Significance of ratio analysis
The ratio analysis is the most important tools of financial analysis. The various groups of people having different interest are interested in analyzing the financial information. The importance of ratio analysis can be summarized for various groups of peoples vested with the diversified interests are as under:
For short term creditors The short term creditors like bankers and suppliers of materials can determine the firms ability to meet its current obligation with the help of liquidity ratio and quick ratio.
For long term creditors The long term creditors like debenture holders and financial institutions can determine the firms long term financial strength and survival with the help of leverage or capital structure ratio as debt equity ratio.
For the management The management can determine the operating efficiency with the firm is utilizing its various in generating the sales revenues with the help of activity ratio such as capital turnover ratio, stock turnover ratio, etc
For investors The investor can determine the magnitude and direction of the movements in firms earning with the help of profitability ratio such as earning per share etc
However, there is no generally used list of ratios that could be applied to any company
Principal elements of financial statements
Balance sheet
Income statement
Statement of cash flows
Statement of stockholders equity
Collectively, these interrelated financial statements provide relevant and timely information about the past and are essential for making crucial business decisions about investment or financing activities today and in the future.
Financial statements are a key component to build trust in the financial community.
7.P/Y=4; n=6*4=24; i=18%; PMT=0; FV=45000
8. FV5=PV(1+i)n=25000*(1+0.09)5 = 38500 (may be, by my calculations)
Part 2
l 15. cash flow is the real measure of a firms performance and is the measure by which the financial markets value a firm. Cash flow is the movement of money into or out of a business, project, or financial product. It is usually measured during a specified, finite period of time.
There are two dimensions to cash flow, cash inflows and cash outflows, and cash flow management involves the effective management of both. An organization's cash flows will arise as a result of operating, investing and financing activities
l Cash flow=Operating profit+depreciation other non-cash items
14. Risk is central to an understanding of modern financial management.
When considering a prospective investment the financial manager, or any rational investor, will be concerned not only with the volume and timing of its expected future cash flows but also with their riskiness.
n In the most basic sense, risk is the chance of financial loss.
Event risk, exchange rate risk, purchasing power risk, tax risk.
4. To broaden their markets- After a company has saturated its home market, growth opportunities are often better in foreign markets.
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n Thus, such US homegrown firms as Coca-Cola and McDonalds are aggressively expanding into overseas markets, and foreign firms such as Sony and Toshiba now dominate the U.S. consumer electronics market.
n Also, as products become more complex, and development becomes more expensive, it is necessary to sell more units to cover overhead costs, so larger markets are critical.
n Thus, movie companies have gone global to get the volume necessary to support pictures such as Titanic.
7. This transaction did not involve a promissory note. As a result, this transaction is recorded in your companys general ledger account Accounts Payable.
Accounts receivable also known as Debtors, is money owed to a business by its clients (customers) and shown on its Balance Sheet as an asset. It is one of a series of accounting transactions dealing with the billing of a customer for goods and services that the customer has ordered
11. Understocking
Cannot cope with unexpected changes in demand
Production line may have to stop therefore firm is paying an idle labour force
Cannot meet customers orders so they may choose to go elsewhere
Increased administration costs if firm is frequently re-ordering
Overstocking
High costs of storage and maintenance
High insurance costs
Possible need for security measures
Large amount of space needed
Money is tied up in stock which could be used elsewhere
Stock may deteriorate or become obsolete
Safe disposal incurs extra cost
n 10. Monthly or annual depreciation, amortization and depletion are used to reduce the book value of assets over time as they are "consumed" or used up in the process of obtaining revenue.
n These non-cash expenses are recorded in the accounting books after a trial balance (a summary of all accounts balances ie, assets, liabilities, equities, revenues and expenses at any given date) is calculated to ensure that cash transactions have been recorded accurately.
n Depreciation is used to record the declining value of buildings and equipment over time. Land is not depreciated.
n Amortization is used to record the declining value of intangible assets such as patents. Depletion is used to record the consumption of natural resources.
n Depletion i s depreciation of wasting assets such as mines, oil wells, timber trees etc.
n 9. The difference between a zero-coupon bond and a regular bond is that a zero-coupon bond does not pay coupons, or interest payments, to the bondholder while a typical bond does make these interest payments.
1. A bond rating is an assessment of the creditworthiness of the issuer. Major rating services include Standard & Poors Corporation (S&P), Moodys Investors Service, Inc. (Moodys), and Fitch.
The purpose of bond ratings is to help investors assess default risk, which is the possibility that the issuer will fail to meet its obligations as specified in the indenture.
2. Five Cs of Credit
Credit analysts generally consider five factors when determining whether to grant credit including character, capacity, capital, collateral, and conditions.
Character involves the customers willingness to pay off debts. It is usually the most important aspect of credit analysis. An applicants prior payment history is generally the best indicator of character.
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Capacity represents the customers ability to meet its obligations. Firms granting credit typically measure capacity by looking at the customers liquidity ratios (such as Quick Ratio, Current Ratio and Debt to Equity Ratio) and cash flow from operations. If meeting obligations from cash flow from operations appears weak, the credit granting firm may then look to the customers capital.
Capital refers to the relative amounts of the customers debt and equity financing. Credit granting firms often consider the customers debt-to-equity ratio and times interest earned ratio (TIER).
Collateral refers to the customers assets that are available for use in securing the credit. The more valuable the collateral, the lower will be the credit risk.
It is obvious, that the interest rate is lower when a collateral exists.
The second important remark is that the lower is the amount of loan in relation to the value of the collateral, the lower should be the interest rate.
Conditions refer to the impact of economic trends that may affect the customers ability to repay debts. A firm that is marginally able to repay its debts in a normal or strong economy may be unable to do so during an economic downturn.
n 3. Systematic Risk - These are market risks that cannot be diversified away. Interest rates, recessions and wars are examples of systematic risks.
Unsystematic Risk - Also known as "specific risk", this risk is specific to individual stocks and can be diversified away as you increase the number of stocks in your portfolio
