LM 10: Financial Analysis Techniques Flashcards
What is the difference between a vertical analysis & horizontal analysis of a balance sheet?
vertical analysis: only one reporting period, dividing all items percentage of total assets
horizontal analysis involves multiple time periods or companies. focuses on the percentage increase or decrease in each item.
What is the vertical analysis of the income statement?
vertical analysis: percentage revenue or total assets
What is cross-sectional analysis & another name for it?
Cross-sectional analysis (aka relative analysis) compares a specific metric of one company to another (P/E ratios or multipler)
What are the 3 techniques in model building and forecasting? SSS
- sensitivity analysis
- scenario analysis
- simulation analysis
What is sensitivity analysis?
A what-if technique that shows range of possible outcomes given different assumptions (inputs)
What is scenario analysis?
models market conditions that put pressure on a portfolio
What is simulation?
computer model to run sensitivity and scenario analysis and generates forecasts based on probability of each outcome.
What are the 5 types of financial ratios?ALSPV
- Activity ratios
- Liquidity ratios
- Solvency ratios
- Profitability ratios
- Valuation Ratios
What are activity ratios?
measure the efficiency of a company’s operations
What are the 9 activity ratios? IDRDPNWFT
- Inventory turnover
- Days of inventory on hand (DOH)
- Receivables turnover
- Days of sales outstanding (DSO)
- Payables turnover
- Number of days payables
- Working capital turnover
- Fixed asset turnover
- Total asset turnover
What is inventory turnover formula and use?
measure of how many times the inventory is sold and replaced over a given period.
cost of goods sold/ average inventory
What is days of inventory on hand (DOH) formula and use?
measurement of how many days it takes a business to sell through their stock of inventory.
number of days in period/ inventory turnover
inventory / (COGS/ 365)
What is receivables turnover formula and use?
measures the number of times a company collects its average accounts receivable balance
revenue / average receivables
What is days sales outstanding (DSO) formula and use?
measures the average number of days it takes a business to receive payment for goods and services purchased on credit
number of days in period / receivables turnover
accounts receivable/ (sales/365)
What is payables turnover formula and use?
measures the rate at which a company pays off its suppliers.
credit purchases / average accounts payables
What is number of days payable formula and use?
measure number of days it take for company to pay off its suppliers
number of days in period / payables turnover
accounts payable / (COGS/365)
What is working capital turnover formula and use?
measures how effective a business is at generating revenue for every dollar of working capital put to use.
revenue /average working capital
What is fixed asset turnover formula and use?
measures how efficient a company is at generating sales from its existing fixed assets.
revenue / average net fixed assets
What is total asset turnover formula and use?
measures the efficiency with which a company uses its assets to produce sales.
revenue / average total assets
What are liquidity ratios?
measure company ability to meet short term obligations
What are the 5 liquidity ratios? CQCDC
- Current ratio
- Quick ratio
- Cash ratio
- Defensive interval ratio
- Cash conversion cycle
What is the current ratio formula and use?
measures a company’s ability to pay short-term obligations
current assets / current liabilities
What is quick ratio formula and use?
measures company’s ability to convert liquid assets into cash to pay for short-tern expenses and whether emergencies
(cash + short-term marketable securities + receivables) / current liabilities.
What is cash ratio formula and use?
measure company’s ability to cover its short-term obligations using only cash and cash equivalents
(cash + short-term marketable securities) / current liabilities.
What is the defensive-interval ratio formula and use?
estimates the number of days that a company can continue operating using only its liquid assets
(short term, cash + marketable securities + receivables) / daily cash expenditures
What is cash conversion cycle formula and use?
measures how many days it takes a company to convert the cash it spends on inventory back into cash by selling its product.
days of inventory on hand (DOH) + days sales outstanding (DSO) - number of days of payables
What are solvency ratios?
measure company ability to meet long-term obligations
What are the 2 types of solvency ratios? DC
- debt ratios
- coverage ratios
What are the 5 debt ratios? DDDFD
- debt to assets ratio
- debt to capital ratio
- debt to equity ratio
- financial leverage
- debt to EBITDA
What is the debt to assets ratio and use?
