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CMA 2: Financial Decision Making > Unit 3: Profitability Analysis & Analytical Issues > Flashcards

Unit 3: Profitability Analysis & Analytical Issues Flashcards

1
Q

Define

Gross Profit Margin

A

The percentage of gross revenues that remains w/ the firm after paying for merchandise

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2
Q

Define

Operating Profit Margin

A

The percentage that remains after SG&A expenses have been paid

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3
Q

Define

Net Profit Margin

A

The percentage that remains after other gains and losses (including int. expense) and income taxes have been added or deducted

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4
Q

Define

EBITDA Margin Percentage

A

EBITDA Margin Percentage =

(EBITDA)

———————————————

Net Sales

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5
Q

Define

Return on Assets = ?

A

Return on Assets =

(Net Income)

———————————————

Avg total assets

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6
Q

Define

Return on Equity = ?

A

Return on Equity =

(Net Income)

———————————————

Avg total equity

*ROE will always be greater than ROA

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7
Q

Under the various return ratios, what can the numerator be adjusted by?

A
  1. Subtacting preferred dividends to leave only income available to common stockholders
  2. Adding back minority interest in the income of a consolidated subsidiary
  3. Adding back int. expense
  4. Adding back both int. expense and taxes so numerator is EBIT –> enhances comparability of firms with different capital structures/tax planning strategy
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8
Q

Under the various return ratios, what can the denominator be adjusted by?

A
  1. Excluding nonoperating assets
  2. Excluding unpoductive assets
  3. Excluding current liabilities to emphasize long-term capital
  4. Excluding debt & preferred stock to get equity capital
  5. Stating invested capital at market value
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9
Q

Calculate the DuPont Model for Return on Assets.

A
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10
Q

Calculate the DuPont Model for Return on Equity

A
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11
Q

Describe the three components for the DuPont Model for Return on Equity.

A
  1. The net profit margin examines a company’s efficiency in generating earnings from sales
  2. Asset turnover component examines how efficiently the company is deploying the totality of its resources to generate revenue
  3. The equity multiplier measures a company’s financial leverage. High financial leverage means that the company relies more of debt to finance its assets
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12
Q

Define

Return on Common Equity

A
  • Think income available to common shareholders (IACS)
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13
Q

Define

DuPont Model for ROCE

A
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14
Q

Define

Sustainable Equity Growth Rate

A
  • The highest growth rate a company can sustain without increasing leverage
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15
Q

Define

Book Value Per Share

A
  • The amount of net assets attributable to the common shareholders per share oustanding
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16
Q

Define

Market/Book Ratio

A

Measures how much an investor must spend to ‘own’ a dollar of net assets

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17
Q

Define

Price/Earnings Ratio

A

It measures how much an investor must spend to ‘buy’ a dollar of EBITDA

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18
Q

Define

Price/EBITDA Ratio

A

Benefits to using EBITDA, including operational comparability and as a proxy for cash flows.

Disadvantages:

  • Overstates income: EBITDA distorts reality
  • Neglects working capital requirements (does not account for the working capital needs of a business - i.e. inventories, receivables, payables)
  • Not effective for valuation: serves the bankers’ and clients’ best interests
19
Q

Define Basic Earnings Per Share (BEPS) = ?

Common Stock vs. Preferred Stock

[Single Capital Structure Firm]

*DEPS should be used if available

A
  • Only calculated for common stock because common shareholders are the residual owners of a corporation
  • Amounts associated w/ preferred stock must be removed during the calulation of EPS
  • IACS: income from cont. operations or net income minus dividends on preferred stock
  • Weight shares for the portion of the reporting period that they were outstanding
20
Q

Define

Earnings Yield

A

Used to determine if a given stock is comparable to others in the industry or to alternative uses of investment money

21
Q

Define

Dividend Payout Ratio = ?

A

Measures what portion of accrual-basis earnings was actually paid out to common shareholders in the form of dividends

22
Q

Define

Dividend Yield = ?

A
23
Q

What are some limitations of ratio analysis?

A
  • Effects of inflation
  • Seasonal factors
  • “Window dressing” financial statements
  • Firms choosing different accounting policies
  • Accounting profit vs. economic profit

*Economic profit is the excess of revenues over the costs of land, labor, and capital.

*A company using LIFO will have a higher level of earnings quality than FIFO ► LIFO presents more conservative numbers on IS & BS

*Inflation casuses misstatement of a firm’s IS & BS

24
Q

What is the largest cost element for any seller of merchandise?

