Financial Statements and Ratio Analysis

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Financial Statements and Ratio Analysis

market/book (M/B) ratio Provides an assessment of how investors view the firm’s performance. Firms expected to earn high returns relative to their risk typically sell at higher M/B multiples.

price/earnings (P/E) ratio Measures the amount that investors are willing to pay for each dollar of a firm’s earnings; the higher the P/E ratio, the greater the investor confidence.

market ratios Relate a firm’s market value, as measured by its current share price, to certain accounting values.

net profit margin Measures the percentage of each sales dollar remaining after all costs and expenses, including interest, taxes, and preferred stock dividends, have been deducted.

operating profit margin Measures the percentage of each sales dollar remaining after all costs and expenses other than interest, taxes, and preferred stock dividends are deducted; the “pure profits” earned on each sales dollar.

gross profit margin Measures the percentage of each sales dollar remaining after the firm has paid for its goods.

fixed-payment coverage ratio Measures the firm’s ability to meet all fixed-payment obligations.

coverage ratios Ratios that measure the firm’s ability to pay certain fixed charges.

debt ratio Measures the proportion of total assets financed by the firm’s creditors.

Measures the firm’s ability to make contractual interest payments; sometimes called the interest coverage ratio

times interest earned ratio

degree of indebtedness Measures the amount of debt relative to other significant balance sheet amounts. ability to service debts The ability of a firm to make the payments required on a scheduled basis over the life of a debt.

financial leverage The magnification of risk and return through the use of fixed- cost financing, such as debt and preferred stock.

total asset turnover Indicates the efficiency with which the firm uses its assets to generate sales

inventory turnover Measures the activity, or liquidity, of a firm’s inventory.

average age of inventory Average number of days’ sales in inventory. average collection period The average amount of time needed to collect accounts receivable.

Indicates the efficiency with which the firm uses its assets to generate sales

total asset turnover

quick (acid-test) ratio A measure of liquidity calculated by dividing the firm’s current assets minus inventory by its current liabilities

benchmarking A type of cross-sectional analysis in which the firm’s ratio values are compared to those of a key competitor or group of competitors that it wishes to emulate

cross-sectional analysis Comparison of different firms’ financial ratios at the same point in time; involves comparing the firm’s ratios to those of other firms in its industry or to industry averages.

current rate (translation) method Technique used by U.S.–based companies to translate their foreign-currency-denominated assets and liabilities into dollars, for consolidation with the parent company’s financial statements, using the year-end (current) exchange rate.

notes to the financial statements Explanatory notes keyed to relevant accounts in the statements; they provide detailed information on the accounting policies, procedures, calculations, and transactions underlying entries in the financial statements.

retained earnings The cumulative total of all earnings, net of dividends, that have been retained and reinvested in the firm since its inception.

balance sheet Summary statement of the firm’s financial position at a given point in time.

current assets Short-term assets, expected to be converted into cash within 1 year or less. current liabilities Short-term liabilities, expected to be paid within 1 year or less.

dividend per share (DPS) The dollar amount of cash distributed during the period on behalf of each outstanding share of common stock.

income statement Provides a financial summary of the firm’s operating results during a specified period.

The letter to stockholders is the primary communication from management. It describes the events that are considered to have had the greatest effect on the firm

stockholders’ report Annual report that publicly owned corporations must provide to stockholders; it summarizes and documents the firm’s financial activities during the past year. letter to stockholders Typically, the first element of the annual stockholders’ report and the primary communication from management.