Transcript • Using Accounting Information for Business Control • BS & P&L statement assist mgers control the financial health & performance of their.

• Using Accounting Information for Business Control
• BS & P&L statement assist mgers control the financial
health & performance of their operation.
• This section focuses 3 main areas of financial analysis:
– Comparative statements analysis,
– Net working capital analysis,
– Ratio analysis
• that are employed to evaluate past financial performances of
businesses.
• 1. Comparative Statements Analysis
• 1st first step in comparative statements analysis is to:
– examine balance sheets & P& L statements for 2 consecutive
periods &
– ook for any changes that may indicate a shift in the financial
condition of the firm.
• Let's examine the comparative B/S of AgBiz Corpn.
• Current Assets:There is a fall in cash & inventories plus a
large increase (500%) in accounts receivable.
• This signal problems for the firm as reflects a reduction in
the firm's liquidity or ability to pay its bills on time.
• Fixed Assets:Unchanged except for a $160,000 (40%) rise
in buildings & eqpmt which may imply a reduction liquidity
• Total Assets: There is an increase in the value of total assets
of 12% (+ $109,200) since last year.
• Current Liabilities:Has increase by 116.7% from last year,
mainly from accounts payable & installment payments &
may reflect a decrease in the firm's liquidity.
• Total Liabilities: Has risen slightly since last year.
• Total owners' equity: Has increased by the amount of net
income ($42,300 from P&L).
• Total Liabilities & Owners' Equity: Has risen by $109,200.
• Note equation: assets = liabilities + owners' equity, or
1,020,000 = 410,000 + 610,000.
• Let's examine the comparative P&L of AgBiz Corpn
• Revenue:There is a 17.2% increase in sales revenues
• Cost of Goods Sold: Rose just by 10% from last yr to meet
the 17.2% increase in sales.
• Operating Expenses: There is over 50% (i.e.51.65) increase
in operating expenses.
• Net Income: Has risen by 41% from last year. This is partly
explained by cost of goods sold staying almost the same.
• Expenditure Pattern (where each $ was spent)
• Year 1: For each $ of sales taken in, $0.821 was spent on
COGS ($1,026,000/$1,250,000), leaving $0.179 to
contribute to operating expenses & profits.
• Year 2: Amount spent on COGS was reduced to $0.771 (i.e.
$1,129,000 /$1,105,000), leaving $0.229 for operating
expenses & profits. This extra $0.050 per sales dollar may
reflect good mgmt.
• Operating Expenses as % of Sales:It rose 4.5% from 15% of
sales to 19.5%, with largest from salaries & wages,
promotion, utilities. These require scrutiny as rising
operating expenses can reduce level of profits
• Income Before Taxes:Rose from 2.9% of sales to 3.5%.
Thus the increases in expenses are well spent, as net income
rose from 2.4% to 2.9& of sales.
• 2. Net Working Capital Analysis
• It measures liquidity by computing the $ that will remain
after selling all current assets & paying all current liabilities
– i.e. measures availability of cash or "near cash" items to
pay bills as they come due.
• It is thus the money used to meet the day-to-day expenses of
the firm & to meet any emergency expenses.
• NWC = difference btwn current assets & current liabilities
as shown on balance sheet. NWC = CA - CL
• CA = items that will turn to cash within next acctg period
• CL = debt items that must be paid within next acctg period.
• NWC = current assets (CA)
current liabilities (CL)
•
Includes: Cash
Includes:Notes payable
Securities
Accounts payable
Accounts receivable Taxes payable
Inventory etc.
Dividends payable etc.
•
• Examination of AgBiz NWC shows a decrease from
Y1 to Y2 but still able to pay all its expected bills.
–
–
–
–
Current assets - Current liabilities = NWC
Yr 1: $205,000
- $41,500
= $163,500
Yr 2: 174,000
89,500
=
84,050
A decrease
$79,450
• Activities that Impact BS and NWC
• 1. Cash purchase of inventory: inventory value rises,
cash falls by similar amount, CA remains same. CL
are unchanged. Thus NWC remains unchanged.
•
CA
CL
= NWC
cash inventory - no change = no change
• 2. Short-term Credit Purchase of Inventory
•
CA
CL
= NWC
inventory
- accounts payable = no change
• Long-term credit purchase of inventory
• CA
CL
= NWC
inventory - no change = rise by amt of inventory change
• 3. Long-term loan payment next year
• CA
CL
= NWC
cash - no change = fall by amt of change in cash
• i.e. if CA or CL is used to meet non-current balance sheet
item, then NWC changes. This is so cos the accounting
equation (assets = liabilities + owners' equity) is always true
• Sources and Uses or Application of Net Working Capital
• Document valuable to mger/shareholders alike, cos it shows
where working capital came from & where it was spent.
• Sources of NWC
Uses of NWC
Profits
Sale of fixed assets
Sale of investments
Over 1 yr loans
Sale of stock
Depreciation
Payment of dividends
Purchase of fixed assets
Purchase of investments
Repayment of debt
Retirement of stock
• Building sources & uses NWC statement requires 2
consecutive BS plus a P&L statements in a 3-step process
• Step One: Calculate NWC for each yr & change in NWC. In
our example yr 1 NWC = $163,500 & yr 2 NWC = $84,050.
