Questions and Answers
What does the Financial Leverage Ratio measure?
Financial Leverage Ratio measures the amount of debt a company uses to finance its assets.
Define Debt to Equity Ratio.
Debt to Equity Ratio compares the total liability to total equity of a company.
What is the formula for calculating the Degree of Combined Leverage (DCL)?
Degree of Combined Leverage (DCL) = Contribution Margin / EBT
What is the purpose of the Interest Coverage Ratio?
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What does the Accounts Receivables Turnover Ratio measure?
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The Inventory Turnover Ratio measures how efficiently a company converts their inventory into sales. It is calculated as Cost of goods sold / ________.
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What is the purpose of liquidity ratios?
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What is the formula for calculating Current Ratio?
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Which of the following items are typically included in Current Assets for calculating Current Ratio? (Select all that apply)
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The Quick Ratio does not include ______ and ________.
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A company with more equity than debt is considered more stable. (True/False)
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What does Financial Leverage refer to?
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What does the Book Value per Share Ratio represent?
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How is the Book Value Per Share calculated?
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What does the Market to Book Ratio represent?
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What does the Shareholders Return Ratio measure?
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What is the formula for Sustainable Growth Rate?
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What is the difference between Accounting Profit and Economic Profit?
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Calculate the Earnings per Share (EPS) given the following information: Net income was $780,000, Income Available for Common Shareholders was $740,000, and Weighted Average Number of Common Shares Outstanding was 110,000.
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What is the Diluted Earnings per Share (DEPS) that takes into account potentially common shares such as convertible bonds, convertible preference shares, options, and warrants?
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Calculate the Diluted Earnings per Share (DEPS) given the following information: Net Income was $1,000,000, Income Available for Common Shareholders was $970,000, and Weighted Average Number of Common Shares Outstanding was 500,000.
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What is the purpose of Adjusting Options and Warrants in the calculation of Diluted Earnings per Share (DEPS)?
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Explain the effect on Income Available to Common Shareholders due to Convertible Securities.
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Define Dividend Payout Ratio (DPR) and provide a formula to calculate it.
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Explain the Price to Earnings Ratio (PE Ratio) and provide a formula to calculate it.
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Define Price to EBITDA Ratio and provide a formula to calculate it.
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What does the Dividend Yield Ratio compare and what is the formula to calculate it?
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Explain the Earnings Yield Ratio and provide a formula to calculate it.
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What is Net Operating Cycle?
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What does Total Assets Turnover Ratio measure?
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What does Fixed Assets Turnover Ratio measure?
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Calculate Total Asset Turnover Ratio if Sales = 30,00,000 and Average Total Assets = 20,00,000.
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Calculate Fixed Assets Turnover Ratio if Sales = 30,00,000 and Average Fixed Assets = 13,00,000.
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What is the effect of FIFO on Inventory?
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What is the effect of LIFO on Inventory?
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What type of profitability ratio is Gross Profit Margin?
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Calculate Gross Profit Margin if Sales = 120,00,000, COGS = 80,00,000, and Gross Profit = 40,00,000.
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Calculate Operating Profit Margin if Operating Income = 15,00,000 and Sales = 120,00,000.
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Calculate Net Profit Margin if Net Income = 10,80,000 and Sales = 120,00,000.
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What is EBITDA?
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Calculate Return on Asset (ROA) if Net Income = 75,000 and Average Total Assets = 5,50,000.
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Calculate Return on Equity (ROE) if Net Income = 75,000 and Average Total Equity = 2,87,500.
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What is Return on Common Equity (ROCE)?
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Calculate Return on Common Equity (ROCE) if Net Income = 55,000, Preferred Dividend = 5,000, and Average Common Shareholders' Equity = 2,75,000.
