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Accounting Test 2
Terms in this set (71)
Three Financial Statements Together
1. Balance Sheet
2. Income Statement
3. Statement of Cash Flow
Mangerial Discussion Analysis
There are no correct set of ranges for ratios
Each businessess and industries are unique
What is their business model?
*Weigh many metrics (ratios) together
*Compare to past performance & industry/competitor benchmarks
Return on Investment
Statement that is the end result, not the cause of success or failure.
*You can't measure everything in financial statements
If you focus solely on financial statements
1. You won't see what's coming because financial statements are based on the past.
2. Focusing on short-term at the expense of long-term.
Financial (Balance Scorecard)
Financial statements and ratios
Customers (Balance Scorecard)
Marketshare; customer satifaction,customer retention, and branding.
*When customers are happy it translate to financial success.
Internal Business Processes (Balance Scorecard)
* What must we do right to succeed.
*Determine key processes and improve on themm (e.g. % defects, wrranty returns, lead time on delivery times, and R&D effort).
Learning and Growth (Balance Scorecard)
* Focus on long-term strategy
Three things to invest in
2. IT systems (upgrade)
3. Organizational structure
* Focus on growth
- growing sales and market
- use more cash than you generate = lower profits and high capital and expenditures, high debt and lower cash flow.
*Focus on maintaining profitability and maintaining strong cash flow.
* Strong profit
* Moderate and high capital investment.
* Focus on maintaining cash flow and minimize investments.
* Strong profit and cash flow.
* Low debt and low capital investment
* How organizations financed in the past (last 5 yrs)?
* Has it relied heavily on debt to keep running?
* Has it sold shares in its business to investors?
* Has it been able to generate its own money?
* Are there any restrictive debt convenants or shareholder obligations that could impact the organization?
Terms of Loan
* Outstanding debt?
* What are the terms of the debt?
* When is it payable?
* When do they project they will retire the debt?
* Who is the debt payable to?
Distribution to owners
* What is the organizations philosophy on sharing the wealth?
Age and types of payables
* Who do they owe money to?
* Who are their vendors?
* Have they established credit with these vendors?
Age and types of Receivables
* Who owes the organization money?
* What is the mix of repeat vs. new customers?
* Who are the main customers and do they have good credit?
* How long are receivables outstanding?
Age and types of Inventory
* Does the organization hold a large amount of inventory?
* How old is the inventory?
* How quickly does the customer receive its product?
* Does it impact inventory levels?
Details on cash-a cash flow statement
* What do they do with there extra cash?
* Do they invest it or distribute it to owners?
* What do they invest in?
Details on income-an income statement
* Get an audited income statement
* What was the gross sales figure?
* How much gross sales did they get to keep?
* What are the expenses?
* Who are the main competitors?
* Get as much finanacial data on the competitor.
* Get information to benchmark against.
Information on steady customers and steady vendors
* Who are the signifcant vendors and customers?
* How is their industry fairing?
* Does the customer rely heavily on one customer or vendor?
Factors that dictate the success of the entity
* Why is the organization successful?
* How well is the organization doing at focusing on its success factors?
Audited financial statements
* More reliable than unaudited financial statements
Business plan or Strategic plan
* Long- term strategies that drive the company and guides it leaders and employees.
Budget or Standard to compare against
* Future plans of the organization into financial terms.
* Can tell a lot about the compnay priorities.
Step 1: Consider the perspective of the users of you story
* What questions would they like your story to answer?
* The answers would dictate what metrics to run.
* Profitability and ROI.
* How well working capital is being managed.
* Can they repay debt?
Step 2: Gain understanding of environmental and market trends
* Do research outside the financial statements
* The MDA section of the 10-K gives you clues about what is going on in the market.
* Who are the competitors?
* Are the customers satisfied with the timeliness of service or product delivery?
* Is the demand for its product or service declining or increasing?
Step 3: Determine what you think the financials should look like
* Want to envision and physically sketch out what the BS, IS, and CFS should look like.
* How financially healthy is the entity?
* What would happen in case of liquidation?
* Who owns the business?
* How profitable is the company?
Step 4: Run a flux analysis on the financial statements-both horizontal and common size.
* One of the best financial analysis tools around
* Stack up key numbers side by side and see how they behave over time.
Common Size Analysis
* Turn everything in percentage
* Pie chart analysis
* Balance Statement
- % of total sales; total assets on the left side & total liabilities on the right side
* Income Statement % of total revenue
* Choose one year as a base year and every other year is fluctuated off that year
Step 5: Decide which ratios are meaningful to the organization
* Choose at least 5 ratios from each category
- liquidity ratios: does the entity have enough liquid resources to cover its obligations?
- profitability ratio: What kind of return the organization bring for its owner?.
-financing ratios: tell us how the organization is getting resources to operate
*Calculate them for the past three years
Step 6: Investigate
* Investigate why the numbers look like they do?
