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Bus. Valuations: Fundamentals
Intro to BV - ch 2
27
Business
Professional
09/26/2008

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Term
Financial Ratio (Trend) Analysis includes
Definition
(1) Historical and normalized BS over period being analyzed, detailing each BS line item
(2) Historical and normalized adjusted IS over the period being analyzed, detailing each IS line item
(3) Common-sized IS (% of Net Sales)
(4) Common-sized BS (% of Total Assets)
(5) Historical and normalized adjusted cash flows from operating activities (on the basis of operations and adjusted for owner/manager discretionary items such as compensation and perquisites) over the period being analyzed
Term
5 Categories of Key Financial Ratios
Definition
(1) Internal Liquidity
(2) Operating Efficiency
(3) Operating Profitability
(4) Business Risk (Operating) Analysis
(5) Financial Risk (Leverage) Analysis
Term
Common-Size Analysis
Definition
(1) BS line items as a % of Total Assets
(2) IS line items as a % of Net Sales
(3) Facilitate comparison with other companies in the same industry
(4) Fundamental step in developing ratio (trend) and comparative analyses
Term
Ratio (Trend) Analysis - effective toold to answer 3 questions
Definition
(1) How well is the company doing?
(2) What are its strengths and wealnesses? but won't identify ALL
(3) What are the relative business and operating risks to the company?
Term
Ratio (Trend) Analysis - benefits
Definition
(1) Measures the relative health or sickness of a business.
(2) Integral tool in trend analysis
(3) Integral tool in comparative analysis
Term
Ratio Analysis as Tool in Trend Analysis
Definition
(1) Compares the company's own ratios to itself over time
(2) Identifies the company's strengths and weaknesses (but not all of them)
(3) Assists in establishing appropriate capitalization rates (helps to identify risk factors particular to subject company)
Term
Ratio Analysis as Tool in Comparative Analysis
Definition
(1) Assists in making comparison's with other companies' or industry averages
(2) Assists in selecting appropriate price/earnings ratios or price/asset multiples relative to the company's indicated performance to compare to comparable companies or industry averages
Term
Use of Historical data in Ratio Analysis
Definition
(1) preferable 5 years or the length of the natural business cycle of the subject company and industry
(2) more than 5 if analyst deems appropriate
(3) less than 5 if info unavailable
Term
Steps in Trend Analysis
Definition
(1) Obtain and analyze GAAP basis or tax basis financial data
(2) List and prepare summaries by year for key financial statement accounts (BS & IS)
(3) Select, compute and compare the relevant financial ratios for each year
(4) Analyze and develop conclusions
Term
Internal Liquidity Ratios (Solvency)
Definition
Measures a firm's ability to pay its near-term financial obligations
(1) Current Ratio
(2) Quick Ratio
(3) Cash Ratio
(4) Receivable Turnover
(5) Inventory Turnover
(6) Payables Turnover
(7) Cash Conversion Cycle
Term
Current Ratio
Definition
(1) Current Assets/Current Liabilities
(2) Provides a good measure of solvency if AR and inventories are liquid
Term
Quick Ratio
Definition
(1) (Cash + Marketable Securities + Receivables)/Current Liabilities
(2) If inventories are not easily liquidated, the quick ratio provides a better indicator of solvency
Term
Cash Ratio
Definition
(1) (Cash + Marketable Securities)/Current Liabilities
(2) Most conservative measure of solvency, used if neither AR nor inventories are liquid
Term
Receivable Turnover
Definition
(1) Net Sales/Avg Receivables
(2) Measures how many times AR are collected (or turned over) during the period being examined
(3) Divide Turnover rate into 365 = average time required to convert receivables to cash
(4) ie 30 days credit, if avg collection time = 41 days then collection lagging but if 60 days credit then collections are ahead
Term
Inventory Turnover
Definition
(1) COGS/Avg Inventory
(2) Measures number of times a company sells (or turns) its inventory during the year
(3) A high Inventory TO and low GP often go tohether maning a low GP requires a higher volume of business to produce a satisfactory ROA
(4) High TO can also indicate better liquidity or superior merchandising or a shortage of needed inventory for sales
(5) Low inventory can indicate poor liquidity, possible overstocking or obsolete inventory or a planned inventory build up may be occurring to avoid material shortages
(6) Divide Turnover rate into 365 = average time required to convert inventory to cash
Term
Payables Turnover
Definition
(1) COGS/Avg Payables
(2) Measures the number of times a year that a company pays its Avg AP balance
(3) If ratio is too high, firm may be paying too quickly and not taking advantage of interest free credit available for AP
(4) If ratio is low, then then the firm may be a credit risk and/or losing valuable discounts
(5) Divide Turnover rate into 365 = average time required to convert payables to cash (paying payables)
Term
Cash Conversion Cycle
Definition
(1) DIO + DSO - DPO
(2) Inventory TO Period + Days to Collect Receivable - Payable Payment Period
(3) Measures the time between the outlay of cash for inventory and the collection of cash from the sale of that inventory
Term
Operating Efficiency Ratios
Definition
(1) Net Fixed Asset Turnover
(2) Total Asset Turnover
Term
Net Fixed Asset Turnover
Definition
(1) Net Sales/Avg FA
(2) can be an indication of management's ability to effectively utilize fixed assets
(3) a low ratio can be an indication of obsolete or impaired fixed assets
Term
Total Asset Turnover
Definition
(1) Net Sales/Avg Total Assets
(2) an indication of management's ability to effectively utilize total assets
(3) a low ratio can be an indication of obsolete or impaired assets
Term
Operating Profitability Ratios
Definition
Used in the evaluation of management performance
(1) Cost of Sales/Sales %
(2) Gross Margin %
(3) Operating Expenses/Sales %
(4) Operating Margin %
(5) Return on Assets % (ROA)
(6) Return on Equity % (ROE)
Term
Cost of Sales/Sales %
Definition
(1) Cost of Sales/Net Sales
(2) an indication of the subject company's operating environment and operating efficiency
(3) if increasing, may indicate competition is forcing company to cut profit margins or it may indictae the company is unable to pass its increasing costs to its customers.
Term
Gross Margin %
Definition
(1) (Net Sales - Cost of Sales)/Net Sales
(2) Expands on the issues found by anlyzing the cost of sales ratio
(3) Note that the COS + GM = 100%
Term
Operating Expenses/Sales %
Definition
(1) Operating Expenses/Net Sales
(2) often used as a measure of management's ability to control its operating expenses
Term
Operating Margin %
Definition
(1) Income from Operations/Net Sales
(2) expands on the issues identified by analyzing the operating expense ratio.
Term
Return on Assets % (ROA)
Definition
(1) Net Income/Avg Total Assets
(2) an important test of management's ability to earn a return on assets funded from all sources (debt and equity)
(3) the NI figure should be before deducting int exp
Term
Return on Equity % (ROE)
Definition
Net Income/Avg Common Equity
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