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  • 17-1

    ACCT 652 week 11 1

    ACCT 652 Accounting

    Ratio analysis, comparative statements, Seal Best, Cost

    volume profit analysisDr. Michael Kinsman

    ACCT 652 week 11 2

    Ratio analysis

    When you go to the doctor, the doctor takes your blood pressure and checks certain other vital signs to check your physical health.

    We are going to check the money pressure and certain other vital signs of companies to check their fiscal health.

    ACCT 652 week 11 3

    What are we looking for?

    Like the doctor, we are looking for unexplained difference.

    Explainable differences may be just fineour management may simply be managing differently or there is another difference.

    Unexplained difference gives us a list of potential problems.

  • 17-2

    ACCT 652 week 11 4

    Your book versus the ratios here

    Your book supplies you many fine ratio definitions. Ignore them.

    Ignore them not because there is anything wrong with them, but because finance, where this stuff is really going to be used, has its own set of parallel ratios.

    There is no sense in learning them twice.

    ACCT 652 week 11 5

    In the real world

    When you do ratios in the real world, you will want to do those ratios for which you have comparisons. Those are generally listed in the front of your comparisons book.

    We will talk later about sources for comparison ratios.

    ACCT 652 week 11 6

    Liquidity RatiosThe liquidity ratios tell us about a firms solvency in the near term

    Acid-Test ratio (or Quick ratio)

    Current ratio

    Current Assets - Inventories Current Liabilities =

    Acid-Test Ratio

    Current Assets Current Liabilities =

    Current Ratio

  • 17-3

    ACCT 652 week 11 7

    Asset management ratios

    Inventory turnover ratio Inventory turnover = Sales/Year end inventories

    Days Sales Outstanding (Average Collection Period)

    Days Accounts Receivable Sales = Outstanding Net Sales

    * 365

    ACCT 652 week 11 8

    Asset management ratios

    Fixed asset turnover ratio

    Total asset turnover ratio

    Fixed asset turnover ratio

    = Sales

    Net fixed assets

    Total asset turnover ratio

    = Sales

    Total assets

    ACCT 652 week 11 9

    Another asset management ratio

    Days Stock on Hand Days Ending Inventory Stock = on Hand Cost of Goods Sold

    * 365

  • 17-4

    ACCT 652 week 11 10

    Long-Term Risk and Capital Structure

    Debt Ratio

    Times Interest Earned

    Total Liabilities = Total Assets

    Debt Ratio

    Times Income Before Interest and Taxes Interest = Earned Interest Expense

    ACCT 652 week 11 11

    Profitability Ratios

    Profit Margin on sales

    Return on total assets

    Profit margin on sales

    Net Income Revenues =

    Return on Total Assets

    Net Income Total assets =

    ACCT 652 week 11 12

    Profitability Ratios

    Return on Common EquityReturn on Common Equity

    Net Income - Preferred Dividends Common Equity =

  • 17-5

    ACCT 652 week 11 13

    Market value ratios

    Price Earnings Ratio

    Dividend yield ratio

    Market to book ratio

    Price/Earnings Ratio

    Market Price Per Share Earnings Per Share =

    Dividend Yield

    Annual Dividends Per Share Market Price Per Share =

    Market/Book Ratio

    Market Price Per Share Book Value Per Share =

    ACCT 652 week 11 14

    Common-Size Comparative Statements

    Common-size comparative statements use percentages to express the relationship of individual components to a total.

    Net sales is usually expressed as 100% on the income statement.

    Total assets is usually expressed as 100% on the balance sheet.

    ACCT 652 week 11 15

    Standards of ComparisonCompare ratios and turnovers with. . .

    Subjective standards acquired from past experiences.

    Ratios and turnovers of competing companies in the same industry.

    Published ratios and turnovers.

    Standards or average ratios and turnovers for the industry.

    Rule-of-thumb standards.

  • 17-6

    ACCT 652 week 11 16

    Seal BestPrepare the ratios for Seal Best, and prepare any additional analysis that will help you (and the class) understand what is happening in this situation.

    If you were an investor in Seal Best, what changes would you make to make the company better. Be specific, both with the changes, the timing of them, and how you would execute them.

