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Principles of Finance > Financial Statements and Planning > Flashcards

Financial Statements and Planning Flashcards

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1
Q

Financial statements contain the financial information necessary to evaluate the company’s ___________.

A

performance.

-The financial statements cover all aspects of a company’s financial situation and act as a guide to the overall state of a company’s finances.

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2
Q

Financial statements in the USA must comply with the _______ set of standards.

A

GAAP.

  • The GAAP, Generally Accepted Accounting Principles, is the benchmark standard to allow for easy comparison of financial statements between companies.
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3
Q

The GAAP (Generally Accepted Accounting Principles) is authorized by the ___________.

A

FASB.

  • The FASB, Financial Accounting Standards Board, is the accounting professions’s rules setting body.
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4
Q

The ________ statement contains a financial summary of the company’s operating results for a particular period.

A

income.

  • The income statement takes into account the company’s operating results, which are the earnings minus the operating costs and taxes.
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5
Q

Earnings before interest and tax (EBIT) is called the _________ profit.

A

operating.

  • The operating profit is a measure of the company’s gross earning power from ongoing operations.
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6
Q

Net profits are earnings ________ tax.

A

after.

  • Net means after tax and liabilities have been deducted.
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7
Q

The balance sheet balances the company’s _______ and debt or equity.

A

assets.

  • In order to present an accurate summary of a company’s financial position, assets must be weighed against liabilities.
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8
Q

______ assets and liabilities are expected to be converted to cash within 12 months.

A

current.

  • They are called current because they are soon converted to cash.
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9
Q

Long-term or fixed assets and liabilities are expected to stay on the company’s books for more than ____ months.

A

12.

  • This is the definition of a long term or fixed asset.
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10
Q

The entry accounts ____________ in the Balance Sheet constitutes the total monies owed to the Company from credit sales made to Customers.

A
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11
Q

The entry ‘Inventories’ in the Balance Sheet indicates ___________ materials, partially and completed goods in the company’s possession.

A

raw.

  • Even though the raw materials have not been utilized yet, they constitute part of the inventory of a company.
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12
Q

The net value of fixed asset are known as the ______ value.

A

book.

  • The book value is calculated by obtaining the difference between the value of the gross fixed assets and the accumulated depreciation of those fixed assets.
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13
Q

_______ equity is a balance sheet item that refers to the book value of the company.

A

stockholders.

  • This is the investment that shareholders have in a company. It is the difference between total assets and total liabilities, in other words, the owner’s share of the business.
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14
Q

The entry for ‘common stock’ on the balance sheet represents it’s ________ value.

A

par.

  • This is the randomly appointed per share value used for accounting purposes.
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15
Q

The statement of retained earnings reconciles the _____ _____ of a company from the start to the end of the accounting period, to be retained in the company, after paying dividends.

A

net profit.

  • The net profit figure is used to give an accurate picture of the earnings retained for company use.
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16
Q

The statement of cash flows summarizes a company’s ___________, investment and financing cash flows over a particular period.

A

operating.

  • This relates to the production of a company’s products and services and so is an integral part of the cash flows of a company.
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17
Q

In preparing their financial statements, US based companies must convert their foreign currency assets and liabilities into dollars using the ______ ______ translation method.

A

current rate.

  • This is the method determined by the FASB, standard no 52. The conversion occurs using the existing exchange rate on the fiscal year end date.
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18
Q

In a translated balance sheet, gains or losses from currency movements in using the current rate transalation method are accumulated in the ____________________ account.

A
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19
Q

Financial ratio analysis involves the application of a calculation and ___________ of those ratios in order to assess the company’s performance.

A

interpretation.

  • This is fundamental to financial ratio analysis because the calculation by itself is meaningless without a benchmark for comparison.
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20
Q

Financial ratio analysis would be of interest to the company’s management, creditors and _____________.

A

shareholders.

  • The shareholders, as owners of the company, will be interested in the company’s performance.
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21
Q

The two types of financial ratio comparisons are cross-section and ____-______ analysis.

A

time-series.

  • These are the two types of comparisons for financial ratios.
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22
Q

Cross-sectional analysis refers to the comparison of a company’s financial ratios at the _____ ______ in time with other companies in the industry or with industry norms.

A

same point.

  • Current data should be used for accurate results.
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23
Q

Evaluation of a company’s performance over time is called ___-____ analysis.

A

time-series.

  • This evaluation compares current with past performance.
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24
Q

In cross-sectional analysis, it is important to investigate major deviations on either side of the norm because it usually indicates that there is a _________.

A

problem.