Define Gross Profit Margin

A
  • COGS is the single largest cost element for any seller of merchandise and has the greatest impact on profitability
  • Gross profit margin is the percentage of its net sales that it is able to keep after paying for merchandise
25
Q

Define

Reporting Currency

A
  • The currency an entity prepares its financial statements in
26
Q

Define

Foreign Currency Translation

A
  • expresses the reporting currency in amounts that
  1. are denominated in (fixed in units of) a different currency or
  2. are measured in a difference currency
27
Q

Define

Functional Currency

A
  • Currency of the primary economic environment in whch an entity operates
28
Q

Define

Foreign Currency Transactions

A
  • Fixed in a currency other than the financial currency
    • Results when an entity buys/sells on credit
    • Borrow/lends
    • Party to derivative instrument
    • Acquires/disposes of assets
29
Q

Define

Current Exchange Rate

A
  • Rate used for currency conversion
30
Q

Define

Spot Rate

A
  • Rate for immediate exchange of currencies
31
Q

Define

Transaction date

A
  • Time when a transaction is recorded under GAAP
  • The gain or loss incurred at the settlement date, which effects the firm’s cash flows, is termed a transaction gain or loss
32
Q

What two exchange rates are needed to calculate a translation?

A
  1. Historical rate - The rate i.e. on the date of the transaction
  2. Current rate - The rate i.e. on the reporting (BS) date
  • Reported as OCI
  • Foreign denominated receivable/payable is adjusted for difference between historical rate and current rate
33
Q

Define

Transaction gain (loss)

A
  • Results from a change in exchange rates between the functional currency and the currency in which the transaction is denominated
34
Q

Detail the foreign exchange transaction that has:

(Using ¥15m)

FX rate on transaction date of $0.1015 per yen

FX rate on reporting date of $0.0101 per yen

FX rate on settlement date of $$0.0102 per yen

A

Transaction Date

Dr Inventory $152,250

Cr A/P $152,250

Reporting Date

Dr A/P $750

Cr Foreign Cur Translation Adj $750

Settlement Date

Dr A/P ($152,250 - $750) $151,500

Dr Foreign Cur Translation Adj. $1,500

Cr Cash $153,000

35
Q

Detail for FX rate fluctuations when:

  • A transaction is settled in a foreign currency
    • Sale, Purchase
  • Resuts in a foreign denominated
    • Payable, Receivable
  • Foreign currency appreciates when:
    • Translation Gain
    • Translation Loss
  • Foreign currency depreciates
    • Translation Gain
    • Translation Loss
A
36
Q

What are the two remeasurement method?

Describe each

A

Temporal method: make financial satement items look as if the underlying transactions had been recorded in the functional currency to begin with

Translation (All-Current Method): assets/liabilities are restated using the current exchange rate on the reporting date; SE is restated at historical rate

*NOTE:

  • BS items carried at historical cost are remeasured at the historical rate
  • BS items carried at their current/future values are remeasured using current rate on the reporting date
37
Q

List the four types of off-balance sheet financing:

A
  1. Investment in unconsolidated subsidiaries
  2. Special purpose entities
  3. Operating leases
  4. Factoring receivables with recourse
38
Q

What is “Investment in unconsolidated subsidiaries” with regard to off-balance sheet financing?

A

Any equity ownership of less than 50% in a subsidiary results in the parent of the firm reporting the equity investment as an asset; thus not reflected as a liability

39
Q

What are “special purpose entities” used for with respect to off-balance sheet financing?

A

A firm may create another firm for the sole purpose of keeping the liabilities associated with a specific project off the parent firm’s books; then have an arrangement to either buy all the output or make guaranteed payments

40
Q

What is the significane of “operating leases” in regards to off-balance sheet financing?

A

Long-term contracts to acquire property or equipment is structured so the full amount of debt does not appear on the balance sheet.

41
Q

Describe “factoring receivables with recourse” in regards to off-balance sheet financing.

A

When a company sells account receivables to a finance company with recourse and leaves the firm contingently liable to the finance company, but does not have to be reported on the company’s balance sheet.

42
Q

List the the main differences between GAAP and IFRS?

A

Revenue recognition - the general rule

Revenue recognition - contstruction contracts

Expense recognition - share-based payments

Intangible assets - R&D costs

Intangible assets - measurement

Inventories - costing method

Inventories - valuation & write-down

Leases

Long-lived assets - measurement and depreciation

Impairment of assets

Financial statement presenation - extraordinary items

43
Q

List the 5 measurement attributes for assets & liabilities when using fair value accounting:

A
  1. Historical cost (assets) or historical proceeds (liabilities)
  2. Current cost
  3. Current market value
  4. Net realizable value
  5. Present value of future cash flows

Fair value as a measurement basis (investment security)

  • held to maturity
  • trading
  • available for sale

These must be remeasured at fair value at every reporting date

CMA 2: Financial Decision Making (10 decks)

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