FIN653_Exam 1

what is ebit margin

EBIt /sales

roe and roa come from___ while pm comes from

IS and BS IS

profit margin is

NI/ Sales for every $1 we keep ____

what is operating cash flow

OCF= EBIt+ depreciation-taxes

ROEs fourth form is

PM is broken up into 3 parts ROE= Tax burden * interest burden * EBIT Margin * TAT* EM

what is the quick ratio?

QR = (CA - Inv)/CL 1. St solvency or liquiidty ratio 2. tells us how much in assets we own in terms of cash & accts receivable for every $1 we owe

What we make for SH given what creditors have put up describes what ratio

ROA

Total debt ratio is

TA-TE/TA or TL/TA it tells us how we pay for our assets how company gets moneys to buy assets (capital structure: SH and creditors) lower=better

range in theory for tdr, d to e, and em

TDR: 0 to 1 D to E: 0 to infinity EM: 1 to infinity

what does a TDR of 1 mean?

TDR= TL/TA all financed by creditors and no equity

1st four categories are information from who? the last category is from who?

accounts accountants and finance

which is cheaper debt or equity?

debt is cheaper than equity

any return can be defined as

profit/initial investment

in theory, we can have no itnerest or tax burden above 1 (t or f)

true because that means getting money back

asset management ratios are also known as

"utilization ratios"

The Current Ratio is 200/100 the new current ratio is 150/50 what happens to the ratio?

%change= 200--> 150= -25% = 100-->50 = -50% Overall ratio: -25%/-50%

who is better and why? TAT for each company listed below: A= 10/100 B=20/100 C=30/100 D=40/100

a= .1, B=.2, c=.3, d=.4 D is the most efficient with their assets. For every $1 in assets, they enerate the most ($0..40 in CF)

a tax burden of 0 means

all income goes towards tazes

an interest burden of 0 means

all income is paid to creditors at interest

an asset is

an investment

mgmt uses financial anaylsis to

analyze the company and self reflect

borrowing is encouraged for things that __ in value

appreciate

what is a current asset?

asset that will be converted to cash in less than a year cash (we know we have it) inventory (looking to sell) accounts receivable (know expected pymnt)

we want ___ and _____ to drive numbers and ROE

asset turnover and ebit margin

what is the third category of ratios?

asset utilization/management/turnover/efficiency

the balance sheet is relative to __ while the income statement is relative to ___

assets sales

in finance we are not a fan of ___- and would rather look for ___

averages , trends and relationships

what does a times interest earned ratio of 1 mean?

bad we can barely cover interest expense and have no margin for error shareholders are left unhappy because there is no money for them

why must we be careful with percentage change?

because base amounts must be considered (think Walmart and Winn-Dixie example) whatever number you use first will determine the outcome (we must know exactly what the numbers are saying) can be misleading (stock share example) Percentage change average of 25% when actually you earned $0 dollars. think $50 to $100 then back to $50

why is there no rule of thumb in finance?

because conditions change

why is asset efficiency so important?

because it shows whether a company has enough to cover variable costs

why are we so concerned with EBIt and TAT?

because no secrets to leverage but are secrets to keeping sales high and asset efficiency

why is the em less importnat than ebit margin adn TAT

because there is no secret to leverage

market value versus book value

book value is what you paid minus deprecitation market value is what it is worth if liquidated today

buying a share of stock is an example of

buying cash flows

stockholders equity includes

common stock and prefrrered stock ROE total includes both

when looking at tax burden and interest burden, what are we looking for ?

consistency

creditors want a lower or higher debt to equity ratio?

creditors want a lower debt to equity ratio because they want to know you owe less

debt is cheaper than equity because

debt is paid first so we get a tax break and we pay creditors before sh, less risk=less return

debt vs equity

debt- promises made equity-promises not made liabilities are obligation of the firm that require a payout of cash within a specific period equity is a claim against firms assets and isnt fixed

adding more money into the circulation can

decrease the value of the dollar inflation example: people have more money cause circulation has increased but inflation occurs when too much money is chasing too few goods and prices are driven up

if the debt to equity ratio is 3, this means?