    ACCT 652 week 11 17

    Seal Best RatiosSeal Best, Inc.Ratios Ind. 1972 1973 1974

    Quick (times) 1.0 2.1 1.0 0.6Current (times) 2.7 4.2 2.6 1.8Inventory turnover (times/year) 7.0 8.7 5.4 3.5Average collection period (days) 32.0 33.0 36.0 49.0Fixed asset turnover (times) 13.0 11.6 10.7 12.4Total asset turnover (times) 2.6 3.2 2.6 1.9Debt ratio (percent) 50.0 23.0 33.0 48.0Return on total assets (percent) 9.0 12.1 6.5 2.8Return on net worth (percent) 18.0 15.7 9.7 5.4Profit margin on sales (percent) 3.5 3.8 2.6 1.4

    ACCT 652 week 11 18

    Percentage Income StatementSeal BestPercentage Income Statement(Also called Common Sized Income Statement)

    Net sales 2,210.0 100.00 2,295.0 100.00 2,380.0 100.00Cost of goods sold 1,768.0 80.00 1,836.0 80.00 1,904.0 80.00

    Gross profit 442.0 20.00 459.0 20.00 476.0 20.00

    Administrative and selling expense 170.0 7.69 187.0 8.15 204.0 8.57Depreciation 68.0 3.08 85.0 3.70 102.0 4.29Miscellaneous expense 34.0 1.54 71.4 3.11 102.0 4.29

    Total operating expense 272.0 12.31 343.4 14.96 408.0 17.14Net income before taxes 170.0 7.69 115.6 5.04 68.0 2.86

    Taxes (50%) 85.0 3.85 57.8 2.52 34.0 1.43

    Net income 85.0 3.85 57.8 2.52 34.0 1.43

    1972 1973 1974

  • 17-7

    ACCT 652 week 11 19

    Data for Cash Flow StatementSeal BestBalance sheet (used as data)

    1972 1973 1974 1972-1973 1973-1974

    Cash 51,000 23,800 17,000 (27,200) (6,800)Accounts receivable 204,000 231,200 323,000 27,200 91,800Inventory 255,000 425,000 688,500 170,000 263,500Property (net) 190,400 214,200 192,100 23,800 (22,100)

    Notes payable bank 85,000 238,000 85,000 153,000Accounts payable 81,600 129,200 255,000 47,600 125,800Accrued expenses 40,800 47,600 64,600 6,800 17,000Long term debt 37,400 34,000 30,600 (3,400) (3,400)Net worth 540,600 598,400 632,400 57,800 34,000

    Difference

    ACCT 652 week 11 20

    Cash Flow StatementOperatingFrom operations:

    From customersSales 2,295,000 2,380,000Minus accounts receivable change (27,200) (91,800)Net from customers 2,267,800 2,288,200

    To suppliersMinus cost of goods sold (1,836,000) (1,904,000)Minus change in inventory (170,000) (263,500)Plus accounts payable change 47,600 125,800Minus operating expense (187,000) (204,000)Minus miscellaneous expense (71,400) (102,000)Minus provision for taxes (57,800) (34,000)Plus change in accrued expense 6,800 17,000Net to suppliers (2,267,800) (2,364,700)

    Net from operations 0 (76,500)

    ACCT 652 week 11 21

    Cash Flow StatementInvesting and Financing Activities

    From investingInvestment to replace depreciation (85,000) (102,000)Minus change in property (23,800) 22,100Net from investing (108,800) (79,900)

    From financingNotes payable, bank 85,000 153,000Long term debt (3,400) (3,400)Net from financing 81,600 149,600

    Change in cash (27,200) (6,800)Beginning cash 51,000 23,800Ending cash 23,800 17,000

  • 17-8

    ACCT 652 week 11 22

    Statement of Cash Flows: Reconciliation of Net Income to

    Cash Flows from OperationsReconciliation of net income to cash flow from operations

    Net income 57,800 34,000Add back depreciation 85,000 102,000Change in accounts receivable (27,200) (91,800)Change in inventory (170,000) (263,500)Change in accounts payable 47,600 125,800Accrued expenses 6,800 17,000

    Net cash flow from operations 0 (76,500)

    ACCT 652 week 11 23

    Importance ofCost-Volume-Profit Analysis

    CVP analysis aids in understanding the relationship between an organizations costs, revenue, volume, and income.

    ACCT 652 week 11 24

    Questions Addressed byCost-Volume-Profit Analysis

    CVP analysis is used to answer questions such as: How much must I sell to earn my desired income? How will income be affectedif I reduce selling prices toincrease sales volume? How will income be affectedif I change the sales mixof my products?

  • 17-9

    ACCT 652 week 11 25

    Why include CVPIve got a computer!

    You might wonder why you should learn CVP when you have a computer to do pro-forma estimates of income under various circumstances.Good point. The reason to learn this is not to

    learn formulas, which are just shortcut pro-forma statements, but instead to learn about fixed, variable, and semi-variable costs that may be useful in doing your pro-formas.

    ACCT 652 week 11 26

    Fixed Costs

    Fixed costs are costs that do not vary over a wide range of the activityyou can make many local phone calls without paying more for your phone.

    If you have fixed costs, your cost per unit declines as you spread those costs over more units.

    ACCT 652 week 11 27

    Cost Behavior Unit Fixed Costs

    Number of Local Calls

    Monthly Basic

    Telephone Charge

    per Local Call

  • 17-10

    ACCT 652 week 11 28

    Cost BehaviorVariable Costs

    Total variable costs change in direct proportion to changes in act

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