Part VI: Financial Management Introduction to Business 3e 15 Copyright © 2004 South-Western. All rights reserved. Accounting and Financial Analysis

Copyright © 2004 South-Western. All rights reserved.

Part VI: Financial ManagementPart VI: Financial Management

Jeff MaduraIntroduction to

Business 3e

Introduction to Business 3e

1515Accounting and Accounting and Financial AnalysisFinancial AnalysisAccounting and Accounting and

Financial AnalysisFinancial Analysis

Copyright © 2004 South-Western. All rights reserved. 15–2

Financial ManagementFinancial Management


Learning GoalsLearning Goals•Explain how firms use accounting.

•Explain how to interpret financial statements.

•Explain how to evaluate a firm’s financial condition.


Accounting and Financial Accounting and Financial AnalysisAnalysis


AccountingAccounting•Accounting involves the summary and analysis of a firm’s financial condition

•How firms use accounting– In the reporting of accurate financial

information to shareholders and creditors (financial accounting) Bookkeeping records financial transactions. Publicly owned firms must have their

financial statement audited and certified as accurate.


How Firms Use AccountingHow Firms Use Accounting•Use financial information to support decisions—managerial accounting– Use historical revenue and cost information

to support budgeting decisions– Use sales information to evaluate impact of

promotion strategy– Use seasonal sales information to determine

future production level


business onlinebusiness online ee -- businessbusiness


Uses of AccountingUses of Accounting•Use financial information to maintain control:– Monitor performance of individuals, divisions,

and products.– Monitor production efficiency.– Identify firm’s strengths and weaknesses.– Audit records to ensure accuracy.


Interpreting Financial Interpreting Financial StatementsStatements

• Income statement– Indicates firm’s revenue, costs, and earnings

over a period of time.

•Balance sheet– Reports book value of all the firm’s assets,

liabilities, and owner’s equity at a given point in time.


Income StatementIncome Statement•Net sales•Cost of goods sold•Gross profit•Operating expenses•Earnings before interest and taxes•Earnings before taxes•Net income (earnings after taxes)


Example of Income Example of Income Statement: Taylor, Inc.Statement: Taylor, Inc.

Exhibit 15.1


Income Statement Items as a Income Statement Items as a Percentage of Net Sales for Percentage of Net Sales for

Taylor, Inc.Taylor, Inc.

Exhibit 15.2


Balance Sheet ItemsBalance Sheet Items•Assets•Liabilities•Owner’s equity


AssetsAssets•Assets are anything owned by the firm– Current assets are those that will be

converted into cash within a year Cash, marketable securities, accounts

receivable, and inventories

– Fixed assets will be used for more than a year The value of plant and equipment is

depreciated to reflect the reduced value (useful life) of the assets over time.


LiabilitiesLiabilities•Liabilities include all of the firm’s debts– Current (short-term) Liabilities

Will be repaid within a year.– Accounts payable– Notes payable

– Long-term liabilities (debt) Will not to be fully repaid within a year.


Liabilities and Owner’s Liabilities and Owner’s EquityEquity

•Owner’s equity– Par (stated) value of all common stock

issued, additional paid-in capital, and retained earnings.


Example of Example of Balance Balance Sheet for Sheet for

Taylor, Inc.Taylor, Inc.


Breakdown of Balance Sheet Breakdown of Balance Sheet for Taylor, Inc.for Taylor, Inc.

Exhibit 15.4


Basic Accounting EquationBasic Accounting Equation

Assets = Liabilities – Owner’s Equity


Responsible Financial Responsible Financial ReportingReporting

•Accounting methods that provide the most accurate indication of a firm’s financial condition– Helps gain credibility with existing and

potential stockholders– Makes it easier for managers to detect and

correct deficiencies


Financial ReportingFinancial Reporting•Role of Auditors

– Certify that financial reports are accurate and within generally accepted reporting guidelines.

•Role of Board of Directors


Ratio AnalysisRatio Analysis•Evaluate the relationships between financial statement variables– Compare ratios with other companies in the

same industry– Assess change in ratios over time– Common ratios

Liquidity Efficiency Financial leverage Profitability


Measures of LiquidityMeasures of Liquidity•The firm’s ability to meet short-term obligations

sLiabilitieCurrent

AssetsCurrent RatioCurrent

sLiabilitieCurrent

ARs Securities Cash RatioQuick


Measures of EfficiencyMeasures of Efficiency

Inventory

goods ofCost turnoverInventory

Assets Total

salesNet overAsset turn


Measures of Financial Measures of Financial LeverageLeverage

•The degree to which firm uses borrowed funds to finance its assets

EquityOwner

Debt term-Long ratioEquity -to-Debt

ExpenseInterest Annual

TaxesandInterest BeforeEarnings

Earned

Interest

Times

ExpenseInterest Annual

TaxesandInterest BeforeEarnings

Earned

Interest

Times


Measures of ProfitabilityMeasures of Profitability

SalesNet

IncomeNet Margin Profit Net

Assets Total

IncomeNet Assetson Return

Equity Owners

IncomeNet Equity on Return


Ratio AnalysisRatio Analysis•Comparing ratios

– Evaluate how a firm’s financial condition compares to other firms in the industry.

•Limitations of ratio analysis– Firms might operate in more than one

industry - makes comparisons difficult.– Accounting practices vary among firms– Seasonality can impact ratios


Ratio AnalysisRatio Analysis•Sources of information on ratios

– Robert Morris Associates– Dun and Bradstreet


Chapter SummaryChapter Summary• Firm’s financial condition is important to financial managers, creditors and stockholders.

• Income statement and balance sheet are the most important financial statements used to evaluate a firm’s financial condition.

• Financial ratios help evaluate a firm’s liquidity, efficiency, profitability, and financial leverage.

Documents

Part VI: Financial Management Introduction to Business 3e 15 Copyright © 2004 South-Western. All rights reserved. Accounting and Financial Analysis