NWC Change = $163,500 - $84,050 = $79,450
• Step two: Determine sources & uses of NWC items. In our
example uses of NWC ($160,200) > the sources of NWC
($80,000) by $79,450 & this is equal to the change in NWC
btwn yr1 & yr 2 as shown in step one.
• Step three: Examine changes CA & CL by calculating the
net changes in CA & CL & their difference. Which should
give same amount as change in NWC (i.e. - $79,450).
• Purpose of sources & uses statement is to show items that
are source of NWC or used for NWC during the year.
• In our example, Profits & long-term borrowings were main
sources of NWC btwn yr 1 & yr 2 & main of NWC was to
the purchase of new fixed assets (buildings & eqpmt).
• To accomplish this, cash & inventories were reduced, while
accounts receivable, accounts payable, & current portion of
long-term debt all rose.
• Mgers like to have major source of funds be profits & major
use of funds be fixed assets, since this would reflect a
healthy, growing firm.
• Figure
Developing Sources & Uses of Net Working Capital Statement
• 1. Determine the Change in the Net Working Capital
• Year
Current Assets - Current Liabilities =
Net Working Capital
1
$205,000 - $41,500
=
$163,500
2
$174,000 - $89,950
=
$84,050
Change in Net Working Capital
=
$79,450
• 2. Determine the Sources and Uses of Net Working Capital
•
Sources of NWC
Uses of NWC
Profits (Retained Earnings) $42,300
Dividends
0
Sale of Fixed Assets
0
Purchase of Fixed Assets
$160,000
Long-Term Borrowings
18,450
Repay Debt
0
Sale of Stock
0
Retirement of Stock
0
Depreciation
20,000
Other Investments
200
Total Sources
$80,750
Total Uses
$160,200
$80,750 $160,200
=
$-79,450
• 3. Determine the Changes within Current Assets and Current Liabilities
Change in Current Assets - Change in Current Liabilities = Change in NWC
$-32,000 Cash
$+33,000
Accounts Payable
+25,000 Acct. Rec.
+250
Taxes Pay,
-24,000 Inventories
+15,200
Current Part of long term Debt
$-31,000 Net Change
$+48,450
Net Change
Current Assets
Current Liabilities
$-79,450 = Change in NWC
• Ratio Analysis
• Looks at the relationship (or ratio) btwn components of BS
and P&L statement. There are 4 main categories of ratios:
–
–
–
–
1. Liquidity ratios – mainly from BS statement
2. Solvency ratios – mainly from BS statement
3. Activity ratios - from both BS and P&L statements
4. Profitability ratios – mainly from P&L.
• Ratios from Balance Sheets
• A. Liquidity Ratios: Measures ability to meet the day-to-day
cash needs of a firm & it concentrates on CA (sources) &
CL (uses) – three (3) ratios have been developed.
• 1. Current Ratio:Measures CA relative to CL. A value of 1
means CL = CA. Like NWC, it shows the firm's ability to
meet its bills in the next period. The larger the ratio ratio the
more liquid the firm & vice versa
–
Current Ratio Year 1: CA
CL
– Current Ratio Year 2: CA
CL
$205,000
$41,500
$174,000
$89,950
4.94
1.93
• 2. Quick Ratio:Measures CA less inventories
relative to CL & shows the firm's ability to pay bills
quickly if inventories cannot be sold. The larger the
ratio ratio the more quickly the the firm can pay its
bills.
– Quick Ratio Year 1: CA - inventories
CL
– Quick Ratio Year 2: CA - inventories
CL
$205,000 – 151,000 1.30
$41,500
$174,000 – 127,000 0.52
$89,950
• 3. Acid Test Ratio:Measures ability to pay bills tomorrow if
inventories & accounts receivable cannot be turned to cash.
– Acid Test Ratio Year 1: Cash
CL
– Acid Test Ratio Year 2: Cash
CL
$49,000
$41,500
$17,000
$89,950
1.18
0.19
• In yr 1 AgBiz is extremely liquid, as it had $1.18 in cash for
each $ it owed in coming year but this reduced to $0.19 in
yr 2.
• B. Solvency Ratios: Measures ability to pay debt & its
relationships btwn assets, liabilities & equity. Analyzes if
firm’s debt or liabilities can be paid off by sale of all assets.
Assets> liabilities = solvent
• 1. Debt to Equity Ratio or Leverage Ratio. Compares the
proportion of financing provided by lenders with that
provided by firm owner – i.e. it determines the relative size
of creditors' claims to owners' or stockholder’s claim & it’s
the ratio of total debt (total liabilities) to owners' equity.
– Debt to Equity Ratio Yr 1: Total debt (liabilities)
Owners equity
– Debt to Equity Ratio Yr 2: Total debt (liabilities)
Owners equity
$343,100
$567,700
$410,000
$610,000
0.60
0.67
• When leverage ratio =1, lenders & owners are providing
equal portion of financing. Smaller values are preferred to
larger ones thus very large leverage ratios result from small
equity, meaning an increasing chance of insolvency
• 2. Debt to Asset Ratio: Measure what part of total assets is
owned to lenders. It shd have a value less than 1& smaller
values are preferred.Thus ratios > 1 means insolvency.
