Unit 3: Profitability Analysis & Analytical Issues Flashcards
Define
Gross Profit Margin
The percentage of gross revenues that remains w/ the firm after paying for merchandise
Define
Operating Profit Margin
The percentage that remains after SG&A expenses have been paid
Define
Net Profit Margin
The percentage that remains after other gains and losses (including int. expense) and income taxes have been added or deducted
Define
EBITDA Margin Percentage
EBITDA Margin Percentage =
(EBITDA)
———————————————
Net Sales
Define
Return on Assets = ?
Return on Assets =
(Net Income)
———————————————
Avg total assets
Define
Return on Equity = ?
Return on Equity =
(Net Income)
———————————————
Avg total equity
*ROE will always be greater than ROA
Under the various return ratios, what can the numerator be adjusted by?
- Subtacting preferred dividends to leave only income available to common stockholders
- Adding back minority interest in the income of a consolidated subsidiary
- Adding back int. expense
- Adding back both int. expense and taxes so numerator is EBIT –> enhances comparability of firms with different capital structures/tax planning strategy
Under the various return ratios, what can the denominator be adjusted by?
- Excluding nonoperating assets
- Excluding unpoductive assets
- Excluding current liabilities to emphasize long-term capital
- Excluding debt & preferred stock to get equity capital
- Stating invested capital at market value
Calculate the DuPont Model for Return on Assets.
Calculate the DuPont Model for Return on Equity
Describe the three components for the DuPont Model for Return on Equity.
- The net profit margin examines a company’s efficiency in generating earnings from sales
- Asset turnover component examines how efficiently the company is deploying the totality of its resources to generate revenue
- The equity multiplier measures a company’s financial leverage. High financial leverage means that the company relies more of debt to finance its assets
Define
Return on Common Equity
- Think income available to common shareholders (IACS)
Define
DuPont Model for ROCE
Define
Sustainable Equity Growth Rate
- The highest growth rate a company can sustain without increasing leverage
Define
Book Value Per Share
- The amount of net assets attributable to the common shareholders per share oustanding
Define
Market/Book Ratio
Measures how much an investor must spend to ‘own’ a dollar of net assets
Define
Price/Earnings Ratio
It measures how much an investor must spend to ‘buy’ a dollar of EBITDA
Define
Price/EBITDA Ratio
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
Define Basic Earnings Per Share (BEPS) = ?
Common Stock vs. Preferred Stock
[Single Capital Structure Firm]
*DEPS should be used if available
- 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
Define
Earnings Yield
Used to determine if a given stock is comparable to others in the industry or to alternative uses of investment money
Define
Dividend Payout Ratio = ?
Measures what portion of accrual-basis earnings was actually paid out to common shareholders in the form of dividends
Define
Dividend Yield = ?
What are some limitations of ratio analysis?
- 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
What is the largest cost element for any seller of merchandise?
Define Gross Profit Margin
- 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
Define
Reporting Currency
- The currency an entity prepares its financial statements in
Define
Foreign Currency Translation
- expresses the reporting currency in amounts that
- are denominated in (fixed in units of) a different currency or
- are measured in a difference currency
Define
Functional Currency
- Currency of the primary economic environment in whch an entity operates
Define
Foreign Currency Transactions
- 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
Define
Current Exchange Rate
- Rate used for currency conversion
Define
Spot Rate
- Rate for immediate exchange of currencies
Define
Transaction date
- 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
What two exchange rates are needed to calculate a translation?
- Historical rate - The rate i.e. on the date of the transaction
- 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
Define
Transaction gain (loss)
- Results from a change in exchange rates between the functional currency and the currency in which the transaction is denominated
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
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
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
What are the two remeasurement method?
Describe each
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
List the four types of off-balance sheet financing:
- Investment in unconsolidated subsidiaries
- Special purpose entities
- Operating leases
- Factoring receivables with recourse
What is “Investment in unconsolidated subsidiaries” with regard to off-balance sheet financing?
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
What are “special purpose entities” used for with respect to off-balance sheet financing?
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
What is the significane of “operating leases” in regards to off-balance sheet financing?
Long-term contracts to acquire property or equipment is structured so the full amount of debt does not appear on the balance sheet.
Describe “factoring receivables with recourse” in regards to off-balance sheet financing.
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.
List the the main differences between GAAP and IFRS?
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
List the 5 measurement attributes for assets & liabilities when using fair value accounting:
- Historical cost (assets) or historical proceeds (liabilities)
- Current cost
- Current market value
- Net realizable value
- 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
