Introduction & Liquidity Analysis

Question 1

What are two different accounting policies for income statements?

Answer 1

• Cost based (divided on types of costs).
• Function based (divided on the different units/functions of the company)

We cannot directly compare two statements that have different policies.

Question 2

What is the clean surplus relation?

Answer 2

Equity is only affected by profit/loss and owner transactions

E(t) = E(t-1) + Net profit - Div + New issue

Question 3

What is the statement of comprehensive income?

Answer 3

The statement where things that affect equity but not profitability are brought up.

Question 4

What are two important business decisions?

Answer 4

1. What changes of assets need to be done?
   - Capital budgeting
   - Affects balance sheet and cash flow statement
2. How to use existing assets in the best possible way?
   - Costing
   - Affects income statement

Question 5

What are three things within a company that affect each other?

Answer 5

• Strategy
• Financial consequences
• Value creation

Question 6

What are the three dimensions of financial analysis?

Answer 6

• Liquidity (short-term survival)
• Profitability
• Financial strength (long-term survival)

Question 7

What are some key ratios of Liquidity?

Answer 7

• Cash & Cash equivalents
• Current ratio
• Quick ratio
• Interest coverage ratio
• Capex ratio
• Cash flow statement (cannot only rely on ratios)

Question 8

What are some things we consider when evaluating performance?

Answer 8

• Benchmarking
• Trends
• Perspective
• Understanding industry and market

Question 9

What does “current” mean in current assets/liabilities?

Answer 9

Due within 1 year

Question 10

What is the current ratio formula and what is a rule of thumb for its value?

Answer 10

Current ratio = Current Assets / Current liabilities

(found in balance sheet)

Rule:
CA>CL, approx. 1,5 - 2

Question 11

What is the Quick ratio formula and what is a rule of thumb for its value?

Answer 11

Quick ratio = (Current assets - Inventory) / Current liabilities

(found in balance sheet)

Rule:
(CA-I)>CL
>1

Question 12

What are strengths and weaknesses of the Current and Quick ratios?

Answer 12

Strengths:
+ Simple

Weaknesses:
- Static (balance sheet only gives view of certain point in time)
- Rule of thumb not valid for all industries (traditionally manufacturing)
- Liquidation scenario

Question 13

What is the interest coverage ratio formula and what is an acceptable level?

Answer 13

Interest coverage ratio = EBIE / Financial expenses

(found in income statement)

EBIE > financial expenses
(2-4 times greater)

Question 14

What companies typically assess the interest coverage ratio?

Answer 14

Banks and rating companies

Question 15

Why do we not want the interest coverage ratio to be too high?

Answer 15

Since borrowing can be necessary for growth (how are they otherwise financing growth?)

Question 16

What are strengths and weaknesses of the interest coverage ratio?

Answer 16

Strengths:
+ Dynamic
+ Shows if financial expenses can be covered

Weaknesses:
- Includes non-cash items (profit is not equal to cash)

Question 17

What is the Capex ratio formula and what is an acceptable level?

Answer 17

Capex ratio = Cash flow from operations / Cash flow from investing activities

(found in cash flow statement)

CFO>CFI
Capex > 1 in the long run

(ratio not applicable is CFI is positive, also not useful when CFO is negative)

Question 18

What are strengths and weaknesses of the Capex ratio?

Answer 18

Strengths:
+ Shows ability to finance investments by own means

Weaknesses:
- Fluctuates over time, not suitable for short periods

Question 19

What is a liquidity budget and in which industries can they be particularly important?

Answer 19

Used for internal purposes, sums up payments to make sure the firm don’t run out of cash. Often done per month, to make sure no problems arise.

Especially important in seasonal industries