CENTURY 21 ACCOUNTING © Thomson/South-Western LESSON 17-2 Calculating Earnings Performance and...
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Transcript of CENTURY 21 ACCOUNTING © Thomson/South-Western LESSON 17-2 Calculating Earnings Performance and...
CENTURY 21 ACCOUNTING © Thomson/South-Western
LESSON 17-2LESSON 17-2
Calculating Earnings Performance and Efficiency Analysis
CENTURY 21 ACCOUNTING © Thomson/South-Western
EARNINGS PERFORMANCE ANALYSISEARNINGS PERFORMANCE ANALYSIS
The amount & consistency of earnings are important measures of a business’s success.
Managers, owners, & creditors are interested in an analysis of earnings performance
Five earnings performance ratios: Rate earned on average total assets Rate earned on average stockholders equity Rate earned on net sales Earnings per share Price-earnings ratio
2
LESSON 17-2
CENTURY 21 ACCOUNTING © Thomson/South-Western
3
LESSON 17-2
page 503
RATE EARNED ON AVERAGE RATE EARNED ON AVERAGE TOTAL ASSETSTOTAL ASSETS
December 31Total Assets
January 1Total Assets
Average Total Assets
+ =÷ 2
($1,759,700.00 + = $1,913,700.00$2,067,700.00) ÷ 2
• The rate found by dividing net income after federal income tax by average total assets is known as the rate earned on average total assets
• To find average total assets add the beginning assets and the ending assets and divide by 2
Current Year Prior Year
January 1 Total Assets $1,759,700.00 $1,437,600.00
December 31 Total Assets 2,067,700.00 1,759,700.00
Average Total Assets 1,913,700.00 1,598,650.00
CENTURY 21 ACCOUNTING © Thomson/South-Western
4
LESSON 17-2
CALCULATING THE RATE EARNED ON CALCULATING THE RATE EARNED ON AVERAGE TOTAL ASSETSAVERAGE TOTAL ASSETS page 504
Current Year Prior Year
Net Income after Federal Income Tax $ 222,300.00 $ 128,400.00
Average Total Assets 1,913,700.00 1,598,650.00
Rate Earned on Average Total Assets 11.6% 8.0%
Average Total Assets
Net Income after Federal Income Tax
Rate Earned on Average Total Assets
÷ =
$222,300.00 ÷ = 11.6%$1,913,700.00
• The rate found by dividing net income after federal income tax by average total assets is known as the rate earned on average total assets• Shows how well a business is using its assets to earn net income
CENTURY 21 ACCOUNTING © Thomson/South-Western
5
LESSON 17-2
CALCULATING THE RATE EARNED ON CALCULATING THE RATE EARNED ON AVERAGE TOTAL ASSETSAVERAGE TOTAL ASSETS page 504
Current Year Prior Year
Net Income after Federal Income Tax $ 222,300.00 $ 128,400.00
Average Total Assets 1,913,700.00 1,598,650.00
Rate Earned on Average Total Assets 11.6% 8.0%
• An 11.6% rate earned on average total assets means that for each $1 of assets, the business earned 11.6 cents in the current year.
• The company will compare this rate to rates of return on alternative investments (bonds, etc.)• Goal is to earn a rate of return that is at least as high as other
types of investments.• If the average investment sources available to this company are
earning 10% then the rate earned on total assets is satisfactory
CENTURY 21 ACCOUNTING © Thomson/South-Western
RATE OF RETURN ON AVERAGE RATE OF RETURN ON AVERAGE STOCKHOLDER’S EQUITYSTOCKHOLDER’S EQUITY
6
LESSON 17-2
Investors compare the rate earned on stockholders’ equity for several businesses to determine the best investment
If a business’s rate earned on stockholders’ equity increases significantly and is at or above industry comparisons then the rate is considered satisfactory
CENTURY 21 ACCOUNTING © Thomson/South-Western
7
LESSON 17-2
RATE OF RETURN EARNED ON RATE OF RETURN EARNED ON AVERAGE STOCKHOLDERS’ EQUITYAVERAGE STOCKHOLDERS’ EQUITY
Average Total Stockholders’
Equity
Net Income after Federal Income Tax
Rate Earned on Average
Stockholders’ Equity
÷ =
$222,300.00 ÷ = 23.4%$950,450.00
December 31Stockholders’
Equity
January 1Stockholders’
Equity
Average Total Stockholders’
Equity+ =÷ 2
($849,300.00 + = $950,450.00$1,051,600.00) ÷ 2
page 505
Calculate average stockholders’ equity (Jan. 1 total stockholders’ equity is the same as the total stockholders’ equity on the prior year’s Dec. 31 balance sheet)
Divide net income after federal income taxes by average total stockholders’ equity to determine the rate earned on average total assets.
CENTURY 21 ACCOUNTING © Thomson/South-Western
RATE EARNED ON NET SALESRATE EARNED ON NET SALES
8
LESSON 17-2
• A business that carefully controls costs should earn a consistent rate on net sales from year to year.
• The rate found by dividing net income after federal income tax by net sales is called the rate earned on net sales
• When determining what is normal businesses that are similar are compared.• If the rate on net sales is lower than the industry standard it is
considered unsatisfactory• If the rate is unsatisfactory the business must increase sales or
reduce costs to maintain an acceptable rate
CENTURY 21 ACCOUNTING © Thomson/South-Western
9
LESSON 17-2
page 506RATE EARNED ON NET SALESRATE EARNED ON NET SALES
Net Income after Federal Income Tax
÷ Net Sales =Rate Earnedon Net Sales
÷ $4,767,200.00 = 4.7%$222,300.00
The component percentage for net income after federal income tax is the same percentage as the rate earned on net sales
CENTURY 21 ACCOUNTING © Thomson/South-Western
EARNINGS PER SHAREEARNINGS PER SHARE
10
LESSON 17-2
The amount of net income earned on one share of common stock during a fiscal period is known as earnings per share
Stockholders & management frequently use earnings per share as a measure of success As earnings per share increase, more people become
interested in buying stock and stock prices go up Increases in earnings per share signal stockholders
that the company is continuing to increase the net income earned for each share.
