Bus Finch 3 Textbook Powerpoint

Chapter Three Evaluating Financial Performance

Copyright Houghton Mifflin Company. All rights reserved.

Copyright Houghton Mifflin Company. All rights reserved.3-*

Learning ObjectivesReview the purpose of financial statements and their form.Define the use of pro forma financial statements.Discuss and illustrate the use of financial ratio analysis.Demonstrate the use of financial ratios in evaluating business strategy.


Copyright Houghton Mifflin Company. All rights reserved.3-*Financial Statement BasicsFinancial statements provide a wealth of information that customers, creditors, investors, managers, employees, regulators, and other stakeholders use to assess a firms past and future performance. Four main reports make up a complete set of financial statements:Balance sheetIncome statementStatement of cash flowsStatement of owners equity


Copyright Houghton Mifflin Company. All rights reserved.3-*The Balance SheetThe balance sheet shows a firms financial position at the end of its fiscal year (or a shorter reporting position) and is based on the fundamental accounting equation and:

Assets = Liabilities + Owners Equity


Copyright Houghton Mifflin Company. All rights reserved.3-*Types of Assets on the Balance SheetCurrent assets Assets that can be converted to cash within one year or the normal operating cycle of the firm, whichever is longer (e.g., cash, accounts receivable, inventory)Fixed assets Economic resources acquired for longer-term business use (e.g., buildings and equipment)Intangible assets Economic resources that have no physical substance (e.g., goodwill, copyrights, patents)


Copyright Houghton Mifflin Company. All rights reserved.3-*Balance Sheet: Liabilities and Owners Equity LiabilitiesCurrent liabilities: debts and obligations that must be repaid using current assets (generally within one year)Long-term liabilities: liabilities for which payment is due after one year Owners EquityOwners equity is the claims on a firms assets by its owners and represents the owners contributed capital to the business plus all undistributed earnings. In other words, owners equity is the remaining interest in a firm after liabilities are deducted from assets.


Copyright Houghton Mifflin Company. All rights reserved.3-*The Statement of Owners EquityThe statement of owners equity details transactions that affect the balance sheet equity accounts during a financial reporting period. The statement of owners equity specifically describes changes to the common or preferred stock accounts and retained earnings.


Copyright Houghton Mifflin Company. All rights reserved.3-*The Income StatementThe Income Statement lists the firms revenues, expenses, and net income for the year or a shorter reporting period.Revenues: Income generated from product or service sales, or other sources (e.g., rent, investments, interest) that is reported on the income statementExpenses: Costs incurred by a company to produce revenue that are reported on the income statementNet income (loss): The key income statement amount equal to total revenues minus total expenses


Copyright Houghton Mifflin Company. All rights reserved.3-*The Statement of Cash FlowsThe statement of cash flows identifies company transactions that generate and consume cash. It also provides important information about the operating, investing, and financing cash flows of the firm. Cash flows from operating activities are those directly associated with the acquisition and sale of a companys products and services.Investing activities include cash flows related to the purchase and sale of a companys noncurrent (fixed or intangible) assets. When companies raise or retire capital from shareholders or creditors (i.e., liabilities and/or contributed capital) or pay cash dividends, they engage in financing activities.


Copyright Houghton Mifflin Company. All rights reserved.3-*Pro Forma Financial StatementsPro forma financial statements are financial statement projections of the firms future operations. (Based on assumptions)


Copyright Houghton Mifflin Company. All rights reserved.3-*Ratio AnalysisRatio analysis is a process in which ratios computed from accounting data are compared and analyzed to develop insights about the performance and business risks of a firm.Compare to PastSpecific CompetitorIndustry


Copyright Houghton Mifflin Company. All rights reserved.3-*Types of RatiosTen ratios are grouped into four categories:Liquiditycurrent and quickLeveragefinancial leverage and debt to equityOperatingaccounts receivable turnover, inventory turnover, and asset turnoverProfitabilitynet profit margin, return on assets (ROA), and return on equity (ROE)


Copyright Houghton Mifflin Company. All rights reserved.3-*Liquidity RatiosThe current ratio measures the firms ability to pay current liabilities from current assets.

