Transcript Chapter 1

Part 6
Financing the
Enterprise
© 2015 McGraw-Hill Education.
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CHAPTER 14
Accounting and Financial Statements
CHAPTER 15
Money and the Financial System
CHAPTER 16
Financial Management and Securities Markets
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Learning Objectives
LO 14-1 Define accounting and describe the different uses of
accounting information.
LO 14-2 Demonstrate the accounting process.
LO 14-3 Examine the various components of an income
statement to evaluate a firm’s bottom line.
LO 14-4 Interpret a company’s balance sheet to determine its
current financial position.
LO 14-5 Analyze the statement of cash flows to evaluate the
increase and decrease in a company’s cash balance.
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The Nature of Accounting
Accounting
• The recording, measurement and interpretation of
financial information
Certified Public Accountant
(CPA)
• An individual who has been
state certified to provide
accounting services ranging
from the preparation of financial
records and the filing of tax
returns to complex audits of
corporate financial records
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Accountants
After the accounting scandals of Enron and Worldcom in
the early 2000’s, Congress passed the:
• Sarbanes-Oxley Act – required firms to be more
rigorous in their accounting and reporting practices
During the latest financial crisis, banks developed
questionable lending practices, leading to:
• Dodd Frank Act – strengthens the oversight of financial
institutions
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Accountants
Private Accountants
• Employed by large corporations, government
agencies, and other organizations to prepare and
analyze their financial statements
• Deeply involved in most of the most important
financial decisions of the organization
Certified Management Accountants (CMAs)
• Private accountants who, after rigorous examination, are
certified by the National Association of Accountants and
who have some managerial responsibility
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Internal Uses of Accounting Information
Managerial Accounting
• The internal use of accounting statements by managers
in planning and directing the organization’s activities
Cash Flow
• The movement of money through an organization
over a daily, weekly, monthly or yearly basis
Budget
• An internal financial plan that forecasts expenses
and income over a set period of time
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External Uses of Accounting Information
Managers use accounting statements to report to outsiders
 Used for filing income taxes, obtaining credit and
reporting results to stockholders
Annual Report
• A summary of a firm’s financial information, products,
and growth plans for owners and potential investors
 Audited financial statements are those signed off
on by a certified public accountant
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The Accounting Equation
Assets = Liabilities + Owner’s Equity
Assets
• A firm’s economic resources, or items of value that it owns,
such as cash, inventory, land, equipment, buildings, and other
tangible and intangible things
Liabilities
• Debts that a firm owes to others
Owners’ Equity
• Equals assets minus liabilities and reflects historical values
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Accounting Standards
 Different entities have different standards for their accounting
methods
 Public and private businesses follow the Generally Accepted
Accounting Principles (GAAP) method

GAAP is generally used in the United States as the standard for
accounting methods (established by the Financial Accounting
Standards Board (FASB))
 Local government entities have a different set of accounting
standards which are set by the Governmental Accounting
Standards Board (GASB)
 Federal government follows yet another set of standards
determined by the Federal Accounting Standards Advisory Board
(FASAB)
 Another set of standards for international companies which
follow the International Financial Reporting Standards (IFRS)
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Double-Entry Bookkeeping
Double-Entry Bookkeeping
• A system of recording and classifying business transactions
that maintains the balance of the accounting equation
Balance
Classification
Break Down
• To keep the
accounting equation
in balance, each
transaction must be
recorded in two
separate accounts
• All business
transactions are
classified as either
assets, liabilities, or
owner’s equity
• Most organizations
further break down
these accounts,
such as assets may
be broken down into
cash, inventory and
equipment
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Accounting Cycle
Accounting Cycle
• The four-step procedure of an
accounting system: examining
source documents, recording
transactions in an accounting journal,
posting recorded transactions, and
preparing financial statements
Ledger
Journal
• A time-ordered list of
account transactions
• A book or computer
file with separate
sections for each
account
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Income Statement