for every $1 we got from shareholders, we have $3 from creditors

the current ratio of .5 tells us that

for every $1 we owe, we will convert $.50 assets into cash .5 is too low because it means we have negative networking capital company has 50 cents in current assets for every 1 in current liabilities

a good lender does what

gives incentive to pay money back

Do we want a high or low TDR and TIER?

high TIER but low TDR

what kind of liquidity ratio do we want?

high but not too hight

how are profitabilitiy ratios determined as good or bad

high is good for EVERYONE

if you are a creditor, do you want a high or low liquidity ratio?

high liquidity ratio (more likely to get paid)

do we want a higher or lower ebit margin

higher= better because means less expenses

Times interest earned ratio tells us

how can we afford it

profitability ratios tells us

how efficiently a company is using its assets and how efficiently it manages its operations

what does the receiveables ratio tell us?

how fast we can sell products sales/acct recievables

Pm is an example of a ratio that tells us what

how much SH get to keep

operation margin is

how much you get to keep before taxes and interest

__- is often the least liquid current asset

inventory

where does the information from category 5 ratios come from>

marketplace and accountants

a measure of profitability is

net income

what is the income statement

tells us how we are doing and what we have spent sales - COGS - Ad Exp - dep'n

describe risk and return using auto insurance?

the higher the risk, the higher the rpemium

what number do we want for inventory turnover ratio

the hight the better because we want to turn and collect on inventory

we determine the price of an asset by looking at

the market

at the end of the day we are concerned with

the market place: public opinion, customers suppliers, investors and employees from the market place

The higher the profit margin,

the more sales i keep

why do we use ratio analysis?

to tell story depending on time and situation

what is the single most important accounting ratio?

ROE how much we are makijng for the group we are workign for

single most important accounting ratio is

ROE (return on equity)

ROE's second form is

ROE= ROA * EM

What financial statements are associated with each financial ratio?

ST (liquidity) and LT (debt) Solvency Ratios - Balance Sheet Asset Efficiency Ratios - Balance Sheet and IS Profitability Ratios - Income Statement

financial ratio categories and where we get the infomration

ST solvency/liquidity- Balance sheet LT solvency/leverage- Balance Sheet Asset Efficiency- Bs + IS Profitability- IS Market Value- Market

why might the TAT be misleading compared to ROA

TAT doesnt pick up expenses so ROA is a more accurate depiction of how much money we are keeping

why would we rather ROA than TAT?

TAT tell us sales over assets and not enough realistic info ROA includes expenses and revenues so more realistic because uses bottom line info

if we have .40 in annual sales and $1 in total assets, what is the total asset turnover and how many years does it take to turn assets completely?

TAT= sales/TA= .4/1 =.4 times 1/.4= 2.5 years to turn assets completely

if the total debt ratio for a comapny is .3, what is the debt to equity and equity multiplier?

TDR = TL/TA = .3/1 A = L + EQ 1 = .3 + EQ EQ = .7 d/e = .3/.7 = .43 EM = Assets/EQ = 1/.7 = 1.43

what is the total debt ratio?

TDR = TL/TA = total assets-total equity/total assets 1. It tells us that for every $1 in assets, how much we owe in liabilities 2. it tells us how the company gets money to buy assets

____ tells us how much and ____ tells us if we can afford it?

TDR tells us how much TIER tells us if we can afford it

What questions do the LT liquidity ratios answer?

TDR, D to E, EM tell us how much debt we have TIER and Cash Coverage tell us if we can afford it

what is the difference between the long term solvency ratios?

TDR, EM, and D to E and LTD (TD without current liab) ratios tell us how much debt we have . ----BS info Times interest earned and Cash coverage tell us if we can afford it ----income sheet info

what does a debt to equity ratio of 1 mean?

