Part One Accounting Principles and Practices

Name: ______Period:______

Financial Analysis

Part One – Accounting Principles and Practices

Sections 3.1, 4.3 (to page 119) and 4.1

Goals

• Describe the three primary financial goals of business
• Identify the characteristics of effective financial goals
• Describe the primary responsibility of the financial manager
• Explain the structure of financial management within an organization
• Differentiate between accounting and finance
• Know the basic accounting equation
• Understand how business transactions affect the accounting equation
• Explain the accounting cycle
• Recognize assumptions, principles, and professional practices that guide accountants’ work

Vocabulary

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Creditor

Principal

Interest

Collateral

SMART goals

Accounting

GAAP

FASB

Creditor

Principal

Money and capital markets

Investments

Financial management

Equities

Accounting equation

Assets

Liabilities

Owner’s Equity

Accounts

Transactions

Entries

Source documents

Journals

Accounting cycle

Trial balance

Fiscal year

Accounting assumptions

Single economic entity

Going concern

Monetary unit

Periodic reporting

Accounting principles

Historical costs

Revenue recognition

Expense and revenue Matching

Full Disclosure

Standard Practice and Conservation

Professional Practices

Due care

Information system

Information integrity

Annual report

Sarbanes-Oxley Act

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Section 3.1 Business Financial Goals

Section 4.3 Financial Management Structure

1)Main Financial Needs

A.Meet financial ______and pay its ______.

B.Provide a competitive ______for investors.

C.Finance future ______and ______to remain competitive.

2)Characteristics of Effective Goals

A.Specific:

B.Measurable:

C.Attainable/Realistic:

D.Results-Oriented:

E.Time Bound:

3)Main Goal of Financial Management: maximize ______wealth.

4)Financial Management Decisions

A.Asset Planning:

B.Asset Financing:

C.Asset Management:

Section 4.1 Financial and Accounting

FinanceAccounting

The Accounting Equation

5)Accounting Assumptions

A.Single Economic Entity

B.Going Concern

C.Monetary Unit

D.Periodic Reporting

6)Accounting Principles

A.Historical Costs

B.Revenue Recognition

C.(Expense & Revenue) Matching

D.Full Disclosure

E.Standard Practice

F.Conservatism

7)Professional Practice

A.Competence

B.Due Care & Sufficient Data

C.Independence & Integrity

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Section 3.1 Homework

1)Textbook page 71 – Questions 1-5

2)How does the sale of products and services by the business provide money to finance operations?

3)Why are the shareholders of closely-held corporations more likely to accept a lower rate of return than shareholders in large corporations?

4)What is the difference between growth and improvement?

5)Is it possible for a business to grow and not improve or to improve but not grow? Explain.

6)What three options do businesses have to finance growth?

7)What compensations do businesses with poor finances often need to make in order to obtain financing?

8)Reword the following goal so that it meets the SMART criteria: To provide an adequate investor return.

9)Under what situations might a company want to focus on meeting current financial obligations?

10)What major financial decision must a company focused on growth make?

11)What can a company do to attract more investors?

12)Textbook page 96 – Questions 16-19

Section 4.3 Homework

13)Textbook page 123 – Questions 1-4, 8

14)Why do companies make investments?

15)How do financial managers determine which assets to purchase?

16)Why are mergers and acquisitions considered part of asset planning?

17)How is a trade credit different from an operating loan?

18)What types of activities are involved in managing fixed assets?

19)What might happen if a company has too many fixed assets and not enough liquid assets? too many liquid assets and not enough fixed assets?

20)Textbook page 136 – Question 18

Section 4.1 Homework

21)Textbook page 109 – Questions 1-5

22)What are the three interrelated areas of finance?

23)How are GAAP and the FASB related to the accounting principle of standard practices?

24)What two items make up the equity of a business?

25)How do accounts help financial managers make decisions?

26)What form is used to record transactions?

27)What is a fiscal year?

28)What is the purpose of a trial balance?

29)Why do accountants have to make adjusting entries?

30)What is the purpose of closing entries?

