Week 5 Financial Statement Analysis

Question 1

Horizontal analysis

Answer 1

Study of percent change year to year. Completed for each line item in financial statement

Question 2

Computing percent change

Answer 2

Horizontal analysis
Change in account = current year- prior year
Percent change in account = change in account / Prior year balance

Question 3

Vertical analysis

Answer 3

Relationship of financial statement item to its base. All items shown as % of total.
Income statement base: total revenue
Balance statement base: total assets

Question 4

Benchmarking

Answer 4

Compares a company to some standard set by others. Allows comparison of companies form same industry of different size

Question 5

5 Categories of computing standard financial ratios

Answer 5

1. Ability to pay current liabilities
2. Ability to sell inventory and collect receivables
3. Ability to pay debts
4. Measuring profitability
5. Analyzing stock investments

Question 6

Ratios that measure ability to pay current liabilities

Answer 6

1. Working capital
2. Current Ratio
3. Acid test (quick ratio)

Question 7

Working capital

Answer 7

RATIO
=Current assets- current liabilities

-ability to pay current liabilities with current assets

Question 8

Current ratio

Answer 8

RATIO
=Current assets/current liabilities

• Generally, 1.5 considered good
• ability to pay current liabilities with current assets

Question 9

Acid test (quick ratio)

Answer 9

RATIO
=(Cash + ST investments + net current receivables)/Current liabilities

• Generally 0.9 - 1 acceptable
• Similar to current ratio with narrower base to measure liquidity
• EXCLUDES inventory and prepaid expense

Question 10

Ratios that measure ability to sell inventory and collect receivables

Answer 10

1. Inventory turnover
2. Accounts receivable turnover
3. Days sales in receivables

Question 11

Inventory turnover

Answer 11

RATIO
=Cost of goods sold/Average inventory for a period

• Number of times company sells its average level of inventory per year
• Strive for profitable turnover
• Cost of goods sold and inventory used because they are reported at cost

Question 12

Days inventory outstanding

Answer 12

365/inventory turnover

-Days it takes to sell average current inventory levels

Question 13

Accounts receivable turnover

Answer 13

RATIO
=net sales/ average net accounts receivable

• Measures ability to collect cash from customers
• ratio of 12 indicates AR balance collected once a month
• high is good but too high may indicate credit is too tight

Question 14

Days Sales in Receivables

Answer 14

RATIO
one day sales = net sales/365
days sales in receivables= average net accounts receivable/ one day sales

• Number of days sales in accounts receivable
• Lower indicates higher cashflow (compare to industry average)

Question 15

Ratios used to measure ability to pay debts

Answer 15

1. Debt ratio

2. Times interest earned

Question 16

Debt ratio

Answer 16

RATIO
=Total assets/total liabilities

• Tells portion of assets financed with debt
• 0.62 is average (professor likes 0.5)

Question 17

Times interest earned

Answer 17

RATIO
=Income from operations/ interest expense

-Shows number of times company could cover interest expense with operating income in a given period

Question 18

Income from operations

Answer 18

Income earned from core of business without looking at other areas of business that may incur income/expense

Question 19

Ratios used to measure profitability

Answer 19

1. Rate of return on sales
2. Rate of return on total assets (ROA)
3. Return on common stockholders equity (ROE)
4. Earnings per share

Question 20

Rate of return on sales

Answer 20

RATIO
=net income/net sales

-Shows percent sales dollar is earned as net income

Question 21

Rate of return on total assets

Answer 21

RATIO
=(net income + interest expense)/average total assets

• Company’s success at turning assets into profit
• Used by investors to see what they would get out of investing

Question 22

Return on common stockholder’s equity

Answer 22

RATIO
=(net income - preferred dividends)/average common stockholder’s equity

• How much is earned for every dollar invested
• Relationship between net income and stockholder’s investment in company

Question 23

Earnings per share

Answer 23

RATIO
=(net income - preferred dividends)/average # of shares outstanding

• Key measure of company’s success
• Income earned for each share of common stock

Question 24

Ratios analyzing stock investments

Answer 24

1. price earnings ratio (P/E)
2. Dividends yield
3. Book value per share common stock

Question 25

Price earnings ratio (P/E)

Answer 25

RATIO
=(market price per share of common stock)/earnings per share

• shows market price of $1 of earnings
• 10 is minimum, 20 is better

Question 26

Dividends yield

Answer 26

RATIO
=Dividends per share/market price per share

• % of stock market value returned annually to stockholders as dividends
• *preferred stockholders pay attention here as their primary reason to invest is dividends

Question 27

Book Value per share of common stock

Answer 27

RATIO
=(Total stockholder’s equity - preferred dividends)/# shares outstanding

• Shown as $
• not based on market value