TL/TE=1/1 50/50 invested by both sh and creditors for every $1 owed to SH we owe $1 to creditors as well

what ratio is used to easily hide leverage? why?

ex: if TDR=.5 D to E= 1 EM=2 EM stands out the most compared to the others, so use .5 to hide leverage

common size stmnts

express the balance sheet as percentage of assets express the income statement as a percentage of sales

true or false: equity cannot be negative

false: equity can be negative how? retained earnijngs

True or false the higher the tax or interest burden the worse it is

false: higher = better

true or false: stock value is fair

false: not fair, just in equilibrium where supply equals demand

interest is a ___ expense

finance expense

what skills do you need to be a business?

financial statement analysis and spreadhseets

what is the difference between total asset turnover and fixed asset turnover?

fixed asset turnover ignores the least liquid assets (inventory) more realistic/reliable view of asset efficiency

suppose your TDR is .6, what does this mean?

for every $1 in assets, 60 cents came from creditors and 40 cents from shareholders

what does it mean to have a times interest ratio of 1

for every $1 in interest, we have $1 to pay it back. so no margin of error 2 problems: SH are getting no money so unhappy and we are barely paying our interest expense

the current ratio can be read how? use example, comapny current ratio is 2.

for every $1 the company owes, it generates 2 in cash

the industry itself can affect ratios. how?

retail company will have inventory so CR will be much greater than QR service company will not have inventory so CR will be same as QR

____ is use to grow the company internally

retained earnings

how are we able to have negative equity>

retained earnings

ROA is

return on assets What are we making for SH given what creditors and SH have put up high NI/Assets for every $1 in assets we keep ___ in NI

profit margin is also known as

return on sales

how much shareholders get to keep of each asset is measured by

roa = net income over assets= net income/liabilties + Se roa tell use how much the sh make for the money 2 groups put up

how much you make for sh based off what they are putting up

roe

fixed asset turnover ratio is

sales/ FA ignores inventory in which you assume youll make money off of

asset turnover ratio is

sales/total assets for every $1 in assets, we generate ___ in sales "big picture ratio"

explain interest rates

set by marketplace paid to creditors supply of money + demand of money dont have control over*

ROE describes your return to who?

shareholders

net income belongs to

shareholders

what do asset management ratios tell us?

they tell us how efficient a company is with its assets to generate sales

if inventory turnover is 3.2 what does this mean?

this means company sold off or turned over inventory 3.2 times during the years also, 365/3.2= days sales in inventory

if the asset turnover ratio is .64 times, what does this mean?

this means that for $1 in total assets, we generated 64 cents in sales

when analyzing financial statements, it is important to take note of

time and situation makes a difference

a look at a company over time

time series analysis

why do we use financial ratios?

to avoid comparing financial statements of different sizes way of comparing and investigating the relationships between different pieces of financial information

why do we break up ROE

to figure out what is driving the numbers. Interest, operating expenses or taxes

why do companies buy assets?

to generate cash flows, to maximize shareholder wealth

also known as the big picture ratio

total asset turnover

which ratio is easier to hide leverage?

total debt ratio

what is the range of the lt solvency ratios

total debt= 0 to 1 debt to equity= 0 to infinity em= 1 to infinity

what is TTM

trail of twelve months

The higher the better times interest earned ratio...true or false?

true

everyone is happy with a high profitability margin

true

in finance, there are no good versus bad numbers (true or false)

true, they are all relative. if you see a high interest rate, then you're happy with one a little bit lower

one way to standardixe financial statements before analysis is to

use percentages instead of total dollars result: common size statements

money expresses

value

an increasing operating margin indicates

we are making more for shareholders because we are keeping more $ of what we sold

why do we depreciate assets?

we do it over useful life

from a constraint point of view, what do we think about debt?

we dont like debt

what aspects of the firm are we attempting to analyze?

we must know what a good ratio is versus a bad

what is the difference between shareholders and creditors?

we owe money to creditors no matter what because of promises (more risky/constraining because we always owe to them) Shareholders are paid only if we have Net Income to spare (no promises)

if assets =$100 and $10 goes to SH, what does this mean?

we pay back $90 to creditors

an ebit margin of 1 means what

we pay no operating expenses

why are we concerned with inventory turnover?

we want to turn (inventory) and collect ($)

what does the balance sheet tell us?

what assets we own and who puts up the money for the assets

accts look an item and ask financors look at an item and ask

what did we pay for it (cost) how much cf is it generating

finance is an example of ___ analysis

what if

what is equity

what sharehodler's own and what you owe them (no promises) defined as the difference between the assets and liabilities of a firm what stockholders would have remaining after firm discharged its obligations listed in the order would be paid over time

The current ratio is a good explanation of

what we owe relative to what we can convert to cash in a year

what is book value?

what we paid for an item-depreciation

cost benefit analysis?

what you put up for it (money) versus what you receive (degree)

when would we want our liquidity ratio to be higher?

when the economy is struggling because this means we can pay bills and suppliers and get other company's assets

inflation

when too much money is chasing too few goods, so prices go up

Short term solvency or liquidity ratios

1. Current ratio (CR) 2. Quick ratio (QR) 3. Cash ratio (Cash)

suppose a total debt ratio is equal to .3, what does this mean?

