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CPCU 540
Chapter 4
51
Other
Not Applicable
09/15/2006

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Term
1. Forecasting
Definition
1. The projection of a company's future operating results or financial condition based on historical and current information
Term
2. Common-size statement
Definition
2. A financial statement in which amounts are reported as a percentage of a base figure
Term
3. Vertical Analysis
Definition
3. The use of common size statements to highlight basic relationships among items within a single set of financial statements
Term
4. Horizontal Analysis
Definition
4. The use of the period to period percentage changes identified in common size statements to identify trends.
Term
5. Gross profit margin
Definition
5. The percentage of sales remaining after deducting the cost of goods sold
Term
6. Net profit margin
Definition
6. The percentage of sales remining after deducting all expenses
Term
7. Return on assets (ROA)
Definition
7. A profitibility ratio that shows how well a company has used its resources
Term
8. Return on Equity
Definition
8. A profitibility ratio that shows the rate of return owners are earning on their investment
Term
9. DuPont Identity
Definition
9. An Analysis of ROA and ROE by breaking them down into their component ratios
Term
10. Asset Turnover
Definition
10. A ratio that emphasizes the efficiency of the company's use ofits assets
Term
11. Equity Multiplier
Definition
11. A ratio that emphasizes the efficiency of the company's use of debt to finance is assets
Term
12. Combined Ratio
Definition
12. A profitibility ratio for insurers that indicates whether an insurer has made any unerwriting loss or gain
Term
13. Loss Ratio
Definition
13. A profitability ratio for insurers that relates loss expenses to earned premiums
Term
14. Financial basis expense ratio
Definition
14. A profitability ratio for an insurer that relates underwriting expenses to earned premiums
Term
15. Trade basis expense ratio
Definition
15. A profitability ratio for an insurer that relates underwriting expenses to written premiums
Term
16. Investment Yield Ratio
Definition
16. A profitability ratio that indicates the total return on investments for an insurer's investment operations.
Term
17. Return on Policyholder's Surplus
Definition
17. A profitability ratio that shows the rate of return an insurer is earning on its resources.
Term
18. Accounts receivable turnover ratio
Definition
18. An efficiency ratio that includes how quickly a business collects the amounts owed by its customers
Term
19. Days sales outstanding
Definition
19. A measure of the number of days it takes, on average, for a company to collect its accounts receivable
Term
20. Inventory turnover Ratio
Definition
20. An efficiency ratio that indicates howquickly inventory is sold, generating either cash (from cash sales) or accounts receivable (from credit sales)
Term
21. Current Ratio
Definition
21. A liquidity ratio that indicates the adequacy of a company's working capital to meet its current financial obligations
Term
22. Acid Test Ratio
Definition
22. A liquidity ratio that provides a measure of a company's ability to meet its current obligations if itcannot sell its inventory
Term
23. Liquidity Ratio
Definition
23. The ratio insurers use to provide a conservative measure of an insurer's ability to meet its financial obligations
Term
24. Debt-to-equity ratio
Definition
24. A leverage ratio that shows the extent to which a company's assets are financed by debt
Term
25. Debt to assets ratio, or debt ratio
Definition
25. A leverage ratio that shows the extent to which a company's assets are fianced by debt
Term
26. Premium to Surplus Ratio
Definition
26. A leverage ratio that indicates an insurer's financial strength by relating net written premiums to policyholders surplus
Term
27. Reserves to Surplus Ratio
Definition
27. A leverage ratio that provides a measure of an insurer's ability to pay claims out of its reserves
Term
28. Insurance Leverage
Definition
28. An indication of the extent to which policyholders' surplus can support a given level of reserves
Term
1. Id the steps in the financial statement analysis process.
Definition
1. The steps in the financial statement analysis process include the following:
a. establish the goals of the analysis
b. review the financial statements and other info
c. select the appropriate analysis techniques
d. apply the appropriate analysis techniques
Term
2. Describe the goals that guide a financial statement analysis
Definition
2. The goals that guide a financial statement analysis:
a. screening; used to classify a co based on whether the co meets one or more pre-established criteria. Involves a pass-fail analysis focusing on specific financial data, applying pre-established criteria, and eliminating unqualified candidates.
b. Evaluation: May be directed at one or more of a co's areas of operating performance, such as profitibility, liquidity, solvency, or efficiency, or toward a more general evaluation
c. Diagnosis: Attempts to determine thereason for aberrant results in specific individual or related financial accounts. The scope of the analysis is limited to a set of accounts that are related to the results in question, rather than the entire operation of the company.
Term
3. Describe the activities an analyst should perform to draw meaningful conclusions from the review of a company's financial statements.
Definition
3. An analyst should perform the following activities to draw meaningful conclusions from the review of a company's financial statements:
1. examine the auditor's report and any accompanying opinions or modifications
2. Review the accounting policies the company uses to prepare its financial statements
3. Gather background info from trade puiblications and other outside sources.
Term
4. Explain how the following techniques are used to analyze financial statements.
a. common-size statements
b. vertical analysis
c. horizontal analysis.
Definition
4. The following techniques are used to analyze financial statements.
a. common-size statements:
Amts are reported as a percentage of a base figure. This technique is useful when the analysis requires evaluating the relative performance or financial condition of two or more co's, especially when those co's differ greatly in size.
b. vertical analysis - common-size stmts are used to highlight basic relationships among items within a single set of financial stmts. This technique is used to ID expense items that rise more quickly or more slowly than the corresponding change in sales.
c. horizontal analysis: Uses period-to-period percentage changes ID'd in common-size stmts to ID trends. This technique is effective for identifying trends and changes in trends for items such as total assets, sales, or net income.
Term
5. Describe the usefulness of the common-size statement format when performing vertical analysis.
Definition