  • Major deviations are usually a warning sign that something is not right with the company.
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25
Q

When cross-sectional and time-analysis are used together, it is called _______ analysis.

A

combined.

  • A combined perspective mixes both types of analysis and presents a clearer picture for the analyst.
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26
Q

When comparing financial statements for the purpose of ratio analysis, they should be dated at the same time of year because the effects of ________ could distort the results.

A

seasonality.

  • Time of year can play a crucial part in analyzing a company’s data, as their type of business may be affected by the season. For example, the turnover for a manufacturer of Christmas novelty products will be dramatically different towards the end of the year, as compared with Springtime.
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27
Q

What are the four types of financial ratios?

A
  1. Liquidity ratios
  2. Activity ratios
  3. Profitability ratios
  4. Debt ratios.
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28
Q

In order to carry out an effective financial ratio analysis, at least two of the financial statements wlll be required by the analyst.

What are these statements?

A

The balance sheet and the income statement.

  • The income statement is necessary as it contains the company’s operating results for the specified time period.
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29
Q

Financial ratio analysis should only be carried out on _________ accounts.

A

audited.

  • Audited accounts have been independently verified as representing the correct financial position of a company. Unaudited accounts carry no such warranty.
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30
Q

The ______ ratio expresses a company’s liquidity and therefore it’s ability to cover it’s short-term liabilities and can be calculated by taking current assets and dividing it by current liabilities.

A

current.

  • This term indicates the short-term nature of a company’s liquidity.
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31
Q

Quick Ratio = Current Assets - _________ divided by Current Liabilities

A

inventory.

  • The quick ratio is similar to the current ratio, except that the inventory is excluded from the calculation. The inventory is excluded as it is the least liquid current asset. The quick ratio will be the better analysis where the inventory cannot be easliy converted to cash.
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32
Q

Although net working capital is strictly speaking, not a financial ratio, it is useful in calculating a company’s overall liquidity and is measured by working out the difference between current assets and current ____________.

A

liabilities.

  • This is the definition and calculation for net working capital.
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33
Q
A

short. Liquidity is a short-term measure of a company’s overall financial position.

34
Q

Measures of overall liquidity should be assessed in conjunction with _________ ratios, as the latter analyzes the rapidity with which the various assets and liabilities can be liquidated.

A

activity.

  • Activity ratios look at each asset and liability that is held to ascertain how quickly it can be liquidated. Therefore, even though two companies may have the same current ratio, the activity ratio may reveal that one company is more liquid than other via analysis of their accounts.
35
Q

Debt ratio = Total liabilities divided by total ___________

A

assets.

  • Debt ratio is derived from calculating the proportion of a company’s assets that are financed by creditors.
36
Q

_____ _______ earned ratio is a measure of a company’s ability to meet it’s contractual interest payments.

A

times interest.

  • This ratio is calculated by dividing earnings before interest and tax by interest. A figure above 3, preferably 5, is acceptable.
37
Q

Fixed payment coverage ratio measures ______ , so that if a company is unable to meet it’s fixed scheduled payments, then it may be forced into bankruptcy.

A

risk.

  • The ratio may indicate the likelihood of a company being forced into bankruptcy if it is unable to meet set payments to it’s creditors. The lower the ratio, the greater the risk.
38
Q

Inventory turnover is used to calculate the activity or liquidity of a company’s inventory by dividing the _________ of goods sold by the inventory.

A

cost.

  • Cost of goods sold divided by the inventory is the formulation used but will only be relevant when comparing it with the industry average.
39
Q

The average collection period is relevant when compared with the company’s _____________ terms.

A

credit.

  • This is because different companies offer different credit terms and so this ratio must be compared with the number of days/months the company allows for payments to be made by Customers.
40
Q

The average payment period is calculated by dividing the accounts ______________ by the average purchases per day.

A

payable.

  • This is the formula used to calculate this ratio.
41
Q

The efficiency with which a firm is utilizing it’s fixed assets to generate sales is called the fixed asset _________________.

A

turnover.

  • Fixed asset turnover is calculated by dividing sales by net fixed assets.
42
Q

The ___ ___ income statement is a method of evaluating profitability, that expresses each item as a percentage of sales.

A

common size.

  • This statement uses the same benchmark, that of sales, for comparison and hence the name common size. It allows for easy comparison between different years.
43
Q

The two ratios of profitability that are commonly mentioned from a common-size report are the ____ and net profit margin.

A

gross.

  • These two ratios give an indication of the profit margins in evaluating a company’s performance.
44
Q

The difference between gross and net profit margin is that the former measures profitability after the company has paid for the goods whereas the latter also takes into account all expenses, including ______.

A

taxes.

