Chapter 3: Cash Flows and Financial Analysis

common size statement

a firm's income statement with every line stated as a percentage of revenue. a balance sheet with every line stated as a percentage of total assets. used to compare companies of different sizes or to identify performance trends in a single company over time

financial analyst

a person who studies the financial results of businesses and makes recommendations on their values as investments

budget

a short-term, financially detailed business plan, usually covering about a calendar quarter

expense

an item of expenditure not closely related to production. contrast with cost

cost

business spending for items closely associated with production. contrast with expense

quick ratio

current assets less inventories divided by current liabilities. a financial ratio that measures a firm's liquidity, the ability to pay its bills in the short run, without depending on converting inventory into cash. also called the acid test

debt ratio

debt divided by total assets. a financial ratio measuring the degree to which the firm uses borrowed money

book value

for a company, the value of equity, equal to total assets minus total liabilities. book value can be stated in total or per share. for an asset, book value is the net of original cost minus accumulated depreciation, and is generally referred to as net book value

return on equity (ROE)

net income divided by equity. a financial ratio measuring performance concentrating on profitability, asset utilization, and the use of borrowed money

return on sales (ROS)

net income divided by sales revenue. a financial ratio measuring performance, concentrating on profitability

return on assets (ROA)

net income divided by total assets. a financial ratio measuring performance concentrating on profitability and asset utilization

earnings before interest and taxes (EBIT)

a measure of a firm's performance without regard to how it is financed. also known as operating profit

economic value added (EVA)

a measure of income that recognizes the cost of equity as well as debt. a positive EVA represents a contribution to shareholder wealth over that required by an equity investor, and is viewed as an increment to MVA. EVA is after-tax EBIT less the product of capital and the cost of capital

Du Pont equations

a series of relationships between financial ratios that illustrates the inner workings of businesses and how performance in one area influences performance in others

financial ratios

a technique of analyzing the strength of a company by forming (financial) ratios out of sets of numbers from the financial statements. ratios are compared with the competition, recent history, and the firm's plan to assess the quality of its performance

annual report

a yearly report on a company's performance prepared by management. an annual report includes financial statements and generally contains verbal and discussions of the firm's operations and prospects

fixed financial charge

an expense item that must be paid regardless of how the firm is performing. essentially, interest and lease payments

finance

the art and science of handling money

D/E ratio

the ratio of a firm's stock price to its earnings per share (EPS). a measure of the value the stock market places on the company and its future prospects

debt to equity ratio

the relative amounts of debt and equity in a firm's capital structure

interest

the return on a debt investment. called interest rate when stated as a percentage of the debt on which is paid

market capitalization

the total value of a company's stock. the number of shares outstanding times the current price

leverage (financial)

the use of borrowed money to multiply financial performance in terms of ROE and EPS

leverage (operating)

the use of fixed as opposed to variable cost in a firm's cost structure

going concern value

the value of a firm as a profit earning business as opposed to as a collection of assets

financial risk

the variation in a fir's financial performance caused by using borrowed money (debt, leverage)

current liabilities

obligations expected to require cash in less than one year, usually payables and accruals

statement of cash flows

one of a firm's financial statements. it details the movement of cash in and out of the company. constructed from the income statement and balance sheet

consolidation

a combination of two or more businesses in which the old legal entities dissolve and a new one with a new name is formed to continue into the future

average collection period (ACP)

a financial ratio that measures how long it takes to collect on credit sales. also called days sales outstanding (DSO)

earnings per share (EPS)

a firm's earnings stated on a per-share outstanding basis. an important measure of business performance in the stock market

equity

an ownership interest. in business, the portion of a firm's capital representing funds belonging to its shareholders. an equity investment is an investment in stock. in general, the portion of an asset's value accruing to its legal owner after subtracting the interest of creditors. in home ownership, the house's market value less the value of mortgages and other loans collateralized by the property

free cash flow

cash generated by a business above that needed for asset replacement and growth

current ratio

current assets divided by current liabilities. a financial ratio that measures a firm's liquidity, the ability to pay its bills in the short-run

fixed and total asset turnover

sales divided by fixed or total assets. financial ratios that measure the firm's ability to generate revenue using its assets

depreciation

the accounting entry allocating the cost of a long-lived asset against income over the asset's life. depreciation is a noncash charge, so net income is generally less than true cash flow by at least the amount of depreciation

market value added (MVA)

the excess of market value measured by the product of stock price and the number of shares outstanding over the book value of equity. an indication of the effectiveness of management in contributing to shareholder wealth

generally accepted accounting principles (GAAP)

the general rules by which financial records are kept

stock market

the network of exchanges, brokers, and investors that trade in stocks

finance

to raise money usually to acquire an asset or to do some project

investing

using a resource (usually money) to improve the future rather than for current consumption. investment by companies generally means buying assets to be used in their businesses. investment by individuals usually means buying financial assets (stocks, bonds, savings accounts) that earn a return

liquidity

with respect to a company, the ability to pay its bills in the short run. with respect to an asset, the readiness with which it can be converted to cash