.3/1= TL/TA for every $1 in assets, we owe 30 cents to creditors and 70 to sh better than .9

ideally we want our debt equity ratio to be?

1 = ideal capital structure; company financed half and half. if higher, means more constraints because promises to creditors

if current ratio=1, Current liabilities=100 then current asstets equal

100

find the percentage change: yr 1: 2 yr 2: 2.5

2.5-2/2 = /5/2= + 25%

ratio analysis includes how many steps

5 steps

if pm is 3%, what does this mean?

97% of sales go towards expenses

percentage change formula

= (End - Beg)/Beg

suppose TIER for company A=100/10 , B=100/20, C=100/40, and D=100/100

A= 10 B=5 C=2.5 D=1 so we like A because for every $1 in interest expense owed, we have $10 to cover it A will have the easiest time paying creditors back D is bad because they have no margin for error and shareholders are unhappy

inventory turnover ratios is

COGS/ Inventory it tells us how quickly we turn inventory and collect on it asset management/utilization ratio higher/better

how does the current ratio convert to the cash ratio?

CR - Inv = QR = Cash + Rec the current ratio to quick ratio subtract inventory then get rid of everything but cash to get cash ratio

What is the current ratio?

CR = CA/CL 1. short term solvency or liquidity ratio 2. tells us how well we are able to pay back our current liabilities with our current assets. 3. found using info on the balance sheet 4. one of the best known and most often used ratios

What is a good number for CR?

CR should be at least one. If less than one than this means that networking capital is negative. Typically, a current ratio result of 2 to 3 is considered positive. If the ratio result is smaller than 2 to 3, it might be an indication that the organization will have trouble paying obligations in the future. However, a current ratio result that is too high might indicate that an organization is not using assets effectively to grow.

if the current ratio for a company is 1. what happens if you pay off a short term loan of $50?

Current ratio= CA/CL=1= 100/100 minus cash (-50) so new CA= 50 minus liabilities (-50) so new CL= 50 no change in ratio

if the current ratio of a company is 1. What happens if you buy $50 worth of inventory with cash?

Current ratio= CA/CL=1= 100/100 minus cash( -50) plus inventory (+50) no affect on ratio

if the current ratio of a company is 2. What happens if you buy $50 inventory with credit?

Current ratio= CA/CL=2= 200/100 plus inventory (+50) plus liabilities (+50) CR = 250/150 = 1.67

what is the cash coverage ratio

EBIT+ Depreciation/ interest depreciation is a non cash flow expense so this ratio is more realistic on saying how much $ we have to afford debt higher=better

times interest earned ratio is

EBIT/interest tells us how many times our operating income can cover interest expense measures how well a company has its interest obligations covered

what is equity multiplier?

EM = Assets/Equity 1. tells us for every $1 put up by shareholders, how much we have in assets

what is the equity multiplier?

EM= TA/TE for every $1 owed to Shareholders, we have ____ in assets like lower ratio= lower debt= less constraints adn less risk if is 2, means for every $1 from sh we have $2 in assets, so $1 is from creditors

enterprise value fomrula is

EVM= Enterprise Value/ EBITDA EBITDA= ebit + depreciation

we pay creditors from

Int on income statement

if a company's current ratio is 1 and quick ratio is 0 this means...

Inv = 100% of CA (Cash, Rec = 0%) the company can only pay for liabilities if they are able to sell inventory

asset management ratios are

Inventory turnover Receivables turnover Total asset turnovers Days sales in inventory Net Working Capital Turnover Fixed Asset Turnover

what are the two presentations of ROA? explain

ROA= NI + INT / Total Assets (2 groups putting money up) ROA= EBIT- Tax/ Assets (1 group- SH putting money up) EBIT- Tax= NI + INT

return to shareholders is known as

ROE

what is the price earnings ratio?

