FINMAN 3

Annual report that publicly
owned corporations must
provide to stockholders; it
summarizes and documents
the firm’s financial activities
during the past year.

the primary communication from management.

It describes the events that are considered to have had the greatest effect on the firm during the year.

the first element of the annual stockholders’ report and the primary communication from management.

ThE FOUR KEY FINANCIAL STATEMENTS

provides a financial summary of the firm’s operating
results during a specified period.

often called earnings before interest and taxes, or EBIT

The dollar amount of cash
distributed during the period
on behalf of each outstanding
share of common stock.

represent the number of dollars earned during the period on behalf of each outstanding share of
common stock

presents a summary statement of the firm’s financial position at a given time

most liquid

least Liquid

represent the total monies owed the firm by its cus-
tomers on credit sales

Net fixed assets represent the difference between gross fixed assets and accumulated depreciation, the total expense recorded for the depreciation of fixed assets.

The net value of fixed assets is called their

As is customary, the assets are listed from the most liquid—cash—down to the least liquid.

amounts owed for credit purchases by the firm

Marketable securities are very liquid short-term investments, such as U.S. Treasury bills or certificates of deposit, held by the firm.

outstanding short-term loans, typically
from commercial banks

amounts owed for services for which a bill
may not or will not be received

represents debt for which payment is not due in the current year.

represents the owners’ claims on the firm.

entry show the historical proceeds
from the sale of preferred stock

The common stock entry is the par value of common stock

represents the amount of proceeds in excess of the par value received from the original sale of common stock.

The sum of the common stock
and paid-in capital accounts divided by the number of shares outstanding represents the original price per share received by the firm on a single issue of common
stock.

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

reconciles the net income earned during a given year, and any cash dividends paid, with the change in retained earnings between the start and
the end of that year.

cash dividends paid, with the change in retained earnings between the start and
the end of that year.

Provides a summary of the firm’s operating, investment, and financing cash flows and
reconciles them with changes in its cash and marketable securities during the period

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.

involves methods of calculating and interpreting financial ratios to analyze and monitor the firm’s performance

The firm’s creditors are interested primarily in the short-term liquidity of the company and its ability to make interest and principal payments. T or F

A secondary concern of creditors is the firm’s profitability; they want assurance that
the business is healthy. T or F

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

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

Evaluation of the firm’s financial
performance over time using
financial ratio analysis.

The most informative approach to ratio analysis combines cross-sectional and
time-series analyses. t or f

A combined view makes it possible to assess the trend in the behavior of the ratio in relation to the trend for the industry.

Ratios that reveal large deviations from the norm merely indicate the possibility of a problem. Additional analysis is typically needed to determine whether there is a problem and to isolate the causes of the problem.

A single ratio does not generally provide sufficient information from which to judge the overall performance of the firm. However, if an analysis is concerned only with certain specific aspects of a firm’s financial position, one or two ratios may suffice.

The ratios being compared should be calculated using financial statements dated at the same point in time during the year. If they are not, the effects of
seasonality may produce erroneous conclusions and decisions

It is preferable to use audited financial statements for ratio analysis. If they have not been audited, the data in them may not reflect the firm’s true financial condition.

The financial data being compared should have been developed in the same way. The use of differing accounting treatments—especially relative to inven-
tory and depreciation—can distort the results of ratio comparisons, regardless of whether cross-sectional or time-series analysis is used.

Liquidity, activity, and debt ratios primarily measure risk.

Profitability ratios measure return. Market
ratios capture both risk and return

A firm’s ability to satisfy its
short-term obligations as they
come due.

refers to the solvency of the firm’s overall financial position, or the ease with which it can pay its bills.

A measure of liquidity
calculated by dividing the firm’s
current assets by its current
liabilities.

one of the most commonly cited financial ratios, measures the firm’s ability to meet its short-term obligations

A higher current ratio indicates a greater degree of liquidity.

A measure of liquidity calculated
by dividing the firm’s current
assets minus inventory by its
current liabilities.

it provides a better measure of overall liquidity only when a firm’s inventory cannot be easily converted into cash.

measure the speed with which various accounts are converted into sales or cash, or inflows or outflows.

activity ratios measure how efficiently a firm operates along a variety of dimensions such as inventory management, disbursements, and collections. t or f

commonly measures the activity, or liquidity, of a firm’s inventory

Another inventory activity ratio measures how many days of inventory the firm has on hand

The average amount of time
needed to collect accounts
receivable.

The average amount of time
needed to pay accounts
payable.

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

The debt position of a firm indicates the amount of other people’s money being
used to generate profits. t or f

the financial analyst is most concerned with
long-term debts because these commit the firm to a stream of contractual payments over the long run. t or f

The more debt a firm has, the greater its risk of being
unable to meet its contractual debt payments. t or f

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

Measures the amount of debt
relative to other significant
balance sheet amounts.