31)Textbook page 136 – Questions 15-17, 20

32)Identify each account as an Asset (A), Liability (L), Owner’s Equity (OE), Revenue (R) or Expense (E).

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A.Accounts Payable

B.Accounts Receivable

C.Administrative Expense

D.Buildings

E.Cash

F.Common Stock

G.Equipment

H.General Expense

I.Interest Expense

J.Inventories

K.Land

L.Long-Term Debts

M.Machinery

N.Marketable Securities

O.Notes Payable

P.Operating Expense

Q.Preferred Stock

R.Retained Earnings

S.Sales Revenue

T.Selling Expense

U.Taxes

V.Vehicles

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Section 4.2 Independent Section

33)Read the section and answer the checkpoint questions on pages 111, 114, and 116 (questions 1-5 only).

34)Read page 115. How did the Sarbanes-Oxley Act restore investor confidence?

Financial Analysis

Part Two – Financial Statement Preparation

Sections 3.2 and 4.3 (pages 119-122)

Goals

• State the purpose of the income statement, statement of retained earnings, balance sheet and cash flow statement
• Be able to prepare an income statement, statement of retained earnings, balance sheet and cash flow statement

Vocabulary

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Financial statements

Understandable

Reliable

Comparable

Balance sheet

Current assets

Receivables

Long-term assets

Depreciation

Current liabilities

Payables

Long-term liabilities

Retained Earnings

Paid-in capital in excess of par

Working capital

Income statement

Revenue

Cost of Revenue

Gross Profit/Income

Operating Expenses

Net Profit/Income

Cash flow statement

Cash receipts

Cash payments

Solvency

Cash from operating activities

Cash from investing activities

Cash from financing activities

Section 3.2 Accounting Statements

A. Income Statement Preparation
Purpose of the Statement:
Use the form below to prepare an income statement for Shutterbug Cameras for the year ended June 30. Shutterbug pays an average tax rate of 30%. During the year Shutterbug Cameras recorded sales revenue of $127,151. Shutterbug paid for the following:
Advertising / $ 2,380
Maintenance / $ 1,950
Rent / $ 10,800
Supplies / $ 5,774
Utilities / $ 4,695
Salaries / $ 4,734
Cost of Goods Sold / $ 64,729
Interest / $ 2,938
Insurance / $ 825

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B. Statement of Retained Earnings Preparation
Purpose of the Statement:
Use the form below to prepare statement of retained earnings for Shutterbug Cameras for the year ended June 30. Shutterbug started the year with retained earnings of $14,364. The company declared a dividend for all shareholders of $15,000. Preferred shareholders were entitled to $5,000 of the dividend.

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C. Balance Sheet Preparation
Purpose of Statement:
Use the form below to prepare a balance sheet for Shutterbug Cameras for the June 30. Shutterbug provided the following information:
Accounts Payable / $ 14,481
Accounts Receivable / $ 5,418
Cash in Bank / $ 137,721.20
Common Stock / $ 60,000
Inventory / $ 82,763
Land and Building / $ 6,303
Lease / $ 64,410
Paid-In Capital in Excess of Par / $ 75,000
Preferred Stock / $ 25,000
Sales Tax Payable / $ 891
Store Equipment / $ 26,769

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D. Cash Flow Statement Preparation
Purpose of Statement:
Use the form below to prepare a cash flow statement for Shutterbug Cameras for the year ended June 30. Shutterbug had the following additional payments and receipts:
Bonds Issued/Paid / $ ( 9,106 )
Common Stock Issued/Repurchased / $ 10,000
Payments from Accounts Receivable / $ 8,751
Payments of Accounts Payable / $ (17,139)
Purchase/Sale of Assets / $ ( 1,067)
Purchase/Sale of Marketable Securities / $ 4,231

Section 3.2 Homework

1)How is profit or loss calculated on an income statement?

2)What important financial information is not reflected in either the balance sheet or the income statement?

3)Which financial statement proved the accounting equation?

4)Which financial statement gives the best indication of a company’s ability to compete in the future?

