sec A Flashcards
1
Q
What is the primary purpose of a Traditional Format Income Statement?
A
External reporting (GAAP/IFRS compliance).
2
Q
What distinguishes the Contribution Margin Format Income Statement?
A
Internal decision-making (cost behavior analysis).
3
Q
In a Traditional Format Income Statement, costs are classified by _______.
A
[function (COGS, SG&A, etc.)]
4
Q
In a Contribution Margin Format Income Statement, costs are classified by _______.
A
[behavior (variable vs. fixed costs)]
5
Q
What key metric is emphasized in the Contribution Margin Format?
A
Contribution Margin (Sales - Variable Costs).
6
Q
What is Operating Income?
A
Profit from core operations (excludes non-operating items).
7
Q
What does EBIT stand for?
A
Earnings before interest and taxes.
8
Q
True or False: Operating Income and EBIT are the same.
A
False.
9
Q
What are the components of Current Assets on a Balance Sheet?
A
- Cash
- Accounts receivable
- Inventory
- Short-term investments
10
Q
What are Non-Current Assets?
A
- PPE
- Intangible assets
- Long-term investments
11
Q
What key principle states that assets must provide future economic benefits?
A
Assets must provide future economic benefits from past transactions.
12
Q
What does the Cash Flow Statement track?
A
Cash inflows and outflows from operating, investing, and financing activities.
13
Q
In which section of the Cash Flow Statement do cash receipts from customers appear?
A
Operating Activities.
14
Q
What effect does lowering the selling price have on Gross Margin and Operating Margin?
A
- Gross Margin ↓: Reduced revenue per unit lowers gross profit.
- Operating Margin ↑: Fixed costs spread over more units (economies of scale).
15
Q
What does Vertical Analysis in financial statements involve?
A
Converts financial statements to percentages (common-size).
16
Q
What is a limitation of Horizontal Analysis?
A
Ignores external factors (inflation, industry shifts).
17
Q
Who primarily uses liquidity ratios?
A
Short-term creditors.
18
Q
What is Net Working Capital (NWC)?
A
Current Assets (CA) - Current Liabilities (CL).
19
Q
What is the ideal benchmark for the Current Ratio?
A
2:1.
20
Q
True or False: A high Current Ratio always indicates good liquidity.
A
False.
21
Q
What does the Debt-to-Equity Ratio measure?
A
Debt reliance vs. equity.
22
Q
What is the impact of high financial leverage?
A
↑ Risk (default) but ↑ Return potential.
23
Q
What is the purpose of the Interest Coverage Ratio?
A
Ability to pay interest.
24
Q
What does a Degree of Financial Leverage (DFL) greater than 1 indicate?
A
Amplified risk/return.
25
What is the formula for the Accounts Receivable Turnover Ratio?
Net Credit Sales / Average Gross Accounts Receivable.
26
What does a high Accounts Receivable Turnover Ratio indicate?
Faster collections, better liquidity.
27
What does the Average Collection Period (ACP) measure?
Average time taken to collect receivables.
28
What is the formula for the Cash Cycle?
Operating Cycle - Days Payables Outstanding.
29
What is the key insight regarding sales growth and liquidity?
Sales growth requires long-term funding (equity/debt) to avoid liquidity strain.
30
What is the formula for the Quick Ratio?
(Current Assets - Inventory - Prepaid) / Current Liabilities.
31
What does a Debt Ratio greater than 1 imply?
High default risk.
32
What is the implication of a high Degree of Operating Leverage (DOL)?
↑ Profit volatility.
33
What does the Credit Sales/Average Gross Accounts Receivable ratio measure?
Efficiency in collecting receivables
## Footnote
A high ratio indicates faster collections and better liquidity, while a low ratio suggests slower collections and potential cash flow issues.
34
What is the formula for Average Collection Period (ACP)?
365 / Accounts Receivable Turnover or (Average Receivables / Net Credit Sales) × 365
## Footnote
ACP indicates the average days to collect receivables.
35
What does a high Average Collection Period (ACP) indicate?
May indicate poor collections or customer distress
## Footnote
It can also be distorted by the natural business year.
36
What is the Inventory Turnover Ratio formula?
COGS / Average Inventory
## Footnote
This ratio measures efficiency in inventory management.
37
What does a high Inventory Turnover Ratio imply?
Quick sales, lower holding costs
## Footnote
Conversely, a low turnover indicates risk of obsolescence or overstocking.
38
What is Days Inventory Outstanding (DIO)?
365 / Inventory Turnover or (Average Inventory / COGS) × 365
## Footnote
DIO indicates the average days inventory is held before sale.
