Ratio Analysis Flashcards
Ratio analysis consists of calculating financial performance using five basic types of ratios:
profitability, liquidity, activity, debt, and market.
Ratio analysis consists of
the calculation of ratios from financial statements and is a foundation of financial analysis.
A financial ratio, or accounting ratio, shows
the relative magnitude of selected numerical values taken from those financial statements.
Liquidity:
availability of cash over short term: ability to service short-term debt.
Ratio:
a number representing a comparison between two things.
Ratio analysis:
the use of quantitative techniques on values taken from an enterprise’s financial statements.
Shareholder:
one who owns shares of stock.
Profitability ratios:
measure the firm’s use of its assets and control of its expenses to generate an acceptable rate of return.
Liquidity ratios:
measure the availability of cash to pay debt.
Activity ratios, also called efficiency ratios:
measure the effectiveness of a firm’s use of resources, or assets.
Debt, or leverage, ratios:
measure the firm’s ability to repay long-term debt.
arket ratios are concerned with shareholder audiences. They measure:
the cost of issuing stock and the relationship between return and the value of an investment in company’s shares.
Ratio analysis is:
a tool for evaluating financial statements but also relies on the numbers in the reported financial statements being put into order to be used for comparison. With a few exceptions, the majority of the data used in ratio analysis comes from the financial statements.
Prior to the calculation of financial ratios, reported financial statements are often:
reformulated and adjusted by analysts to make the financial ratios more meaningful as comparisons across time or across companies.
Earnings management:
a euphemism, such as creative accounting, to refer to fraudulent accounting practices that manipulate reporting of income, assets, or liabilities with the intent to influence interpretations of the income statements.
Valuation:
the process of estimating the market value of a financial asset or liability.
One of the advantages of ratio analysis is that:
it allows comparison across companies. However, while ratios can be quite helpful in comparing companies within an industry and even across some similar industries, cross-industry comparisons may not be helpful and should be done with caution.
Metric:
a measure for something; a means of deriving a quantitative measurement or approximation for otherwise qualitative phenomena.
Valuation:
the process of estimating the market value of a financial asset or liability.
One of the advantages of ratio analysis is that it allows comparison across companies, an activity which is often called:
benchmarking.
Benchmark:
a standard by which something is evaluated or measured.
Ratio:
a number representing a comparison between two things.
Trend analysis is:
the practice of collecting information and attempting to spot a pattern or trend in the same metric historically by examining it in tables or charts. Often this trend analysis is used to predict or inform decisions around future events.
Trend analysis can be performed in different ways in finance. Fundamental analysis relies on:
historical financial statement analysis, often in the form of ratio analysis.
Trend analysis using financial ratios can be complicated by changes to companies and accounting over time. For example:
a company may change its business model and begin to operate in a new industry, or it may change the end of its financial year or the way it accounts for inventories.
The operating margin equals
operating income divided by revenue.
Operating income:
revenue—operating expenses. (Does not include other expenses such as taxes and depreciation).
The operating margin (also called the operating profit margin or return on sales) is a
ratio that shines a light on how much money a company is actually making in profit. It is found by dividing operating income by revenue, where operating income is revenue minus operating expenses.
Operating margin formula:
The operating margin is found by dividing net operating income by total revenue.
However, the operating margin is not a perfect measurement. It does not include things like:
capital investment, which is necessary for the future profitability of the company. Furthermore, the operating margin is simply revenue.
Profit margin measures :
the amount of profit a company earns from its sales and is calculated by dividing profit (gross or net) by sales.
Profit margin is:
the profit divided by revenue.
There are two types of profit margin:
gross profit margin and net profit margin.
Net profit:
the gross revenue minus all expenses.
Gross profit:
the difference between net sales and the cost of goods sold.
The profit margin ratio is broadly:
the ratio of profit to total sales times 100%. The higher the profit margin, the more profit a company earns on each sale.
Net Profit Margin:
The percentage of net profit (gross profit minus all other expenses) earned on a company’s sales
Gross Profit Margin:
The percentage of gross profit earned on the company’s sales.
The return on assets ratio (ROA) measures
how effectively assets are being used for generating profit.
ROA is:
net income divided by total assets.
The ROA is the product of two common ratios:
profit margin and asset turnover.
A higher ROA is better, but there is no metric for a good or bad ROA. An ROA depends on:
the company, the industry and the economic environment.