The ability of a firm to make
the payments required on a
scheduled basis over the life
of a debt.

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

measures the proportion of total assets financed by the firm’s creditors.

The higher this ratio, the greater the amount of other people’s money being used to generate profits. t or f

Measures the relative
proportion of total liabilities
and common stock equity used
to finance the firm’s total
assets.

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

in the time ineterest earned ratio the higher its value, the better able the firm is to fulfill its interest obligations. t or f

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

A useful tool for evaluating profitability in relation to sales is the

An income statement in which
each item is expressed as a
percentage of sales.

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

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.

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

The net profit margin is a commonly cited measure of the firm’s success with re-
spect to earnings on sales. t or f

generally of interest to present or prospec-
tive stockholders and management

often called the return on investment (ROI

measures the overall effectiveness of management in generating profits with its
available assets.

The higher the firm’s return on total assets, the better. t of F

measures the return earned on the common stock-
holders’ investment in the firm.

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

commonly used to assess the owners’ appraisal
of share value.

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. t or f

provides an assessment of how investors view the
firm’s performance. It relates the market value of the firm’s shares to its book—
strict accounting—value

“Cash is king” is an old saying in finance. t of f

the lifeblood of the firm, is
the primary ingredient in any financial valuation model.

A portion of the costs of fixed
assets charged against annual
revenues over time.

the depreciable value of an asset (the
amount to be depreciated) is its full cost, including outlays for installation. t or f

The time period over which an asset is depreciated is called

The shorter the depreciable life, the larger the annual depreciation deductions
will be, and the larger will be the tax savings associated with those deductions, all
other things being equal.

The appropriate depreciable
life of a particular asset as
determined by MACRS.

Cash flows directly related to
sale and production of the
firm’s products and services.

Cash flows associated with
purchase and sale of both
fixed assets and equity
investments in other firms.

Cash flows that result from
debt and equity financing
transactions; include
incurrence and repayment of
debt, cash inflow from the sale
of stock, and cash outflows
to repurchase stock or pay
cash dividends.

A decrease in an asset, such as the firm’s cash balance, is an inflow of cash. t or f

is a noncash charge,

An expense that is deducted on
the income statement but does
not involve the actual outlay of
cash during the period;
includes depreciation,
amortization, and depletion

Because depreciation is treated as a separate cash inflow, only gross rather
than net changes in fixed assets appear on the statement of cash flows. t or f

The change in net fixed assets is equal to the change in gross fixed assets minus
the depreciation charge. t or f

Direct entries of changes in retained earnings are not included on the state-
ment of cash flows. t or f

The cash flow a firm generates
from its normal operations;
calculated as net operating
profits after taxes (NOPAT)
plus depreciation.

The amount of cash flow
available to investors (creditors
and owners) after the firm has
met all operating needs and
paid for investments in net
fixed assets and net current
assets.

Planning that begins with
long-term, or strategic,
financial plans that in turn
guide the formulation of
short-term, or operating,
plans and budgets.

Plans that lay out a company’s
planned financial actions and
the anticipated impact of those
actions over periods ranging
from 2 to 10 years.

Specify short-term financial ac-
tions and the anticipated im-
pact of those actions.

A statement of the firm’s
planned inflows and outflows
of cash that is used to estimate
its short-term cash
requirements.

The key input to the short-term financial planning process is the firm’s sales
forecast. t or f

The prediction of the firm’s
sales over a given period,
based on external and/or
internal data; used as the key
input to the short-term financial
planning process.

A sales forecast based on the
relationships observed between
the firm’s sales and certain key
external economic indicators.

A sales forecast based on a
buildup, or consensus, of sales
forecasts through the firm’s
own sales channels

All of a firm’s inflows of cash
during a given financial period.

All outlays of cash by the firm
during a given financial
period.

The mathematical difference
between the firm’s cash
receipts and its cash
disbursements in each period.

The sum of the firm’s beginning
cash and its net cash flow for
the period.

Amount of funds needed by the
firm if the ending cash for the
period is less than the desired
minimum cash balance; typically
represented by notes payable.

The (excess) amount available
for investment by the firm if the
period’s ending cash is greater
than the desired minimum cash
balance; assumed to be invested
in marketable securities.

The cash budget indicates whether a cash shortage or surplus is expected in each
of the months covered by the forecast. t or f

Projected, or forecast, income
statements and balance sheets

A simple method for
developing the pro forma
income statement; it forecasts
sales and then expresses the
various income statement items
as percentages of projected
sales.

a pro forma income statement constructed using the percentage-of-sales method gener-
ally tends to understate profits when sales are increasing and overstate profits when
sales are decreasing. t or f