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51 Cards in this Set
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Limitations of Financial Statement Analysis

1. Comparability: Differences in accounting methods between companies (i.e. inventory costing) make it difficult to compare their financial data.
2. Look beyond the ratios: Should be viewed as a starting point and raise additional questions. 

Financial ratios of interest to common stockholders

1. Earnings Per Share
2. PriceEarnings Ratio 3. Dividend Payout Ratio 4. Dividend Yield Ratio 5.Return on Total Assets 6. Book Value Per Share 7. Return on Common Stockholder's Equity 

Financial ratios of interest to shortterm creditors (suppliers)

1. Working Capital
2. Current Ratio 3. Acidtest (Quick) Ratio 4. Accounts Receivable Turnover 5. Inventory Turnover Ratio 

Financial ratios of interest to longterm creditors

1. Times Interest Earned Ratio
2. DebtToEquity Ratio 

Horizontal Analysis

A sidebyside comparison of of two or more years' financial statements.


Vertical Analysis

The presentation of a company's financial statements in commonsize form.


3 Primary tools used in financial statement analysis

1. Comparative Statements (horizontal analysis).
2. Commonsize Statements (vertical analysis). 3. Ratios. 

Comparative Statements

Financial statements that show changes in line items from one year to the next expressed in dollars and percent. Compares each line item.


Commonsize Statements

Financial statements that show changes in line items from one year to the next expressed as a percentage of assets, or of liabilities and stockholders' equity (balance sheet), or as a percentage of sales (income statement).


Horizontal Analysis is also known as...

Trend Analysis


Gross Margin (Gross Profit)

Sales Revenue  Cost of Goods Sold


Gross Margin Percentage

Gross Margin
 Sales (measure of profitability) 

Earnings Per Share

Net income  Preferred dividends
 Average number of common shares outstanding 

Net Income Available For Common Stockholders =

Net Income  Preferred Dividends


Price Earnings Ratio

Market Price Per Share
 Earnings Per Share (states that a stock is selling for ___ times its earnings per share) 

Dividend Payout Ratio

Dividends Per Share
 Earnings Per Share (a measure of current earnings being paid out as dividends) (there is no "correct" payout ratio) (companies within the same industry often have similar payout ratios) 

2 Ways investors in stock make money

1. Capital gains
2. Dividends 

Companies with excellent prospects for profitable growth...

often pay little or no dividend.


Companies with limited opportunity for profitable growth, but with steady, dependable earnings,...

often pay out higher dividends.


Dividend Yield Ratio

Dividends Per Share
 Market Price Per Share (measures the rate of return from dividends only) 

Return On Total Assets

Net Income + [Interest Expense x (1  Tax rate)]
 Average Total Assets (a measure of operating performance) 

Return On Common Stockholders' Equity

Net Income  Preferred Dividends
 Average Common Stockholders' Equity 

To measure the effectiveness of financial leverage...

Compare: Return On Total Assets with Return On Common Stockholders' Equity


Average Common Stockholders' Equity

Average Total Stockholders' Equity  Average Preferred Stock


Financial Leverage

Difference between the rate of return on assets and the rate paid to creditors.


Positive Financial Leverage exists if...

the rate of Return On Total Assets exceeds the rate of return paid to creditors.


Negative Financial Leverage exists if...

the rate of Return On Total Assets is less than the rate of return paid to creditors.


Positive Financial Leverage benefits...

the stockholders.


Some debt in a company's capital structure can be beneficial if...

Positive Financial Leverage exists.


Book Value Per Share

Total Stockholders' Equity  Preferred Stock
 number of Common Shares Outstanding (measures the amount that would go to common stockholders if all assets were sold at their book values) 

If Market Value Per Share exceeds Book Value Per Share...

the stock may appear to be overpriced.


Market prices reflect expectation about...

1. Future earnings
2. Future dividends 

Ordinarily, the market value of a stock...

exceeds its book value.
(because of anticipated future earnings and dividends) 

Working Capital

Current Assets  Current Liabilities


Current Asset

Assets that will be converted to cash or consumed within one year or an operating cycle, whichever is longer.


Current Liability

Obligation due within one year or an operating cycle, whichever is longer.


Working Capital must be financed with:

1. Longterm debt
2. Equity (both are expensive) 

A large and growing Working Capital balance may not be a good sign because it could be a result of...

unwarranted growth in inventories.


Current Ratio

Current Assets
 Current Liabilities (measures shortterm debtpaying ability) 

Usually, Current Ratios should be at least___.

2


Even with a Current Ratio of 2 or better, companies may have difficulties meeting financial obligations if the majority of their assets are...

less liquid (i.e. inventories).


The AcidTest (Quick) Ratio is a more rigorous test of a company's ability to meet its shortterm debts than the...

Current Ratio.


AcidTest (Quick) Ratio

Cash + Marketable Securities + Accounts Receivable
+ ShortTerm Notes Receivable  Current Liabilities ("quick" assets are more liquid assets) 

Ideally, each dollar of liability should be backed by at least...

1 dollar of quick assets.


Accounts Receivable Turnover

Sales On Account
 Average Accounts Receivable Balance (measures how quickly credit sales are converted into cash) (greater is better) 

Average Collection Period

365 days
 Accounts Receivable Turnover (measures in days how quickly credit sales are collected) 

Inventory Turnover

Cost Of Goods Sold
 Average Inventory Balance (measures how many times a company's inventory has been sold and replaced during the year) (greater is better) 

Average Sale Period

365 days
 Inventory Turnover (measures the number of days needed on average to sell the entire inventory) 

Times Interest Earned Ratio

Earnings before interest expense and income taxes
 Interest Expense (measures ability to repay longterm loans) 

Times Interest Earned Ratio should be at least___in order to protect longterm creditors.

2


DebtToEquity Ratio

Total Liabilities
 Stockholders' Equity (measures ability to reasonably balance debt to equity) 