5. The common-size stmt format is useful in vertical analysis when the analyst intends to make inter-company comparisons because the format eliminates the differences in the sizes or nature of the co's. It also eliminates the effects of inflation when comparisons are made across time.
Term
6. Explain why it is important for the analyst to have an understanding of the co being reviewed using vertical analysis.
Definition
6. It is important for the analyst to have an understanding of the co being reviewed using vertical analysis because companies may have significantly different combinations of assets and liabilities depending on their individual corporate goals.
Term
7. Explain how multiple-period vertical analysis might be helpful to the following insurance professionals:
a. underwriters
b. loss adjustors
Definition
7. multiple-period vertical analysis might be helpful to the following insurance professionals in the following ways:
a. underwriters: can assess an applicants loss exposure to ensure the proper premium is charged.
b. loss adjustors: can estimate the amt of onventory lost by reviewing inventory amts recorded before and after a loss.
Term
8. Describe the following percentage indicators used in analyizing financial statements:
a. gross profit margin
b. net profit margin
Definition
8. The following percentage indicators are used in analyizing financial statements:
a. gross profit margin: used as an indicator of a co's profitibility. It represents the percentage of sales remining after deducting the cost of goods sold.
b. net profit margin: is used as an indicator of overall profitability. It represents the percentage of sales remaining after deducting all expenses.
Term
9. Id capital structure trends an analyst mgiht expect to see when performing vertical analysis of a co implementing a strong growth strategy
Definition
9. An analyst performing vertical analysis of a co implementing a strong growth strategy might expect to see the following capital structures trends:
-changes such as increased long-term debt or increased common stock as a percentage of total assets
-increased operating expenses as a percentage of total sales
-increased amts of property, plant, and equipment as a percentage of total assets.
Term
10. ID the focus of multiple period vertical analysis of financial statements
Definition
10. The focus of multiple period vertical analysis of financial statements is on the composition of assets and liabilities over time are consistent with the co's biz strategy
Term
11. Describe the two methods of conducting borizontal analysis of financial statements
Definition
11.The following are two methods of conducting horizontal analysis of financial statements:
1. year to year analysis: determines the percentage change in values for statement items between consecutive years in the period being considered
2. Base-year-to date analysis: determines the percentage change in stmt item values for each successive year relative to the earliest year of the period under consideration.
Term
12. Id the major income statement components on which the analyst focuses when conducting horizontal analysis.
Definition
12.The major income statement components on which the analyst focuses when conducting horizontal analysis are:
a. sales
b. cost of goods sold
c. gross profit
d. operating expenses
e. net income
Term
13. Describe the following GAAP based ratios used to examine a co's profitability, and indicate how to calculate each:
a. net profit margin
b. return on assets
c. return on equity
d. Dupont Identity
Definition
13. The following GAAP based ratios are used to examine a co's profitability,
a. net profit margin - the amt of each dollar of sales that remains after deducting all the expenses for the accounting period. The higher the percentage, the better the net profit margin. Calculated as follows:
net profit margin = net income/sales
b. return on assets (ROA): A ratio that shows how well a company has used its resources. The higher the ROA, the more efficiently mgmt has used those assets. Calculated as follows:
ROA = net income /total assets
c. return on equity (ROE): a ratio that shows the rate of return owners are eanring on their investment. Calculated as follows:
ROE = net income /owners equity
d. Dupont Identity: analysis of roa and roe by breaking them down into their component ratios. ROA depends on asset turnover and net profit margin. Calculated as follows:
asset turnover x net profit margin = (sales/total assets) x (net income/sales)
= net income /total assets
=return on assets
Term
14. Describe the following SAP-based ratios used to examine a co's profitibility:
a. combined ratio
b. investment yield ratio
c. return on policyholders' surplus
Definition
14.The following SAP-based ratios used to examine a co's profitibility:
a. combined ratio: indicates whether an insurer has experienced an underwriting loss or gain. A combined ratio in excess of 100 percdent indicates an underwriting loss. calculated as follows:
combined ratio = loss ratio + expense ratio
b. investment yield ratio: indicates the total return on investments for an insurer's investment operations. calculated as follows:
investment yield ratio = net investment earnings/invested assets
c. return on policyholders' surplus: shows the rate of return an insurer is earning on its resources. calculated as follows:
return on policyholders' surplus = net income/policyholders surplus
Term
15. Describe the two ways of calculating the expense ratio
Definition
15. The two ways of calculating the expense ratio are as follows:
1. financial basis expense ratio-relates underwriting expenses to earned premiums. calculated as follows:
underwriting expenses/earned premiums
2. trade bais expense ratio-relates underwriting expenses to written premiums. used because SAP requires that costs are expensed as they are incurred. calculated as follows:
underwriting expenses/written premiums
Term
16.Describe two tunrover ratios typically used in GAAP-based efficiency analysis of a noninsurer
Definition
16. The following are two tunrover ratios typically used in GAAP-based efficiency analysis of a noninsurer:
1. Accounts receivable turnover ratio - Indicates how quickly a business collects the amts owed by its customers. Typicallly, a high ratio indicates efficiency. Calculated as follows:
credit sales / accounts receivable
2. Inventory turnover ratio - Indicates how quickly inventory is sold, generating either cash or accounts receivable. A low inventory turnover ratio may indicate inefficiency. Calculated as follows:
cost of goods sold / inventory
Term
17. Explain why evaluating an insurer's liquidity is important and how to calculate the liquidity ratio
Definition
17. Liquidity is a co's ability to convert assets to cash to satisfy its obligations. Evaluating an insurer's liquidity is important because of the regulatory emphasis on maintaining solvency. A value greater than one is considered favorable. Calculated as follows:

Liquidity ratio = (cash + invested assets) / (unearned premium reserve + loss and LAE reserve)
Term
18. Describe the following measures for evaluating a company's financial leverage:
a. debt-to-equity ratio
b. debt-to-assets ratio
c. premium-to-surplus ratio
d. reserves-to-surplus ratio
Definition
18. the following ratios are used to measure leverage:
a. debt-to-equity ratio: measures the extent to which a co is financed by borrowing rather than by using its own funds. A ratio higher than 100 percent indicates that the co is mostly financed by debt. Calculated as follows:

Debt-to-equity ratio = long term debt / owners equity

b. debt-to-assets ratio: shows the extent to which a co's assets are financed by debt. A ratio less than one indicates that the co is financing most of its assets through the equity contributions of its shareholders. Calculated as follows:
Debt-to-assets ratio = total liabilities / total assets
c. premium-to-surplus ratio: Indicates an insurer's financial strength by relating net written premiums to policyholders' surplus. It measures the extent to which a given level of policyholders' surplus can support a given level of premiums. Calculated as follows:

premium-to-surplus ratio = net written premiums / policyholders' surplus
d. reserves-to-surplus ratio - a measure of an insurer's ability to pay claims out of its reserves. Calculated as follows:

reserves-to-surplus ratio = (unearned premium reserve + loss and LAE reserve) / policyholders' surplus
Term
19. Describe the guidelines for determining the importance of specific financial ratios in financial statement analysis.
Definition
19. In financial statement analysis, there are no concrete guidelines for determining the importance of specific financial ratios or at what level they are too high or too low.
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