Price looks at future cash flows earnings looks at past cash flows it tells us what we think about the future relative to the past

waht does ROA describe and how do we know this?

ROA is NI/ Total Assets or NI / L + SE ROA tells us what we make for SH given what SH and creditors put up

ROE's third form is

ROA is broken up into two ROE= PM * TAT * EM

suppose the companies below has the following p/e ratios. what do they tell us? PE ratio A=2 B=10 C=25 D=30 E=245

The market likes E the most but it may not be the best to invest in (overvalued) a high pe for mgmt is great but for investors it may not be worth it

How should we read a current ratio of 1.31?

This means the company owns $1.31 in currents assets for every $1 in current liabilities or the company has current liabilities covered 1.31 times over

what is the times interest earned ratio

Times interest earned ratio= EBIT/Interest how many times over can i cover my interest and pay creditors for every $1 in interest owed, we earned $10 from operations tells us how much money we have to pay interest expense

ultimately, a higher profit margin means

more sales we are actually getting to keep means less expenses

describe the realtionship between the three long term solvency ratios

Total Debt ratio d to e ratio and em are just variations Em: d to e plus 1

what is the TAT?

Total asset turnover ration tells us how efficient we are with our assets. For every $1 in assets, we are generating __ in sales higher=better mgmt consultants use this because we see how well we take care of current customers (think walmart and asset efficiency)

explain the quick version of the ROE breakdown in one sentence:

We break up roe into 2 parts, find the secret and break up ROA, find the secret and break up profit margin

if GM is determined to be driven by a tax refund and leverage, and FDX is determined to be driven by higher EBIT and TaT, who do we like better?

We like FDX better because we want ROE numbers to be driven by TAT and EBIT margin

what is a sensitivity analysis?

What-if analysis statisitics "Is Em driving increase of ROE?"

how do you know if you are looking at a successful current ratio?

a creditor wants a high CR because there's a better chance they will be paid back a manager wants a high but not too high ratio because too high means not being very efficient with assets

why might a high PM be misleading?

a high PM may happen because of low interest rates and low taxes and not neccessarily from what mgmt has done

income statement explains financial information during

a particular time period such as a quarter or a year

what is a treasury security?

a security issued by the federal government

balance sheet is

a snapshot of a point in time

the balance sheet is

a snapshot picture of a point in time (but things can change)

a tax burden of 116.20 signals

a tax refund

if the balance sheet is like a snapshot, the income statement is like

a video recording

suppose price earnings ratio for the companies are found below. what does this tell us? PE ratio A: 10/1 B:10/10 C:10/100 D:10/1000

a=10 b=1 c=.1 d=.01 relative to the past, company a has the brightest future for every $1 earned last year, we expect 10 in future cash flows

long term ratios tell us

ability to meet long term obligations

suppose we have debt to equity Company A: 1 Company B: 3 Company c: 6 what do we like better as a manager? as a consultant?

as a manager we like 1 the most (evenly supported) a consultant might like B because like the use some debt but not too much debt

do we like debt?

as long as we can afford it, yes we like debt but not too much debt. leverage magnifies gains and magnifies losses (make more with more debt, and lose more with more debt)

what is the relationship between the balance sheet and the income statement?

as net income increases, owner's equity increases as net income decreases, owner's equity decreases

walmart's claim to fame

asset efficiency and logistics (very smart when use assets. get things in and get things out)

if the Quick ratio is equal to 1 and the current ratio is equal to 1, you are probably looking at what type of industry?

athletic training or service industry with no inventory (not a retailer)

what ratios are good for measuring good management?

ebit margin (ebit/sales) and tat (sales/assets) operational income and TAT are most importantw

why is the asset turnover ratio high?

because it measures efficiency but doesn't pick up expenses, so ROA is more accurate

why is our ultimate goal to maximize shareholder wealth?

because we believe this is how we will maximize utility and happiness different things make people so we maximize value and let them decide what to do with it

the higher the cash coverage ratio, the ___

better

what happens to firm value as borrowing increases?

borrowing increases so firm value increases

more liquidity is better when

economy is bad so we can purchase other company's assets

4 things we borrow for

education health care business home

can we have negative assets? negative liabilities? negative equity?

can have negative equity

what is cash flow?