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Study Notes
Liquidity Ratios
- Liquidity ratios measure a firm's ability to meet its short-term obligations
- Types of liquidity ratios:
- Current Ratio
- Quick Ratio
- Cash Ratio
- Working Capital Ratio
- Cashflow Ratio
Current Ratio
- Most commonly used liquidity ratio
- Measures the ratio of current assets to current liabilities
- Standard current ratio is 2:1
Quick Ratio
- Also known as Acid Test Ratio
- More conservative than current ratio as it excludes inventory and prepaid expenses
- Measures firm's ability to pay short-term debts using most liquid assets
- Standard quick ratio is 1:1
Cash Ratio
- Most conservative liquidity ratio
- Includes only cash, cash equivalents, and marketable securities
Working Capital Ratio
- Measures the percentage of working capital (current assets - current liabilities) to total assets
Cashflow Ratio
- Measures ability to meet short-term obligations using operating cash flow
Impact on Current Ratio
- Prepaid expenses overstate current ratio
- High accounts receivables from bankrupt customers reduce liquidity despite good current ratio
- Paying short-term obligations just before reporting can improve current ratio temporarily (window dressing)### Activity Ratios
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Average Collection Period (ACP): measures the length of time it takes to collect cash from sales
- Formula: ACP = 365 / Accounts Receivable Turnover Ratio (ARTR)
- ARTR = Annual Net Credit Sales / Average Accounts Receivable
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Inventory Turnover Ratio (ITR): measures how efficiently a company converts inventory into sales
- Formula: ITR = Cost of Goods Sold (COGS) / Average Inventory
- Days Sales in Inventory (DSI) = 365 / ITR
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Accounts Payable Turnover Ratio (APTR): measures how efficiently a company pays its accounts payable
- Formula: APTR = Annual Credit Purchases / Average Accounts Payable
- Days Payable Period = 365 / APTR
Operating Cycle
- Measures the length of time it takes to convert investment in inventory back into cash
- Formula: Operating Cycle = Days Sales in Inventory (DSI) + Average Collection Period (ACP)
Net Operating Cycle
- Measures the length of time it takes to convert investment in inventory back into cash, considering payable days
- Formula: Net Operating Cycle = Days Sales in Inventory (DSI) + Average Collection Period (ACP) - Days Payable Period
Total Assets Turnover Ratio and Fixed Assets Turnover Ratio
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Total Assets Turnover Ratio (TATR): measures the amount of sales revenue generated from total assets
- Formula: TATR = Sales / Average Total Assets
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Fixed Assets Turnover Ratio (FATR): measures the amount of sales revenue generated from fixed assets
- Formula: FATR = Sales / Average Fixed Assets
FIFO and LIFO Effect
- FIFO (First-In-First-Out): Decreases Cost of Goods Sold (COGS) and increases Gross Profit
- LIFO (Last-In-First-Out): Increases Cost of Goods Sold (COGS) and decreases Gross Profit
Profitability Ratios
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Gross Profit Margin: measures the percentage of gross profit out of sales
- Formula: Gross Profit Margin = (Gross Profit / Sales) x 100
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Operating Profit Margin: measures the percentage of operating profit out of sales
- Formula: Operating Profit Margin = (Operating Profit / Sales) x 100
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Net Profit Margin: measures the percentage of net profit out of sales
- Formula: Net Profit Margin = (Net Profit / Sales) x 100
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EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) Margin: measures the profitability of a company's operations
- Formula: EBITDA Margin = (EBITDA / Sales) x 100
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Return on Assets (ROA): measures the return a company earns on its assets
- Formula: ROA = (Net Income / Average Total Assets) x 100
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Return on Equity (ROE): measures the return a company earns on its shareholders' equity
- Formula: ROE = (Net Income / Average Shareholders' Equity) x 100
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Return on Common Equity (ROCE): measures the return a company earns on its common shareholders' equity
- Formula: ROCE = (Net Income - Preferred Dividend / Average Common Shareholders' Equity) x 100
Market Ratios
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Earnings Per Share (EPS): measures the amount of income available to each common shareholder
- Formula: EPS = (Net Income - Preferred Dividend / Weighted Average Number of Common Shares Outstanding)
- Diluted Earnings Per Share (DEPS): measures the EPS considering the potential issuance of shares
- Dividend Payout Ratio: measures the proportion of earnings distributed as dividends
- Price to Earnings Ratio (PE Ratio): measures the market value of a company's shares relative to its earnings
- Price to EBIDTA Ratio: measures the market value of a company's shares relative to its EBIDTA
- Dividend Yield Ratio: measures the proportion of earnings distributed as dividends relative to the market price of the shares
- Earnings Yield Ratio: measures the proportion of earnings relative to the market price of the shares
- Market to Book Ratio: measures the market value of a company's shares relative to its book value
- Book Value Per Share: measures the book value of a company's shares
- Shareholders' Return: measures the return earned by shareholders### Market Ratios
- Proceeds from treasury stock are used to purchase common stock at the average market price.
