Analysis of Financial Statements

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• Chapter 4
• Analysis of Financial Statements

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Ratio Analysis Notes

• When analyzing a firm, we compare financial _____
  rather than dollar figures to diminish the
  effects of differences in _____ (i.e., scale
  effects).
• Industry averages are arithmetic _____, rather
  than means, to remove the distorting effects of
  _____ values.

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Liquidity Ratios(MicroDrive p.124)

• Liquidity ratios measure the ability of to pay
  _____.
• What is the current ratio for our firm?
• If the industry norm is 4.2, this is a(n) _____
  comparison.

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• What is the quick ratio for our firm?
• If the industry norm is 2.1, this is a(n) _____
  comparison.
• While the current ratio assumes that _____ will
  be converted into cash within a year, the quick
  ratio assumes that _____ are illiquid.

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Asset Management Ratios

• Asset management ratios measure how efficiently
  management is using its _____. These ratios are
  also known as _____ or _____ ratios.
• What is the inventory turnover ratio?
• If the industry norm is 9.0, this is a(n) _____
  comparison.

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• What is the fixed assets turnover ratio for our
  firm?
• If the industry norm is 3.0, this is a(n) _____
  comparison.
• Caution If the fixed assets are older than
  average, this will cause the FA Turnover ratio to
  be artificially _____.

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• What is the total assets turnover ratio for our
  firm?
• If the industry norm is 1.8, this is a(n) _____
  comparison.
• Caution If current assets are excessive, this
  will cause the TA Turn ratio to be artificially
  _____.

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• What is the days sales outstanding (DSO) for our
  firm? (also known as the _____)
• If the industry norm is 36 days, this is a(n)
  _____ comparison.
• Caution If a company has excess inventories, it
  might be influenced to offer more _____ credit
  terms.

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Debt Management Ratios

• Debt management ratios measure the companys use
  of _____ (i.e., nonequity) financing. (also known
  as _____ ratios)
• What is the debt ratio for our firm?
• If the industry norm is 40, this is a(n) _____
  comparison.

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• What is the times interest earned (TIE) ratio for
  our firm?
• If the industry norm is 6.0, this is a(n) _____
  comparison.
• Note that the debt ratio focus is on the _____ of
  debt, while the TIE focus is on _____.

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• What is the EBITDA coverage ratio for our firm?

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• If the industry norm is 4.3, this is a(n) _____
  comparison.
• Like the TIE ratio, the EBITDA coverage ratio
  measures _____, but the EBITDA coverage ratio
  assumes that _____ categories of fixed payments
  must be met (not just interest expense)
• The EBITDA coverage ratio also assumes that
  payments are made out of _____, rather than book
  profit.

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Profitability Ratios

• Profitability ratios measure the _____ of
  management. (also known as the proverbial
  _____)
• The profit margin measures profit per _____, and
  is
• If the industry norm is 5.0, this is a(n) _____
  comparison.

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• The basic earning power ratio focus is on profit
  before _____, and is
• If the industry norm is 17.2, this is a(n) _____
  comparison.
• Note EBIT is also known as _____.

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• What is the return on total assets ratio (ROA)
  for our firm?
• If the industry norm is 9.0, this is a(n) _____
  comparison.

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• What is the return on equity ratio (ROE) for our
  firm?
• If the industry norm is 15.0, this is a(n) _____
  comparison?

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Market Value Ratios

• Market value ratios measure the markets
  perception of the _____ of the firm.
• What is the price earnings ratio (P/E) for our
  firm?
• If the industry norm is 12.5, this is a(n) _____
  comparison.

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• Caution If a firms profitability is low, it
  will cause the P/E ratio to be artificially _____.

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• What is the price to cash flow ratio (P/CF) for
  our firm?
• If the industry norm is 6.8, this is a(n) _____
  comparison.
• Caution If a firm is undergoing rapid expansion,
  its high depreciation charges will cause the P/CF
  ratio to be artificially _____.

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• What is the market to book ratio (M/B) for our
  firm?
• If the industry norm is 1.7, this is a(n) _____
  comparison.
• Note Of the three market value ratios, the M/B
  is _____ subject to distortion.

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Methods of Comparisons

• Comparing a firms ratios to its industry
  averages is called _____ analysis or
  _____.
• Observing how a firms ratios change over time is
  called _____ analysis or _____ analysis.
• A third approach is comparison to _____ of
  comparable size in the same industry.

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Du Pont Analysis

• The Du Pont analysis refers to two formulas that
  show how selected ratios are linked to _____.
• What are its components?

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• What are the Du Pont values for our firm?
• The analysis indicates that _____ is our firms
  greatest weakness, followed by _____.

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A broader example of how ratios are
inter-connected

• What would be our revised balance sheet if we
  reduce DSO to 36 days, and use the additional
  cash to reduce short-term debt?

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• The excess cash was used to reduce debt. It also
  could have been used to
• - _____ dividends
• - _____ stock
• - _____ business (future profit)
• Note Inventories also too high. If inventories
  are reduced, cash balances will _____. (Same
  effect as reducing receivables.)

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Limitations of Ratio Analysis

• Ratio comparisons are less valid if your firm or
  the industry average firm operate in
  _____ .
• The industry average may not be a(n) _____
  goal.
• Balance sheet values are based on _____ costs and
  may not reflect _____ values.

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• Ratio comparisons may be less valid if your
  companys fiscal year and the fiscal year for the
  industry average firm are _____.
• Management has considerable latitude in its
  ability to manipulate reported profits in the
  _____.

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• Ratio comparisons in seasonal industries may be
  more distorted by the fact that the firms tend to
  close their books during the _____ active part of
  the season, when working capital items are
  typically _____.

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• Variations in how the cost of items sold are
  recognized may further distort ratio comparisons.
  
• In an inflationary environment, companies that
  use FIFO (rather than LIFO) will report a _____
  cost of goods sold and a _____ reported profit.

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• There is typically a trade-off between ____ and
  _____. While a high current ratio reflects
  greater liquidity, it also tends to result in
  _____ profitability.
• Profitability ratios are measures of _____
  profit, and do not reflect the effect on
  shareholder _____. A firms profits could be
  above average, and the stock price still fall if
  the reported profits are _____ than the market
  was expecting.

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Independent Reading

• What is the difference between the IASB and the
  FASB? (p. 131)
• What are a common-size balance sheet and a
  common-size income statement? (p. 137-139)
• Is a company in a safer if (p.144-145)
• - the bulk of its revenues are tied to one
  customer or many customers?
• - it has a larger of its business generated
  overseas or domestically?