5)Which number of the financial statements represents the amount of income available to stockholders?

6)What items can cause a change in retained earnings?

7)Textbook page 79 – Questions 1, 2, 3, 4, 5, 8

8)Identify the statement(s) on which each account is found:

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A.Vehicles

B.Taxes

C.Selling Expense

D.Sales Revenue

E.Retained Earnings

F.Preferred Stock

G.Operating Expense

H.Notes Payable

I.Marketable Securities

J.Machinery

K.Long-Term Debts

L.Land

M.Inventories

N.Interest Expense

O.General Expense

P.Equipment

Q.Dividends

R.Common Stock

S.Cash

T.Buildings

U.Administrative Expense

V.Accounts Receivable

W.Accounts Payable

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9)Use the information to prepare an income statement, statement of retained earnings, balance sheet and cash flow statement for Kramer Corporation for the year ended December 31.All numbers are in thousands.

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Accounts Payable $80.0

Accounts Receivable $200.0

Accumulated Depreciation $600.0

Cash $40.0

Common Stock Dividends $39.5

Common Stock $100.0

Cost of Goods Sold $1,500.0

Depreciation Expense $50.0

Fixed Liabilities $90.0

Interest Expense $20.0

Inventory $190.5

Marketable Securities $10.0

Notes Payable $100.0

Other Assets $70.0

Other Current Liabilities $30.0

Paid-In Capital in excess of par $250.0

Plant & Equipment $1,100.0

Preferred Stock Dividends $10.5

Preferred Stock, $100 par, 500 shares $50.0

Retained Earnings, Jan. 1 $250.0

Sales $2,000.0

Selling and Admin. Expense $220.0

Taxes $99.5

Additional Information for Cash Flow Statement

Payment from Accounts Receivable $10.5

Payments of Accounts Payable ($50.0)

Sale of Assets $9.5

Purchase of Marketable Securities ($200.0)

Common Stock Issued $15.0

Bonds Paid ($1,000.0)

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10)Use the information given to prepare an income statement, statement of retained earnings, balance sheet and cash flow statement for Argyle Textiles for the year ended December 31. All numbers are in millions.

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Tax Expense $18.0

Sales $750.0

Salary Expense $15.0

Retained Earnings $130.0

Rent Expense $40.0

Preferred Stock $5.0

Preferred Dividends $4.0

Notes Payable $50.0

Marketable Securities $1.2

Long-Term Bonds $152.2

Land and Buildings $345.0

Inventory $135.0

Interest Expense $20.0

Depreciation Expense $30.0

Cost of Goods Sold $600.0

Common Stock $10.0

Common Dividends $10.0

Cash in Bank $9.0

Accumulated Depreciation $155.0

Accounts Payable $15.0

Accounts Receivable $90.0

Paid-In Capital in Excess of Par $50.0

Additional Information for Cash Flow Statement

Payment from Accounts Receivable $5.5

Payments of Accounts Payable ($5.0)

Sale of Assets $9.5

Sale of Marketable Securities $2.0

Common Stock Repurchased ($1.0)

Bonds Issued $1.0

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11)Use the information given to prepare an income statement, statement of retained earnings, balance sheet and cash flow statement for Computron Industries for the year ended December 31.

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Cash $52,000

Accounts Receivable $402,000

Inventories $836,000

Plant and Equipment $527,000

Accumulated Depreciation $166,200

Accounts Payable $315,200

Notes Payable $225,000

Bonds Payable $424,612

Common Stock $100,000

Paid-in Capital in Excess of Par $300,000

Preferred Stock $60,000

Retained Earnings $279,768

Sales $3,850,000

Cost of Goods Sold $3,250,000

Administrative Expenses $430,300

Selling Expenses $20,000

Interest Expense $76,000

Tax $29,480

Common Stock Dividends $86,000

Preferred Stock Dividends $12,000

Additional Information for Cash Flow Statement

Bonds Issued $10,000

Payment from Accounts Receivable $114,000

Payments of Accounts Payable ($95,000)

Purchase of Marketable Securities ($20,000)

Sale of Assets $9,500

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12)Textbook page 96 & 97 – Question 20, 23, 26-28.

