Chapter 5: Analysis of Financial Statements

Which of the following is an operating performance ratio? A) Debt to total assets B) Times interest earned C) Payout ratio D) B and C E) None of the above

D

Which of the following ratios is not a liquidity ratio? A) receivables turnover B) inventory turnover C) accounts payable turnover D) asset turnover

D

Equation: Gross Margin (GM)

Gross Profit/Net Sales

Equation: Debt to Capitalization (D/C)

Long Term Debt/LTD + Owners' Equity

Liquidity ratios

these examine the adequacy of the firm in meeting its future obligations

Financial ratios

these indicate the stability of the long-term capital structure of a firm

Operating ratios

these measure the efficiency of the firm in generating profits.

An analyst discovers that inventory increased by 15% from one year to the next. This is an example of A) horizontal analysis B) vertical analysis C) qualitative analysis D) none of the above

A

The ratio that indicates the overall efficiency of the investment in and use of assets is A) ROA B) ROE C) Prince to earnings D) None of the above

A

Equation: Average Inventory Period (AIP)

Average Inventory/Daily Cost of Goods Sold Daily COGS is COGS/365

Equation: Operating Cycle (OC)

Average Receivables Period + Average Inventory Period

Equation: Average Collection Period (ACP)

Average Receivables/Daily Sales Daily Sales are Net Sales/365

Equation: Inventory Turnover (I/T)

Cost of Goods Sold/Average Inventory

Equation: Working Capital (WC)

Current Assets - Current Liabilities

Equation: Current Ratio (Cur.)

Current Assets/Current Liabilities

A commercial bank uses ratios extensively to analyze their customers. Which ratio is of the utmost interest to the banker? A) Payout B) Return on equity C) Price-earnings D) Current

D

The ratio that relates how much debt a company has in proportion to its equity is A) current B) debt to total assets C) shareholders' equity to assets D) debt to equity

D

Equation: Payout (PO)

Dividends/Net Income

The ratio that shows how investors value the stock is A) Payout ratio B) Earnings per share C) Return on equity D) Return on assets E) None of the above

E - Price/Earnings ratio

True or False: Analysts can rely principally on ratio analysis and other quantitive measures for enough information to make informed decisions. Qualitative techniques provide interesting but non-essential data, icing on the cake, as it were.

False

True or False: Profit margin provides the user with a comprehensive profit picture of a firm.

False

True or False: Ratio analysis is unqualifiedly the best method of financial statement analysis.

False

True or False: Horizontal analysis compares the components of the balance sheet with a base item, expressing various components as percentage of the base.

False - that is vertical analysis.

Equation: Price-Earnings (P/E)

Market Price/EPS

Equation: Earnings per Share (EPS)

Net Income/Average # Shares Outstanding

Equation: Return on Assets (ROA)

Net Income/Average Assets

Equation: Return on Equity (ROE)

Net Income/Average Owners' Equity

Equation: Profit Margin Ratio (Return on Sales/ROS)

Net Income/Net Sales

Equation: Asset Turnover (A/T)

Net Sales/Average Assets

Equation: Receivables Turnover (R/T)

Net Sales/Average Receivables

Equation: Times Interest Earned (X/I)

Profit before taxes and interest/Interest

Equation: Quick Ratio (Quick)

Quick Assets (cash + marketable securities + receivables)/Current Liabilities

Present value

Rather than multiplying a known current value by an interest rate to compute its future value, discounting takes a known future quantity and divides it by an interest rate factor to determine its present value. PV = A x 1 /(1+i)^n

Equation: Equity to Assets or Equity Ratio (E/A)

Total Equity/Total Assets

Equation: Debts to Assets or Debt Ratio (D/A)

Total Liabilities/Total Assets

Equation: Debt to Equity (D/E)

Total Liabilities/Total Equity

True or False: A company's operating cycle is a measurement of the average length of time from the point of a sale to the collection of an account receivable. This measure is an important tool used in measuring operating efficiency and in forecasting the cash requirements of the firm.

True

True or False: Current ratios and quick ratios indicate the relative liquidity of a company. These two ratios are essential in that they provide an analyst with information concerning a company's ability to meet its current obligations.

True

True or False: Debt-to-Equity and Debt-to-Assets ratios usually provide a clear picture of financial leverage employed by a firm. The higher the level of debt, the higher the implied financial risk. An informed reader, however, understands that it is appropriate to draw this general conclusion only when comparing firms within the same, or very similar industries.

True

True or False: Financial analysts interpret historical financial data in order to better predict the future performance of the reporting entity.

True

True or False: Horizontal and vertical analysis are two key techniques used in analyzing financial statements, usually applied in tandem. Briefly stated, vertical analysis requires that significant element be measured as a percentage of a base to which its related. For example, the various components of an income statement might be measured as a percentage of sales. This technique can be applied to the balance sheet as well.

True

True or False: ROE shows how much income was earned for every dollar invested by owners.

True

True or False: Return on assets is sometimes called return on investment.

True

True or False: The inventory turnover ratio is one indicator of a firm's operating efficiency. Typically, faster turns means that management is doing a better job of buying or controlling inventory.

True

True or False: The quick ratio is more liquid than the current ratio.

True

Two major elements of return on assets (ROA) are profit margin and asset turnover. An analysis of these two component parts can provide valuable insights into a firm's performance.

True

Horizontal analysis

compares how the balance sheet and income statement items change from year to year.

Future value

describes the projected value of a given amount of money after a specific increment of time, taking into account the time value of money. FV = A x (1+i)^n