PPT Flashcards
What is the profit margin of Allied?
3.9%
This is below the industry average of 5.0%
What are the two reasons for Allied’s subpar profit margin?
- High operating costs
- Heavy use of debt
What does the Times-Interest-Earned (TIE) ratio measure?
The firm’s ability to meet its annual interest payments
How is the TIE ratio calculated?
Earnings before interest and taxes (EBIT) divided by interest charges
What was Allied’s TIE ratio?
3.2 times
This is below the industry average of 6 times
What does a low debt ratio indicate for creditors?
Greater cushion against creditors’ losses in the event of liquidation
What was Allied’s debt ratio?
47.8%
This exceeds the industry average of 36.4%
What are the six profitability ratios mentioned?
- Operating Margin
- Profit Margin
- Return on Total Assets
- Return on Common Equity
- Return on Invested Capital
- Basic Earning Power (BEP)
How is the operating margin calculated?
Operating income (EBIT) divided by sales
What is a limitation of using ratios for analysis?
Difficult to generalize whether a ratio is ‘good’ or ‘bad’
What does a high current ratio indicate?
A strong liquidity position, but could also indicate excessive cash
What is the formula for calculating Days Sales Outstanding (DSO)?
Accounts receivable divided by average daily sales
What does a high Days Sales Outstanding (DSO) indicate?
Customers are not paying their bills on time
What was Allied’s DSO compared to the industry average?
46 days, above the industry average of 36 days
What does the inventory turnover ratio measure?
How effectively the firm uses its inventory
What is the fixed assets turnover ratio?
Sales divided by net fixed assets
What was Allied’s fixed assets turnover ratio?
3.0 times
Slightly above the industry average of 2.8
What does the total assets turnover ratio measure?
Turnover of all of the firm’s assets
What is the basic earning power (BEP) ratio?
Operating income (EBIT) divided by total assets
What does the BEP ratio indicate?
The raw earning power of the firm’s assets before taxes and debt influence
What was Allied’s BEP ratio compared to the industry average?
Lower than the industry average of 18%
What are market value ratios used for?
- Investors deciding to buy or sell a stock
- Investment bankers setting share price for IPO
- Firms deciding how much to offer for another firm
What can distort comparisons in ratio analysis?
- Different accounting practices
- Window dressing techniques
- Seasonal factors
What is ‘window dressing’ in financial statements?
Techniques employed by firms to make their financial statements look better
What are market value ratios primarily used for?
They are used by investors, investment bankers, and firms in decision-making processes related to buying/selling stocks, setting share prices for IPOs, and evaluating mergers.
Market value ratios reflect investor expectations about a company’s future financial performance.
List the three primary market value ratios mentioned.
- Price/Earnings Ratio
- Market/Book Ratio
- Enterprise Value/EBITDA Ratio
How is the profit margin calculated?
Net income divided by sales.
The profit margin indicates how much profit a company makes for every dollar of sales.
What does ROA stand for and how is it calculated?
Return on Assets; calculated as net income divided by total assets.
What is the significance of a company’s ROIC being less than 2%?
It is considered a value destroyer.
What are the two key differences between ROIC and ROA?
- ROIC is based on total invested capital
- ROIC uses after-tax operating income (NOPAT) instead of net income
How is Return on Common Equity (ROE) calculated?
Net income divided by common equity.
What does a low ROA suggest about a firm’s use of debt?
It can indicate a conscious decision to use a great deal of debt, leading to high interest expenses and lower net income.
What does the Price/Earnings (P/E) ratio indicate?
The dollar amount investors will pay for $1 of current earnings.
What does a high Market/Book (M/B) ratio suggest about a company?
It indicates that the company is well regarded by investors, suggesting low risk and high growth.
What is the primary use of trend analysis?
To predict future stock price movements based on past performance.
What does the Enterprise Value/EBITDA (EV/EBITDA) ratio measure?
It measures the relative market value of all the company’s key financial claims.
