Week 7 Flashcards
in analysing financial statements what 3 characteristics of a business are examined
1: liquidity
2: solvency
3: profitability
what are the bases of comparative analysis
1: intra entity analysis
2: industry averages
3: inter entity basis
what is intra entity analysis
compares an item or financial relationship within an entity. it is useful in detecting trends
what is industry averages
compares an item or financial relationship of one entity with industry averages. gives information to relative performance
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
what are the 2 tools for financial statement analysis
1: horizontal analysis
2: ratio analysis
what does horizontal analysis do
estimates a series of financial statement data over time
what does ratio analysis do
expresses the relationship among selected items of financial statement data
what is horizontal analysis also called
it is also called trend analysis
what is the purpose of horiziontal analysis
determine the increase or decrease that has taken place
does horizontal analysis use a base year
year
what is the formula for measuring % increase or decrease from base period
current year amount - base year amount / base year
what is the formula for measuring as a % of the base period
current year amount / base year amount
what can ratios be used for in analysis of financial statements to evaluate
liquidty
solvency
profitability
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
what do solvency ratios measure
solvency ratios measure the ability of an entity to survive over a long period of time
what do profitability ratios measure
measure of the profit or operating success of an entity for a given period of time
what 3 types of ratio comparison are used
1: intra entity comparisons
2: industry average comparisons
3: inter entity comparisons
what is the measure of liquidity with liquidity ratios
how quickly an entity can convert its current assets into cash
what are the ratios used to asses liquidity
current ratio acid test ratio receivables turnover inventory turnover creditors turnover
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
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