CENTURY 21 ACCOUNTING © Thomson/South-Western
11
LESSON 17-2
page 507EARNINGS PER SHAREEARNINGS PER SHARE
Net Income after Federal Income Tax
÷ =Earnings per
ShareShares of Capital Stock Outstanding
= $3.71$222,300.00 ÷ 60,000.00
CENTURY 21 ACCOUNTING © Thomson/South-Western
12
LESSON 17-2
page 508PRICE-EARNINGS RATIOPRICE-EARNINGS RATIO
Earnings per Share
Market Price per Share
Price-Earnings Ratio
÷ =
$43.50 ÷ = 11.7 times$3.71
• Investors want to buy stock in companies that will earn a reasonable return on their investment
• The relationship between the market value per share of stock and the earnings per share is known as the price-earnings ratio• Relates profitability to the amount that the investors
currently pay for the stock• Usually expressed as a ratio
CENTURY 21 ACCOUNTING © Thomson/South-Western
13
LESSON 17-2
page 508PRICE-EARNINGS RATIOPRICE-EARNINGS RATIO
Earnings per Share
Market Price per Share
Price-Earnings Ratio
÷ =
$43.50 ÷ = 11.7 times$3.71
• A comparison to last year’s price-earnings ratio indicates an increase from 9.5 to 11.7 • The change indicates that investors considered the
stock more valuable & were willing to pay more for the stock per dollar earned by the company in the current year.
• This is considered a favorable trend.
CENTURY 21 ACCOUNTING © Thomson/South-Western
EFFICIENCY ANALYSISEFFICIENCY ANALYSIS
14
LESSON 17-2
• The profitability & continued growth of a business are influenced by how efficiently the business utilizes its assets
• The operating cycle of a merchandising business consists of 3 phases:• Purchase merchandise• Sell merchandise, frequently on account• Collect the accounts receivable
• The faster a business can convert accounts receivable and merchandise inventory into cash, the more efficient & profitable the business will be
CENTURY 21 ACCOUNTING © Thomson/South-Western
ACCOUNTS RECEIVABLE TURNOVER ACCOUNTS RECEIVABLE TURNOVER RATIORATIO
15
LESSON 17-2
• A business accepts accounts receivable to encourage sales. However, the earnings process is not complete until the business receives cash for sales on account• An efficient company closely monitors the length of time
required to collect its receivables• The number of times the average amount of accounts
receivable is collected annually is known as the accounts receivable turnover ratio• Monitors a business’s accounts receivable collection
efficiency
CENTURY 21 ACCOUNTING © Thomson/South-Western
16
LESSON 17-2
page 509
ACCOUNTS RECEIVABLE ACCOUNTS RECEIVABLE TURNOVER RATIOTURNOVER RATIO
Average Book Value of Accounts
Receivable
Net Sales on Account
Accounts Receivable
Turnover Ratio÷ =
$4,767,200.00 ÷ = 9.1 times$521,600.00
Ending Book Value of Accounts
Receivable
Beginning Book Value of Accounts
Receivable
Average Book Value of Accounts
Receivable
+ =÷ 2
($569,200.00 + = $521,600.00$474,000.00) ÷ 2
The turnover ratio indicates accounts receivable are being collected 9.1 times per year. If the terms are n/30 then this amount should be 12 times per year
CENTURY 21 ACCOUNTING © Thomson/South-Western
17
LESSON 17-2
page 510
AVERAGE NUMBER OF DAYS AVERAGE NUMBER OF DAYS FOR PAYMENTFOR PAYMENT
Accounts Receivable
Turnover RatioDays in Year
Average Number of Days for Payment
÷ =
365 ÷ = 40 days9.1
• To figure the average number of days customers are taking to pay their accounts receivable you would divide the number of days in a year by the accounts receivable turnover ratio.
• If the terms are n/30 then the 40 days would be considered unsatisfactory
CENTURY 21 ACCOUNTING © Thomson/South-Western
MERCHANDISE INVENTORY TURNOVER MERCHANDISE INVENTORY TURNOVER RATIORATIO
18
LESSON 17-2
• A company earns income when it sells merchandise – the faster is sells the more efficient & generally more profitable the business
• The number of times the average amount of merchandise inventory is sold annually is known as the merchandise inventory turnover ratio
• An optimum merchandise inventory turnover ratio is determined by two factors:• Amount of sales• Number of days needed to replenish inventory
CENTURY 21 ACCOUNTING © Thomson/South-Western
19
LESSON 17-2
page 510
MERCHANDISE INVENTORY MERCHANDISE INVENTORY TURNOVER RATIOTURNOVER RATIO
Average Merchandise
Inventory
Cost of Merchandise
Sold
Merchandise Inventory
Turnover Ratio÷ =
$2,602,800.00 ÷ = 5.4 times$485,850.00
December 31Merchandise
Inventory
January 1Merchandise
Inventory
Average Merchandise
Inventory+ =÷ 2
($423,800.00 + = $485,850.00$547,900.00) ÷ 2
• The 5.4 turnover ratio indicates that the inventory is being sold 5.4 times in a year.• The average number of days’ sales in merchandise inventory is 68 days
(365 days\5.4 turnover ratio)• If previous experience indicates an inventory turnover ratio of about 6.0 then the
turnover ratio is unsatisfactory• Would result in lost sales because some items were out of stock before new inventory
arrived.