  • Net profit margin means profitability after expenses and taxes have been accounted for.
45
Q

The __________ the gross and net profit margin, the better.

A

higher.

  • A higher margin means that the company is making a bigger profit on the products and services sold. The average figure varies from industry to industry, so must be compared with the industry average.
46
Q

The return on total assests (ROA) is calculated by dividing the net profit ________ _______ by the total assets.

A

after taxes.

  • This is the formula specified. ROA measures the efficiency of a company to turnover profits with available resources.
47
Q

The ______________ measures the stockholders return on their investment in the company.

A

ROE.

  • Return On Equity (ROE) is calculated by taking net profits after taxes and dividing it by stockholders equity. The higher the ratio, the better the return for the stockholders.
48
Q

________________ is the portion of a company’s earnings allocated to each outstanding share.

A

EPS.

  • Earnings per share (EPS)is a company’s net income divided by its number of outstanding shares and represents the dollar amount earned on behalf of each share outstanding. It does not equate to the amount of earnings distributed to the stockholders.
49
Q

How is the P/E ratio calculated?

A

The P/E ratio is calculated by taking the current market price of a stock and dividing by the earnings per share (EPS).

50
Q

What does a high P/E ratio signify?

A

A high P/E ratio signifies that there is a high level of confidence in a company’s future performance.

  • The higher ratio means the investor is prepared to pay more for each dollar earned by the company.
51
Q

Single ratio analysis of a company is unreliable in determining its financial condition, so a _________ ratio analysis should be conducted.

A

complete.

  • The complete ratio analysis is a more reliable guide to a company’s health as it is more thorough and detailed.
52
Q

What are two well-known methods of complete ratio analysis?

A
  1. The Dupont system
  2. The summary analysis approach
53
Q

What is ROA?

How does one calculate ROA?

A

ROA tells an investor how much profit a company generated for each $1 in assets.

Return on Assets:

Net profit margin * asset turnover

or

Net income ÷ Total average assets for the period

54
Q

What is the Dupont system/identity?

A

The Du Pont identity breaks down Return on Equity (that is, the returns that investors receive from the firm) into three distinct elements.

This analysis enables the analyst to understand the source of superior (or inferior) return by comparison with companies in similar industries (or between industries).

The Du Pont identity, however, is less useful for some industries, such as investment banking, that do not use certain concepts or for which the concepts are less meaningful.

55
Q

What is ROE?

A

ROE (Return on equity) is the amount of net income returned as a percentage of shareholders equity.

ROE is expressed as a percentage and calculated as:

Return on Equity = Net Income/Shareholder’s Equity

56
Q

What does ROE measure?

A

Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested.

57
Q

What is Asset turnover?

How is it calculated?

A

Asset Turnover tells an investor the total sales for each $1 of assets

Asset Turnover = Revenue ÷ Average assets for period

58
Q

How does one calculate ROE in the Dupont system?

A

Return on Equity = (Net Profit Margin) (Asset Turnover) (Equity Multiplier).

59
Q

The purpose of using the financial leverage multiplier (FLM) is to reflect the effect of _____ on the stockholders return.

A

debt.

  • The FLM (equity multiplier) is the ratio of total assets to stockholders equity and therefore reveals the leverage effect, in other words, debt.
60
Q

The advantages of using the Dupont system are that the financial position of a company can be analyzed by the net profit margin, the use of debt and the ________ __________ turnover.

A

total asset.

  • Total asset turnover (efficiency of asset use) is important to demonstrate how a company uses its resources to generate sales and profits.
61
Q

The summary of ratio analysis system will allow the analyst to examine the four following aspects of a company’s performance; liquidity, ________, profitability and debt.

A

activity.

  • Activity ratios are key to dissecting the liquidity of the inventory and individual accounts within.
62
Q

Breakeven analysis is a tool used to ascertain when a business will be able to cover all its _________ and begin to make a profit.

A

expenses.

  • In order to conduct this analysis, the level of revenue must be calculated and offset against all operating costs.
63
Q

The three types of costs that need to be analyzed to conduct breakeven analysis are; variable, fixed and __________ costs.

A

semivariable.

  • Some costs are neither fixed or variable but are semi-fixed and semivariable, for example sales commissions.
64
Q

A company’s operating breakeven point occurs when earnings before interest and tax equals _____.

A

zero.

  • In order to reach the breakeven point, the level of revenue generated must match all operating costs, therefore that occurs when earnings before interest and tax equal to zero.

Where P=sale price per unit, Q = sales quantity in units, FC=fixed operating cost and VC=variable operating costs;

the formula for calculating the breakeven point is Q=FC/(P-VC)

65
Q

The operating breakeven point will change if the fixed costs, price of the product or _____ _______ are altered.

