Financial Statement Analysis D366 Study Guide PDF

lOMoARcPSD|51072428 Financial Statement Analysis D366 Study Guide Financial Statement Analysis (Western Governors University) Scan to open on Studocu Studocu is not sponsored or endorsed by any college or university Downloaded by...

lOMoARcPSD|51072428 Financial Statement Analysis D366 Study Guide Financial Statement Analysis (Western Governors University) Scan to open on Studocu Studocu is not sponsored or endorsed by any college or university Downloaded by Olivia ([email protected])  lOMoARcPSD|51072428 Financial Statement Analysis D366 Important Definitions: Transitory Income – Income that is not expected to be part of a company’s regular ongoing earnings. Peripheral Activity – Activities not central to the business’s earnings. Contingent Income – Income that is dependent on certain conditions or events occurring. Special Purpose Entity (SPE) – A legal entity that is created to complete a specific, temporary, or narrow objective. They can be used to: > Hold assets as collateral for loans, pass financial risk to other investors or entities, take advantage of favorable tax circumstances, and generate liquidity. Accruals – Revenues earned, or expenses incurred that impact a company’s net income on the income statement, but cash related to the transaction hasn’t yet occurred. Cost of Goods Sold - The total cost of producing and selling a product or service. Financing - The process of obtaining funds from a lender to make a purchase and then paying back the funds over time. Investing - Putting money into an asset or project with the expectation of earning a profit. Equity - The value of the shares issued by a company. Earnings management - Occurs when management uses judgment in financial reporting and alters financial statements to mislead users. Real Earnings Management - Intentionally changing the timing or structure of an operation, investment, or financing transaction to increase earnings. Depreciation - A reduction in the value of an asset with the passage of time, due to wear and tear. Amortization - An accounting technique used to periodically lower the book value of a loan or an intangible asset over a set period of time. Current Replacement Cost - The estimated cost of replacing an asset or service at the current market price. Fair Value (Mark-To-Market) - Measures a company's assets and liabilities based on their current market value Adjusted Historical Cost - The value of an asset after it has been adjusted to account for wear and tear, depreciation, or impairment. Goodwill - An intangible asset that represents the premium paid to acquire a business above its fair market value. Tax Basis - The value of the asset for tax purposes. Book Value - The value of a business or asset as it appears on a balance sheet. Common-size balance sheet – A Balance sheet that expresses all amounts as a percentage of total assets. Downloaded by Olivia ([email protected])  lOMoARcPSD|51072428 Common-size income statements – An income statement that expresses all items as a percentage of total revenues. Percentage change financial statements – Statements that express rates of growth year over year. Horizontal integration strategy - A business strategy where a company acquires or merges with another company in the same industry and at the same stage of production. Industry diversification strategy - A business strategy that involves a company entering a new industry or market to create a new product or service. Product differentiation strategy - A business strategy that highlights a product's unique qualities to make it stand out from competitors. Low-cost leadership strategy - A business strategy that aims to reduce costs to offer products or services at a lower price than competitors. Accrual Accounting - A method of recording revenues and expenses when they are earned or incurred, regardless of when cash is exchanged. Indirect Method - An accounting technique used to calculate cash flow from operating activities in a cash flow statement. You start with a business's net income, then adjust for non-cash expenses and changes in working capital. This method uses accrual accounting, so you don't need to calculate separately to convert net income to cash flow from operating activities. Common adjustments include depreciation, amortization, accounts payable, and increases or decreases in balance sheet line items. Direct Method - An accounting technique used to prepare a cash flow statement that shows a company's cash inflows and outflows. The direct method records cash as it's received from customers or paid out to suppliers and shows the changes in cash over a period of time. Mixed Attribute Measurement Model – A financial accounting method that uses multiple measurement bases to determine the value of assets and liabilities on financial statements. Market Value of Assets - The price of an asset on the marketplace, based on the prices buyers are willing to pay and what sellers are willing to accept. Asset-Based Valuation - A method for determining the value of a company by subtracting its liabilities from the value of its assets. Discount Cash Flow (DFC) - A method for estimating the value of an investment or business by calculating the present value of its future cash flows. DFC relies heavily on the DFC growth rate, which reflects how much the cash flows are expected to increase or decrease over time. Net Working Capital - The difference between a company's current assets and its current liabilities. Dividends - A sum of money paid regularly by a company to its shareholders out of its profits. Preferred Dividends - A portion of a company's earnings that are paid to preferred shareholders before common stock dividends. Downloaded by Olivia ([email protected])  lOMoARcPSD|51072428 Small-Cap Company - A company with a market capitalization between $250 million and $2 billion. Mid-Cap Company - A company with a market capitalization between $2 and $10 billion. Large-Cap Company - A company with a market capitalization over $10 billion. Zero Market-Cap Company - A company that has a market capitalization of absolutely zero. Gross Margin Percentage Index (GMI) – Used to compare a company’s current gross margin to the gross margin of the previous year. GMI = Current years gross margin / Previous years gross margin If the GMI is greater than 1: The company improved its profitability relative to sales If the GMI is equal to 1: gross margin has not changed f the GMI is