8 Introduction to Financial Statement Analysis Free Online FlashCards

What does the income statement report?

It reports revenue, expenses, and profit or loss over a period.

What does the balance sheet show?

It reports assets, liabilities, and owners’ equity at a specific date, following $\text{Assets} = \text{Liabilities} + \text{Equity}$.

What does the statement of cash flows report?

It reports cash movements from operating, investing, and financing activities over a period.

What does the statement of changes in equity explain?

It explains changes in owners’ interests over a period.

Why can a profitable company still have different cash flows?

Under accrual accounting, revenue or expenses may be recorded before cash is received or paid, so profit and cash are not the same.

Why is a financial ratio not a definitive verdict?

Ratios are useful for comparisons over time and with similar businesses, but accounting methods, seasonality, business models, and industry norms affect their meaning.

What does gross profit margin measure?

It is $\frac{\text{Revenue} - \text{Cost of goods sold}}{\text{Revenue}}$; it shows the share of sales remaining after direct costs.

How do operating margin and net profit margin differ?

Operating margin is $\frac{\text{Operating income}}{\text{Revenue}}$; net profit margin is $\frac{\text{Net income}}{\text{Revenue}}$. Net margin includes interest and income taxes.

What does return on assets measure?

Return on assets is $\frac{\text{Net income}}{\text{Average total assets}}$; it indicates how effectively assets generate profit.

What does return on equity measure, and why can a high result mislead?

Return on equity is $\frac{\text{Net income}}{\text{Average owners’ equity}}$. A high result may reflect strong performance, a small equity base, or substantial borrowing.

How do working capital and the current ratio assess liquidity?

Working capital is $\text{Current assets} - \text{Current liabilities}$. The current ratio is $\frac{\text{Current assets}}{\text{Current liabilities}}$, comparing near-term resources with obligations.

What does the quick ratio include and exclude?

It is $\frac{\text{Cash} + \text{Short-term investments} + \text{Accounts receivable}}{\text{Current liabilities}}$. It excludes inventory and other less readily available current assets.