A

variable costs.

  • A change in the variable costs will impact the revenue required to cover that cost.
66
Q

Where P=sale price per unit, Q = sales quantity in units, FC=fixed operating cost and VC=variable operating costs; the formula for calculating the breakeven sales point is __________ = FC/(P-VC).

A

Q.

In order to determine the quantity of unit sales necessary to breakeven, the formula Q = FC/(P-VC) needs to be applied.

67
Q

Two well-known methods to breakeven analysis are calculating the breakeven point in terms of dollars and finding the ______ breakeven point.

A

cash.

The cash method is useful when noncash costs; for example, depreciation, constitutes a sizeable chunk of a company’s fixed operating costs. These costs are then excluded from the calculation of the breakeven point.

68
Q

The breakeven in dollars analysis is useful for companies who sell a ________ product.

A

variety.

Where a company sells various products at different prices, the traditional formula for breakeven analysis does not work very well. Therefore, a contribution margin that assesses the percentage of each sales dollar left after satisfying the variable operating costs, will meet the needs of these companies.

69
Q

The three limitations to breakeven analysis are that it assumes a ________ revenue and operating costs functions, is limited to the short term and has difficulty breaking down the semivariable costs into fixed and variable components.

A

nonvarying.

  • A company rarely faces revenue and operating costs that are constant, for example, the sale price per unit usually goes down with increased sales volume. The timeframe for the analysis is usually one year and so has limitations for long term use. Semivariable costs are difficult to break down because they are not always predictable.
70
Q

Operating leverage occurs when there are ______ _______ costs in a company’s income stream.

A

fixed operating.

  • Where fixed operating costs occur, it can be potentially utilized to magnify the changes in sales on EBIT. An increase in sales causes an increase in EBIT that is more than proportional. Conversely, a decrease in sales causes a decrease in EBIT that is more than proportional.
71
Q

The degree of operating leverage (DOL) can be calculated by taking the percentage change in EBIT and dividing that by the percentage change in ________.

A

sales.

  • This is the formula for calculating DOL. Whenever DOL is more than 1, operating leverage exists.
72
Q

If a company should increase their fixed operating costs; that would have the effect of __________ the degree of operating leverage (DOL).

A

increasing.

The DOL would go up as the fixed costs directly impact on the calculation of DOL at a base level of sales.

Where P=sale price per unit, Q=sales quantity in units, FC=fixed operating cost and VC=variable operating costs; the formula for calculating DOL at base level sales DOL=Q x (P-VC)/Q x (P-VC)-FC

73
Q

Business risk is the risk of a company being unable to meet its ______ ______.

A

operating costs.

  • There is a business risk in increasing operating costs as higher sales revenue will have to be generated.
74
Q

Financial leverage takes place when there is fixed ___________ cost in a company’s income stream.

A

financial.

  • Where fixed financial costs occur, it can be potentially utilized to magnify the effect of changes in EBIT on the EPS.
75
Q

The two types of fixed financial charges found on the Income Statement are interest on debt and ______ _____ dividends.

A

preferred stock.

  • This charge must be paid whether or not there is suitable EBIT to cover the cost.
76
Q

The effect of financial leverage is that an increase or decrease in a company’s EBIT has a higher than ____________ increase or decrease effect on the EPS.

A

proportional.

  • Financial leverage has the effect of magnifying the effects of a change in EBIT on the EPS.
77
Q

_______ =EBIT/EBIT-I-(PDx1/1-T).

A

DFL.

Where EBIT=earnings before tax,

I=Interest,

PD=total preferred dividends,

and T=Tax,

the degree of financial leverage (DFL) can be calculated by using this formula : DFL at base level of EBIT=EBIT/EBIT-I-(PDx1/1-T).

78
Q

Financial risk is the risk of a company being unable to cover it’s financial costs, with the risk rising where there is increased financial ________.

A

leverage.

  • The risk here is the company not being able to meet it’s monetary costs, for example interest payments. Increased financial leverage means the company will have to make a higher EBIT to break even.
79
Q

Total leverage combines the potential uses of _____ and fixed costs to magnify the effects of changes in sales on a company’s EPS.

A

financial.

  • Both financial and fixed costs are utilized for total leverage.
80
Q

Q x (P-VC)/Q x (P-VC)-FC-I-(PDx1/1-T). This is the formula for calculating __________.

A

DTL.

  • This is the formula for calculating Degree of Total Leverage (DTL). DTL can also be calculated by multiplying DOL and DFL.
81
Q
A

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