less than 1: The company’s profitability relative to sales has decreased If the GMI is less than 0: The company is incurring losses from its core operations Business products’ four phases: (1) introduction (2) growth – Rapid increase in sales and debt financing (3) maturity – Slow down in sales (4) Decline – Loss in sales or even profit Porter’s Five Forces Model: A framework for analyzing an industry's competitive strength and profitability. Relies on competition in the industry, potential of new entrants, power of suppliers, power of customers, and threat of substitutes >Buyer power and supplier power represent vertical competition. >Competition in the industry, potential of new entrants and threat of substitutes represent horizontal competition. Ratios / Formulas Downloaded by Olivia ([email protected])  lOMoARcPSD|51072428 Short-Term liquidity Ratios - Financial metrics that assess a company’s ability to pay its short- term debts using its current assets. Profitability Ratios - Financial metrics used to measure and evaluate the ability of a company to generate income (profit) relative to revenue, assets, operating costs, and shareholders' equity during a specific period. Solvency Ratios - Financial metrics that assess a company's ability to pay its debts and generate enough cash flow. Net Income - The amount of money an individual or business has left after deducting expenses, taxes, and other costs. Net Income = Revenue - Expenses - Interest Expense − Tax Expense or = EBIT - Interest Expense - Tax Expense Earnings before Interest and Taxes (EBIT) Note: Similar Formulas exist such as Earnings before Interest, Taxes, and Amortization (EBITA) and Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA). EBIT = Net Income - Operating Expenses EBITA = Net Income + Interest +Taxes + Amortization EBITDA = Operating Income + Depreciation + Amortization Enterprise Value (EV) - A company's total value, including its market capitalization, debt, and cash. EV = Market Capitalization + Total Debt − Cash and Cash Equivalents Market Capitalization = Market Price per Share × Number of Shares Outstanding Comments: Many ratios exist using EV and EBIT/ EBITA/ EBITDA. Break down what the question is asking for to its part and divide them to get the desired ratio. These ratios can include: EV / EBIT, EV / EBITA, EV / EBITDA, EBIT / EV, EBITA/ EV, and EBITDA / EV Return on Assets (ROA) - A profitability ratio that shows how much profit a company generates from its assets. ROA = Net Income / Total Assets Downloaded by Olivia ([email protected])  lOMoARcPSD|51072428 Return on common equity (ROCE) - A financial ratio that measures how much profit a company generates for each dollar invested in common equity. Common Equity - The total value of all investments in a company made by common shareholders (Also known as shareholders' or owners' equity) ROCE = ( Net income - Preferred Dividends ) / Average Common Equity Note: If the company's ROCE exceeds the return demanded by shareholders, it indicates that the company is efficiently generating value for its investors. If not, it may suggest under performance. (Basic) Earnings per share (EPS) - A financial metric that measures how much profit a company makes per share of common stock. EPS = Company's net income / Total number of outstanding shares (Diluted) Earnings per share (EPS) - A metric used in fundamental analysis to gauge a company's quality of EPS assuming all convertible securities have been exercised. Convertible securities include all outstanding convertible preferred shares, convertible debt, equity options which are mainly employer-based options, and warrants. Price-earnings ratio (P/E) - A way to value a company by comparing the price of a stock to its earnings. P/E = Market Price per Share / Company's earnings-per-share (EPS) Price-to-Sales (P/S or Sales Multiple Valuation) - A financial metric that helps investors understand how much a company's stock is worth relative to its sales. P/S = Company’s Market Capitalization / Total Sales (Revenue) P/S Valuation - A valuation ratio that compares a company's stock price to its revenues. P/S Valuation = Revenue × P/S Multiple Current ratio - A liquidity measurement used to track how well a company may be able to meet its short-term debt obligations. Downloaded by Olivia ([email protected])  lOMoARcPSD|51072428 Current Ratio = Current Assets / Current Liabilities Quick Ratio (Acid Test) – A liquidity ratio that measures how sufficient a company's short-term assets are to cover its current liabilities, excluding inventory. Quick Ratio = Current Assets – Inventory / Current Liabilities Operating Cash Flow to Current Liabilities Ratio (OFC Ratio) – A liquidity ratio that measures a company's ability to pay its current liabilities with cash generated from its core business operations. OFC Ratio = Cash flow from operations / Current liabilities Inventory Turnover Ratio – The rate that inventory stock is sold, or used, and replaced. Inventory Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory Average Inventory = Beginning Inventory + Ending Inventory / 2 Note: If ending inventory is not given, purchases are used to approximate ending inventory. Ending Inventory = Beginning Inventory + Purchases – COGS Days in Inventory – Days in Inventory = Days given in the problem / Inventory Turnover Ratio Free Cash Flow to Equity (FCFE) - The amount of cash a business generates that is available to be potentially distributed to shareholders. FCFE = Net Income + Depreciation and Amortization (D&A) – Change in Net Working Capital – Capital Expenditures (Capex) + Net Borrowing Continuing Value (CV) - The current value of a company's future cash flows, assuming a constant growth rate. CV = ( FCFn x (1 + g)) / ( WACC - g ) FCFn = Free Cash Flow (For the desired period) Downloaded by Olivia ([email protected])  lOMoARcPSD|51072428 g = Growth Rate WACC = Weighted average cost of capital (rate) Present Value - The current value of a future sum of money or cash flow stream. PV = FV x (1 / ((1 + r) ^n)) FV = Future Value r = Rate of Return or Discount Rate n = Number of Periods Sum of the Present Value of Free Cash Flows - The total current value of a company's projected future free cash flows. Sum of the Present Value of Free Cash Flows = ( FCFE 1 x r1 ) + ( FCFE2 x r2 ) + ( FCFE3 x r3 ) +.... r = Rate of Return or Discount Rate or = ∑(FCF_t / (1 + r)^t) t = Time r = Rate of Return or Discount Rate Downloaded by Olivia ([email protected])