Chapter 3
Analyzing Financial Statements
By Boundless
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The operating margin is a ratio that determines how much money a company is actually making in profit and equals operating income divided by revenue.
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Profit margin measures the amount of profit a company earns from its sales and is calculated by dividing profit (gross or net) by sales.
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The return on assets ratio (ROA) measures how effectively assets are being used for generating profit.
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The Basic Earning Power ratio (BEP) is Earnings Before Interest and Taxes (EBIT) divided by Total Assets.
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Return on equity (ROE) measures how effective a company is at using its equity to generate income and is calculated by dividing net profit by total equity.
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Inventory turnover is a measure of the number of times inventory is sold or used in a time period, such as a year.
Days sales outstanding (also called DSO or days receivables) is a calculation used by a company to estimate their average collection period.
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Fixed-asset turnover is the ratio of sales to value of fixed assets, indicating how well the business uses fixed assets to generate sales.
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Total asset turnover is a financial ratio that measures the efficiency of a company's use of its assets in generating sales revenue.
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Current ratio is a financial ratio that measures whether or not a firm has enough resources to pay its debts over the next 12 months.
The Acid Test or Quick Ratio measures the ability of a company to use its assets to retire its current liabilities immediately.
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The DuPont equation is an expression which breaks return on equity down into three parts: profit margin, asset turnover, and leverage.
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Return on equity measures the rate of return on the ownership interest of a business and is irrelevant if earnings are not reinvested or distributed.
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Sustainable-- as opposed to internal-- growth gives a company a better idea of its growth rate while keeping in line with financial policy.
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The dividend payout and retention ratios offer insight into how much of a firm's profit is distributed to shareholders versus retained.
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Return on assets is a component of return on equity, both of which can be used to calculate a company's rate of growth.
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With a few exceptions, the majority of the data used in ratio analysis comes from evaluation of the financial statements.
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While ratio analysis can be quite helpful in comparing companies within an industry, cross-industry comparisons should be done with caution.
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Comparing the financial ratios of a company to those of the top performer in its class is a type of benchmarking.
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Trend analysis consists of using ratios to compare company performance on an indicator over time, often to forecast or inform future events.
Financial statement analyses can yield a limited view of a company because of accounting, market, and management related limitations of such analyses.
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General price level changes creates distortions in financial statements. Inflation accounting is used in countries with high inflation.
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Disinflation is a decrease in the inflation rate; a slowdown in the rate of increase of the general price level of goods, services.
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Deflation is a decrease in the general price level of goods and services and occurs when the inflation rate falls below 0%.