quick ratio (acid test ratio)
more conservative measure of liquidity because it excludes inventories and less liquid current assets from the numerator
(cash + marketable securities + receivables) / current liabilities
is the most conservative measure of liquidity.
(cash+ marketable securities)/current liabilities
long-term debt-to-equity ratio
measures long-term financing sources relative to the equity base
total long-term debt long-term debt-to-equity = .
financial leverage ratio
variation of the debt-to-equity ratio that is used as a component of the DuPont model.
Total assets/ total equity
Gross profit margin
gross profit/ revenue
Net profit margin
net income/ revenue
pre-tax earnings / revenue
This category includes several ratios also referred to asset utilization or turnover ratios (e.g., inventory turnover, receivables turnover, and total assets turnover). They often give indications of how well a firm utilizes various assets such as inventory and fixed assets.
Sales per share, earnings per share, and price to cash flow per share are examples of ratios used in comparing the relative valuation of companies.
what do you do if you have a ratio dealing with both IS and BS?
find the average of the BS account rather than using the end-of-the-year balance
annual sales/ average receivables
average collection period, or days of sales outstanding
average number of days it takes for the company's customers to pay their bills
365/ receivables turnover
what might a collection period that is too high or too low mean?
too high means that customers are too slow in paying their bills, which means too much capital is tied up in assets; A collection period that is too low might indicate that the firm's credit policy is too rigorous, which might be hampering sales.
cost of goods sold/ average inventory
days of inventory on hand
365/ inventory turnover
too high- too much capital is tied up in inventory and could mean that inventory is obsolete
too low- firm has inadequate stock on hand, which could hurt sales
payables turnover ratio
measure of the use of trade credit
purchases / average trade payables
number of days of payables
365/ payables turnover ratio
inverse of the payables turnover ratio multiplied by 365
total asset turnover
effectiveness of the firm's use of its total assets to create revenue
Manufacturing businesses that are capital-intensive might have asset turnover ratios near one, while retail businesses might have turnover ratios near 10
Low asset turnover ratios might mean that the company has too much capital tied up in its asset base. A turnover ratio that is too high might imply that the firm has too few assets for potential sales, or that the asset base is outdated.
fixed asset turnover
revenue/ avg net fixed assets
A turnover ratio that is too high might imply that the firm has obsolete equipment, or at a minimum, that the firm will probably have to incur capital expenditures in the near future to increase capacity to support growing revenues.
Since "net" here refers to net of accumulated depreciation, firms with more recently acquired assets will typically have lower fixed asset turnover ratios.
working capital turnover
revenue/ avg working capital
Some firms may have very low working capital if outstanding payables equal or exceed inventory and receivables. In this case the working capital turnover ratio will be very large, may vary significantly from period to period, and is less informative about changes in the firm's operating efficiency.
defensive interval ratio
another measure of liquidity that indicates the number of days of average cash expenditures the firm could pay with its current liquid assets
(cash+ marketable securities+ receivables)/
average daily expenditure
expenditures: cash expenses for costs of goods, SG&A, and R&D
cash conversion cycle
is the length of time it takes to turn the firm's cash investment in inventory back into cash, in the form of collections from the sales of that inventory.
=days sales outstanding + days of inventory on hand - number of days payables
firm's use of fixed-cost financing sources
total debt/ total shareholder's equity
Increases and decreases in this ratio suggest a greater or lesser reliance on debt as a source of financing.
Some analysts include the present value of lease obligations and/or non-interest- bearing current liabilities, such as trade payables.
total debt/total debt+ total shareholders' equity
Capital equals all short-term and long-term debt plus preferred stock and equity. Increases and decreases in this ratio suggest a greater or lesser reliance on debt as a source of financing
total debt/ total assets
fixed charge coverage ratio
(EBIT + lease payments)/
interest payments + lease payments
Here, lease payments are added back to operating earnings in the numerator and also added to interest payments in the denominator. Significant lease obligations will reduce this ratio significantly compared to the interest coverage ratio. Fixed charge coverage is the more meaningful measure for companies that lease a large portion of their assets, such as some airlines.
when would fixed charge coverage be more useful than interest coverage ratio?
Fixed charge coverage is the more meaningful measure for companies that lease a large portion of their assets, such as some airlines.