- Adjusting income available to common shareholders due to the decrease in interest expense (net of tax) or decrease in preferred dividends if convertible securities are converted increases income available to common shareholders in the EPS calculation.
Diluted Earnings per Share (DEPS)
- Step 1: Calculate basic earnings per share (EPS) = Income Available to Common Shareholders / Weighted Average Number of Common Shares Outstanding.
- Step 2: Calculate the EPS effect of options = Cash received if options are exercised / Average Market Price.
- Step 3: Add the EPS effect of options to WANCSO.
- Step 4: Calculate the EPS effect of convertible bonds and convertible preference shares.
- Step 5: Rank the EPS effects from lowest to highest.
- Step 6: Add the EPS effects from lowest to highest, and if the next item is added and EPS is higher than before, it is an anti-diluted effect and not included.
Dividend Payout Ratio (DPR)
- DPR = Common Dividend / Income Available to Common Shareholders.
- Example: Net Income = $1,300,000, Preferred Dividend = $50,000, Dividend distributed to common shareholders = $20,000, No. of Shares = 10,000, DPR = 20,000 / (1,300,000 - 50,000) = 0.25 or 25%.
Price to Earnings Ratio (PE Ratio)
- PE Ratio = Market Price Per Share / Earnings per Share.
- Example: Market Price per Share = $40, Earnings per Share = $5, PE Ratio = 40 / 5 = 8.
Price to EBITDA Ratio
- Price to EBITDA Ratio = Market Price Per Share / EBITDA per Share.
Dividend Yield Ratio
- Dividend Yield Ratio = Dividend per Share / Market Price per Share.
- Example: Dividend per Share = $2, Market Price per Share = $10, Dividend Yield Ratio = 2 / 10 = 0.2 or 20%.
Earnings Yield Ratio
- Earnings Yield Ratio = Earnings per Share / Market Price per Share.
- Example: Earnings per Share = $5, Market Price per Share = $10, Earnings Yield Ratio = 5 / 10 = 0.5 or 50%.
Book Value per Share Ratio
- Book Value per Share = (Total Shareholders' Equity - Preferred Shareholders' Equity) / No. of Common Shares Outstanding.
Market to Book Ratio
- Market to Book Ratio = Market Price per Share / Book Value per Share.
Shareholders Return Ratio
- Shareholders Return Ratio = (Trading Stock Price - Beginning Stock Price + DPS) / Beginning Stock Price.
Comparative Financial Statement
- Vertical Analysis: Expresses each item in financial statements as a percentage of the total amount.
- Horizontal Analysis: Evaluates trends for a single business over a period of several years.
Special Issues
- Functional Currency: The currency of the primary economic environment in which the entity operates.
- Reporting Currency: The currency of the parent company.
- Remeasurement: The restatement of financial results prepared under other principles into US GAAP.
- Translation: The conversion of financial results from functional currency to reporting currency.
Accounting for Changes/Errors
- Methods for changes or corrections of accounts:
- Retrospective Application: for changes in accounting principle or reporting entity.
- Restatement: for correcting errors in previously issued financial statements.
- Prospective Application: for changes in accounting estimates.
Earnings Quality
- Refers to the validity and accuracy of reported earnings or information.
- Factors affecting earnings quality:
- Selection of accounting principle.
- Character of Management.
- Business Environment.
Sustainable Growth Rate
- Measures the ability of a firm to grow using only internal funds.
- Sustainable Growth Rate = (1 - Dividend Payout Ratio) × Return on Common Equity.
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Description
This quiz covers financial statement analysis, a key topic in the Certified Management Accountant (CMA) USA certification. Learn how to analyze financial statements and make informed decisions.