Income Statement
• A financial report that shows an organization’s profitability
over a period of time – month, quarter, or year
Revenue
• The total amount of money received from
the sale of goods or services, as well as
from related business activities
Cost of Goods Sold
• The amount of money a firm spent to buy
or produce the products it sold during the
period to which the income statement
applies
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Income Statement
Gross Income (or Profit)
• Revenues minus the cost of goods sold required
to generate the revenues
The income available after paying all expenses of production
Expenses
• The costs incurred in the day-to-day operations of
an organization
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Income Statement
Common expense accounts:
1. Selling, general, and administrative expenses
(including depreciation)
2. Research, development and engineering expenses
3. Interest expenses
Depreciation
• The process of spreading the costs of long-lived
assets such as building and equipment over the total
number of accounting periods in which they are
expected to be used
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Income Statement
Net Income
• The total profit (or loss) after all expenses,
including taxes, have been deducted from
revenue; also called net earnings
 Most companies present the current
year’s results along with the previous
two years’ income statements
 The portion of net income the business
does not keep is what it pays out as
dividends to shareholders
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Balance Sheet
Balance Sheet
• A “snapshot” of an organization’s
financial position at a given moment
•
Shows assets and the funding used to pay for these
assets, such as bank debt or owners’ equity
•
Takes its name from its reliance on the accounting
equation: assets must equal liabilities plus owners’
equity
•
The balance sheet is an accumulation of all financial
transactions since the company’s founding
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Balance Sheet - Assets
Listed in descending order of liquidity – how fast they can be turned into cash
Current Assets
• Assets used or converted into cash within the course of a
calendar year
• Cash, temporary investments, accounts receivable and inventory
Accounts Receivable
• Money owed a company by its clients or customers who have
promised to pay for the products at a later date
Long-term, or fixed assets represent a commitment of funds of at least one year
Items include: long-term investments, plant and equipment, and intangible
assets such as reputation, patents and trademarks
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Balance Sheet - Liabilities
Current Liabilities
• A firm’s financial obligation to short-term creditors,
which must be repaid within one year
Accounts Payable
• The amount a company owes to suppliers for goods
and services purchased with credit
Accrued Expenses
• An account representing all unpaid financial
obligations incurred by the organization
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Pro Forma Financial Statements
Pro forma financial statements are used to make
decisions about future operations changes within a
company
 Include balance sheets, income statements, and cash flow

statements.
When a company is considering a change, composing pro forma
financial statements will show
 Whether profits will increase or decrease
 The magnitude of expenses involved
 Whether the company needs financing to
facilitate the proposed change
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Statement of Cash Flows
Statement of Cash Flows
• Explains how the company’s cash changed from
the beginning of the accounting period to the end
 The balance sheet shows the cash account in one
point of time; most investors want a better picture of
how cash flows into and out of the company
 The statement of cash flows takes the cash balance
from one year’s balance sheet and compares it with
the next while providing detail about how the firm
used the cash
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Statement of Cash Flows
The change in cash is detailed in these three categories
Cash From
Operating
Activities
• Calculated by combining the changes in
the revenue, expense, current assets and
current liability accounts
Cash From
Investing
Activities
• Calculated from changes in the long-term
or fixed asset accounts
Cash From
Financing
Activities
• Calculated from changes in the long-term
liability accounts and the contributed
capital accounts in owners’ equity
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Ratio Analysis
Ratio Analysis
• Calculations that measure an organization’s
financial health
Profitability Ratios
• Ratios measuring the amount of operating income
or net income an organization is able to generate
relative to its assets, owners’ equity, and sales
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Profitability Ratios
Net Income (Net Earnings)
$1,245.7
Profit Margin =
i=i
= 10.65%
Sales (Total Net Revenues)
$11,700.4
So, for every $1 in sales, Starbucks generated
profits after taxes of nearly 11 cents