Return on Assets ROA
profitability relative to funds invested in the company by common stockholders, preferred stockholders, and suppliers of debt financing.
net income + interest expense(1-tax rate)/ average total assets
*interest expense must be added back so that debt holders are included in the equation
operating return on assets
measure of return on assets that includes both taxes and interest in the numerator
operating income / avg total assets
return on total capital (ROTC)
EBIT / avg total capital
total capital = short- and long-term debt, current portion of longterm debt, preferred equity, retained earnings, common equity
what does total capital include?
short- and long-term debt, current portion of longterm debt, preferred equity, retained earnings, common equity
how to calculate ROTC for firms dependent on operating leases as a major form of financing?
include the present value of operating leases on the balance sheet as a fixed asset and as a long-term liability.
return on equity ROE
net income / avg total equity
return on common equity
net income - preferred dividends/ avg common equity
what could low return on total capital mean? (ROTC)
there could be a problem stemming from the low asset turnover and low profit margin
possible reason that return on equity could be higher than that of the industry?
because of its greater use of leverage (page 152)
why is the leverage ratio called the equity multiplier?
b/c you can use it to multiply to ROA (which is the net profit margin x asset tunover) in order to find ROE
what does a low ROE indicate?
it has a low net profit margin, low asset turnover, or it has too little leverage
Why can't Per-share measures for different companies cannot be compared?
b/c A firm with a $100 share price can be expected to generate much greater earnings, cash flow, EBITDA, and EBIT per share than a firm with a $10 share price.
sustainable growth rate
how fast the firm can grow without additional external equity issues while holding leverage constant
g = RR x ROE
Retention rate (RR)
proportion of earnings reinvested
(net income available to common - dividends declared) / net income avaiable to common
1 - dividend payout ratio
dividend payout ratio
dividends declared/ net income available to common
standard deviation of sales/ mean sales
CV of net income
operating risk and financial leverage
Debt to EBITDA
total debt/ EBITDA
EBITDA is essentially your Cash flows so this ratio measures how long it will take to pay off your total debt
Understand what kinds of ratios are used for Credit Analysis
these are ratios that measure the ability of a company to service and repay its debt
interest coverage ratios (with EBITorEBITDA)
return on capital
debt to EBITDA
useful in predicting firm bankruptcies
-a low score indicates high probability of failure
-based on a firm's working capital to assets, retained earnings to assets, EBIT to assets, market to book value of a share of stock, and revenues to assets
segment profit margins, asset utilization (turnover), and return on assets
a portion of a larger company that accounts for more than 10% of the company's revenues or assets, and is distinguishable form the company's other lines of business in terms of the risk and return characteristics of the segment
based on questions such as what if: what will be the effect on net income if sales increases by 3% rather than the estimated 5%
based on specific scenarios ( a specific set of outcomes for key variables) and will also yield a range of value for financial statement items
a technique in which probability distributions for key variables are selected and a computer is used to generate a distribution of values for outcomes based on repeated random selection of values for key variables
in a common size, would u estimate expenses as a percent of Net income or sales?
sales! NEVER NET INCOME
NRV net realizable value
the expected sales price less the estimated selling costs and completion costs
if NRV is less than the BS of inventory, the inventory is written down to net realize value and the loss is recognized in the IS;
lower of cost or market
market is usually equal to replacement cost, but cannot be greater than the NRV or less than (NRV - normal profit margin)
number 6 page 192 perfect problem
Costs that are capitalized for fixed assets and costs that are expensed
purchase price that include freight and taxes
installation costs, and rebuilding costs
because they provide future economic benefits
costs that are expensed when incurred: initial training costs, and repair and maintenance BC they don't provide future economic benefits
is used to account for business combinations. Under the acquisition method, the purchase price is allocated to the identifiable assets and liabilities of the acquired firm on the basis of fair value. Any remaining amount of the purchase price is recorded as goodwill. Goodwill is said to be an unidentifiable asset that cannot be separated from the business itself.
units-of-production method (depreciation method)
based on usage rather than time. Depreciation expense is higher in periods of high usage.
[(original cost- salvage value) / life in output units ] * output units in the period
the useful life of each component is estimated and depreciation expense is computed separately for each.
revaluation model (amortization method)
that permits long-lived assets to be reported at their fair values, as long as active markets exist for the assets so their fair value can be reliably (and somewhat objectively) estimated ONLY UNDER IFRS
An asset is impaired when its carrying value (original cost less accumulated depreciation) exceeds this amt. The recoverable amount is the greater of its fair value less any selling costs and its value in use. The value in use is the present value of its future cash flow stream from continued use.
If impaired, the asset's value must be written down on the balance sheet to the recoverable amount. An impairment loss, equal to the excess of carrying value over the recoverable amount, is recognized in the income statement.