total amount of debt a company has relative to its assets
total debt / total assets
What is the debt to capital ratio and use?
measurement of a company’s financial leverage
total debt/ (total debt + total shareholders equity)
What is debt to equity ratio formula and use?
tells you how much debt you have per $1 of equity
total debt / total shareholders equity
What is financial leverage formula and use?
measures amount of debt a company is taking to finance and grow its business
average total assets / average total equity
What is debt to EBITDA formula and use?
measuring the amount of income generated and available to pay down debt before covering interest, taxes, depreciation, and amortization expenses.
total debt / EBITDA
What are the 2 coverage ratios?
- Interest coverage
- Fixed charge coverage
What is interest coverage formula and use?
measures number of times EBIT can cover interest payments
EBIT (earnings before interest and taxes) / Interest Expense
What is fixed charge coverage formula and use?
measures a company’s ability to meet fixed charges from its earnings before interest and taxes (EBIT)
(EBIT + Lease payments) / (Interest payments + lease payments)
What are profitability ratios?
measure company ability to generate profits from revenue and assets
What are the 2 types of profitability ratios? RR
- Return on sales
- Return on investment
What are the 4 return on sales ratios? GOPN
- Gross profit margin
- Operating profit margin
- Pretax margin
- Net profit margin
What is gross profit margin formula and use?
measure of profitability that shows the percentage of revenue that exceeds the cost of goods sold (COGS).
gross profit / revenue
What is operating profit margin formula and use?
measures how much profit a company makes on a dollar of sales after paying COGS and operating expenses but before EBIT or earnings before interest and taxes.
operating profit / revenue
What is pretax margin formula and use?
How many cents of profit business has generated for each dollar of sales before deducting taxes.
EBT (Earnings before tax but after interest) / revenue
What is net profit margin formula and use?
measures how much net income or profit is generated in relation to its revenue.
net income/ revenue
What are the 5 return on investment ratios? ORRRR
- Operating ROA
- ROA
- Return on invested capital
- ROE
- Return on common equity
What is operating ROA formula and use?
measure how well a company is using its assets to generate profits from its operations
operating profit / average total assets
What is ROA formula and use?
how profitable a company’s assets are in generating revenue.
net income / average total assets
What is the return on invested capital formula and use?
measures how well a company’s management has utilized its capital structure
EBIT (earnings before interest and taxes) * (1- effective tax rate) / short and long-term debt and equity
NOPAT / short & long-term debt & equity
What is ROE formula and use?
measure of how well a company is handling money that shareholders have contributed
net income / average total equity
What is return on common equity formula and use?
measures profit or net income a company earns per dollar of common shares equity
(Net income - preferred dividends) / average common equity
What are valuation ratios?
measures how a company is valued and what type of return an investor may get
What are the 3 types of valuation ratios? VPD
- Valuation Ratios
- Per share quantities
- Dividend related quantities
What are 4 types of valuation ratios? PPPP
- Price to earnings
- price to cash flow
- Price to sales
- Price to book value
What is price to earnings formula and use?
a way to value a company by comparing the price of a stock to its earnings.
price per share/ earnings per share.
What is price to cash flow formula and use?
measures how much cash a company generates relative to its stock price
price per share/ cash flow per share
What is price to sales formula and use?
measures how much investors are willing to pay per dollar of sales for a stock.
price per share/ sales per share
What is price to book value formula and use?
measures the amount of money shareholders would receive if assets were liquidated and liabilities were paid off.
price per share/ book value per share
What are the 5 types of per share quantities ratios? BDCED
- Basic EPS
- Diluted EPS
- Cash flow per share
- EBITDA per share
- Dividends per share
What is basic EPS formula and use?
total amount of net income a company genereates for each common share outstanding
basic eps = (net income - preferred dividends) / weighted average of common shares outstanding
What is diluted EPS formula and use?
used for EPS that has a complex capital structure
diluted EPS = (net income - preferred dividend) / (weighted average number of shares outstanding + conversion of any in the money options, warrants, and other diluted securities)
What is cash flow per share formula and use?
operating cash flow on a per-share basis
(CFO - Preferred dividends) / weighted average # of shares outstanding
What is EBITDA per share formula and use?
