Week 1 - Chapter 14

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Return on common stockholders' equity

(net income - preferred dividends) / average common stockholders' equity

Financial statements

4 types - Balance sheet, income statement, statement of cash flow, and statement of stockholder's equity. A complete set also includes the notes

Market Share

A company's percentage share of the total dollar sales within its industry

Management's Discussion and Analysis

A discussion by management of the company's performance during the current year and its financial position at year-end. These discussions are included in the annual reports of publicly owned companies.

Ratio

A mathematical expression of the relationship of one item to another. Ratios are particularly important in understanding financial statements because they permit us to compare information from one financial statement with information from another financial statement. For example, we might compare net income (taken from the income statement) with total assets (taken from the balance sheet) to see how effectively management is using available resources to earn a profit.

Current ratio

A widely used measure of short-term debt-paying ability is the current ratio. This ratio is computed by dividing total current assets by total current liabilities. The higher the current ratio, the more liquid the company appears to be

accounts payable

Amount a company owes to vendors or supplies for goods and services you've already received

multiple-step income statement

An income statement that includes subtotals of profitability at intermediate steps is a multi-step income statement. The cost of goods sold is deducted from net sales to determine the subtotal gross profit. 2. Operating expenses are deducted to obtain a subtotal called operating income (or income from operations). 3. Income tax expense and other nonoperating items are taken into consideration to arrive at net income.

accouting equation

Assets = Liabilities + Owner's Equity

Balance sheet

Assets=Liability + Stockholder's Equity. Assets are cash, inventory, and equipment

Analysis by long-term creditors

Bondholders and other long-term creditors are interested in 3 factors: rate of return on their investment, the firm's ability to meet it's interest requirements, and the firm's ability to repay the principal of the debt when it falls due

Interest coverage ratio

Bondholders consider their investments to be safe if the company earns enough to cover their annual interest expense by a comfortable margin. Operating income before interest and tax/annual interest expense

Operating Income

Common examples include interest earned on investments and income tax expense. Operating income (or income from operations) shows the relationship between revenue earned from customers and expenses most directly related to producing this revenue. In effect, operating income measures the profitability of a company's basic or core business operations and leaves out other types of revenue and expenses. Revenue-COGS-operating expenses

Component Percentages

Component percentages indicate the relative size of each item included in a total. For example, each item in a balance sheet could be expressed as a percentage of total assets.

Current Ratio

Current assets to current liabilities. Current assets/current liabilities= number:1 or just number

Current Liabilities

Current liabilities are existing obligations that are expected to be paid by using the enterprise's current assets. Common examples include: Accounts payable. Notes payable (due within one year). Unearned revenue. Accrued expenses such as: Income taxes payable. Salaries payable. Interest payable

Dividend yield

Dividends per share/by market price per share determine the yield rate of a company's stock. Dividend yield is especially important to those investors whose objective is to maximize the dividend revenue from their investments.

Gross profit rate or profit margin

Dollar amount of gross profit/net sales

Measures of Profitability

Drawn from the income statement. Percent change in key measurements, gross profit rates, operating income, net income as a percentage of sales, earnings per share, return on assets, and return on equity

Fundamental analysis

Evaluating stock price by looking at the underlying profitability of the company

Classified Financial Statements

Financial statements in which similar items are arranged in groups and subtotals are shown to assist users in analyzing the statements. Most business organizations use these. An example is a balance sheet that separates assets and liabilities into current and non-current categories

Comparative Financial Statements

Financial statements of a company for two or more years presented in a side-by-side format to facilitate comparison

Consolidated Financial Statements

Financial statements that show the combined activities of a parent company and its subsidiaries.

Operating income/profit

Gross profit-operating expenses

Gross profit rate

Gross profit/net sales

Debt ratio

If a business fails and must be liquidated, the claims of creditors take priority over those of the owners. A measure of a creditor's long-term risk. A basic measure of the safety of creditors' claims is the debt ratio, which states total liabilities as a percentage of total assets. A company's debt ratio is computed by dividing total liabilities by total assets. High debt ratio indicates an extensive use of leverage.

Classified Balance Sheet

In a classified balance sheet, assets are usually presented in three groups: Current assets, Plant and equipment, other assets. Liabilities are classified into two categories: Current liabilities, Long-term (noncurrent) liabilities

Standards of Comparison

In using dollar and percentage changes, trend percentages, component percentages, and ratios, financial analysts constantly search for some standard of comparison against which to judge whether the relationships they have determined are favorable or unfavorable. • Two commonly used standards are: 1. The past performance of the company being analyzed. 2. The performance of other companies in the same industry. For internal management purposes, another important comparison is with expected or budgeted numbers.

