Using Accounting Information for Business Control and Planning

1. Chapter 13 Using Accounting Information for Business Control and Planning

2. Introduction • The value of an accounting system helps agribusiness managers understand, evaluate, and monitor the financial health and performance of their business • The controlling management function can be accomplished using the balance sheet and profit-and-loss statement

3. Comparative Statement Analysis • Balance sheets and P&L statements from two periods are placed side by side and examined for any significant changes in dollars or percentages that could affect financial condition of the firm • Changes over time are measured against industry standards from sources such as Robert Morris Associates • Comparative balance sheet analysis – figure 13-1, text page 190 • Comparative profit-and-loss statement analysis– figure 13-2, text page 191

6. Net Working Capital Analysis • NWC is the difference between current assets and current liabilities as expressed on the balance sheet NWC = current assets – current liabilities • Net Working Capital Analysis tells managers • Where the firm’s money is coming from – business profits, loans, stock sales, and so on • Where the firm is spending its money –purchase of fixed assets, dividend payment, debt payment, and so on

7. The Sources and Uses of Net Working Capital Statement

8. The 3-Step Process for Developing aSources and Uses Statement • Calculate the NWC for each year from the balance sheet and determine the change in the NWC between the two periods • Determine the items that constitute the sources and uses of NWC • Examine the changes that occurred within the current assets and liabilities See figure 13-3, text page 195

10. Ratio Analysis • Ratio analysis examines the relationship among various components of the balance sheet and P&L statement • Evaluates ratios by comparing current information to changes over time and to industry standards • Four categories • Liquidity Ratios • Solvency Ratios • Activity Ratios • Profitability Ratios

11. Liquidity Ratios • Current Ratio: the relationship between current assets and current liabilities as listed on the balance sheet • Quick Ratio = • Acid Test Ratio: the ultimate test of liquidity current assets Current Ratio = current liabilities current assets – inventories current liabilities cash Acid Test Ratio = current liabilities

12. Solvency Ratios total debt = total liabilities • Debt to Equity Ratio = • Times InterestEarned Ratio = owners’ equity income before taxesand interest expense interest expense

13. Activity Ratios cost of goods sold • Inventory TurnoverRatio = • Accounts ReceivableTurnover Ratio = • Accounts PayableTurnover Ratio = inventory level credit sales accounts receivable purchases on credit accounts payable

14. Profitability Ratios profit before taxes • Return on Investment(ROI) Ratio = • Return onOwners’ Equity = • Profit as a Percentageof Sales Ratio = total assets profit before taxes owners’ equity profit before taxes total sales

15. Developing Pro Forma Cash Flow Budgets • Determine the cash outflows: Use the monthly sales estimates from the marketing plan. Developed from ratios and other information on the balance sheet and income statement • Determine cash inflows: Begin by using the same cash sales estimates from the marketing plan. Developed from ratios and other information on the balance sheet and income statement • Develop the pro forma cash flow budget: Combine the cash inflows and outflows for the period to determine the pro forma cash flow budget for the period See figures 13-4, 13-5, and 13-6, text pages 203, 205, 206

19. The Pro Forma Cash Flow BudgetHelps Managers Answer Five Key Questions • Does the business need to borrow money? • If so, how much money needs to be borrowed? • When does the money need to be borrowed? • How will the money be repaid? • When will the money be paid?

20. Discussion Questions • Explain how the accounting system gives an accurate record of business financial dealings to managers, owners, and government regulators. • Explain how the controlling management function can be accomplished using the data found in the balance sheet and the profit-and-loss statement. Name two of its uses. • Compare and contrast how comparative statement analysis, net working capital analysis, and ratio analysis can help managers and owners evaluate a firm’s financial performance. Use examples to show that each type of analysis illuminates a different area of financial performance. Show how they can be combined to assist managers in accomplishing the controlling function. • Explain why a regular part of business financial analysis should be the use of industry standards and year-to-year comparisons.

21. Illustrate with an example how a new business could use industry standard data to make a pro forma (estimated) profit-and-loss statement and balance sheet for the intended business. Give an example to illustrate that changes in net working capital are caused only by changes in current assets or current liabilities that affect a non-current part of the balance sheet. Explain why all three steps of the procedure to develop a sources and uses of net working capital statement have the same answer for the change in net working capital. What does a manager gain by having a sources and uses of net working capital statement? Use an example to explain the difference between liquidity and solvency in a business. Explain the difference between the current ratio and net working capital methods to analyze liquidity. Which one does a better job? Explain your choice.

22. How do you know if a ratio’s value is good or bad? Is it possible for a ratio to be too high or too low? Explain your answer using one of the ratios given the chapter. Explain which of the four types of ratios – liquidity, activity, solvency, and profitability – is most important to the firm in the long run. Use an example to explain your answer. Use an example to explain how the profit-and-loss statement differs from a cash flow statement for a business. Which one is more important to a business? Explain your answer.