13)Which accounts should you add together to get total common stockholders’ equity?

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Income Statement

Sales

-Cost of Goods Sold

Gross Profit

-Operating Expenses

Operating Profit

-Interest Expense

Income before taxes

-Tax Expense

Net Income

Balance Sheet

Assets

Current Assets

+ Fixed Assets

Total Assets

Liabilities

Current Liabilities

+ Long-Term Liabilities

Total Liabilities

Stockholders’ Equity

+Preferred Stock

+ Common Stock

+ Paid-In Capital in Excess of Par

+ Retained Earnings

Total Stockholders’ Equity

Total Liabilities and S/E

Cash Flow Statement

Cash Flow from Operations

Net Income

+ Payments from A/R

-Payments to A/P

Cash Flow from Operations

Cash Flow from Investing

Purchase/Sale of Assets

+/- Purchase Sale of Marketable Sec.

Cash Flow from Investing

Cash Flow from Financing

Common Stock Issue/Repurchase

-Stock Dividends

+/- Bonds Issued/Paid

Cash Flow from Financing

Net Cash Flow

Statement of Retained Earnings

Beginning Retained Earnings

+ Net Income

-Dividend Payments

Ending Retained Earnings

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Financial Analysis

Part Three – Ratio Analysis

Section 4.4

Goals

• Recognize important ratios used to analyze the financial condition of a business
• Identify the five ratio categories and the purpose of each category
• Use current financial statements to perform a complete ratio analysis for a company
• Analyze ratios using cross-sectional and time-series analysis
• Define leverage and explain how it can be used to improve investor return

Vocabulary

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financial ratios

ratio analysis

financial leverage

benchmark company

cross-sectional analysis

time-series analysis

liquidity ratios

activity ratios

debt ratios

profitability ratios

market ratios

profit margin

EBIT

ROA

ROE

EPS

P/E Ratio

Hoover’s

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RATIO ANALYSIS

Ratio / Formula / What It Means
Liquidity - ability to satisfy short-term debt
Current Ratio / Current Assets
Current Liabilities / Value of liquid assets available to cover short-term debt
Quick Ratio / Current Assets – Inventory
Current Liabilities / Same as current except inventory is not included in liquid assets
Activity – speed with which various accounts are converted into sales or cash
Inventory Turnover / Sales
Inventory / How many times during the year the company turns over inventory (reorders)
Average Age of Inventory / 360
Inventory Turnover / How many days goods stay in stock before being sold
Accounts Receivable Turnover / Total Sales
A/R / How quickly customer accounts are paid
Average Collection Period / Accounts Receivable
Sales ÷ 360 / Number of days it takes company to collect from customers
Total Asset Turnover / Sales
Total Assets / How efficiently the company is using its assets to generate sales
Debt Ratios – degree of indebtedness and the ability of the firm to pay debts
Debt Ratio / Total Liabilities
Total Assets / Percentage of firms assets owned by others (creditors).
Times Interest Earned / Operating Income
Interest Expense / How many times a year the company makes enough income to pay interest expenses
Profitability – ability to earn income
Gross Profit Margin / Gross Profit
Sales / Percentage of sales dollar left after goods are purchased
Operating Profit Margin / Operating Profit
Sales / Percentage of sales dollar left after goods are purchased & operating expenses paid
Net Profit Margin / Net Income
Sales / Percentage of sales dollar left after all expenses are deducted
Return on Assets / Net Income
Total Assets / How much money the firm earned from each dollar of asset investment
Return on Equity / Net Income
CS Equity / How much money the firm earned from each dollar of shareholder investment
Market Ratios – relate a firm’s current price in the market to the accounting values
Earnings per Share / Net Income
# CS shares outstanding / Number of dollars earned on behalf of each shareholder.
Price/Earnings (P/E) / Market Price
Earnings per Share / How much money are investors willing to pay for each dollar of a firm’s earnings
Market to Book / Market Price
CS Equity ÷ Issued Shares / How much more investors are willing to pay for stock than the amount listed in the balance sheet

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Section 4.4 Homework

1)What is the purpose of performing a ratio analysis?

