D367 Innovation in Finance - Set 5 - Part 1

Correct Answer: The difference between a company’s current assets and current liabilities

Working capital represents a company’s ability to cover its short-term obligations and maintain liquidity for day-to-day operations.

Correct Answer: To project a company’s future financial position

Pro forma financial statements are used to estimate a company’s future financial condition by forecasting expected revenues, expenses, and cash flows.

Correct Answer: The proportion of a company’s assets financed by debt

The debt ratio is a financial metric that compares a company’s total debt to its total assets, indicating the extent to which the company is financed through debt.

Correct Answer: To increase the company’s earnings by using debt

Financial leverage involves using borrowed funds to increase potential returns on equity, with the aim of amplifying profits.

Correct Answer: To break down return on equity into its components

The DuPont analysis separates return on equity into three key components: net profit margin, asset turnover, and financial leverage, providing insight into the factors driving a company’s profitability.

Correct Answer: A ratio that assesses a company’s ability to pay its short-term obligations

Liquidity ratios, such as the current ratio and quick ratio, indicate how easily a company can convert assets into cash to meet its short-term liabilities.

Correct Answer: Gross margin is calculated as revenue minus cost of goods sold, while net margin is calculated as net income divided by revenue

Gross margin measures profitability before operating expenses, while net margin measures profitability after all expenses, including taxes.

Correct Answer: The company’s ability to pay its short-term obligations with its current assets

The current ratio compares a company’s current assets to its current liabilities, providing insight into its short-term liquidity.

Correct Answer: The mix of a company’s debt and equity financing

Capital structure refers to the way a company finances its operations, typically through a combination of debt (loans, bonds) and equity (stock).

Correct Answer: The discount rate that makes the net present value of a project equal to zero

The internal rate of return is used to evaluate the profitability of potential investments, with a higher IRR indicating a more favorable investment opportunity.

Correct Answer: The ratio of net income to total assets

Return on assets measures how efficiently a company uses its assets to generate profit, indicating overall operational efficiency.

Correct Answer: The ratio of a company’s stock price to its revenue per share

The P/S ratio helps investors evaluate a company’s stock price relative to its revenue, providing insight into how much investors are willing to pay for each dollar of sales.

Correct Answer: The amount of debt used to finance a company’s assets

Financial gearing refers to the use of debt (borrowed funds) in a company’s capital structure, which can amplify both potential returns and risks.

Correct Answer: Income generated from operating activities before interest and taxes are deducted

EBIT is a measure of a company’s profitability from core operations, excluding the effects of interest payments and taxes.

Correct Answer: How efficiently a company uses its assets to generate sales

The asset turnover ratio measures a company’s ability to generate sales from its assets, indicating how efficiently its resources are being utilized.

Correct Answer: To allocate the cost of an asset over its useful life

Depreciation spreads the cost of a tangible asset over its useful life, reflecting the asset’s gradual decrease in value due to wear and tear.

Correct Answer: A measure of a company’s total assets divided by total equity

The equity multiplier is a financial leverage ratio that shows how much of a company’s assets are financed by shareholders’ equity, with higher values indicating greater reliance on debt.

Correct Answer: The length of time required to recover the initial investment in a project

The payback method is a simple capital budgeting technique used to determine how long it will take for an investment to generate enough cash flow to recover the initial cost.

Correct Answer: The ratio of a company’s net income to its number of outstanding shares

Earnings per share represent the portion of a company’s profit allocated to each outstanding share of common stock, serving as an indicator of a company’s profitability.

Correct Answer: To project a company’s future cash flows and financial health

Financial forecasting helps businesses predict future revenues, expenses, and cash flows, allowing for better planning and decision-making.