test II: analysis of results through ratios

Question 1

users of financial info: investors and financial analysts

Answer 1

analysts interpret the info about companies and make recs to investors

Question 2

users of financial info: lenders and vendors

Answer 2

use financial info to determine if a firm is expected to make good on loans

Question 3

users of financial info: management

Answer 3

use financial info to pinpoint strengths and weaknesses in operations

Question 4

sources of financial info: annual report

Answer 4

• required for all publicly traded firms

- presents the company in a positive light

Question 5

sources of financial info: brokerage firms and investment advisory services

Answer 5

ex.: TD brokerage

Question 6

the annual report (parts)

Answer 6

• letter to shareholders (review the results and events of the last year)
• management discussion and analysis (analyzing financial results)
• audited financial statements for the past year and previous years (income statement, balance sheet and statement of cash flow)
• notes to financial statements (edited)
• other recent and historic financial info

Question 7

income statement

Answer 7

revenues, sales, cogs, operating expenses, profits/loss, taxes and interests

Question 8

balance sheet

Answer 8

assets, debts, equity (part of the assets that actually belongs to the shareholders after all debts are paid)

Question 9

cash flow

Answer 9

operating, financing and investment activities

Question 10

cost of goods sold

Answer 10

direct costs attributed to production

Question 11

operating expenses

Answer 11

expenses of the organization’s day-to-day activities (selling expenses, general and admin expenses and amortization)

Question 12

statement of cash flow

Answer 12

reports on the movement of cash within the firm
- can be affected by cash sells or collection of receivables, purchase or sale of assets, payment of debts and returns on investments

Question 13

cash inflow or outflow from: operating activities

Answer 13

day-to-day

- cash sales, credit sales, buying inventory, production expenses, etc.

Question 14

cash inflow or outflow from: investing activities

Answer 14

activities dealing with the acquisition or sale of capital assets
- purchasing or selling capital assets or long-term assets

Question 15

cash inflow or outflow from: financing activities

Answer 15

dealing with securing funds

- borrowing through loans and bonds, repaying them, selling new shares, repurchasing shares and paying dividends

Question 16

constructing the statement of cash flow: cash account

Answer 16

sum of cash flows from operating, investing and financing activities must equal the change in cash

Question 17

cash flow from operating activities should be used to

Answer 17

• replace equipment or other capital assets that need to be modernized
• invest in various areas to remain competitive
• pay dividends

Question 18

free cash flow

Answer 18

• any money left

- can be used to aggressively develop new business opportunities

Question 19

ratio analysis (functions)

Answer 19

• highlight different areas of performance
• each ratio is meaningful to operations of the business
• can vary widely among industries (can be compared within the same industry)

Question 20

categories of financial ratio: profitability

Answer 20

allow assessment of the firm’s ability to make money

Question 21

gross profit margin

Answer 21

gross income/ total revenue = every $ of sales generates …% of gross profit

• profits after manufacturing cost (cogs)
• indication of efficiency

Question 22

net profit margin

Answer 22

net income/ total revenue = every $ of sales generates …% of net profit

• efficiency of management operation expenses
• return on sales

Question 23

return on assets (roa)

Answer 23

net income/ total assets = every $ of assets generates $… of net profit
- hum much net profit is generated by a company’s assets

Question 24

return on equity (roe)

Answer 24

net income/ equity = every $ of equity generates $… of net profit

• measures return on investment of the owner’s take in the company
• can be compared to alternate investments

Question 25

categories of financial ratio: debt management

Answer 25

determine if the firm is using so much debt that it is assuming excessive financial risk

Question 26

total debt ratio

Answer 26

total liabilities/ total assets = …% of assets are financed

• reliance on loans and ability to pay
• 66% is high (over-leveraged)
• overhead

Question 27

categories of financial ratio: liquidity

Answer 27

indicate firm’s ability to pay its bill in the short run

Question 28

current ratio

Answer 28

current assets/ current liabilities = for every $ of short-term liabilities, there’s $… of current assets

• measures company’s liquidity
• ability to pay debts (short term)

Question 29

quick ratio

Answer 29

current assets - inventory/ current liabilities = a firm has $… in short term assets, without considering the value of its inventory, to cover every $ of short term debts
- measures liquidity without the inventory

Question 30

categories of financial ratio: asset management

Answer 30

show firm’s ability to generate revenue using minimum amount of assets

Question 31

inventory turnover

Answer 31

cogs/ inventory = inventory turns over about every … months
- measures how quickly a company sells its inventory

Question 32

average collection period

Answer 32

accounts receivable x 360/ annual credit sales = it takes the firm … days to collect payments from their customers

• days sales outstanding
• time to collect credit sales
• 30 days is usually acceptable

Question 33

capital asset turnover

Answer 33

sales/ capital assets = every $ of capital assets generates $… of sales
- how much sales are generated by the long term assets

Question 34

categories of financial ratio: market value

Answer 34

give an indication of how investors feel about firm’s financial future

Question 35

price-earning ratio

Answer 35

price for shares/ earnings per shares = investors have or don’t have faith in upcoming results

• compares the market price of a stock with the net income per share
• high: demonstrates that investors seem to display high faith in the upcoming results

Question 36

comparing results (can be compared with)

Answer 36

• history (trends)
• budget (expected/ desired ratios)
• competition (compared with same industry)
• the industry in general

Question 37

making sense of the results

Answer 37

while the discrepancies may not always lead to answers but they often lead to pertinent questions

Question 38

comparing results in the same industry: which business to invest in

Answer 38

• safer ratios, less debt, less potential for growth, less revenues
• high debt ratio, investing in the future of the company, real potential for growth, higher revenues

Question 39

comparing results in the same industry: difference in gross profit

Answer 39

• efficiency (production and workers)
• not going in debt
• selling prices

Question 40

comparing results in the same industry: problem with quick ratio

Answer 40

• most of current assets are inventory

- doesn’t sell it fast enough

Question 41

comparing results in the same industry: satisfaction with return on equity

Answer 41

• investing

- not much to repay debts (debt ratio)

Question 42

comparing results in the same industry: shorter collection period

Answer 42

• gets paid faster (stricter), needs the money

- hinder sales (sells less)

Question 43

comparing results in the same industry: difference in capital assets turnover

Answer 43

• more sales

- less capital assets

Question 44

limits of ratio analysis

Answer 44

• diversified companies (ex.: general electric)
• inflation may distort the financial results and ratios (ex.: an industry experiencing high levels of inflation would have to raise their prices, hence inflating the revenues)
• window dressing: creative accounting can make the books look far more appealing than they really are
• illegal or misleading