2)What three activities are required when performing a ratio analysis?

3)What are the five categories of financial ratios? What does each category tell you about the business?

4)Under what circumstances would the current ratio be the preferred measure of overall firm liquidity? Under what circumstances would the quick ratio be preferred?

5)A company has a total asset turnover of 0.85. What does this number mean? Who would be most interested in this number: the stockholders or the managers? Why?

6)What ratio measured the degree of indebtedness? What ratio assesses the firm’s ability to pay debts?

7)Why is it important to calculate all three profit margins (gross, operating and net)?

8)What would explain a firm’s having a high gross profit margin and a low net profit margin?

9)Which measure of profitability is probably of greatest interest to the investing public? Why?

10)Why are market-to-book ratios generally greater than 1.0?

11)What should you consider when selecting which comparative information to use?

12)What is a benchmark company and how is it used when analyzing financial ratios?

13)Textbook page 133 – Questions 1, 2, 3, 4, 5

14)Textbook page 136 – Questions 19, 22

15)Beacon Company’s total current assets, total current liabilities, and inventory for the past 4 years follow:

Item / 1998 / 1999 / 2000 / 2001
Total current assets / $ 16,950 / $ 21,900 / $ 22,500 / $ 27,000
Total current liabilities / 9,000 / 12,600 / 12,600 / 17,400
Inventory / 6,000 / 6,900 / 6,900 / 7,200

a. Calculate the firm’s current and quick ratios for each year.

b. Comment on the firm’s liquidity over the 1998-2001 period.

c. If you were told that Beacon Company’s inventory turnover for 1998-2001 and the industry averages were as follows, would this support or conflict with your evaluation in part b? Why?

Inventory turnover / 1998 / 1999 / 2000 / 2001
Beacon Company / 6.3 / 6.8 / 7.0 / 6.4
Industry average / 10.6 / 11.2 / 10.8 / 11.0

16)The new owners of Celestial Natural Foods have hired you to help them diagnose and cure problems that the company has had in maintaining adequate liquidity. First, you perform a liquidity analysis. You then do an analysis of the company’s short-term activity ratios. Your calculations and industry norms are listed.

Celestial / Industry norm
Current ratio / 4.5 / 4.0
Quick ratio / 2.0 / 3.1
Inventory turnover / 6.0 / 10.4
Average collection period / 73 days / 52 days

a. What recommendations about the amount and the handling of inventory could you make to the new owners?

b. What recommendations about amount and handling of accounts receivable could you make to the owners?

17)Gemtel, Inc., ended 2001 with net profit before taxes of $218,000. The company is subject to a 40% tax rate and must pay $32,000 in preferred stock dividends before distributing any earnings on the 85,000 shares of common stock currently outstanding.

a. Calculate Gemtel’s 2001 earnings per share (EPS).

b. If the firm paid common stock dividends of $0.80 per share, how many dollars would go to retained earnings?

18)Complete the 2001 balance sheet for Orphan Industries using the information that follows it.

Balance Sheet

Orphan Industries

December 31, 2001

Cash$ 30,000 Accounts payable$ 120,000

Marketable securities 25,000 Notes payable ______

Accounts receivable______Accruals 20,000

Inventories 225,000 Total current liabilities ______

Total current assets______Long-term debt ______

Net fixed assets______Stockholders’ equity 600,000

Total assets______Total liabilities stockholders’ equity ______

The following financial data for 2001 is also available:

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(1) Sales totaled $1,800,000.

(2) There are 360 days in the year.

(3) The average collection period was 40 days.

(4) The current ratio was 1.60.

(5) The total asset turnover ratio was 1.20.

(6) The debt ratio was 60%.

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19)Arnold Roberts recently inherited a stock portfolio from his uncle who was a very wise investor. To learn more about the companies that he is now invested in, Arnold performs a ratio analysis on each one and decides to compare them to each other. Some of his ratios are listed below.