16

Enterprise value

Answer 16

market value of the business

a good measure to value a firm for a potential takeover

enterprise value = market value of equity + debt - cash

Question 17

Income statement

Answer 17

lists firms revenues and expenses over a period of time

looking at flow

all about net income which measures a firms profit after tax and interest expenses

Question 18

Net income formula

Answer 18

= (total sales - cost of sales)

• (selling, general, admin expenses + R&D + depreciation and amortisation)

+ (other income - other expenses)

+(interest income - interest expenses)

• taxes

= pre-tax income - taxes

Question 19

Gross profit formula

Answer 19

= total sales - cost of sales

Question 20

Operating expenses

Answer 20

= selling, general, admin expenses + R&D + depreciation and amortisation

Question 21

Operating income

Answer 21

= gross profit - operating expenses

Question 22

Earnings before interest & taxes (EBIT)

Answer 22

= operating income + (other income - other expenses)

Question 23

Pre-tax income

Answer 23

= EBIT + (interest income - interest expenses)

Question 24

what can net income be used for?

Answer 24

pay dividends to the shareholders

retained in the firm (can be used for reinvestment)

Question 25

earnings per share (EPS)

Answer 25

= net income/shares outstanding EPS may go down due to stock options or convertible bonds to take into account of possible dilution, we can look at diluted EPS

Question 26

Statement of cash flows

Answer 26

net income typically doesn't equal the amount of cash the firm has earned net income is accounting profit, but no change of cash

Question 27

where does the difference between net income and change of cash come from?

Answer 27

- Non-cash items expenses that are listed in the income statement that do not involve cash payment e.g depreciation and amortisation - use of cash not on the income statement investment in property, plant and equipment payment of the principal amount of debt

Question 28

3 sections of statement of cash flows

Answer 28

operating activity investment activity financing activity

Question 29

Operating activity

Answer 29

adjusts net income by all non-cash items related to operating activities and changes in net working capital

Question 30

Cash from operating activities

Answer 30

= net income + depreciation, amortisation and other non-cash items - change in accounts receivable + change in accounts payable - change in inventories

Question 31

Investment activity

Answer 31

capital expenditures buying or selling marketable securities

Question 32

Financing activity

Answer 32

- payment of dividends (retained earnings = net income - dividends) - change in borrowings (interest expenses already deducted when calculating net income

Question 33

Cash from financing activities

Answer 33

= (sales of stock - purchasing of stock) - dividends paid + increasing in borrowing

Question 34

Cash from investments activities

Answer 34

= capital expenditure | acquisitions and other investment activities

Question 35

change in cash & cash equivalents

Answer 35

= cash from operating activities + cash from investment activities + cash from financing activities

Question 36

Change in stockholders' Equity

Answer 36

= addition to retained earnings + net sales of stock = (net income - dividends) + (sales of stock - repurchases of stock)

Question 37

other financial statement information

Answer 37

management discussion and analysis (off-balance sheet transactions) notes to the financial statements

Question 38

Gross Margin

Answer 38

= gross profit/sales

Question 39

operating margin

Answer 39

= operating income/sales

Question 40

EBIT margin

Answer 40

= EBIT/sales

Question 41

Net profit margin

Answer 41

= net income/total sales

Question 42

Current ratio

Answer 42

= current assets/current liabilities

Question 43

quick ratio

Answer 43

= (cash + short-term investments + accounts receivable) /current liabilities

Question 44

cash ratio

Answer 44

= cash/ current liabilities

Question 45

accounts receivable days

Answer 45

= accounts receivable/ average daily sales

Question 46

accounts payable days

Answer 46

= accounts payable/ average daily cost of sales

Question 47

inventory days

Answer 47

= inventory/average daily cost of sales

Question 48

accounts receivable turnover

Answer 48

= annual sales/accounts receivable

Question 49

accounts payable turnover

Answer 49

= annual cost of sales/accounts payable

Question 50

inventory turnover

Answer 50

= annual cost of sales/inventory

Question 51

interest coverage ratios

Answer 51

EBIT/interest EBITDA/interest (EBIT + depreciation and amortisation)

Question 52

debt-equity ratio

Answer 52

= total debt/total equity

Question 53

debt-to-capital ratio

Answer 53

= total debt/(total equity + total debt)

Question 54

Net debt

Answer 54

= total debt - excess cash & short-term investments

Question 55

debt-to-enterprise value ratio

Answer 55

= net debt/market value of equity + net debt

Question 56

equity multiplier

Answer 56

= total assets/book value of equity = 1 + debt-equity ratio

Question 57

P/E ratio

Answer 57

= market capitalisation/net income = share price/EPS

Question 58

enterprise value to EBIT

Answer 58

= market value of equity +debt - cash/EBIT

Question 59

enterprise value to sales

Answer 59

= (market value of equity + debt - cash)/sales

Question 60

enterprise value to EBITDA

Answer 60

= (market value of equity + debt - cash)/EBITDA

Question 61

return on equity

Answer 61

= net income/book value of equity

Question 62

return on assets

Answer 62

= net income + interest expense/ total assets

Question 63

return on invested capital

Answer 63

= EBIT(1 - tax rate)/book value of equity + net debt

Question 64

The DuPont identity

Answer 64

ROE = returns on equity = (net income/sales) x (sales/total assets) x (total assets/book value of equity) = net profit margin x asset turnover x equity multiplier