CFA (Chartered Financial Analyst) Financial Statement Analysis Flashcards

24 sample cards from the Financial Statement Analysis deck

Sampled from the end of the deck, so these are different cards from the ones shown on the syllabus page.

1. Define a deferred tax asset (DTA) and give a common cause.

   A DTA arises when taxable income is currently higher than accounting income, so future taxes will be reduced. Common causes: tax loss carryforwards, or expenses (e.g., warranty provisions) recognized for accounting before they are deductible for tax.

2. What is a valuation allowance for deferred tax assets?

   Under US GAAP, a contra-account that reduces a DTA to the amount that is more likely than not to be realized. Under IFRS, the DTA is recognized only to the extent realization is probable (no separate allowance account).

3. How is income tax expense related to taxes payable and deferred taxes?

   $$\text{Income tax expense} = \text{Taxes payable} + \Delta\text{DTL} - \Delta\text{DTA}$$ It equals current tax plus the net change in deferred tax balances.

4. Define the statutory tax rate and the effective tax rate.

   The statutory tax rate is the legally enacted corporate income tax rate in the jurisdiction. The effective tax rate is the actual rate borne: $$\text{Effective tax rate} = \frac{\text{Income tax expense}}{\text{Pre-tax income}}$$

5. Name two reasons the effective tax rate may differ from the statutory tax rate.

   Permanent differences (e.g., tax-exempt income, non-deductible expenses), tax credits, different tax rates across jurisdictions (foreign operations), and changes in valuation allowances or enacted tax rates.

6. How is the carrying value of a bond issued at a discount accounted for using the effective interest method?

   Interest expense = beginning carrying value × market (effective) rate at issuance. The discount amortizes as the difference between interest expense and the coupon cash paid, increasing carrying value toward par over time.

7. Under the current lease standards, how does a lessee account for a lease (IFRS 16 / ASC 842)?

   The lessee recognizes a right-of-use (ROU) asset and a lease liability on the balance sheet. Under IFRS 16, nearly all leases are treated as finance-type (amortization + interest). Under US GAAP, leases are classified as finance or operating, affecting the income-statement pattern.

8. Contrast the income-statement effects of a finance lease versus an operating lease (US GAAP).

   Finance lease: separate amortization of the ROU asset plus interest expense — front-loaded total expense. Operating lease: a single straight-line lease expense. Both report an ROU asset and lease liability on the balance sheet.

9. What is the purpose of ratio analysis in financial statement analysis?

   To standardize financial data so a company's performance and financial condition can be evaluated over time (trend analysis) and compared against peers or industry benchmarks (cross-sectional analysis).

10. Write the formulas for the current ratio and the quick (acid-test) ratio.

    $$\text{Current ratio} = \frac{\text{Current assets}}{\text{Current liabilities}}$$ $$\text{Quick ratio} = \frac{\text{Cash} + \text{Marketable securities} + \text{Receivables}}{\text{Current liabilities}}$$

11. Define the inventory turnover ratio and days of inventory on hand (DOH).

    $$\text{Inventory turnover} = \frac{\text{COGS}}{\text{Average inventory}}$$ $$\text{DOH} = \frac{365}{\text{Inventory turnover}}$$

12. Write the formula for receivables turnover and days of sales outstanding (DSO).

    $$\text{Receivables turnover} = \frac{\text{Revenue}}{\text{Average receivables}}$$ $$\text{DSO} = \frac{365}{\text{Receivables turnover}}$$

13. Define the cash conversion cycle (net operating cycle).

    $$\text{Cash conversion cycle} = \text{DOH} + \text{DSO} - \text{Days payable outstanding}$$ It measures the time between cash outlay for inputs and cash collection from sales.

14. Write the debt-to-equity and interest coverage (times interest earned) ratios.

    $$\text{Debt-to-equity} = \frac{\text{Total debt}}{\text{Total shareholders' equity}}$$ $$\text{Interest coverage} = \frac{\text{EBIT}}{\text{Interest expense}}$$

15. Define net profit margin, return on assets (ROA), and return on equity (ROE).

    $$\text{Net profit margin} = \frac{\text{Net income}}{\text{Revenue}}, \quad \text{ROA} = \frac{\text{Net income}}{\text{Average total assets}}, \quad \text{ROE} = \frac{\text{Net income}}{\text{Average equity}}$$

16. State the three-part (traditional) DuPont decomposition of ROE.

    $$\text{ROE} = \underbrace{\frac{\text{Net income}}{\text{Revenue}}}_{\text{Net profit margin}} \times \underbrace{\frac{\text{Revenue}}{\text{Avg assets}}}_{\text{Asset turnover}} \times \underbrace{\frac{\text{Avg assets}}{\text{Avg equity}}}_{\text{Financial leverage}}$$

17. State the five-part (extended) DuPont decomposition of ROE.

    $$\text{ROE} = \frac{\text{NI}}{\text{EBT}} \times \frac{\text{EBT}}{\text{EBIT}} \times \frac{\text{EBIT}}{\text{Revenue}} \times \frac{\text{Revenue}}{\text{Avg assets}} \times \frac{\text{Avg assets}}{\text{Avg equity}}$$ i.e., tax burden × interest burden × EBIT margin × asset turnover × leverage.

18. Explain vertical and horizontal common-size analysis.

    Vertical common-size: each line item is expressed as a percentage of a base (income-statement items as % of revenue; balance-sheet items as % of total assets). Horizontal common-size: each item is expressed relative to a base-year value to show growth/trends over time.

19. What is segment reporting and why is it useful to analysts?

    Companies disclose financial information (revenue, profit, assets) for operating segments — business or geographic units evaluated by management. It lets analysts assess the performance, growth, and risk of distinct parts of a diversified company separately.

20. What does 'financial reporting quality' encompass, and how does it differ from earnings quality?

    Reporting quality refers to the decision-usefulness of the information — whether it is relevant and faithfully represents economics (GAAP-compliant, complete, unbiased). Earnings (results) quality refers to whether the reported earnings are high, sustainable, and provide an adequate return — i.e., the quality of the underlying performance itself.

21. Name common warning signs (red flags) of earnings manipulation.

    Growing gap between net income and operating cash flow; rising receivables or inventory faster than sales; frequent one-time/non-recurring charges; aggressive revenue recognition; capitalizing costs that should be expensed; and frequent changes in accounting estimates or auditors.

22. How can accruals be used to assess earnings quality?

    High accruals (the difference between accrual-based earnings and cash flow) relative to assets suggest lower-quality, less persistent earnings. $$\text{Accruals ratio} \approx \frac{\text{Net income} - \text{(CFO} + \text{CFI)}}{\text{Average net operating assets}}$$ Lower accruals generally signal higher earnings quality.

23. What are the main steps in building a financial forecast for a company?

    Forecast revenue (often top-down or bottom-up with a growth rate), then project margins/expenses, working capital and capital expenditures, financing and capital structure, and finally derive projected income statement, balance sheet, and cash flows — checking that the model articulates (balances).

24. In credit analysis versus equity analysis, what is the primary focus of each?

    Credit analysis focuses on a borrower's ability to service and repay debt — emphasizing solvency, leverage, interest coverage, and cash flow stability (downside/default risk). Equity analysis focuses on value creation and growth — profitability, returns (ROE), and future cash flow/earnings potential (upside).

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Financial Statement Analysis flashcards FAQ