Post on 21-Dec-2015
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Saturday, November 16th
• Midterm
• Topic: Accounting & Finance
• Quiz #5
• Extra Credit #1
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Accounting and Financial
Analysis
Earnings of Firm
Value of Firm
Accounting Function
Summary and Analysis of a
Firm’s Financial Condition
Management decisions such as
how much to produce and how many employees
to hire
Marketing decisions such as pricing and the
amount of promotion necessary
Finance decisions such as
the amount of debt financing versus equity
financing that is appropriate
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Accounting
Firms use accounting to:
Process of:•Report financial conditions•Support decisions•Control business operations
Process of:•Report financial conditions•Support decisions•Control business operations
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Guideline Establishment
• GAAP (Generally Accepted Accounting Principles)• FASB (Financial Accounting Standards Board)• SEC (Securities and Exchange Commission)• IRS (Internal Revenue Service)
• GAAP (Generally Accepted Accounting Principles)• FASB (Financial Accounting Standards Board)• SEC (Securities and Exchange Commission)• IRS (Internal Revenue Service)
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Two Types of Accounting
Managerial: concerned with preparing information for review by those on the inside of the firm.
Financial: concerned with preparing information for review by those on the outside of the firm.
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Audit for Control
Is a formal evaluation of the records used to prepare a firm’s financial statement.
Internal AuditorsInternal Auditors
External AuditorsExternal Auditors
Employees who analyze and evaluate the company.
Public accountants who work for an independent accounting firm.
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Two Major Financial Statements
Income Income
Balance SheetBalance Sheet
Reports the book value of assets, liabilities, and owner’s equity of a firm at a given point in time.
Indicates the revenue, costs, and earnings of a firm over a given time frame.
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Sample Income Statement
Net sales $20,000
Cost of goods sold 16,000
Gross profit $ 4,000
Selling expense $1,500
General & administrative 1,000
Total operating expense 2,500
Earnings before interest and taxes 1,500
Interest expense 500
Earnings before tax $1,000
Income tax (at 30%) 300
Net income $ 700
Net sales $20,000
Cost of goods sold 16,000
Gross profit $ 4,000
Selling expense $1,500
General & administrative 1,000
Total operating expense 2,500
Earnings before interest and taxes 1,500
Interest expense 500
Earnings before tax $1,000
Income tax (at 30%) 300
Net income $ 700
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Assets (in thousands)Current assets Cash $ 200Marketable securities 300Accounts receivable 500Inventory 1,000Total current assets $ 2,000Fixed assetsPlant and equipment $10,000 Less accumulated depreciation 2,000Net fixed assets 8,000Total assets $10,000Liabilities & Owner’s Equity (in thousands)Current liabilities Accounts payable $ 600Notes payable 400Total current liabilities $ 1,000Long-term debt $ 5,000 Common stockholder’s equity Common stock $ 1,000Additional paid-in capital 2,000 Retained earnings 1,000Total owner’s equity $ 4,000Total liabilities and owner’s equity $10,000
Assets (in thousands)Current assets Cash $ 200Marketable securities 300Accounts receivable 500Inventory 1,000Total current assets $ 2,000Fixed assetsPlant and equipment $10,000 Less accumulated depreciation 2,000Net fixed assets 8,000Total assets $10,000Liabilities & Owner’s Equity (in thousands)Current liabilities Accounts payable $ 600Notes payable 400Total current liabilities $ 1,000Long-term debt $ 5,000 Common stockholder’s equity Common stock $ 1,000Additional paid-in capital 2,000 Retained earnings 1,000Total owner’s equity $ 4,000Total liabilities and owner’s equity $10,000
Balance Sheet
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Ratio Analysis
• Liquidity• Efficiency• Leverage• Profitability
• Liquidity• Efficiency• Leverage• Profitability
A quantitative measurement used to evaluate a firm’s financial performance.
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Three Profitability Ratios
Indicates a firm’s overall performance in terms of its ability to generate revenue in excess of expenses.
Return on Assets = Net Income/ Total assets
Net Profit Margin = Net Income/Net Sales
Return on Equity = Net Income/ Total Owners’ Equity
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Liquidity
Measures a firm’s ability to meet its short term obligation.
Current Ratio = Current Assets/Current Liabilities
Acid-Test Ratio or Quick Ratio = Quick Assets/Current Liabilities
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Measures of Efficiency
Inventory Turnover = Costs of Goods Sold/Average Value of Inventory For A Period of Time
Asset Turnover = Net Sales/Total Assets
Used to analyze how well the firm is managing its assets.
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Leverage or Debt Ratios
The degree to which a firm is relying on debt financing.
Debt to Owners’ Equity = Long-Term Debt/Owners’ Equity
Times Interest Earned = Earnings Before Interest & Taxes/Annual Interest Expense
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Debt vs Equity Financing
Firm’s Financing Decisions
Firm’s cost of capital (funds) used to support
business operations
Firm's Earnings
Firm's Value
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Four Factors in Determining Creditworthiness
• The planned use for the borrowed funds.• Financial condition of the firm.• Outlook of the industry and environment of the firm.• Available collateral.
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Major Types of Financing
Debt financing• Act of borrowing funds.
Equity financing• Act of receiving investment from owners (by
issuing stock or retaining earnings).
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Methods of Debt Financing
• Borrowing From Financial Institutions
Fixed-rate loans
Floating-rate loans• Issuing Bonds
Secured
Unsecured
Call Feature• Issuing Commercial Paper
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Three Interest Rate Charge Scenarios
I1 (Fixed rate)
I2 (Floating ratewhile interest ratesare rising)
I3 (Floating ratewhile interest ratesare declining)
Inte
rest
Rat
e
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Prime Rates
0%
5%
10%
15%
20%
'80 '82 '84 '86 '88 '90 '92 '94 '96 '98
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Methods of Equity Financing
• Retaining Earnings
Keep earnings after taxes for expansion.• Issuing Stock
Common.
Preferred.
The act of receiving investment from owners by retained earning or issuing stock.
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Initial Public Offering (IPO)Advantages of IPOs:• Gain access to more funds.• Obtain funds without increasing existing debt level.Disadvantages of IPOs:• Must inform shareholders of their financial condition.• Expenses associated with reporting of information
must be filed with SEC.• Difficulty in encouraging stock purchase.• Ownership structure is diluted.• Investment banks charge high fees.
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Issuing of Securities
Origination• Investment bank advises firm on amount of stock
and bonds to issue.
Underwriting• Investment bank guarantees a price to the issuing
firm.
Distribution• Prospectus is distributed to investors.
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Capital Structure
•Use of Debt
Interest payments are tax deductible.
Can claim interest payments during year as expense.
Increased risk of default.
May result in high interest payments.
Creditors may not be willing to provide additional credit.•Equity Financing
Eliminates many of the above concerns.
The composition of debt versus equity financing.
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Return on Equity& Financial Leverage
0
10
20
30
40
50
60
10 20 30 40 50 60 70 80 90 100
Proportion (%) of Assets Financed with Equity
Pe
rce
nt
MultiMedia by Stephen M. Peters © 2001 South-Western College Publishing
Interest Expense& Financial Leverage
0
100
200
300
400
500
600
700
800
900
10 20 30 40 50 60 70 80 90 100
Proportion (%) of Assets Financing with Equity
Do
llars
(th
ou
sa
nd
s)