Week 7 Flashcards by Jack Harris

in analysing financial statements what 3 characteristics of a business are examined

1: liquidity
2: solvency
3: profitability

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what are the bases of comparative analysis

1: intra entity analysis
2: industry averages
3: inter entity basis

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what is intra entity analysis

compares an item or financial relationship within an entity. it is useful in detecting trends

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what is industry averages

compares an item or financial relationship of one entity with industry averages. gives information to relative performance

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what is inter entity basis

compares item or financial relationship of one entity with same in one or more competing entities. gives information about competitive performance

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what are the 2 tools for financial statement analysis

1: horizontal analysis
2: ratio analysis

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what does horizontal analysis do

estimates a series of financial statement data over time

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what does ratio analysis do

expresses the relationship among selected items of financial statement data

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what is horizontal analysis also called

it is also called trend analysis

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what is the purpose of horiziontal analysis

determine the increase or decrease that has taken place

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does horizontal analysis use a base year

year

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what is the formula for measuring % increase or decrease from base period

current year amount - base year amount / base year

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what is the formula for measuring as a % of the base period

current year amount / base year amount

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what can ratios be used for in analysis of financial statements to evaluate

liquidty
solvency
profitability

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what do liquidity ratios measure

liquidity ratios measures short term ability of entity to pay its maturing obligations and to meet unexpected needs for cash

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what do solvency ratios measure

solvency ratios measure the ability of an entity to survive over a long period of time

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what do profitability ratios measure

measure of the profit or operating success of an entity for a given period of time

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what 3 types of ratio comparison are used

1: intra entity comparisons
2: industry average comparisons
3: inter entity comparisons

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what is the measure of liquidity with liquidity ratios

how quickly an entity can convert its current assets into cash

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what are the ratios used to asses liquidity

current ratio
acid test ratio
receivables turnover
inventory turnover
creditors turnover

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what is the current ratio

evaluates entity’s liquidity and short term debt paying ability it shows for every dollar of current liabilities how many dollars of current assets are on hand

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what is the acid test ratio

measure of an entity’s immediate short term liquidity it shows for every dollar of current liabilities how many dollars of short term liquid assets are available

what is the receivables turnover ratio

measure of the number of times on average receivables are collected during the period, and how quickly they are turned into cash

is this ratio turned into terms of days and if so how so

yes it is. the ratio is divided by 365

what is the general rule with the receivables turnover ratio

that collection period should not exceed credit term period

what is the inventory turnover ratio

measures the number of times on average the inventory is sold during the period

is this ratio turned into terms of days and if so how so

yes it is the ratio is divided by 365

is a higher or lower ratio better (creditors turnover)

a higher ratio indicates better payment then a lower ratio

is it better to have a high or low inventory ratio

low because this prevents the chance of inventory obsolence occurring

what is the operating cycle

is the sum of average debtors collection period and the average days to sell inventory (in days)

what does the operating cycle measure

the time it takes to turn an item of inventory in the warehouse into cash

what is the creditors turnover ratio

measures the time it takes to make payment following the credit purchase of inventory

is creditors turnover turned into average period in days

yes it is

what are the solvency ratios

debt to total assets ratio interest coverage (times interest earned) cash debt coverage

what is the debt to assets ratio

the debt to assets ratio measures the % of total assets provided by creditors and indicates the degree of business leverage

is it better to have a high or low debt to assets ratio

low

what is the interest coverage ratio

the interest coverage ratio provides an indication of an entity's ability to meet interest payments as they fall due

what is the cash debt coverage ratio

the cash debt coverage ratio is a cash based measure used to evaluate solvency. measure of the % cash flows from operating activities per dollar of total liabilities

what does the cash debt coverage ratio show

proportion of total liabilities funded by cash flows generated each year from normal activities of entity

what do profitability ratios affect

a business ability to obtain finance, liquidity and ability to grow

what are the profitability ratios

``` return on equity payout ratio return on assets ratio asset turnover ratio gross profit margin ratio expense ratio cash return on sales ratio ```

what is the return on owners equity ratio

how many dollars of profit were earned for each dollar of equity

what is return on owners equity influenced by

debt to total assets ratio. more return on equity if highly geared but more business risk

what is the payout ratio

measures the % of profits distributed to owners via drawings or dividends

what is the return on assets ratio

measure of managements efficiency in managing the assets of the business can also be called ROI

what is the profit margin ratio

measure of the % of each dollar of sales that results in profit

what is the asset turnover ratio

measures how efficiently a company uses its assets to generate sales

what does the asset turnover ratio show

dollars of sales produced by each dollar invested in assets

what is the gross profit margin ratio

measure of the % of each dollar of sales that results in gross profit

what is the expense ratio

a measure of the expenses incurred for every dollar of net sales

what does the expense ratio show

for every dollar of net sales how many dollars are expenses

what is the cash return on sales ratio

measure of the % of each dollar of sales that results from cash operating activities

what are the limitations of financial statement analysis

1: estimates 2: cost (inflation) 3: atypical data 4: overdiversification