ACCT 423 By Travelsi Slaheddine

1. Jazan University College of Business Administration الإدارة المحاسبية Management Accounting ACCT 423 By TravelsiSlaheddine

2. Plan Unit 1:Analysis of Financial Statements (Ratio Analysis) Unit 2 : Cash Flow Statement Unit 3: Funds Flow Statement

3. Unit 1:Analysis of Financial Statements (Ratio Analysis)

4. Ratio Analysis : Meaning Ratios analysis means a tool used by individuals to conduct a quantitative analysis of information in a company's financial statements. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company. Financial statement are: Balance Sheet, Income Statement, Cash Flow Statement and Funds Flow Statement.

5. Balance Sheet

6. Elements of Balance Sheet A summary of the assets, liabilities, and equity of a business at a particular point in time, usually at the end of the firm’s fiscal year. Assets = Liabilities + Equity (Resources of the (Obligations of (ownership left over business enterprise) the business) Residual) Fixed Assets Long-term Common stock outstanding (Plant, Machinery, Equipment (Notes, bonds, & Additional paid-in capital Buildings) Capital Lease Retained Earnings Current Assets Obligation) (Cash, Marketable Securities, Current Liabilities Account Receivable, Inventories) (Accounts Payable, Wages and salaries, Short-term loans Any portion of long-term Indebtedness due in one-year)

8. Ratio Analysis: Purpose • To identify aspects of a business’s performance to aid decision making • Quantitative process – may need to be supplemented by qualitative factors to get a complete picture • Four (4) main areas:

9. Ratio Analysis • Liquidity – the ability of the firm to pay its way • Investment/shareholders – information to enable decisions to be made on the extent of the risk and the earning potential of a business investment • Profitability– how effective the firm is at generating profits given sales and or its capital assets • Activity– the rate at which the company sells its stock and the efficiency with which it uses its assets.

10. A. Liquidity Ratio 1. Acid Test ratio • Also referred to as the ‘Quick ratio’ • (Current assets – stock) : liabilities • 1:1 seen as ideal • The omission of stock gives an indication of the cash the firm has in relation to its liabilities (what it owes) • A ratio of 3:1 therefore would suggest the firm has 3 times as much cash as it owes – very healthy! • A ratio of 0.5:1 would suggest the firm has twice as many liabilities as it has cash to pay for those liabilities. This might put the firm under pressure but is not in itself the end of the world!

11. A. Liquidity Ratio 2. Current Ratio • Looks at the ratio between Current Assets and Current Liabilities • Current Ratio = Current Assets : Current Liabilities • Ideal level? – 1.5 : 1 • A ratio of 5 : 1 would imply the firm has SAR 5 of assets to cover every SAR 1 in liabilities • A ratio of 0.75 : 1 would suggest the firm has only 75p in assets available to cover everySAR 1 it owes • Too high – Might suggest that too much of its assets are tied up in unproductive activities – too much stock, for example? • Too low - risk of not being able to pay your way

12. B. Investment/Shareholders • Earnings per share – profit after tax / number of shares • Price earnings ratio – market price / earnings per share – the higher the better generally. Comparison with other firms helps to identify value placed on the market of the business. • Dividend yield – ordinary share dividend / market price x 100 – higher the better. Relates the return on the investment to the share price.

13. Earnings per share The portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company's profitability.Calculated as:

14. Profitability • Profitability measures look at how much profit the firm generates from sales or from its capital assets • Different measures of profit : • Gross profit – effectively total revenue (turnover) – variable costs (cost of sales) • Net Profit – effectively total revenue (turnover) – variable costs and fixed costs (overheads) • ROCE : Return On Capital Employed

15. Profitability • The higher the better • Enables the firm to assess the impact of its sales and how much it cost to generate (produce) those sales • A gross profit margin of 45% means that for everySAR 1 of sales, the firm makes 45p in gross profit

16. Profitability • Net profit takes into account the fixed costs involved in production – the overheads • Keeping control over fixed costs is important – could be easy to overlook for example the amount of waste - paper, stationery, lighting, heating, water, etc. • e.g. – leaving a photocopier on overnight uses enough electricity to make 5,300 A4 copies. (1,934,500 per year) • 1 ream = 500 copies. 1 ream =SAR 5.00 (on average) • Total cost therefore=SAR 19,345 per year – or 1 person’s salary