39
What is the Accounts Payable Turnover Ratio formula?
Annual Credit Purchases / Average Accounts Payable
## Footnote
This ratio measures the frequency of paying suppliers.
40
What does a high Days Payable Outstanding (DPO) indicate?
Extended payment terms which may signal liquidity issues
## Footnote
Conversely, a low DPO indicates quick payments, which may improve supplier relations.
41
What is the Total Asset Turnover formula?
Net Sales / Average Total Assets
## Footnote
This ratio measures efficiency in using total assets to generate sales.
42
What does the Operating Cycle consist of?
DIO + Average Collection Period
## Footnote
It measures the time from inventory purchase to cash collection.
43
What does the Cash Cycle measure?
Time between paying suppliers and collecting cash from sales
## Footnote
A shorter cycle indicates efficient working capital management.
44
What is the formula for Book Value Per Share (BVPS)?
(Total Equity - Preferred Equity) / Common Shares Outstanding
## Footnote
BVPS represents theoretical equity per common share if liquidated.
45
What does a Market-to-Book Ratio greater than 1 indicate?
Market optimism about future earnings
## Footnote
It suggests growth prospects.
46
What is the Price-Earnings (P/E) Ratio formula?
Market Price per Share / Earnings per Share (EPS)
## Footnote
A high P/E indicates high growth expectations.
47
What does a high Dividend Yield suggest?
Income focus
## Footnote
A low yield typically indicates a growth focus.
48
What is the Dividend Payout Ratio formula?
Dividends per Share / EPS or Total Dividends / Net Income
## Footnote
A high ratio indicates mature companies, while a low ratio suggests growth companies.
49
What does Total Shareholder Return (TSR) measure?
Total return (dividends + capital gains)
## Footnote
It is used to compare performance across investments.
50
What is Basic EPS (BEPS) calculated as?
Income Available to Common Shareholders / Weighted Average Common Shares Outstanding
## Footnote
IAC is calculated as Net Income minus Preferred Dividends.
51
What is the purpose of Diluted EPS (DEPS)?
Reflects EPS if all dilutive securities are converted to common stock
## Footnote
This includes options, convertible bonds, etc.
52
What is the Treasury Stock Method used for?
To calculate the impact of options/warrants on diluted EPS
## Footnote
It assumes proceeds from exercise are used to repurchase shares at the average market price.
53
What does the Gross Profit Margin formula represent?
(Gross Profit / Net Sales Revenue) * 100
## Footnote
It measures profitability after direct production costs.
54
What is the EBITDA Margin formula?
(EBITDA / Net Sales Revenue) * 100
## Footnote
EBITDA adds back non-cash expenses to evaluate operating cash profitability.
55
What does Return on Assets (ROA) measure?
Efficiency in using assets to generate profits
## Footnote
It is calculated as (Income / Average Total Assets) * 100.
56
What is the purpose of the DuPont Model?
To decompose ROA and ROE into underlying drivers
## Footnote
It helps identify areas for improvement in profitability metrics.
57
What does a high Return on Equity (ROE) indicate?
Efficient use of equity
## Footnote
High ROE may result from high leverage or high margins.
58
What is the formula for Return on Equity (ROE)?
ROE = Income / Average Total Equity × 100
## Footnote
Alternatively, ROE can be expressed as ROA × Equity Multiplier.
59
What does the Equity Multiplier measure?
Measures how much debt finances assets.
## Footnote
A higher multiplier indicates more leverage, which increases ROE but adds risk.
60
How does increasing sales with existing assets affect ROA?
↑ (Turnover ↑ or Margin ↑)
## Footnote
Efficiency improves as sales increase while assets remain constant.
61
What is the effect of reducing operational costs on Net Profit Margin?
↑ (Lower costs → Higher profit)
## Footnote
This leads to an increase in both ROA and ROE.
62
How does increasing leverage (debt) impact ROA if ROA is less than the cost of debt?
↓ (ROA < cost of debt)
## Footnote
Increasing debt can amplify returns if ROA exceeds the cost of debt.
63
What is the Sustainable Equity Growth Rate (SEG)?
SEG is the maximum rate at which a company can grow its sales using only internally generated funds (retained earnings).
## Footnote
SEG is calculated as (1−Dividend Payout Ratio) × ROE.
64
What is the impact of FIFO inventory valuation during rising prices?
↑ Net Income → Higher ROA & ROE.
## Footnote
FIFO matches older, lower costs with current revenues.
65
What are the benefits of ratio analysis?
