module 4 Flashcards
Vertical Analysis
expresses financial statements in ratio form
▪ Income statement items: as a percent of net sales
▪ Balance sheet items: as a percent of total assets.
facilitate comparisons across companies of different sizes and comparisons of accounts within a set of financial
statements.
Horizontal Analysis
is the scrutiny of financial data across
time.
• Horizontal analysis is used to evaluate trends in the financial
condition of an organization.
• allows current year common size statements to be compared to
those of prior years and to the organization’s goals and objectives
ROE
The most common analysis metric used by managers
and investors alike
▪ ROE relates net income to the average total
stockholders’ equity.
ROE measures return from the perspective of the
company’s stockholders.
Traditional DuPont analysis
Traditional DuPont analysis that disaggregates ROE into
components of profitability, productivity, and leverage.
ROE reflects both
▪ Company performance (as measured by ROA)
▪ How assets are financed (as measured by Financial Leverage)
▪ ROE is higher when there is more debt and less equity
for a given level of assets.
ROA
measures return from the
perspective of the entire company (enterprise level).
▪ This return includes both profitability (numerator) and
total company assets (denominator).
▪ To earn a high ROA, the company must be profitable
and manage assets (hold the lowest level of assets
possible to achieve the desired profit).
▪ ROA analysis encourages managers to focus on both
the income statement and the balance sheet.
Financial Leverage
Financial leverage measures the
relative use of debt versus equity to
finance the company’s assets.
▪ Financial leverage is important
because debt is a contractual
obligation and a company’s failure to
repay principal or interest can result in
legal repercussions or even
Managers can increase ROA by:
Increase PM: increase profitability for a given level of assets
▪ Increase AT: reduce assets while still generating same profit lev
Gross Profit Margin
Influenced by both the selling price of a company’s
products and the cost to make or buy those products
▪ Generally high and increasing gross profit margin is better
▪ Low or decreasing gross profit margin signals more
competition or less demand for the company’s products
▪ Competitive intensity has increased
▪ Product line has lost appeal
▪ Product costs have increased
▪ Product mix has changed
▪ Volume has declined and fixed costs have not
Operating Expense margin
Measures general operating costs for each sales dollar
▪ Consider each expense in whatever detail the company
provides in its income statement
▪ Compare margins over time and against peers (making
sure that peers have similar business models)
▪ Total SG&A Expenses/Total Revenue (Sales)
Cash conversion cycle
Cash conversion cycle is the average number of days to:
▪ Buy inventory on credit (accounts payable)
▪ Sell inventories of credit (accounts receivable)
▪ Collect the receivables
▪ Pay the accounts payable
liquidity
refers to cash availability: how much cash a
company has, and how much it can raise on short
notice.
Two of the most common ratios used to assess the
degree of liquidity
▪ Current ratio
▪ Quick ratio
▪ Both ratios link required near-term payments to cash
available in the near-term.
Solvency
refers to a company’s ability to meet its debt
obligations over the longer-term.
▪ Solvency is crucial because an insolvent company is a
failed company.
▪ Two general approaches to measuring solvency:
1. Use balance sheet data to assess the proportion of capital
raised from creditors
2. Use income statement data and assesses the profit
generated relative to debt payment obligations
