Chapter 3: Working with Financial Statements

Alpha Co. has cost of goods sold of $61.2 million, net income of $9.6 million, sales of $120 million, and total assets of $150 million. A common-size income statement will show cost of goods sold of _____ percent and a net profit of _____ percent.

51;8 61.2/120 = 51 9.6/120 = 0.08 * We We do it out of $120 (sales) because common-size income statements look at percentages out of total sales.

A firm with a profit margin of 6.8 percent generates _____ cents in net income for every one dollar in sales.

6.8 cents

common size balance sheet

All items in the balance sheet are expressed as a percentage of total assets

Rock construction has current assets of 45 million, total liabilities and equity of 67 million, and sales of 59 million. How would current assets be expressed on a common-size balance sheet?

Assets = liabilities + equity $45m/$67m = 67% * We do it out of $67 (total liabilities + equity which is total assets) because common-size balance sheets look at percentages out of total assets.

Financial Ratios

relationships determined from a firm's financial information and used for comparison purposes

equity interest

share of stock

The EBITDA ratio is similar in spirit to

the PE ratio

Price per share

the amount of money needed to buy one piece of stock

Statement of Cash Flows

the financial statement that identifies a firm's sources and uses of cash in a given accounting period

Total debt ratio

total debt ratio = (total assets - total equity) / total assets

BC Toys has total equity of $584,000. There are 35,000 shares outstanding at a market price of $54 per share. What is the market to book ratio?

Book value per share = 584,000/35,000 = 16.7 so 54/16.7 = 3.24 times

Cal's market has return on equity (ROE) of 15%. What does this mean?

Cal's generated $0.15 in profit for every $1 of book value of equity.

Cash ratio

Cash / Current Liabilities

Cash ratio

Cash Ratio = Cash / Current Liabilities - very short-term creditor may be interested in this

cash flow identity

Cash flow from assets = Cash flow to creditors + Cash flow to owners/stockholders

Accounts Payable Turnover

Cost of Goods Sold / Average Accounts Payable

Current ratio

Current Ratio = Current Assets / Current Liabilities - a measure of short-term liquidity - unit of measurement is either dollars or times - the higher the current ratio, the better (indicates liquidity)

Debt-equity ratio

Debt-equity ratio = Total debt/Total equity

Interval measure ratio

Interval measure = Current assets/Average daily operating costs -useful if facing a strike and cash inflows begin to dry up. How long can the business keep running? - also useful for newly founded or startup companies with little revenue

Inventory turnover

Inventory turnover = Costs of goods sold/Inventory *The higher this ratio, the more efficiently we are managing our inventory

Long-term debt ratio

Long-term debt ratio = Long-term debt/(Long-term debt + Total equity) *(Long-term debt + Total equity) also known as Total Capitalization

Enterprise Value (EV)

Market Capitalization + Market Value of Interest Bearing Debt - Cash

Return on Assets (ROA)

Net Income/Total Assets *Measure of profit per dollar of assets

Return on Equity (ROE)

Net Income/Total Equity or: (Profit margin) x (total asset turnover) x (equity multiplier) *Measure of how the stockholders fared during the year. *Measure of profitability

Net working capital (NWC) to total assets ratio

Net working capital to total assets = Net working capital/Total assets - low value may indicate low liquidity

Quick ratio

Quick Ratio = (Current Assets - Inventory) / Current Liabilities

Recievables Turnover

Sales/Accounts Recievable *tells how fast we collect on the sales

Net Working Capital (NWC) turnover

Sales/NWC *Tells how much work we can get out of our working capital

Fixed asset turnover

Sales/Net fixed assets *For every dollar in fixed assets, we generated $x in sales.

Total asset turnover ratio

Sales/Total Assets *For every dollar in assets, we generated $x in sales.

Financial statements are the primary means of communicating financial information both within and outside of the firm.

True

Sources of Cash

a firm's activities that generate cash

uses/applications of cash

activities that involve spending cash

Common Size Income Statement

an income statement in which each item is expressed as a percentage of sales(or revenues)price

Earnings Growth Rate

change in earnings/earnings

book value per share

common equity / shares outstanding

Days' sales in inventory

days' sales in inventory = 365 days/Inventory turnover *Tells us how long on average it took us to turn over our inventory

Dividends Per Share (DPS)

dividends paid to common stockholders / common shares outstanding

A times interest earned (TIE) ratio of 3.5 times means a firm has _____ that are 3.5 times greater than the firm's interest expense.

earnings before interest and taxes

What does EBIT stand for?

earnings before interest and taxes

Times interest earned ratio

earnings before interest and taxes (EBIT)/Interest

Equity multiplier

equity multiplier = total assets / total equity or 1 + Debt-equity ratio or (total equity + total debt)/total equity

Price earnings ratio (PE)

market price per share/earnings per share * Market value ratio

Market-to-book ratio

market value per share/book value per share *if market-to-book ratio is greater than 1, then value was CREATED for shareholders

Profit Margin

net income/net sales *Means we generate $x in profit for every dollar in sales *high Profit Margin is desirable

Earnings Per Share (EPS)

net income/shares outstanding

Earnings per share (EPS)

net income/shares outstanding

Price-earnings Ratio (PE)

price per share/earnings per share

Price-sales ratio

price per share/sales per share

When a company has negative earnings for an extended period of time, analysts will often resort to the

price-sales ratio

BC Corporation has 1,800 shares outstanding and earned $2,700 last year on assets of $2 million and equity of $1.5 million. What is the PE ratio if the stock is currently selling at $18 per share?

$18/ (2,700/1,800) = 12 times earnings per share = 2,700/1,800

Which of the following are sources of cash?

-Increase in notes payable -decrease in accounts receivable

Which of the following are uses of cash?

-increase in inventory -increase in property, plant, and equipment -decrease in accounts payable

BT Tools has current assets totaling $9.2 million, including $4.3 million in inventory. The company's current liabilities total $8.1 million. What is the quick ratio?

.60 (9.2 - 4.3)/8.1

What is the debt-equity ratio for a company with $3.5 million in total assets and $1.4 million in equity?

1.50 times Total debt = Assets - Equity (b/c assets=liabilities+equity) 3.5-1.4=2.1 Debt/equity = 2.1/1.4= 1.50 times

Alpha Co. has interest expense of $1.2 million, total assets of $84 million, sales of $76 million, long-term debt of $12.1 million. How will interest expense be recorded in the common-size income statement?

1.58% $1.2m/$76m = 0.01578 *We do it out of $76 (sales) because common-size income statements look at percentages out of total sales.

Nestor's has net income of $315,000, total sales of $3.52 million, total assets of $4.4 million, and total equity of $1.98 million. What is the return on equity?

315,000/1.98 = 159,090 so 15.91%

Days' Sales in Payables

365 / payables turnover

Days' Sales in Receivables (Average collection period or ACP)

365/receivables turnover

Better Life Inc. had net income of $375,000 on sales of $3.5 million and assets of $4.1 million this year. What is the profit margin?

375,000/3.5= 107,142 so 10.71%