cash flow os generated by the firm and paid to creditors and shareholders. it is classified as cash flow from operations, cash flow from changes in fixed assets cash flow from changes in working capital

best measure of liquidity is the

cash ratio

a very short term creditor may be interested in the ___ ratio

cash ratio because it tells me cash/liabilities for every $1 we owe, we know how much we own in assets($)

whats the difference between a stock market and casino

casino has to have winner and loser (wealth transfer) stok market can have all winners and all losers

what are retainined earnings?

come from net income. they are used to grow the company and are left over after we pay dividends (the higher, the better)

net working capital is

current assets-current liabilities when positive this means that the cash that will become available over the next 12 months will be greater than the cash that must be paid out

The _______ measures how many times you can cover your current liabilities.

current ratio

what is the debt to equity ratio?

d/e = TL/TE = total debt/ total equity 1. tells us that for every $1 shareholders have put up, how much we got from creditors 2. 1 = ideal capital structure; company financed half and half.

what is cheaper, debt or equity?

debt is cheaper than equity because BH takes less risk / creditors are paid first - less risky (lower return) and tax breaks (paid before the government) stockholders are last to be paid

creditors are paid an amount generally referred to as

debt service

we is debt cheaper than equity

debt we get a taxx break, less risky, paid first so lower return, government pays part of bill

what drives interest rates

demand for money and supply of money

certain transactions will affect liquidity ratios how?

depending on proportions and percentage change of the ratios

for leverage and liquidity ratios do we want high or low?

depends on who is asking

examples of non cash expenses are

depreciation and amoritization

how do you use sensitivity analysis?

determine if EM is driving the increase of ROE look at year 1 (2003) versus year 2 (2005) take 2005 (EM) plug into 2003 equation of ROE if ROE was driven by EM, the projected/calculated ROE will equal the ROE on the financial statement for 2005

what happens to net income>

dividends: given to shareholders retained earnings: grow the company internally

ebit is

earnings before interest and taxes. also known as operating income

net income is typically expressed how on the income statement?

earnings per share. which is net income/total shares outstanding

how can we hide ratios?

easiest to hide the tdr because it has a smaller range (0-1) so numbers typically look like they fit in (cant lend more than assets)

managers only have influence and control over

ebit (operational income)

the most important part of an income statement is

ebit + dep= EBITDA

do we want a higher or lower TIER ratio

higher=better

LT Solvency Ratios tell us

how much leverage we have? (TDR) and can we afford it? (TIER)

profit margin ratio tells us

how much we generate in net income for every dollar in sales how much are we keeping of sales "return on sales" see income statement for this info want higher

the balance sheet tells us what?

how much we have in assets and who puts up the money for it

how much and can we afford it is explained by

how much--TDR can we afford it --- TIER

ROE is

how profitable we are being for sh given what sh have put up return on equity NI/ equity for every $1 in equity, we keep ___ in NI

Liquidity

how quickly something can be converted to cash with minimal or no loss in value

what do long term leverage ratios tell us?

how we are getting money to buy assets

what is a dividend?

how we pass cash flows to shareholders

CR=1, QR=1, and Cash ratio=1 if given CL= 100 and 0 assets are from inventory and 0 are to receivables this means that

if given CL= 100: 0% of assets are from inventory, 0% are from receivables, 100% of assets from cash

relationship between balance sheet and income statement

if net income is positive, equity increases if net income is negative, equity decreases

how is net working capital and cash flow different?

if you buy inventory with cash--> net working capital DOES NOT change but Cash flows do because they decrease

finance likes to explain the world how?

in percentage change because percentage/average alone can be misleading

when can you fool the market?

in the short run but no the long run

the __ measures performance over a specific period (say a year)

income statement

to determine if a company is profitable, where do we look?

income statement

as retained earnings .and equity increase, we can expect stock prices to

increase

if you can cut expenses, you can

increase EBIT, EBT and Net Income

what do we pay good managers for?

increased profitability from lowered operating expenses controlling ratios: TAT and PM

as the TDR increases, leverage...

increases

what is the problem of borrowing too much?

increases the chance of bankruptcy

asst mangements ratios tell us

intensity and efficiency of assets

an important cash outflow to creditors is

interest expense

if the times earned ratio is 10 this means that

interest is covered 10 times over for ever $1 owed in interest expense, we have $10 to cover it

why do we evaluate financial ratios?