17. Profitability • Return on Capital Employed (ROCE) = Profit / capital employed x 100 • The higher the better • Shows how effective the firm is in using its capital to generate profit • A ROCE of 25% means that it uses every SAR 1 of capital to generate 25p in profit • Partly a measure of efficiency in organisation and use of capital

18. Financial

19. Asset Turnover • Asset Turnover = Sales turnover / assets employed • Using assets to generate profit • Asset turnover x net profit margin = ROCE

20. Stock Turnover • Stock turnover = Cost of goods sold / stock expressed as times per year • The rate at which a company’s stock is turned over • A high stock turnover might mean increased efficiency? • But: dependent on the type of business – supermarkets might have high stock turnover ratios whereas a shop selling high value musical instruments might have low stock turnover ratio • Low stock turnover could mean poor customer satisfaction if people are not buying the goods (Marks and Spencer?)

21. Debtor Days • Debtor Days = Debtors / sales turnover x 365 • Shorter the better • Gives a measure of how long it takes the business to recover debts • Can be skewed by the degree of credit facility a firm offers

22. Limitations of Ratios Analysis • Comparison with industry averages is difficult if the firm operates many different divisions. • “Average” performance is not necessarily good. • Seasonal factors can distort ratios. • Sometimes it is difficult to tell if a ratio value is “good” or “bad.” • Often, different ratios give different signals, so it is difficult to tell, on balance, whether a company is in a strong or weak financial condition.

23. Limitations of Ratios Analysis • Ratios are presented on a percentage basis • Relative size is ignored (e.g., both large & small firms can be compared) • It is assumed that all numbers used are correct (consider both possible errors and earnings management) • If the numbers are not reliable, ratios are not particularly useful

24. Unit 2 : Cash Flow Statement

25. Why Cash Flow Statement? • Shareholder value is now widely accepted as an appropriate standard for performance in US business. The stock market sends a clear message that earning per share is not the most important measure. Now is growth for growth’s sake. What matters is long-term cash generation. (Werner & LeBer, “Managing for Shareholder Value--From Top to Bottom,” Harvard Busines Review, Nov.-Dec. 1989 pp. 52-65.)

26. Basic Form of Cash Flow Statement • Cash Flow From Operating Activities • Direct method or indirect method (direct requires also a reconciliation of net income to cash flow from operating activities) • Cash Flow from investing activities • Cash Flow from financing activities • Total (positive or negative) cash flow is added to beginning cash balance and should result in ending cash balance

27. Flow from Operating Activities • Includes: • Current assets • except Marketable securities and s-term notes receivable which are investing • Current Liabilities • except s-t notes payable which are financing • Revenue and Expenses (includes interest expense and revenue, and dividends received)

28. Flow from Investing Activities • Includes: • Short-term and long-term investments • Short-term and long term notes receivable • Property, Plant and Equipment (depreciation affects operating activities) • Intangible Assets

29. Flow from Financing Activities • Includes: • Short-term and long-term loans • Capital Stock and Paid in Capital in excess of par • Retained earnings (net income aspect is operating) • Dividends Paid

30. General Theory • Take revenue or expense account (includes cash and accrual) • adjust out accrual amounts • Result is net cash in or out. • Too expensive to classify all cash transactions into operating, financing, investing activities. Cheaper to use accrual systems and adjust out accrual information

31. Operating ActivitiesIndirect Method • Net Income • + Depreciation exp (noncash exp) • + Losses from sale of assets • (full amount of sale already included in investing section) • - Gains from sale of assets • (full amount of sale already included in investing section) • - increases in current assets • + decreases in current assets • + increases in current liabilities • - decreases in current liabilities • = Net cash from operating activities

32. Operating Activities Direct Method • + Cash Received from Customers • - Cash paid for inventory • - Cash paid for operating expenses • - Cash paid for income taxes • - Cash paid for interest • + Cash received from dividends and interest • = Net cash from operating activities

