Podcast
Questions and Answers
Industries requiring significant capital investment are typically categorized as having low barriers to entry under Porter's Five Forces.
Industries requiring significant capital investment are typically categorized as having low barriers to entry under Porter's Five Forces.
False (B)
A low industry growth rate typically increases competitive rivalry among existing firms.
A low industry growth rate typically increases competitive rivalry among existing firms.
True (A)
Strong supplier bargaining power typically increases profits for market participants.
Strong supplier bargaining power typically increases profits for market participants.
False (B)
An analyst's adjustment to increase the write-down of inventory based on estimated damage will increase the level of reported profit.
An analyst's adjustment to increase the write-down of inventory based on estimated damage will increase the level of reported profit.
A limitation of the traditional approach to decomposing ROE is that it fails to differentiate between interest-bearing and non-interest-bearing debt.
A limitation of the traditional approach to decomposing ROE is that it fails to differentiate between interest-bearing and non-interest-bearing debt.
Which of the following is an example of real earnings management?
Which of the following is an example of real earnings management?
Which practice leads to an understatement of liabilities?
Which practice leads to an understatement of liabilities?
Which statement about financial leverage is FALSE?
Which statement about financial leverage is FALSE?
Using the following information, calculate the inventory turnover for ABC Co. for 2005, choosing the closest number: Sales = $19,535, Cost of Goods Sold = $15,101, Inventory = $2,708 (all in millions).
Using the following information, calculate the inventory turnover for ABC Co. for 2005, choosing the closest number: Sales = $19,535, Cost of Goods Sold = $15,101, Inventory = $2,708 (all in millions).
A firm has consistently generated a Return on Equity (ROE) exceeding 12% for the last three years. Given the provided data, which are the two largest drivers of profitability? Net operating profit margin (%): 3.5 Return on net operating assets (%): 6.5 Return on non-operating assets (%): 17.4 Operating assets ($m): 180.2 Non-operating assets ($m): 19.0 Spread (%): 3.5 Debt balance ($m): 80 Owners' equity balance ($m): 77.5
A firm has consistently generated a Return on Equity (ROE) exceeding 12% for the last three years. Given the provided data, which are the two largest drivers of profitability? Net operating profit margin (%): 3.5 Return on net operating assets (%): 6.5 Return on non-operating assets (%): 17.4 Operating assets ($m): 180.2 Non-operating assets ($m): 19.0 Spread (%): 3.5 Debt balance ($m): 80 Owners' equity balance ($m): 77.5
Beyond net profit, identify one other level of profitability and briefly describe what insights it might reveal about a business.
Beyond net profit, identify one other level of profitability and briefly describe what insights it might reveal about a business.
Explain the importance of 'identifying potential red flags' in accounting analysis and give two examples of such red flags.
Explain the importance of 'identifying potential red flags' in accounting analysis and give two examples of such red flags.
In financial analysis, a low industry ______ rate can intensify competitive rivalry among firms.
In financial analysis, a low industry ______ rate can intensify competitive rivalry among firms.
________ earnings management involves making actual changes to operational or investment activities to influence reported earnings.
________ earnings management involves making actual changes to operational or investment activities to influence reported earnings.
Match each profitability metric with its primary function:
Match each profitability metric with its primary function:
Match each term with its description:
Match each term with its description:
Deferring marketing expenditure until the following financial reporting period is an example of accounting manipulation and not real earnings management.
Deferring marketing expenditure until the following financial reporting period is an example of accounting manipulation and not real earnings management.
An increased Return on Equity (ROE) can be achieved through
An increased Return on Equity (ROE) can be achieved through
Which of the following is one of the two largest drivers of profitability as revealed when using the detailed / alternate decomposition of ROE?
Which of the following is one of the two largest drivers of profitability as revealed when using the detailed / alternate decomposition of ROE?
In regards to ROE, define what Spread represents.?
In regards to ROE, define what Spread represents.?
Flashcards
Supplier Bargaining Power
Supplier Bargaining Power
When suppliers have strong bargaining power, they can demand higher prices or better terms, reducing the profits of companies that buy from them.
Analyst Inventory Adjustment
Analyst Inventory Adjustment
Adjustments made by an analyst might decrease the level of damaged inventory, and the level of profit compared with the reported amount.
Traditional ROE Decomposition Limitation
Traditional ROE Decomposition Limitation
It does not distinguish between interest-bearing debt and non-interest-bearing debt when analyzing return on equity.
Deferring Marketing Expenditure
Deferring Marketing Expenditure
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Underfunded Pension Obligations
Underfunded Pension Obligations
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Financial Leverage Stability
Financial Leverage Stability
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Financial Leverage
Financial Leverage
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EBIT Margin
EBIT Margin
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Identifying Potential Red Flags
Identifying Potential Red Flags
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Reported Profit Grows Faster Than Cash Flow
Reported Profit Grows Faster Than Cash Flow
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Accounts Receivable Growing Faster Than Sales
Accounts Receivable Growing Faster Than Sales
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Study Notes
True/False Questions
- An industry needing significant capital investment does not have low barriers to entry per Porter's 5 Forces.
- Low growth rate in an industry decreases competitive rivalry.
- Strong supplier bargaining power decreases the profits of market participants.
- An accounting adjustment increasing inventory write-down decreases the level of profit, compared to the reported amount.
- Traditional ROE decomposition fails to differentiate between interest-bearing and non-interest-bearing debt.
Multiple Choice Questions
- An example of real earnings management is deferring marketing expenditure until the following financial reporting period.
- Failure to record underfunded pension obligations will lead to an understatement of liabilities.
- It is false that greater financial leverage for a firm leads to more stable earnings growth.
- For ABC Co. in 2005, the inventory turnover is closest to 6.18 (Cost of Goods Sold is $15,101 and Inventory is $2,708).
- Return on non-operating assets and financial leverage are the two largest drivers of profitability using the detailed ROE decomposition.
Short Written Answers
- Profitability analysis should consider various levels beyond net profit, each offering unique insights.
- Gross profit indicates the margin strength from core product sales and reveals information about prices and procurement efficiency.
- EBIT margin measures overall business profitability, excluding financing costs.
- EBITDA margin measures overall business profitability, excluding non-cash costs like depreciation/amortization, and financing.
- Identifying potential red flags is crucial for assessing earnings quality and detecting questionable accounting practices.
- One red flag is when reported profit grows faster than cash flow, which indicates aggressive accounting.
- Another red flag is unexplained changes in accounting policies suggest efforts to manipulate financial appearances.
- Accounts receivable growing faster than sales may indicate loosened credit policies, potentially leading to larger bad debt.
Alternative Decomposition of ROE and ROIC Formulas
- ROE (Return on Equity) can be decomposed into: Return on invested capital + (Return on invested capital - Effective interest rate after tax) × Financial leverage, or Return on invested capital + Spread × Financial leverage
- ROIC (Return on Invested Capital) can be decomposed into: Return on operating assets + Return on investment assets
- Return on operating assets = NOPAT/Sales) × (Sales/Operating assets)
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