internal use: self reflections and projections external use: trick is to sell and collect

two important current assets used in asset mgmt ratios are

inventory and accounts receivables

what is the law of large #s

more observations you take, the closer you get to the true mean(average)

why is the cash coverage ratio important?

it adds back depreciation (depreciation is a non cash flow expense) because you pay interest on not just ebit but depreciation also

why do we like debt?

it is cheaper than equity someone else's money magnifies gains and losses

is a TDR of 0 good or bad?

it is good. It means that for every $1 we own in assets, $0 came from creditors. so that means we only owe shareholders which we have made no promises too.

what is the problem with Profit margin

it is net income/ sales includes taxes set by government includes interest set by marketplace management has no control over therese

what does it mean to have an equity multiplier of 2?

it tells us that for every $1 we have from shareholders, we have $2 in assets. This means we have $1 from creditors. company is financed 50/50

good versus bad ratio example

its all about relativity and perspective gas prices may be high to those who have seen the low and vice versa

analysts ust use ___ for interpreting for results

judgment look for trends and relationships

why do we like a lower TDR?

less promises=less constraints and less owed to creditors

____is a measure of risk

leverage

example explaining there is no secret to leverage

leverage is clear. more risk = more return gas pedal example. speed=risk and return increased speed, much longer for vehicles to stop, more car deaths

explain how their is no secret to leverage

leverage results are expected more rsk= higher return

there are no secrets to

leverage/borrowing but there are secrets to being profitable higher pm if less expenses relative to sales, there is a secret to less expenses

how does liability constrain a company?

liabiility is something we have to pay back to creditors (we made a promise whether we have the income of not)

name something liquid versus something not very liquid

liquid: cash not liquid: real estate

every company has underlying value called the

liquidation value

the more stock that is in the marketplace for a company, prices do what?

lower prices

what ratios tell us how uch debt adn if we can afford it

lt solvency/leverage ratios

what do we refer to when we genrally speak of the value of an asset or the value of the firm

market value

tobins q=

market value of assets/replacement value of assets

price is the ____ of the firm

market value: price at which willing buyers and sellers would trade the assets

who decides the company's value?

marketplace

what is the price per share of stock

markeys average worth

our ultimate goal is to

maximize shareholder wealth

Our REAL goal is to

maximize utility and happiness

why might consultatnts like a higher debt to equity ratio?

means they have more leverage which could lead to more return

what is the problem with the times interest earned ratio

measure is based on EBIT which is not really a measure of cash available to pay interest

suppose the CR is 15, who is happy?

mgrs arent so happy because means inefficient with cahs, inventory and recievables (assets) but creditors want to see high CR

what is the optimal capital structure?

mix of debt and equity that maximizes firm value

a higher equity multiplier means

more debt and more constraints and higher risk

the higher the profit margin, the

more for sh= dividends or re (cash)

why is it easier to price a new car than a used car?

new cars are more homogenous used cars hace dents and scratches in finance there is no theory so we have to look at trends and relationships

do cash flows appear on an income statement?

no depreciation is a noncash item that is an expense against revenue but does not affect cash flow

some problems with financial statements are

no finance theory finding comparable sized firms one time events seasonal variations

can we have negative assets?

no we cannot cannot have negative liability either CAN have negative equity

does total debt = total liabilities?

no, but we should assume so TD= long term debt TL= long term and short term debt (everything you owe)

do we make a decision off of one observation?

no, one observation (number) doesn't say a whole lot by a few observations (numbers) do

what does a low M to Book ratio indicate?

not using enough money to make a profit (less than 1) someone can come in, buy the assets and liquidate the company

what are current liabilities?

obligations paid within the next year

why do we analyze financial statements>

of interest to shareholders, creditors, and firms own management

what do we have control over as managers?

operating expenses secrets to lowering this

ebit margin is sometimes called the

operating margin

economic profit considers

opportunity cost

highest firm value is

optimal capital structure

short term solvency ratios tell us

our ability to pay bills in short run

problem with ratio analysis

overanalysis because dont know where to start

look at a company compared to its competitors

peer evaluation

choosing a benchmark can be done in two ways

peer evaluation: compeittion comparison. use similiar firm and or industry averages. ratios are analyzed by reference to indsutry standards time series analysis: using histroy to see what trends are developing

how do we calculate percentage change?

