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Accounting & Financial Reporting. BUSG 503 Michael Dimond. Financial Accounting for MBAs. Course Overview Introductions Schedule Resources How do I get an A in this class?. Financial Accounting for MBAs. Accounting Information Who uses it? What does it contain? How is it presented?.
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Accounting & Financial Reporting BUSG 503Michael Dimond
Financial Accounting for MBAs • Course Overview • Introductions • Schedule • Resources • How do I get an A in this class?
Financial Accounting for MBAs • Accounting Information • Who uses it? • What does it contain? • How is it presented?
Basic Financial Analysis • Financial figures are related, and they can reveal many details about a company, its performance, and its value • Accounting figures are prepared according to specific rules and certain distortions exist. • There are so many numbers… where shall we begin?
Meaningful Ratio Analysis • Analysis means to break something down to understand it. • Ratio analysis should be used to answer a specific question or set of questions. • If you were examining the financial statements for a company, you might start with this basic question: “Is this a good use of investors’ money?” • What financial ratio would answer this question? How about Return on Equity? • How do you compute Return on Equity (ROE)?
Analyzing ROE • ROE = NI ÷ Equity and answers the question, “is this a good use of investors’ money?” • If you were to break this down, there are three basic questions to answer: How profitable is this business? How efficiently are assets being used? How much does financial leverage help the investors? • What financial ratios would answer these questions? Profit Margin (PM) Total Asset Turnover (TAT) Equity Multiplier (EM)
Drivers of ROE • Profit Margin (PM) = NI ÷ Sales and answers the question, “How profitable is this business?” • Total Asset Turnover (TAT) = Sales ÷ Total Assets and answers the question, “How efficiently are assets being used?” • Equity Multiplier (EM) = Total Assets ÷ Equity and answers the question, “How much does financial leverage help the investors?”
The DuPont Identity • ROE is directly driven by profitability, efficiency and leverage. • ROE = PM x TAT x EM How does that work? • The numerators and denominators cancel to reduce the equation to NI ÷ Equity
A word about ROA • ROA = Return on Assets • What’s the difference between Equity & Assets? • Leverage • What’s the difference between ROE & ROA? • Leverage • ROE = PM x TAT x EM • EM represents leverage • ROA = PM x TAT • No leverage
Digging Deeper with Financial Ratios • How would you analyze profitability, efficiency and leverage? • How do profitability, efficiency and leverage relate? • What affects profitability? • What drives sales? • What is the composition of assets? • How were assets paid for? • How are liabilities managed? • Where shall we begin?
Common-Size Financial Statements • Shows each line item as a percent of an appropriate total. • Common-size balance sheet • % of Total Assets • Shows the composition of assets • Liabilities & equity items are also shown as % of total assets • Debt Ratio = Total Liabilities ÷ Total Assets • Common-size income statement • % of Sales • PM = Net Income as % of Sales
Common-Size Income Statement 100% 7.19% 5.77%
Common-Size Balance Sheet 100% 45.68% 44.34%
We don’t make a common-size CF Statement There are other ways to examine relevant information which would be more helpful
Vertical & Horizontal Analysis • Vertical Analysis compares figures as a percent of a relevant total (“common size” financial statements) • Horizontal Analysis compares the same figure over a series of periods (showing % change or % growth)
Measuring growth • Financial figures change from year to year • To find the % change (“% growth”) over a 1-year period, divide the difference of the two figures by the first year’s value: • [ending – beginning] / [beginning] OR • [ending] / [beginning] - 1 • Measuring growth over more than one period means we need to find the average growth during that time.
