CMA USA Financial Statement Analysis

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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?

The Interest Coverage Ratio measures the ability of a company to pay interest expense using earnings before interest and tax (EBIT). Signup and view all the answers

What does the Accounts Receivables Turnover Ratio measure?

Efficiency of collecting accounts receivables Signup and view all the answers

The Inventory Turnover Ratio measures how efficiently a company converts their inventory into sales. It is calculated as Cost of goods sold / ________.

Average inventory Signup and view all the answers

What is the purpose of liquidity ratios?

The purpose of liquidity ratios is to measure a firm's ability to meet its short-term obligations. Signup and view all the answers

What is the formula for calculating Current Ratio?

Current Ratio = Current Assets / Current Liabilities Signup and view all the answers

Which of the following items are typically included in Current Assets for calculating Current Ratio? (Select all that apply)

Cash in Hand Signup and view all the answers

The Quick Ratio does not include and __.

inventory, prepaid expenses Signup and view all the answers

A company with more equity than debt is considered more stable. (True/False)

True Signup and view all the answers

What does Financial Leverage refer to?

Financial Leverage refers to the use of debt to increase earnings. Signup and view all the answers

What does the Book Value per Share Ratio represent?

The per share amount for common shareholders if the company was liquidated at the amounts reported on the balance sheet. Signup and view all the answers

How is the Book Value Per Share calculated?

4 Signup and view all the answers

What does the Market to Book Ratio represent?

Ratio between the company's current market price per common share and its book value per share. Signup and view all the answers

What does the Shareholders Return Ratio measure?

Total return shareholders earn on their investment in the company's common stock. Signup and view all the answers

What is the formula for Sustainable Growth Rate?

(1 - payout ratio) * Return on common equity Signup and view all the answers

What is the difference between Accounting Profit and Economic Profit?

Economic profit considers explicit costs and implicit costs, while Accounting profit only considers explicit costs. Signup and view all the answers

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.

EPS = $740,000 / 110,000 = $6.72 Signup and view all the answers

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?

DEPS takes into account all potentially common shares that were outstanding and calculates what the EPS would have been if these potential shares were actually outstanding. Signup and view all the answers

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.

DEPS = $970,000 / 500,000 = $1.94 Signup and view all the answers

What is the purpose of Adjusting Options and Warrants in the calculation of Diluted Earnings per Share (DEPS)?

The purpose is to add the EPS effect of options and warrants to the Weighted Average Number of Common Shares Outstanding and calculate intermediate debts. Signup and view all the answers

Explain the effect on Income Available to Common Shareholders due to Convertible Securities.

The effect is a decrease in interest expense (net of tax) or a decrease in preferred dividends if the convertible securities are converted, resulting in an increase to income available to common shareholders in the numerator of the EPS calculation. Signup and view all the answers

Define Dividend Payout Ratio (DPR) and provide a formula to calculate it.

DPR measures how much dividend a company pays to common shareholders from income available to common shareholders. The formula to calculate DPR is: DPR = Common Dividend / Income available to common shareholders. Signup and view all the answers

Explain the Price to Earnings Ratio (PE Ratio) and provide a formula to calculate it.

PE Ratio shows what the market is willing to pay for a stock based on its current earnings. The formula to calculate PE Ratio is: PE Ratio = Market Price Per Share / Earnings per share. Signup and view all the answers

Define Price to EBITDA Ratio and provide a formula to calculate it.

Price to EBITDA Ratio compares the market price of a share with earnings before interest, tax, depreciation, and amortization. The formula to calculate Price to EBITDA Ratio is: Price to EBITDA Ratio = Market Price Per Share / EBITDA per share. Signup and view all the answers

What does the Dividend Yield Ratio compare and what is the formula to calculate it?

The Dividend Yield Ratio compares the dividend per share with the price paid for buying that share. The formula to calculate Dividend Yield Ratio is: Dividend Yield Ratio = Dividend Per Share / Market Price per share. Signup and view all the answers

Explain the Earnings Yield Ratio and provide a formula to calculate it.

The Earnings Yield Ratio measures the relationship between earnings per share and the current market price of that share. The formula to calculate Earnings Yield Ratio is: Earnings Yield Ratio = Earnings Per Share / Market Price per share. Signup and view all the answers

What is Net Operating Cycle?

Day sales in + Day period of - Day period of payable Signup and view all the answers

What does Total Assets Turnover Ratio measure?

Amount of sales revenue generated from the use of average total assets Signup and view all the answers

What does Fixed Assets Turnover Ratio measure?

Amount of sales revenue generated from the use of average fixed assets Signup and view all the answers

Calculate Total Asset Turnover Ratio if Sales = 30,00,000 and Average Total Assets = 20,00,000.

1.5 Signup and view all the answers

Calculate Fixed Assets Turnover Ratio if Sales = 30,00,000 and Average Fixed Assets = 13,00,000.

2.3 Signup and view all the answers

What is the effect of FIFO on Inventory?

Decrease Signup and view all the answers

What is the effect of LIFO on Inventory?

Increase Signup and view all the answers

What type of profitability ratio is Gross Profit Margin?

Profitability ratio Signup and view all the answers

Calculate Gross Profit Margin if Sales = 120,00,000, COGS = 80,00,000, and Gross Profit = 40,00,000.

33.33% Signup and view all the answers

Calculate Operating Profit Margin if Operating Income = 15,00,000 and Sales = 120,00,000.

12.5% Signup and view all the answers

Calculate Net Profit Margin if Net Income = 10,80,000 and Sales = 120,00,000.

9% Signup and view all the answers

What is EBITDA?

Earnings Before Interest, Taxes, Depreciation, and Amortization Signup and view all the answers

Calculate Return on Asset (ROA) if Net Income = 75,000 and Average Total Assets = 5,50,000.

13.63% Signup and view all the answers

Calculate Return on Equity (ROE) if Net Income = 75,000 and Average Total Equity = 2,87,500.

26.08% Signup and view all the answers

What is Return on Common Equity (ROCE)?

Return on common equity measures how much return a company generates using common shareholders' equity Signup and view all the answers

Calculate Return on Common Equity (ROCE) if Net Income = 55,000, Preferred Dividend = 5,000, and Average Common Shareholders' Equity = 2,75,000.

17.69% Signup and view all the answers

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
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
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
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

Total Assets Turnover Ratio (TATR): measures the amount of sales revenue generated from total assets
- Formula: TATR = Sales / Average Total Assets
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

Gross Profit Margin: measures the percentage of gross profit out of sales
- Formula: Gross Profit Margin = (Gross Profit / Sales) x 100
Operating Profit Margin: measures the percentage of operating profit out of sales
- Formula: Operating Profit Margin = (Operating Profit / Sales) x 100
Net Profit Margin: measures the percentage of net profit out of sales
- Formula: Net Profit Margin = (Net Profit / Sales) x 100
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) Margin: measures the profitability of a company's operations
- Formula: EBITDA Margin = (EBITDA / Sales) x 100
Return on Assets (ROA): measures the return a company earns on its assets
- Formula: ROA = (Net Income / Average Total Assets) x 100
Return on Equity (ROE): measures the return a company earns on its shareholders' equity
- Formula: ROE = (Net Income / Average Shareholders' Equity) x 100
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

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.

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 = (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.