33. Cash Received from Customers • Sales • - Increase in A/R (receive less cash) OR + Decreases in A/R (receive more cash) • - writeoffs (beg allowance +bad debt exp. - ending allowance) • + Increase in unearned revenue (receive more cash) OR - Decrease in unearned revenue (receive less cash) • = Cash Received from Customers

34. Sales + Beg Net A/R - End Net A/R - Bad debt exp adj - Beg unearned rev + End undearned rev = Cash from Customers Sales + Beg A/R - End A/R - writeoffs = beg allowance + bad debt exp. - ending allowance - Beg unearned rev + End unearned rev = Cash from Customers Cash Received from Customers(other variations)

35. Cash Paid For Inventory • Cost of Goods Sold • + End Inventory • - Beginning Inventory • = Purchases • + Beg A/P • - End A/P • = Cash paid for inventory

36. Cash Paid for Operating Expenses • Operating Expenses (do not include interest exp., depreciation exp., nor gains & losses from sale of investments) • - Beg prepaids • + End prepaids • + Beg accrued exp • - End accrued exp • = Cash paid for operating expenses

37. Cash Paid for Income Taxes • Income Tax Exp • + Beg tax payable • - End tax payable • = Cash paid for income Taxes

38. Cash Paid for Interest • Interest Exp • + Beg interest payable • - End interest payable • = Cash paid for interest

39. Cash Received from dividends and interest • Dividend and Interest Income • + Beg interest receivable • - End interest receivable • = Cash Received from dividends and interest

40. Cash Flow from Investing Activities • Cash received (sale) or paid (purchase) for: • short term investments • long-term investments • property plant and equipment • Whole cash amount received or paid. • Look at change in investment and fixed asset accounts but may need more specific information

41. Example Equipment • Balance Sheet Amount Change: Beg $300,000, Ending $400,000 • Can your just say net cash out for equipment was $100,000? • Why?

42. Example Equipment Continued • Sold Equipment for $65,000 cash that had book value of $40,000 (original cost $100,000) • Bought equipment $200,000 with $80,000 down and the rest on a long term note payable • Accumulated depreciation increased by $50,000

43. Example EquipmentResults on Cash Flow Statement • Cash from sale of equipment $65,000 • Gain on sale $25,000 subtracted from NI on indirect method (make sure amt is not included in direct method either) • Depreciation exp $110,000 ($50,000 increase in accum deprec from B/S + $60,000 acum depr reduced when sold equip added back in indirect method (make sure amt is not included in direct method operating expenses • Cash paid for purchase of equipment $80,000 • Noncash investing & financing Activities • Issued long-term note payable for some equipment $120,000

44. Equipment ExampleThink about journal entries • Cash 65,000Accum Depr 60,000 Equip 100,000 Gain 25,000 Sale of equipment • Depr Exp 110,00 Accum. Depr 110,000 Year end Adj J/E for equip depr. • Equipment 200,000 Cash 80,000 L-T Note Payable 120,000 Equip Purchase

45. Financing Activities • Cash received from: • sale of stock • issuance of debt • Cash paid for • Payment of debt (principle only, interest is in operating activities) • Payment of dividends • Look at change in stock, debt and retained earnings (May need more details) (for R/E only dividends portion applies to financing activities while net income portion should tie into indirect method in operating activities)

46. Ways to Check Your Work • Indirect and Direct methods must equal each other • Net cash flow added to beginning cash balance must equal ending cash balance (Marketable securities are most often included as part of these cash balances.) • In template must account for every change in B/S accounts and every item on income statement (some noncash items are adjusted out or not included in cash flow calculations)

47. Unit 3: Funds Flow Statement

48. FUNDS STATEMENT The funds statement was also known as a “statement of funds flow” or a “statement of sources and applications of funds” This statement was deemed to be necessary as the balance sheet and income statement did not present a complete picture of an entity’s economic activities The statement was seen as necessary to summarise investing and financing activities

49. MEANING OF FUND FLOW The term of ‘Funds Flow’ has made up with the two words – Funds and Flow of funds. Let us first we understand these meaning and then we see how funds flow statement is prepared.

50. THE TREM ‘FUND’ IS USED IN THREE SENSES – CASH - In narrow sense, the term ‘fund’ is used to mean only the cash and bank balance.