EBITDA / weighted average number of shares outstanding
What is dividends per share formula and use?
measures the amount of dividends on a per share basis.
common dividends declared / weighted average number of common stock outstanding
What are the 3 types of dividends related quantities ratios? DRS
- dividend payout ratio
- retention rate
- sustainable growth rate
What is dividend payout ratio formula and use?
measures the percentage of net income that goes to the dividend program.
dividends / net income
What is retention rate ratio formula and use?
measures the percentage of net income that is retained to grow the business, rather than being paid out as dividends.
1- dividend payout ratio
What is sustainable growth rate formula and use?
maximum rate of growth that a company or social enterprise can sustain without having to finance growth with additional equity or debt.
retention rate * ROE (ROE = ROA*Leverage Ratio)
What is credit risk?
risk of loss caused by failure to make a promised payment
What is credit analysis?
evaluation of a company’s credit worthiness/ credit risk
What is the credit rating process?
a quantified assessment of a company’s credit worthiness or ability to make debt payments.
What are the 7 ratios to measure credit rating? EFFEEDR
- EBITDA interest coverage
- FFO(funds from operations) to debt
- Free operating cash flow to debt
- EBIT margin
- EBITDA margin
- Debt to EBITDA
- Return on capital
What is EBITDA interest coverage formula and use?
indicator of how easily a firm can pay the interest on its outstanding debt
EBITDA/ total interest expense
What is FFO to debt formula and use?
measures of the ability of a company to pay off its debt using only net operating income
FFO/ total debt
What is free operating cash flow to debt formula and use?
measures how long it would take company to repay its debt if all of its cash flows went to debt repayment.
(CFO - capital expenditures)/ total debt
What is EBIT margin formula and use?
profitability ratio to measure how efficiently a company converts its revenue into profits before paying interest and taxes.
EBIT/ Total revenues
What is EBITDA margin formula and use?
measure of a company’s operating profit as a percentage of its revenue.
EBITDA/ Total Revenues
What is debt to EBITDA formula and use?
measuring the amount of years it would take for a company to pay back its debt
total debt/ EBITDA
What is return on capital formula and use?
measures the amount of money a company makes that is above the average cost it pays for its debt and equity capital.
EBIT/ Average capital
What is DuPoint Analysis?
a breakdown of ROE with of 3 or 5 different financial ratios that allows you to see the strengths and weakness of the various components of ROE
What is the 3 financial ratios to 3 step dupoint analysis, and what are the formulas to those 3 financial ratios?
ROE = net profit margin * asset turnover * financial leverage
ROE = (net income/ revenue) * (revenue/ average total assets) * (average total assets/ average total shareholders equity)
What is the 5 financial ratios to 5 step dupoint analysis, and what are the formulas to those 5 financial ratios?
ROE = tax burden * asset turnover * financial leverage ratio * interest burden * EBIT margin
ROE = (1- tax rate) * (revenue/ average total assets) * (average total assets/ average shareholders equity) * (EBT/ EBIT) * (operating income/ revenue)
What is the simple formula for return on equity and use?
measure of how well a company is handling money that shareholders have contributed.
net income / average total equity
Is high debt to equity more or less solvent?
less solvent, meaning company is using more debt to finance the business.
What does equity analysis focus on and what does credit analysis focus on?
equity analysis focuses on growth
credit analysis focuses on risk
What are 4 limitations to using ratios? HICD
- heterogenous operations (company operates more than one industry)
- inconsistent indications
- considerable judgement
- different account standards
What is regression analysis?
a graph that shows the relationship between 2 variables
What is an operating segment?
unit of company with its own distinct financial information. for instance coke, coke zero, diet coke; all different segments
