Unit 3 Video Notes Flashcards
benchmarking
means comparing the company’s ratios to something that is meaningful
trend analysis
means looking at how the ratios have changed over time
Profitability Ratios:
Operating Margin Gross Profit Margin Net Profit Margin Return on Total Assets (ROA) Return on Equity (ROE)
Operating Margin
how much of a company’s sales on a % basis are generating operating profit
Gross Profit Margin
how much of the company’s sales on a % basis are generating gross profit (Sales – COGS)
Net Profit Margin
how much of a company’s sales on a % basis are generating Net Income
Return on Total Assets (ROA)
how effective is the company in using its assets to generate profits
Return on Equity (ROE)
how effective is the company in using its equity to generate profits
Liquidity Ratios
Current Ratio: can the company pay its short-term debts (liabilities) using short-term assets?
Quick Ratio: can the company pay its short-term debts (liabilities) using short-term assets excluding inventory?
Debt Ratio
can the company pay its long-term debts (liabilities) using its total assets?
Market Ratios:
Price/Earnings Ratio (P/E): used to determine the relative value of a company – higher P/E means the investor is paying more per dollar of net income so it should have a higher price than a similar firm with a lower P/E. Often quoted as TTM (trailing 12 months)
Price-To-Book Ratio – how much value is management creating from its assets – higher is better
The 4 financial statements
Income Statement
Balance Sheet
Cash Flow Statement
Statement of Owner’s Equity
What is the Income Statement?
The Income Statement contains all of the revenue, expenses, interest and taxes that the company pays and reflects the result of that as Net Income (aka the BOTTOM LINE). This reflects MOST of the firm’s operations.
INCOME STATEMENT
Important to know the following:
Important to know the following:
Revenue (sales of the company’s products or services)
Cost of Goods Sold (aka COGS)
= Gross Profit (aka Gross Margin)
Operating Expense (aka S,G&A expenses) (Salaries, Rent, Office Expenses, etc.)
Depreciation/Amortization Expense (non-cash expenses since we don’t write a check for this)
= Earnings Before Interest and Taxes (EBIT) (aka Operating Profit and Operating Income)
Interest Expense (from Notes Payables and Long-Term Debt)
= Earnings Before Taxes (EBT)
- Taxes
= Net Income
GAAP
GAAP stands for Generally Accepted Accounting Principles and are the guidelines that govern how accountants record transactions.
Matching Principle
expenses are recognized when they occur and are “matched” against recognized revs
Fair Market Value
estimate of the value of an asset based on knowledgeable information on what a buyer might reasonably pay for it
Revenue Recognition
occurs when revenue is considered realizable and earned (not when cash is paid)
Non-Cash Expenses
A non-cash expense is an expense where you are not writing a check to pay for the expense. The 3 most common non-cash expenses are:
Depreciation – records the accounting use of any of the fixed assets (machinery, equipment, etc.) that the company purchased
Amortization – records the accounting use of any intangible asset (goodwill, IP, etc.) that we have on the balance sheet
Obsolescence – when an asset (inventory or fixed asset) is not productive due to spoilage, breakage, etc.
What is the balance sheet and why is it so important?
The balance sheet lists all of the company’s assets (stuff it owns or uses to generate sales and profits) and all of the ways it uses to pay for those assets (liabilities (debt) and Owner’s Equity (stock + the company’s accumulated net profits))
The key to the balance sheet is that it ALWAYS balances (hence, the name)!
Since the balance sheet always has to balance, we have a basic relationship that we use to reflect that balance:
Super Important Equation #1:
Total Assets = Total Liabilities + Owner’s Equity
