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45 Cards in this Set
- Front
- Back
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financial statement analysis
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concerned with assessing the financial condition of the company - to be most useful, comparisons should be made from one year to another as well as with other companies within the same industry - must not rely on just financial statement analysis in making a judgment about a company
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ratios
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should be viewed as a starting point for analysis rather than as an end in themselves - indicate what should be pursued in greater depth
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problem with comparisons
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companies may use different accounting methods such as LIFO and FIFO - differences in accounting methods may make comparisons difficult
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3 common analytical techniques for financial statement analysis
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1) dollar and percentage changes on statements - horizontal analysis
2) common size statements (vertical analysis) 3) ratios |
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horizontal analysis
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also known as trend analysis involves analyzing financial data over time - 2 or more yearly statements are placed side by side and changes between years are analyzed
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trend percentages
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when data from a number of years are used to compute - a base year is selected and the data for all years are stated as a percentage of that base year.
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change meanings
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a) showing changes in dollar form helps to identify the most significant changes
b) showing changes in percentage form helps to identify the most unusual changes c) trend percentages are often computed - each item stated as a percentage of the same item in a base year |
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vertical analysis
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in a common sized statement, amounts on the balance sheet are stated as a percentage of total assets and amounts on the income statement are stated as percentage of net sales - showing them in a common-size form helps the analyst see the relative importance of the various items
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common-size financial statement
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a vertical analysis in which each financial statement item is expressed as a percentage
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gross margin percentage
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particularly important item on the common-size income statement - a rough measure of the overall profitability of a company's products
gross margin percentage = gross margin / sales |
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when fixed costs are in gross margin percentage
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when fixed costs are included in the cost of goods sold, the gross margin percentage should increase and decrease with sales volume - the fixed costs are spread across more units
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common stockholder ratios
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several ratios provide measures of how well the company is doing from the shareholder's perspective
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earnings per share
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an important measure of the annual earning available for common shareholders - preferred dividends are subtracted from net income since they are not an expense on the income statement but reduce the earnings that can be distributed to common shareholders
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earnings per share (of common stock) equation
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net income - preferred dividends / average number of common shares outstanding (to find, take common stock and multiply by par value per share)
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price earnings ratio
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shows the relation between the market price of a share of stock and the stock's current earnings per share - tend to be similar for companies in the same industry - a big factor affecting the price-earnings ratio is future earnings growth
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if company is likely to have higher future earnings growth
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if investors believe one company is likely to have higher future earnings growth than another, they will bid up the price of the stock with a higher expected future earnings growth and hence it will have a high price-earnings ratio
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price earnings ratio equation
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market price per share / earnings per share
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dividend payout ratio
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gauges the proportion of current earnings being paid out as dividends - a company with a high dividend payout ratio is paying out most of its earnings to shareholders as dividends rather than reinvesting the earnings in the company
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dividend payout ratio equation
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dividends per share / earnings per share
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dividend yield ratio
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measures the cash yield on the common stockholder's investment - investors hope to profit from both dividends and increases in the market value of the stock they own - it measures only the contribution of the dividends
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dividend yield ratio
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dividends per share / market price per share
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profitability ratios
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return on total assets
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a measure of how effectively a company has used its assets. interest expense is added back to net income to show earnings before any distributions have been made to creditors and shareholders.
this adjustment results in a total return on assets that measures operating performance independently of how assets were financed. |
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return on total assets equation
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net income + interest expense x (1 - tax rate) / average total assets
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return on common stockholders' equity
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measures a company's ability to generate income. as with earnings per share, preferred dividends are subtracted from net income since preferred dividends reduce the earnings available to common shareholders
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return on common stockholders' equity equation
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net income - preferred dividends / average common stockholders' equity (equity includes common stock and retained earnings)
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financial leverage
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involves purchasing assets with funds obtained from creditors or from preferred stockholders at a fixed rate of return
- if the assets in which the funds are invested earn a greater return than the fixed rate of return required by the suppliers of the funds, then financial leverage is positive. -financial leverage is negative if the assets earn a return that is less than the fixed rate of return required by creditors |
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sources of leverage
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include long-term debt, preferred stock and current liabilities.
-long-term debt is usually a more effective source of financial leverage than preferred stock since interest on long term debt is tax-deductible, whereas dividends on preferred stock are not |
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book value per share
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measures the common stockholders' equity on a per share basis - usually less than market value per share.
-market value reflects investors' expectations concerning future earnings and dividends -by contrast, book value measures financial effects of already completed transactions and hence looks to the past |
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book value per share equation
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total stockholders' equity - preferred stock / number of common shares outstanding
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short term credit ratios
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short-term creditors are concerned with being paid on time and are far more concerned with a company's financial assets and cash flows than with its accounting net income
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working capital
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measures the excess of current assets over current liabilities
-negative working capital signals that current assets are insufficient to cover current liabilities |
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current ratio
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widely used measure of short-term debt-paying ability.
-the current ratio, along with working capital, should be interpreted with care - the composition of the assets and liabilities is very important. -a high current ratio does not necessarily mean the company is easily able to pay its current liabilities - may be that inventory is difficult to sell quickly |
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current ratio equation
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current assets / current liabilities
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acid-test (quick) ratio
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designed to measure how well a company can meet its short-term obligation using only its most liquid current assets
-current receivables includes accounts receivable and short-term notes receivable (no inventories or prepaid expenses - hard to convert into cash) |
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acid-test (quick) ratio equation
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quick assets / current liabilities
quick assets: cash, marketable securities, accounts receivable, short-term notes receivable |
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accounts receivable turnover
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ratio measures the relation between sales on account and accounts receivable
-the higher the ratio, the quicker accounts receivable are collected. this is easier to see if the accounts receivable turnover is divided into 365 days |
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accounts receivable turnover equation
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sales on account / average accounts receivable balance
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average collection period
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the average number of days required to collect credit sales
-ordinarily a short average collection period is desirable 365 days / accounts receivable turnover |
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inventory turnover ratio
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relates cost of goods sold to the average inventory balance
-the higher this ratio, the quicker inventory is sold. cost of goods sold/ average inventory balance |
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average sale period
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average is 10 - 90 days. measures how many days on average it takes to sell inventory
-the average sale period can differ dramatically from one industry to another (sale period in a florist shop than a jewelry shop, florist have to sell quicker) 365 days / inventory turnover |
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long-term credit ratios
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long-term creditors are concerned with both the near-term and the long-term ability of a company to repay its debts
less than 1 inadequate, 2 or more is sufficient |
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times interest earned ratio
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gauges the ability of a company to pay the interest it owes
-generally the higher the times earned, the greater the ability of the company to make interest payments earnings before interest expense and income taxes (net operating income) / interest expense |
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debt-to-equity ratio
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relates debt (liabilities) to equity (stockholders' equity)
-the lower this ratio, the greater the excess of assets over liabilities, therefore creditors generally prefer a low debt-to-equity since this provides a large cushion of protection 0.0 to 3.0 are common |
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debt to equity ratio equation
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total liabilities / stockholders' equity
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