What is the importance of horizontal analysis?
It compares financial data over multiple periods to identify trends.
What does vertical analysis involve?
Listing each line item as a percentage of a base figure within the statement.
What is the primary liquidity ratio and how is it calculated?
Current Ratio; calculated by dividing current assets by current liabilities.
Define Asset Management Ratios.
Ratios that measure how effectively a firm is managing its assets.
What are the four subcategories of Asset Management Ratios?
- Inventory turnover ratio
- Days sales outstanding ratio
- Fixed assets turnover ratio
- Total assets turnover ratio
What does a low inventory turnover ratio indicate?
It suggests that the company is holding too much inventory, which may be unproductive.
What does a company’s net income indicate in the context of the statement of cash flows?
It indicates how much cash the firm is generating.
What is the significance of comparing a company’s ratios to industry averages?
It helps assess performance relative to competitors and industry standards.
What does it mean if a company’s P/E ratio is below its industry average?
It suggests the company may be regarded as relatively risky or having poor growth prospects.
What does the term ‘NOPAT’ stand for?
Net Operating Profit After Tax.
What is the purpose of benchmarking in ratio analysis?
To compare a company’s performance against industry leaders to set high-level performance targets.
What financial statements are typically included in an annual report?
- Balance Sheet
- Income Statement
- Statement of Cash Flow
- Statement of Stockholders’ Equity
What is Vertical Analysis primarily used for?
Most often used on the income statement
Vertical Analysis is useful in making period-to-period comparisons.
What does a rise in direct costs from 30% to 40% of gross sales indicate?
Either costs have risen or there are inefficiencies that need to be addressed
This is critical for company managers to monitor.
How is the Current Ratio calculated?
By dividing current assets by current liabilities
It is the primary liquidity ratio.
What happens to the Current Ratio if current liabilities rise faster than current assets?
The current ratio will fall, indicating possible trouble
This can signal financial difficulties for the company.
What is the Current Ratio for Allied if current assets are $1,000 and current liabilities are $310?
3.2
The industry average is 4.2, indicating a somewhat weak liquidity position.
What does a high Current Ratio indicate?
A strong liquidity position or potential inefficiencies
It might indicate too much old inventory or cash not being managed efficiently.
What is the Quick Ratio also known as?
Acid test
It measures the firm’s ability to pay off short-term obligations without relying on inventory sales.
How is the Quick Ratio calculated?
By deducting inventories from current assets and dividing by current liabilities
This highlights the least liquid assets.
What does a Quick Ratio of 1.2 for Allied indicate?
It is relatively low compared to the industry average of 2.2
However, if accounts receivable can be collected, liabilities can still be paid.
What are the two most commonly used liquidity ratios?
- Current Ratio
- Quick Ratio
Liquidity ratios show the relationship of cash and current assets to current liabilities.
In Vertical Analysis, how is each line item in financial statements represented?
As a percentage of a larger number
For income statements, it’s a percentage of gross sales; for balance sheets, it’s a percentage of total assets.
What do liquidity ratios indicate?
The firm’s ability to pay off debts maturing within a year
They provide insight into short-term financial health.
What do Asset Management Ratios assess?
How efficiently the firm is using its assets
They help in evaluating operational efficiency.
What do Debt Management Ratios indicate?
How the firm has financed its assets and its ability to repay long-term debt
These ratios are crucial for understanding financial leverage.
What do Profitability Ratios measure?
How profitably the firm is operating and utilizing its assets
They are essential for assessing overall financial performance.
What do Market Value Ratios reflect?
What investors think about the firm and its future prospects
They provide insights into market perceptions and valuations.
What is the purpose of Ratio Analysis?
To express the relationship among selected items of financial statement data
It helps in comparing financial performance over time.
What are the five categories of ratio analysis?
- Liquidity Ratios
- Asset Management Ratios
- Debt Management Ratios
- Profitability Ratios
- Market Value Ratios
Each category provides different insights into financial health.