* Simplification
* Comparability
* Trend Analysis
* Benchmarking
* Operational Insights
## Footnote
These benefits help in evaluating a company's performance effectively.
66
True or False: Translation adjustments in financial statements affect net income.
False
## Footnote
Translation adjustments go to Other Comprehensive Income (OCI) and do not affect net income.
67
What is the purpose of the re-measurement method in foreign currency transactions?
Convert to functional currency.
## Footnote
This method is used when the currency of record does not equal the functional currency.
68
What happens to net monetary assets during inflation?
Lose purchasing power.
## Footnote
Conversely, monetary liabilities gain value as they are repaid with less valuable currency.
69
What does a change in accounting principle require in terms of retained earnings?
Adjust opening retained earnings for cumulative effect of prior periods.
## Footnote
This is done as if the new method was always used.
70
What is the definition of Economic Profit?
Revenue – (Explicit + Implicit Costs).
## Footnote
It accounts for opportunity costs, providing a more comprehensive view of profitability.
71
Fill in the blank: The formula for ROE is __________.
Net Income - Preferred Dividends / Average Common Equity
72
What is the impact of high customer concentration on ROA and ROE?
↓ (Revenue risk)
## Footnote
This can lead to reduced equity volatility.
73
What are the indicators for determining a functional currency?
* Currency of cash flows
* Sales prices
* Financing
* Intra-group transactions
## Footnote
These indicators help assess the primary economic environment of the subsidiary.
74
What effect does accelerated depreciation have on net income?
↓ Net Income (early years)
## Footnote
This results in lower ROA and ROE during those years.
75
What is the consequence of using LIFO during inflation?
↑ COGS → lower net income
## Footnote
This helps match current costs with revenues, reducing profit inflation.
76
What is the formula for Accounting Profit?
Revenue – Explicit Costs
## Footnote
Example: 500K revenue – 300K expenses = $200K profit.
77
What does Economic Profit take into account that Accounting Profit does not?
Implicit Costs
## Footnote
Implicit Costs = Opportunity Costs (e.g., lost rent/income from alternative choices).
78
What is the impact of using economic profit for decision-making?
It assesses true profitability including hidden costs.
79
What is the definition of Depreciation in accounting?
Systematic cost allocation over asset life.
80
How does Economic Depreciation differ from Accounting Depreciation?
Economic Depreciation reflects decline in market value.
81
What factors determine Earnings Quality?
* Business Environment
* Accounting Principles
* Management Practices
82
What are some Red Flags in Management Practices that indicate low earnings quality?
* Overstated inventory/understated liabilities
* Sudden cuts in R&D/maintenance
* Revenue concentration
83
What is Earnings Persistence?
The stability and predictability of a company’s earnings over time.
84
What are the steps to Recast Earnings?
* Segregate Discretionary Expenses
* Remove Unusual Items
* Reclassify Periods
* Tax Adjustments
85
Which metrics indicate better earnings quality?
* Earnings Variability: Lower = better
* Earnings Trend: Consistent growth = higher persistence.
86
What is the Big Bath tactic in earnings management?
Recognize all losses in a bad year.
87
What does the Quick Ratio measure?
Liquidity without inventory.
88
What is the formula for the Cash Ratio?
Cash + Equivalents + Marketable Securities / Current Liabilities.
89
What does a high Debt-to-Equity ratio imply?
Higher risk and higher return potential.
90
What is the purpose of Coverage Ratios?
To assess a company's ability to meet its fixed obligations.
91
What does the Interest Coverage ratio measure?
Ability to pay interest.
92
What does the Degree of Financial Leverage (DFL) indicate?
Sensitivity of net income to EBIT changes.
93
What does a higher Accounts Receivable Turnover Ratio signify?
The company is collecting its receivables quickly.
94
What is the formula for Days Inventory Outstanding (DIO)?
365 / Inventory Turnover Ratio.
95
What does the Cash Cycle measure?
Operating Cycle minus Days Payable Outstanding.
96
What is the formula for Book Value Per Share (BVPS)?
Total Equity - Preferred Equity / Common Shares Outstanding.
97
What does a Market-to-Book ratio greater than 1 indicate?
Market optimism about future earnings.
98
What is the formula for Total Shareholder Return (TSR)?
(Ending Price - Beginning Price + Dividends) / Beginning Price.
99
What does the Gross Profit Margin measure?
(Gross Profit / Net Sales Revenue) * 100.
100
What is the DuPont Model used for?
Breaking down Return on Assets (ROA) and Return on Equity (ROE).
101
What is the Sustainable Equity Growth Rate (SEG)?
Maximum rate at which a company can grow sales using retained earnings.
102
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