Current Assets/Current Liabilities

What does it mean? 2:1 is a good measure


Copyright Houghton Mifflin Company. All rights reserved.3-*Liquidity RatiosThe quick ratio is a more conservative measure of a companys liquidity because it eliminates inventory and prepaid expenses from the numerator. (Current Assets-Inventory-Prepaid Expenses)/Current LiabilitiesWhat does it mean? 1:1 is a good measure


Copyright Houghton Mifflin Company. All rights reserved.3-*Leverage RatiosThe financial leverage ratio reports the proportion of a firms assets that owners control relative to the amount of the owners investment in the company.Total Assets/Owners Equity

What does it mean? 1 means no debt. High number means a lot of debt


Copyright Houghton Mifflin Company. All rights reserved.3-*Leverage RatiosThe debt to equity ratio is a leverage ratio that also expresses the relationship between the capital contributions of creditors and owners. This ratio compares what the firm owes to creditors with what the owners have invested. Total Debt or Liabilities/Owners EquityWhat does it mean? 1 means Debt=Equity or 50% of Assets are debt and 50% equity


Copyright Houghton Mifflin Company. All rights reserved.3-*Operating RatiosAccounts receivable turnover ratio reports how frequently (on average) accounts receivable are collected during the year. This ratio measures both the quality of receivables as well as the efficiency of the firm's collection and credit policies.

Net Sales Revenue/Accounts Receivable (Average)

What does this mean? We want a high turnover. This means we are converting AR to cash.


Copyright Houghton Mifflin Company. All rights reserved.3-*Operating RatiosThe inventory turnover ratio measures the efficiency with which a firm manages and sells its inventory.

Cost of Goods Sold/Inventory (Average)

What does this mean? We want a high inventory turnover. This means we are do not have capital tied up in inventory.


Copyright Houghton Mifflin Company. All rights reserved.3-*Operating Ratios The asset turnover ratio is a general measure of a firms ability to generate revenues from its assets. Generally, the higher this ratio becomes, the smaller the investment required to generate sales and the more profitable the firm will be.

Net Sales Revenue/Total Assets (Average)

What does this mean? Higher turnover is better. This means were are using assets efficiently to produce revenue.


Copyright Houghton Mifflin Company. All rights reserved.3-*Profitability RatiosThe net profit margin ratio measures a companys ability to transform sales dollars into profits after considering all revenues and expenses.

Net Income/Net Sales Revenue

What does this mean? Higher is better. Are we converting sales dollars to profit.


Copyright Houghton Mifflin Company. All rights reserved.3-*Profitability RatiosThe return on assets ratio measures the firms ability to manage its assets to create net income.

Net Income/Total Assets (Average)

What does this mean? Higher is better. We are using assets efficiently to produce income.


Copyright Houghton Mifflin Company. All rights reserved.3-*Profitability RatiosThe return on equity ratio measures a firms ability to generate a return to shareholders.Net Income/Owners Equity (Average)

What does this mean? Higher is better. This measures the return on investment.


Copyright Houghton Mifflin Company. All rights reserved.3-*Other Financial Performance MeasuresEarnings per share (EPS) is net income divided by the number of shares of stock held by owners.The DuPont system uses three key ratios to provide managers with insight into how the firms decisions and activities produce a return to shareholders: profit margin, asset utilization (turnover), and financial leverage


Ratio Analysis ProjectDivide into 7 groups for the 7 IndustriesComplete individual portion of group project for next week. I will check for completion.After the test next week, get together in groups and discuss the analyze the ratios.Type one group summary for the ratio analysis.Turn the group summary and individual work in on September 29th.Copyright Houghton Mifflin Company. All rights reserved.3-*


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Bus Finch 3 Textbook Powerpoint