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Profitability Ratios
Return on Assets =
Net Income (Net Earnings)
$1,245.7
i=i
= 16.92%
Total Assets
$7,360.4
For every $1 in assets, Starbucks generated a return
of close to 17%, or profits of 16.92 cents
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Profitability Ratios
Net Income
$1,245.7
Return on Equity =
i=i
= 28.39%
Stockholders' Equity
$4,387.3
For every $1 invested by Starbucks stockholders, the
company earns 28.39% return, or 28.39 cents
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Asset Utilization Ratios
Asset Utilization Ratios
• Ratios that measure how well a firm uses its
assets to generate each $1 of sales
 Managers use asset utilization ratios to pinpoint
areas of inefficiency in their operations
 These ratios – receivables turnover, inventory
turnover, and total asset turnover – relate balance
sheet assets to sales, which are found on the
income statement
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Asset Utilization Ratios
Sales (Total Net Revenues)
$11,700.4
Receivables Turnover =
i=i
= 30.27 X
Receivables
$386.5
Starbucks collected its receivables a little more than
30 times per year; mainly because most of their sales
are in cash and not credit
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Asset Utilization Ratios
Inventory Turnover =
Sales (Total Net Revenues)
$11,700.4
i=i
= 12.11X
Inventory
$965.8
Starbucks’ inventory turnover indicates they replaced
their inventory 12.11 times last year, or slightly more
than once a month
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Asset Utilization Ratios
Total Asset Turnover =
Sales (Total Net Revenues)
$11,700.40
=
= 1.59X
Total Assets
$7,360.40
Starbucks generated $1.59 in sales for every $1 in
total corporate assets
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Liquidity Ratios
Liquidity Ratios
• Ratios that measure the speed with which a company
can turn its assets into cash to meet short-term debt
 High liquidity ratios may satisfy a creditor’s need for
safety, but may indicate the company is not using
its current assets efficiently
 Liquidity ratios are best examined in conjunction
with asset utilization ratios because high turnover
ratios imply cash is flowing through very quickly
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Liquidity Ratios
Current Ratio =
Current Assets
$3,794.9
i=i
= 1.83X
Current Liabilities
$2,075.8
Starbuck’s current ratio indicates that for every $1 of
current liabilities, the firm had $1.83 of current assets
on hand
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Liquidity Ratios
Current Assets - Inventory
Quick Ratio =
i=i
Current Liabilities
$2,829.1
$2,075.8
= 1.36X
In 2011, Starbucks had $1.36 invested in current
assets (after subtracting inventory) for every $1 of
current liabilities
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Debt Utilization Ratios
Debt Utilization Ratios
• Ratios that measure how much debt an organization is
using relative to other sources of capital, such as
owners’ equity
 Debt financing is riskier than equity as it demands
a monthly payment regardless of profitability
 Recessions affect heavily indebted firms far more
than those financed through equity
 Most companies tend to keep debt-to-asset levels
below 50 percent
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Debt Utilization Ratios
Debt to Total Assets =
Debt (Total Liabilities)
i=i
Total Assets
$2,973.1
= 40%
$7,360.4
For every $1 of Starbucks’ total assets, 40% is
financed with debt and 60% with owners’ equity
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Debt Utilization Ratios
EBIT (Operating Income)
$1,728.5
Times Interest Earned =
i=i
= 51.91X
Interest
$33.3
Starbucks paid $33.3 million in interest expense, but
that amount was covered nearly 51.91 times by
income before interest and taxes
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Per Share Data
Net Income
$1,245.7
Diluted Earnings Per Share =
i=i
= $1.62
# Of Shares Outstanding (Diluted)
769.7
Starbucks lists diluted earnings per share as $1.62 in
2011, diluted shares include potential shares that
could be issued
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Per Share Data
Dividends Per Share =
Dividends Paid
$389.5
i=i
= $0.52
# Of Shares Outstanding
748.3
The dividend declared on the income statement was
0 but the actual dividends paid were 52 cents
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Importance of Integrity in Accounting
 The recent financial crisis and recession showed
another example of a failure in accounting reporting
 Banks and other financial institutions often held
assets off their books by manipulating accounts
 On the other hand, the city of El Dorado, Kansas
made transparency a top priority and won a
Certificate of Achievement for Financial Accounting
 Transparency and accuracy in reporting revenue,
income and assets develops trust from investors
and other stakeholders
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Discussion
?
?
Why are accountants
so important to a
corporation? What
function do they
perform?
Why are debt ratios
important in assessing
the risk of the firm?