percentage change = (end-beg)/beginning (order of numbers makes a difference)

what are two ways to analyze ROE?

percentage change through the years (Remember FD from 03-05 ebit margin increase caused roe increased) sensitivity analysis

what is sensitivity analysis?

plug in different numbers to see the relationship

the relationship between risk and return is

positive

how do we calculate the price of a financial asset:

present value of expected future cash flows

market value is also known as the

price

market value=

price

where does information for the price earnings ratio come from>

price from stocks and shares in the marketplace earnings from accts

what is the price sales ratio?

price per share/sales per share doesnt include expenses used because some companies dont have numbers for past earnijngs

market to book ratio tells us what?

price/bv or market value/book value

how much shareholders get to keep of sales is measured by

profit margin

what ratio tells us the % of sales we get to keep

profit margin if pm is 10%, means 10% of sales we get to keep all else equal, the high pm, roe, and roa wanted because SH and investors are both happy

any return is calculated as

profit/initial investment

best known and most widely used ratios

profitability ratios

For our liquidity ratios, we expect Net income to increase and debt to decrease, but what actually happens?

proportions affect the ratio.**

Business is

qualitative and quantitative

risk management, why?

reduces uncertainty less risk= lower return

what is the difference between shareholders and creditors?

shareholders are potential investors that get money last (net income) - no promises Creditors are those who extend/loan credit to us and receive money first (interest) - promises

also known as money put up also known as money borrowed

shareholders equity liabilities

stocks are riskier. why?

shareholders get paid last

what is the the difference between short term and long term debt?

short term debt means we just dont have the cash flows to line up for the obligation/we haven't paid the bill yet; long term debt means we can't afford it

why do we want to be liquid>

so we can pay bills buy assets at discounts cash does nothing for us (just sits there)

3 reasons we like debt

someones else money cheaper than equity magnifies gains/losses

st versus lt loan existence

st because we dont have the cash flows that line up right now, cash doesnt exist yet, or havent gotten around to pay lt because we dont have the money

how do we determine the price of a financial asset?

stock, bonds, mortgage, savings acct. where we buy cash flows

why are stocks riskier than bonds?

stockholders are last to be paid debt is cheaper than equity because BH take less risk

whats riskier? stock or bonds? why?

stocks are riskier than bonds so Shareholders expect higher return volatility in the market (increased market risk)

returns on average are higher with ___

stocks than treasury and securities (bonds)

one of the largest cash outflows a firm experiences is

taxes

4 reasons we borrow

taxes, home, business, education

what are the books used for?

taxes, ow the business is, to sell the business

the most important item that can be extracted from financial statements is

the actual cash flow of the firm

if the current ratio is 2.2, what does this mean?

the company has an efficient amount of assets in the short run to pay current liabilities without going to outside financing

a current ratio of 20 would mean?

the company is not very efficient with assets

how is the quick ratio similar to the current ratio?

the current ratio becomes the quick ratio when inventory is subtracted so we have a better idea of meeting interest obligations (inventory isn't promised to convert to cash)

earnings are what?

the market tells us about our company

capital structure is defined as

the mix of debt and equity

on a per share basis, what stock is the most value=able?

the one with the highest price

what is price

the present value of expected future cash flows + sell $

enterprise value

the price of the whole company the value of the company (market value) what the company is worth in book value is not the same as the marketplace value

problems with ratios:

there are so many numbers we dont know whwre to start have to know what numbers are actualyl telling us window dressins is used to make financial statement look better there are different accounting methods

what is the finance theory?

there is no fiannce theory

what is the problem with financial statements?

there is no fiannce theory and numbers are always changing

what is the problem with ratios?

there is so much info, we don't know where to start - what are the numbers actually saying?

why do we like someone who has been in business for 20 years?

they have made it through the good and bad years (through high and low interest rates)

is it possible to have more than 100% debt. explain

yes it is assets depreciate faster than you can pay the debt off if net income keeps dropping then equity decreases expenses that cant be paid will be added to liabilities

an interest burden of 1 means

you pay no interest

a tax burden of 1 means

you pay no taxes