– Debt to Asset Ratio Yr 1: Total debt (liabilities)
Total Assets
– Debt to Asset Ratio Yr 2: Total debt (liabilities)
Total Assets
$343,100
$910,800
$410,000
$1,020,000
0.38
0.40
• 3. The Times Interest Earned Ratio: Lenders are concerned
with the level of risk they are assuming when they loan
money to firms. One measure of risk is the size of the firm’s
pretax earnings relative to the interest payment. These
figures can be obtained from the P&L statement.
– Int. Earned Ratio Yr 1: Income before tax + interest
Interest paid
– Int. Earned Ratio Yr 1: Income before tax + interest
Interest paid
$36,000+$4000
$4000
$51,000+$5000
$5000
10.0
11.2
• In yr 1, there was $10 of income for each & of interest due
but this rose to $11 in yr 2. Thus, interest payment is not in
jeopardy cos as interest rose, income has risen more.
• C. Activity Ratios:Deals with activity of firm with respect to
inventory levels, credit payments, & own bill paying.
• 1. Inventory Turnover Ratio: Assist mgers determining how
much inventory to be kept on hand. One way to measure
inventory activity is to calculate number of times inventory
is used up or turned over in the year. Its done by dividing
COGS (from P&L) by the level of inventory shown on BS.
– Inventory Turnover Ratio Yr 1: COGS
inventory level
– Inventory Turnover Ratio Yr 2: COGS
inventory level
$1,026,000
$151,000
$1,129,000
$127,000
6.79
8.89
• In yr 1 inventory turned over 6.79 times & in yr 2 it turned
over 8.89 times, thus, the inventory turned over more
quickly in year 2 than in year 1
• 2. Accounts Receivable Turnover Ratio. Measures length of
time a firm has to wait to get its money from credit sales. It
calculated by dividing credit sales (10% of Sales in our
example) by value of accounts receivable
– Ac Rec Turnover Ratio Yr 1: credit Sales
$125,000
accounts receivables $5,000
– Ac Rec Turnover Ratio Yr 2: credit Sales
$146,500
accounts receivables $30,000
25
4.88
• In yr 1the accounts receivable turned over 25 times or once
every 14.6 days, & 4.88 times or once every 74.8 days in yr
2.
• Thus, there was a substantial increase in the length of time
(14.6 to 74.8 days) required to get money from credit sales.
Such a jump requires managers to examine the firm’s credit
policies, which may be a source of the liquidity problem.
• 3. The Accounts Payable Turnover Ratio: Measures
how fast the firm pays its own bills. It calculated by
dividing credit purchases – e.g. 25% of purchases
assumed to be on credit (from P&L statement) by
level of accounts payable (from BS)
– Ac Payable T/Ratio yr 1:credit purchases
accounts payables
– Ac Payable T/Ratio yr 1:credit purchases
accounts payables
$269,250 13.5
$20,000
$276,250 5.21
$53,000
• Thus, in yr 2 it took over 2.5 times as long for the
firm to pay its bills. This is a serious increase &
deserves some mgmt attention as it could have been
caused by its liquidity problems.
• D. Profitability Ratios: Measures how efficient the firm is in
using its resources to produce profit. 3 ratios are presented
• 1. Return on Investment Ratio (ROI). Also called return on
capital or return on asset. The ROI ratio measures the profit,
or return on money invested in the firm, & its relationship
btwn before-tax profit (from P&L) & total assets (from BS).
– ROI in yr 1: before-tax profit x 100 $36,000 x 100
total assets
$910,800
– ROI in yr 2: before-tax profit x 100 $51,000 x 100
total assets
$1,020,000
3.95%
5.00%
• In vr 1 there was a return of 3.95% on monev invested & in
yr 2 this rose to 5.00%. Thus, it shows that the firm was
using its resources more efficiently in year 2.
• 2. Return on Owners' Equity Ratio (ROE). The ROI
ratio can be misleading as it is a mixture of both
debt & equity capita,thus, ROE may be a more
appropriate measure of return. It is the ratio of
before-tax profit (from P&L) to owners' equity
(from BS)
– ROI in yr 1: before-tax profit x 100 $36,000 x 100
owners equity
$567,700
– ROI in yr 2: before-tax profit x 100 $51,000 x 100
owners equity
$610,000
6.34%
8.36%
• ROE rose from 6.34% in yr 1 to 8.4% in yr 2. This
higher return may reflect a good job on the part of
mgmt.
• 3.Profit as a Percentage of Sales Ratio:Measures the
profit earned from sales revenue. Its the relationship
btwn the before-tax profit & total sales (from P&L)
– PPS Ratio yr 1: before-tax profit
$36,000
total sales
$1,250,000
– PPS Ratio yr 2: before-tax profit
$51,000
total sales
$1,465,000
2.88%
3.48%
• This ratio shows improvement as profit from each
dollar of sales revenue rose from $0.0288 in yr 1 to
$0.0348. This may reflect good management.