* Hard to get a root cause of an issue
Step 7: Make general conclusions about liquidity, profitability, and financing
* Highlight both positive and negative trends
* Run more ratios if necessary
* Document conclusions
Step 8: Compare the benchmarks
* Must compare them against something else:
- industry averages
- past history
Problems with Benchmarking
* he company is part of a conglomerate and its financial results are impossible to separate from the mother company.
* The company use different accounting policies, might use LIFO instead of FIFO
* The company is a different size
* The company calculates its metrics differently, there is no GAAP for financial ratios.
* The company delays publications of results or does not publish at all.
* The company likes to dress up its financial results
Step 9: Represent these conclusions graphically and narratively
* Create a report to summarize your conclusions
Step 10: Consider making recommendations for improvements
* Point out weaknesses and make recommendations for improvement.
* How much are of our sales are left?
Sales -(COGS)=Gross Profit (Margin)-(Oper. Exp)=Oper Inc.-(taxes and interest)=Net Income
Net Income/Net Sales (Higher is better)
Gross Profit Margin (Gross Profit %)
Gross Profit (Margin)/Net Sales (Higher is better)
* Comparing profits earned to the resources used to generate them.
* Resources as little as possible
* Generating a big return as possible
Net Income/Average total assets (Higher is better)
Income Statement and Balance Sheet Ratios
* IS/IS: over the entire period (Higher is better)
* BS/BS: at the end of the period
Income statement/Average Balance Sheet
* Prior year (beginning)+Current year (ending Bal)/2
Return on Investment (ROI)
Net Income/Av. long term debt+average equity (Higher is better)
Return on Equity
* Owner investment and retained earnings
Net Income/Average Equity
Earnings per Share (EPS)
* Income available to Common Stockholders
(Net Income)-(Preferred Dividends)/Avg. number of shares Common Stock Outstanding
Price to Earnings Ratio
* What multiple of earnings is the market willing to pay?
Market Price per share (Common Stock)/Earnings per Share (EPs) ratio
* Can we generate cash fast enough to cover liabilities due in the short run (1yr or less)
-no = bankruptcy
Current Assets & Current Liabilities
* CA: Earn within a year
- Cash, AR, Inventory, Prepaid Expenses
*CL: Pay within a year
- AP, Acc Expenses, Unearned revenue
Net Working Capital
* Current Assets - Current Liabilities = Working Capital
* Positive, but small
* How much resources we have tied up in daily operations
* Current Assets/Current Liabilities
* Very close to 1
* Close to 2 is traditional
Quick Ratios (Acid Test)
(Cash) + (Marketable Securities) + (Accts Rec.)/Current Liabilities
Days Supply of Inventory
* How many days of inventory do we have on hand?
* How much cash is tied up in inventory?
Average Inventory/(COGS/365) (Lower is better)
Days Receiving Outstanding (Days of Sales OS)
* How long to collect from customers?
Average Accts Rec/(Sales/365) (Lower is better)
Days Payable Outstanding
* How long do we take to pay our suppliers?
Avg. Payables/(Sales/365) (Higher is better)
* How many das does it take us to buy inventory, pay for it, and collect our cash?
Days Supply of Inventory + Days Rec. Outstanding - Days Pay Outstanding = Cash Conversion Cycle (Lower is better)
* How many times do we buy and sell inventory in a year?
COGS/Avg. Inventory (Higher is better)
Accounts Receivable Turnover
* How many times did we sale and collect our acct. rec.
Sales/Avg. Accts. Rec.
Percent Uncollectible (Bad debt percentage)
Allowance for Doubtful Accts. (AFDA) on (Balance Sheet)/Gross Acct. Rec
* Balance sheet shows net Accts. Rec.
Operating Cash Flows
* Cash from operations exceed Net Income
* Bought and sold investments in other organizations
* Invested in fixed assets and rainy day cash
* Use some of its cash to buy back stock, (their own stock)
Operating Cash Index
* Are we collecting on our cash?
Cash Flow from Operations/Net Income (Higher)
Cash Flow Index
* Are we generating enough cash to cover Short term debt/obligations?
Cash Flow from Operations/Net Income (Higher)
Cash Flow Adequacy Ratio
* Is cash flow from selling our product or services enough to get us the extra goodies we need to grow and keep our investors happy?
CF Operations/Capital Invest. + inventory additions + dividends + debt uses
* Found on Statement of Cash Flows
Percentage of Fixed Assets Depreciation
* How old are our fixed assets?
* Is there a need for big capital expenditure I the future?
Accumulated Depreciation/Gross Depreciable Fixed Assets
*Net of Fixed Assets + Acc. Dep. - Land = Gross Dep. FA
* Lower is newer
* Higher is older
Debt to Equity
Total Liability/Total Assets
* % of assets financed through debt (Lower)
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