Chapter 3 - Financial Statements and Ratio Analysis

Liquidity

A firm's ability to satisfy its short-term obligations as they come due.

Current Ratio

A measure of liquidity calculated by dividing the firm's current assets by its current liabilities.

Quick (Acid-Test) Ratio

A measure of liquidity calculated by dividing the firm's current assets minus inventory by its current liabilities.

Public Company Accounting Oversight Board (PCAOB)

A not-for-profit corporation established by the Sarbanes-Oxley Act of 2002 to protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports.

Benchmarking

A type of cross-sectional analysis in which the firm's ratio values are compared to those of a key competitor or group of competitors that it wishes to emulate.

Common-Size Income Statement

An income statement in which each item is expressed as a percentage of sales.

Stockholders' Report

Annual report that publicly owned corporations must provide to stockholders; it summarizes and documents the firm's financial activities during the past year.

Average Age of Inventory

Average number of days' sales in inventory.

Cross-Sectional Analysis

Comparison of different firms' financial ratios at the same point in time; involves comparing the firm's ratios to those of other firms in its industry or to industry averages.

Long-Term Debt

Debt for which payment is not due in the current year.

Time-Series Analysis

Evaluation of the firm's financial performance over time using financial ratio analysis.

Notes to the Financial Statements

Explanatory notes keyed to relevant accounts in the statements' they provide detailed information on the accounting policies, procedures, calculations, and transactions underlying entries in the financial statements.

Total Asset Turnover

Indicates the efficiency with which the firm uses its assets to generate sales.

Ratio Analysis

Involves methods of calculating and interpreting financial ratios to analyze and monitor the firm's performance.

Financial Accounting Standards Board (FASB) Standard No. 52

Mandates that U.S. - based companies translate their foreign-currency-denominated assets and liabilities into dollars, for consolidation with the parent company's financial statements. This is done by using the current rate (translation) method.

Activity Ratios

Measure the speed with which various accounts are converted into sales or cash - inflows or outflows.

Inventory Turnover

Measures the activity, or liquidity, of a firm's inventory.

Degree of Indebtedness

Measures the amount of debt relative to other significant balance sheet amounts.

Price/Earnings (P/E) Ratio

Measures the amount that investors are willing to pay for each dollar of a firm's earnings; the higher the _____ the greater the investor confidence.

Times Interest Earned Ratio

Measures the firm's ability to make contractual interest payments; sometimes called the interest coverage ratio.

Fixed-Payment Coverage Ratio

Measures the firm's ability to meet all fixed-payment obligations.

Return on Total Assets (ROA)

Measures the overall effectiveness of management in generating profits with its available assets; also called the return on investment (ROI).

Operating Profit Margin

Measures the percentage of each sales dollar remaining after all costs and expenses other than interest, taxes, and preferred stock dividends are deducted; the "pure profits" earned on each sales dollar.

Net Profit Margin

Measures the percentage of each sales dollar remaining after all costs and expenses, including interest, taxes, and preferred stock dividends, have been deducted.

Gross Profit Margin

Measures the percentage of each sales dollar remaining after the firm ahs paid for its goods.

Debt Ratio

Measures the proportion of total assets financed by the firm's creditors.

Return on Common Equity (ROE)

Measures the return earned on the common stockholders' investment in the firm.

DuPont Formula

Multiples the firm's net profit margin by its total asset turnover to calculate the firm's return on total assets (ROA).

Income Statement

Provides a financial summary of the firm's operating results during a specified period.

Statement of Cash Flows

Provides a summary of the firm's operating, investment, and financing cash flows and reconciles them with changes in its cash and marketable securities during the period.

Market/Book (M/B) Ratio

Provides an assessment of how investors view the firm's performance. Firms expected to earn high returns relative to their risk typically sell at higher multiples.

Coverage Ratios

Ratios that measure the firm's ability to pay certain fixed charges.

Statement of Retained Earnings

Reconciles the net income earned during a given year, and any cash dividends paid, with the change in retained earnings between the start and the end of that year. An abbreviated form of the statement of stockholders' equity.

Market Ratios

Relate a firm's market value, as measured by its current share price, to certain accounting values.

Modified DuPont Formula

Relates the firm's return on total assets (ROA) to tis return on common equity (ROE) using the financial leverage multiplier (FLM).

Current Assets

Short-term assets, expected to be converted into cash within one year or less.

Current Liabilities

Short-term liabilities, expected to be paid within one year or less.

Statement of Stockholders' Equity

Shows all equity account transactions that occurred during a given year.

Balance Sheet

Summary statement of the firm's financial position at a given point in time.

DuPont System of Analysis

System used to dissect the firm's financial statements and to assess its financial condition.

Current Rate (translation) Method

Technique used by the U.S. - based companies to translate their foreign-currency-denominated assets and liabilities into dollars, for consolidation with the parent company's financial statements, using the year-end (current) exchange rate.

Ability to Service Debts

The ability of a firm to make the payments required on a scheduled basis over the life of a debt.

Financial Accounting Standards Board (FASB)

The accounting profession's rule-setting body, which authorizes generally accepted accounting principles (GAAP).

Paid-In Capital in Excess of Par

The amount of proceeds in excess of the par value received the original sale of common stock.

Average Collection Period

The average amount of time needed to collect accounts receivable.

Average Payment Period

The average amount of time needed to pay accounts payable.

Retained Earnings

The cumulative total of all earnings, net of dividends, that have been retained and reinvested in the firm since its inception.

Dividend Per Share (DPS)

The dollar amount of cash distributed during the period on behalf of each outstanding share of common stock.

Financial Leverage

The magnification of risk and return through the use of fixed-cost financing, such as debt and preferred stock.

Generally Accepted Accounting Principles (GAAP)

The practice and procedure guidelines used to prepare and maintain financial records and reports; authorized by the Financial Accounting Standards Board (FASB).

Financial Leverage Multiplier (FLM)

The ratio of the firm's total assets to its common stock equity.

Letter to Stockholders

Typically, the first element of the annual stockholders' report and the primary communication from management.