Return on investment

Include: Return on assets and return on equity

Measures of Profitability

Key measures of profitability include: • Gross profit rates. Operating income. Net income as a percentage of sales. Earnings per share. Return on assets (ROA). Return on equity (ROE).

Net income

Many equity investors consider net income (or net loss) to be the most important figure in a company's financial statements. Financial analysts often compute net income as a percentage of net sales (net income divided by net sales).

Accounts receivable

Money coming in to a company for goods and services already rendered

Operating Cycle

Most companies have several operating cycles within a year. This means that they do the following multiple times throughout the year: Use cash to purchase inventory. Sell the inventory. Collect the receivable in cash. Some companies have relatively long operating cycles such as ship or airplane construction.

Gross profit

Net Sales - COGS

Earnings per share

Net income/number of shares of common stock or shares of capital stock outstanding

Operating expense ratio

Operating expense/net sales Management generally has greater control over operating expenses than over revenue. The operating expense ratio is often used as a measure of management's ability to control its operating expenses

horizontal analysis

Past performance of a company. Horizontal analysis demonstrates the changes over a number of consecutive periods.

Vertical or static analysis

Past performance of a company. Vertical analysis covers a single accounting period by computing each amount as a component percentage of a given base.

Non current assets

Property, plant and equipment

Annual report

Publicly owned corporations issue annual reports that provide a great deal of information about the company. Annual reports include the following. Comparative audited financial statements. 5- to 10-year summaries of key financial data. Management's discussion and analysis (MD&A) of the company's operating results, liquidity, and financial position.

Return on Assets (ROA)

ROA is used in evaluating whether management has earned a reasonable return with the assets under its control. In this computation, return usually is defined as operating income. Operating income/average total assets

Working Capital

Relationship between current assets and current liabilities. Important for assessing how liquid a company is, which a short term investor would care about. The excess of current assets over current liabilities, or current assets - current liabilities.

Return on Investment (ROI)

Return/average amount invested. A common method of evaluating the efficiency with which financial resources are employed is to compute the rate of return earned on these resources.

accounts recievable turnover rate

The accounts receivable turnover rate is determined by dividing net sales by the average balance of accounts receivable. The number of days required (on average) to collect accounts receivable then may be determined by dividing the number of days in a year (365) by the turnover rate.

Trend Percentages

The changes in financial statement items from a base year to the following years are sometimes expressed as trend percentages to show the extent and direction of change. 1. First, a base year is selected and each item in the financial statements for the base year is given a weight of 100 percent. 2. The second step is to express each item in the financial statements for the following years as a percentage of its base-year amount. This computation consists of dividing an item such as sales in the years after the base year by the amount of sales in the base year Current year/Base year

Dollar Change

The dollar amount of any change is the difference between the amount for a comparison year and the amount for a base year.

Inventory turnover rate

The inventory turnover rate indicates how many times during the year the company is able to sell a quantity of goods equal to its average inventory. This rate is determined by dividing the cost of goods sold for the year by the average amount of inventory on hand during the year. The number of days required to sell this amount of inventory may be determined by dividing 365 days by the turnover rate.

Percent Change

The percentage change is computed by dividing the amount of the dollar change between years by the amount for the previous year. if a negative amount or 0 appears in the base year, the percent change cannot be computed

Operating cycle

The period of time required for a merchandising company to convert its inventory into cash

Quick ratio or acid-test ratio

The quick ratio compares only the most liquid current assets— called quick assets—with current liabilities. Quick assets include cash, marketable securities, and receivables—the current assets that can be converted most quickly into cash. Helpful when evaluating the liquidity of companies that have inventories of slow-moving merchandise like real estate. Quick assets/current liabilities

Return on Equity (ROE)

The return on equity ratio looks only at the return earned by management on the stockholders' investment—that is, on owners' equity. Net income/average total stockholder's equity

Leverage

Using borrowed money to earn a return greater than the cost of borrowing, increasing the net income and the return on common stockholders' equity

Current assets

cash and other assets expected to be exchanged for cash or consumed within a year or the operating cycle (whichever is longer) without interfering with the normal business operations. Listed in order of liquidity on the balance sheet Cash. Marketable securities. Receivables. Inventories. Prepaid expenses

Price Earnings Ratio

dividing the current market price per share of the company's stock by annual earnings per share (cannot be computed for a company with a net loss.)

Non operating items

interest expense and tax income expense

Window dressing

measures taken by management specifically intended to make a business look as strong as possible at the financial statement date

Liquidity

refers to a company's ability to meet its continuing obligations as they come due.

Financial Statement Analysis

taking key items from these financial statements and gleaning as much useful information as possible from them


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