According to U.S. GAAP, an asset is impaired when:
Effects of immediately expensing rather than capitalizing development costs on: earnings, CFO, and asset turnover
capitalizing = higher assets, higher equity, higher CFO, and higher earnings in the first year and lower earnings in later years, and smoother reporting
What happens to interest incurred during construction of an asset?
it is generally capitalized and is added to the asset's value and depreciated over the life of the asset; b/c it results in higher interest coverage ratio (lower denominator) some analysts reverse the transaction and add the capitalized interest to interest expense for the period
Which of the following is least likely considered in determining the useful life an intangible asset?
A.Initial cost. B Legal, regulatory, or contractual provisions.C Provisions for renewal or extension.
A initial costs have nothing to do with the useful life of an intangible asset
Research and development costs
Under IFRS, research costs, which are costs aimed at the discovery of new scientific or technical knowledge and understanding, are expensed as incurred. However, development costs are capitalized. Development costs are incurred to translate research findings into a plan or design of a new product or process.
Under U.S. GAAP, both research and development costs are generally expensed as incurred. One exception is software development costs.
Where is a revaluation surplus recognized?
it's recognized in shareholder's equity
Where is the recovery or loss of equipment recognized?
Cost-fair value from last year
this is recorded on the income statement as a loss or gain
Which of the following disclosures would least likely be found in the financial statement footnotes of a firm?
A. Accumulated depreciation. B.Carrying values by asset class. C.Average age of assets.
Average age of assets is not a required disclosure
also known as current tax expense; but not the same as income tax expense
tax loss carryforward
a current or past loss that can be used to reduce taxable income (thus, taxes payable) in the future; can result in a deferred tax asset, rather than them paying us
net amount of an asset or liability used for tax reporting purposes
income before tax or earnings before tax
income tax expense
expense recognized in IS that includes taxes payable and changes in deferred tax assets and liabilities (DTA and DTL)
income tax expense = taxes payable + delta DTL - delta DTA
deferred tax liability
Balance sheet amounts that result from an excess of income tax expense over taxes payable that are expected to result in future cash outflows.
created when income tax expense (income statement) is greater than taxes payable (tax return) due to temporary differences.
paying more tax in the future b/c ur paying less now
deferred tax assets
Balance sheet amounts that result from an excess of taxes payable over income tax expense that are expected to be recovered from future operations. Can also result from tax loss carryforwards.
pay less tax in the future b/c ur paying more now
Reduction of deferred tax assets based on the likelihood the assets will not be realized.
Net balance sheet value of an asset or liability.
A difference between taxable income (tax return) and pretax income (income statement) that will not reverse in the future.
A difference between the tax base and the carrying value of an asset or liability that will result in either taxable amounts or deductible amounts in the future. Several examples of how temporary differences arise are presented later in this review
Differences between the treatment of an accounting item for tax reporting and for financial reporting can occur when:
1. The timing of revenue and expense recognition in the income statement and the tax return differ.
2. Certain revenues and expenses are recognized in the income statement but never on the tax return or vice-versa.
3. Assets and/or liabilities have different carrying amounts and tax bases.
4. Gain or loss recognition in the income statement differs from the tax return.
5. Tax losses from prior periods may offset future taxable income.
6. Financial statement adjustments may not affect the tax return or may be recognized in different periods.
Deferred tax liabilities occur when:
• Revenues (or gains) are recognized in the income statement before they are included on the tax return due to temporary differences.
• Expenses (or losses) are tax deductible before they are recognized in the income statement.
The most common way that deferred tax liabilities are created
when different depreciation methods are used on the tax return and the income statement.
A deferred tax asset is created when taxes payable (tax return) are greater than income tax expense (income statement) due to temporary differences. Deferred tax assets occur when:
Revenues (or gains) are taxable before they are recognized in the income statement. Expenses (or losses) are recognized in the income statement before they are tax deductible. Tax loss carryforwards are available to reduce future taxable income.
typical causes of deferred tax assets
Post-employment benefits, warranty expenses, and tax loss carryforwards
If deferred tax liabilities are expected to reverse in the future, they are best classified by an analyst as liabilities. If, however, they are not expected to reverse in the future, they are best classified as:
equity (DTL decreased and equity increased by the same amount)
Determine the tax base of a company's assets and liabilities.
IFRS v. GAAP for DTL And DTA
IFRS: DTL and DTA always non-current
GAAP: DTL and DTA current and non-current depending on reversal
type of depreciation for tax purposes
double-declining ; so there's more depreciatio n in the beginning
228 and cfa video 24:47
FINISH LATER (END OF STUDY SESSION)