Chapter 13: Financial Statement Analysis

earnings per share (EPS)

Amount of a company's net income earned for each share of its outstanding common stock.

efficient capital market

A capital market in which market prices fully reflect all information available to the public.

common-size statement

A financial statement that reports only percentages (no dollar amounts).

trend percentage

A form of horizontal analysis that indicates the direction a business is taking.

weighted-average cost of capital

A weighted average of the return demanded by the company's stockholders and lenders. Often referred to as the weighted-average cos of capital (WACC).

book value per share of common stock

Common stockholders' equity divided by the number of shares of common stock outstanding. The recorded amount of each share of common stock outstanding.

current ratio

Current assets divided by current liabilities. Measures a company's ability to pay current liabilities with current assets.

working capital

Current assets minus current liabilities; measures a business's ability to meet its short-term obligations with its current assets. Also called net working capital.

capital charge

The amount the stockholders and lenders charge a company for use of their money. Calculated as (Notes payable + Loans payable + Long-term debt + Stockholders' equity) x Cost of capital.

benchmarking

The comparison of a company to a standard set by other companies, with a view toward improvement.

vertical analysis

Analysis of a financial statement that reveals the relationship of each statement item to a specified base, which is the 100% figure.

trading on the equity

Another name for leverage.

quick (acid-test) ratio

Another name for the acid-test ratio.

DuPont Anaysis

Detailed method of analyzing rate of return on common stockholders' equity. Rate of return on sales x Asset turnover x Leverage = Return on average common stockholders' equity.

accounts receivable turnover

Measures a company's ability to collect cash from credit customers. To compute accounts receivable turnover, divide net credit sales by average net accounts receivable.

accounts payable turnover

Measures the number of times per year a company pays off its accounts payable. Assuming all purchases are on credit, to compute accounts payable turnover, divide purchases (cost of goods sold + ending inventory) by average accounts payable. When inventories are immaterial, or when there is very little difference between beginning and ending inventories, substitute cost of good of sold for purchases.

rate of return on assets

Net income - preferred dividends/ average total assets. This ratio measures a company's success in using its assets to earn income for the person who finance the business. Also called return on total assets. Can be computed using the first two elements of DuPont Analysis (Rate of return on net sales x Asset turnover).

rate of return on common stakeholder's equity

Net income minus preferred dividends, divided by average common stockholder's equity. A measure of profitability. Also called return on equity. Also can be computed with DuPont Analysis.

day's sales in receivables

Ratio of average net accounts receivables to one day's sales. Indicates how many day's sales remain in Accounts Receivables awaiting collection. Also called collection period and day's sales outstanding.

leverage ratio

Ratio of average total assets to average common stakeholder's equity. Measures the number of dollars of assets provided by each dollar of invested capital.

inventory turnover

Ratio of cost of goods sold to average inventory. Indicates how rapidly inventory is sold.

dividend yield

Ratio of dividends per share of stock to the stock's market price per share. Tells the percentage of a stock's market value that the company returns to stockholders as dividends.

times-interest-earned ratio

Ratio of income from operations to interest expense. Measures the number of times that operating income can cover interest expense. Also called the interest-covering ratio.

price-earning ratio

Ratio of the market price of a share of common stock to the company's earnings per share. Measures the value that the stock market places on $1 of a company's earnings.

acid-test ratio

Ratio of the sum of cash plus short-term investments plus net current receivables to total current liabilities. Tells whether the entity can pay all its current liabilities if they come due immediately. Also called quick ratio.

debt ratio

Ratio of total liabilities to total assets. States the proportion of a company's assets that is financed with debt.

rate of return on net sales

Ratio on net income - preferred dividends to net sales. A measure of profitability. Also called return on sales.

horizontal anaysis

Study of percentage changes in line items on comparative financial statements.

asset turnover

The dollars of sales generated per dollar of assets invested. Formula is Net sales / Average total assets.

cash conversion cycle

The number of days it takes to convert inventory to receivables, and receivables into cash, after paying off payables. The formula is Days' inventory outstanding + Days' sales outstanding - Days' payables outstanding.

economic value added (EVA)

Used to evaluate a company's operating performance. EVA combines the concepts of accounting income and corporate finance to measure whether the company's operations have increased stockholders' wealth. EVA = Net income before taxes + Interest expense - Capital charge.