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BSAD 221 Introductory Financial Accounting Donna Gunn, CA

BSAD 221 Introductory Financial Accounting Donna Gunn, CA. Understanding The Business. Past Performance. Present Condition. Future Performance. Income, sales volume, cash flows, return- on-investments, EPS. Assets, debt, inventory, various ratios. .

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BSAD 221 Introductory Financial Accounting Donna Gunn, CA

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  1. BSAD 221Introductory Financial AccountingDonna Gunn, CA

  2. Understanding The Business PastPerformance PresentCondition FuturePerformance Income, sales volume, cash flows, return- on-investments,EPS. Assets, debt, inventory, various ratios. Sales and earnings trends are good indicators of future performance.

  3. IndividualCompanyFactors IndustryFactors Economy-wideFactors The Investment Decision No Yes Invest?

  4. Understanding a Company’s Strategy BusinessStrategy OperatingDecisions Transactions FinancialStatements

  5. Time seriesanalysis Comparison with similar companies Financial Statement Analysis Financial statement analysisis based on comparisons.

  6. Ratio analysis, or percentageanalysis, is used to express the proportionate relationship between two different amounts. Ratio and Percentage Analyses

  7. Express each item on a particular statement as a percentage of a single base amount. Net saleson the incomestatement Total assetson the balancesheet Component Percentages

  8. The comparative income statements of Home Depot for 2006 and 2005 appear on the next slide. Prepare component percentage income statements where net sales equal 100%. Component Percentages

  9. 2007 Cost ÷ 2007 Sales

  10. Continued Comparative Statements

  11. Comparative Statements

  12. Tests of liquidity focus on the relationship between current assets and current liabilities. Common Liquidity Ratios: Current Ratio Quick Ratio Inventory Turnover Receivable Turnover Days’ Sales in Receivables Tests of Liquidity

  13. Current Ratio Current Assets Current Liabilities = Current Ratio $18,000 $12,931 = = 1.39 to 1 Current Ratio This ratio measures the ability of the company to pay current debts as they become due.

  14. Quick Ratio Quick Assets Current Liabilities = Quick Ratio $3,837 $12,931 = = 0.30 to 1 Quick Ratio (Acid Test) This ratio is like the current ratio but measures the company’s immediate ability to pay debts.

  15. Inventory Turnover Cost of Goods Sold Average Inventory = $61,054 ($11,401 + $12,822) ÷ 2 Inventory Turnover = 5.0x = Inventory Turnover This ratio measures how quickly the company sells its inventory.

  16. Average Days’ Supply in Inventory Days in Year Inventory Turnover = Average Days’ Supply in Inventory 3655.0 = 73 Days = Average Days’ Supply in Inventory This ratio measures the average number of days it takes to sell the inventory.

  17. Net Credit Sales Average Net Receivables Receivable Turnover = $90,837 ($2,396 + $3,223) ÷ 2 Receivable Turnover = 32.3 Times = Receivable Turnover This ratio measures how quickly a company collects its accounts receivable.

  18. Days Sales in Receivables Average Net A/R One Days Sales = ($2,396 + $3,223)÷2 $90,837÷ 365 =11.3 Days = Days Sales in Receivables This ratio measures the average number of days it takes to collect receivables.

  19. Average Age of Receivables Days in a Year Receivable Turnover = 36532.3 Average Age of Receivables = 11.3 Days = Average Age of Receivables This ratio measures the average number of days it takes to collect receivables. Same as prior slide – just more common approach.

  20. Measuring Ability to Pay Long Term Debt • Measure a company’s ability to meet its long-term obligations. • Common Tests of Solvency: • Debt to Equity • Times Interest Earned

  21. Debt-to-Equity Ratio Total Liabilities Owners’ Equity = Debt-to-Equity Ratio $27,233 $25,030 = = 1.09 (or 109%) Debt-to-Equity Ratio This ratio measures the amount of liabilities that exists for each $1 invested by the owners.

  22. Times Interest Earned Net Interest Income Tax Income Expense Expense Interest Expense + + = Times Interest Earned $5,761 + $392 + $3,547$392 = 24.7 Times = Times Interest Earned This ratio indicates a margin of protection for creditors.

  23. Profitability is a primary measure of the overall success of a company Common Profitability Ratios: Return on Net Sales Return on Assets Return on Equity EPS Gross Margin Tests of Profitability

  24. Net Income Net Sales Return on Net Sales = $5,761 $90,837 = 6.3% = Return on Net Sales (AKA Profit Margin) This ratio tells us the percentage of each sales dollar that is income.

  25. Return on Assets Net Income + Interest Exp. (net of tax) Average Total Assets = $5,761 + ($392 × (1 - .38)) ($44,405 + $52,263) ÷ 2 Return on Assets = = 12.4% Return on Assets Corporate tax rate is 38%. This ratio is generally considered the best overall measure of a company’s profitability.

  26. Net Income –Pref. Dividends Average CommonEquity Return on Equity = $5,761 ($26,909 + $25,030) ÷ 2 Return on Equity = = 22.2% Return on Equity This measure indicates how much income was earned for every dollar invested by the common share owners.

  27. Net Income Available to Common Shareholders Weighted-Average Number of Common Shares Outstanding EPS = $5,761 2,054 EPS = = $2.80 Earnings per Share (EPS) Average number of shares outstanding is from Home Depot’s 2006 Income Statement. Earnings per share is probably the single most widely watched financial ratio.

  28. Net Sales - COGS Net Sales Gross Profit Margin = $90,837- 61,054 $90,837 Gross Profit Margin = 32.8% = Gross Profit Margin This ratio tells us the percentage of each sales dollar after we’ve paid for the cost of the product

  29. Market tests relate the current market price of a share of stock to an indicator of the return that might accrue to the investor. Common Market Tests: Price Earnings Ratio Dividend Yield Book Value per share of Common Stock Analyzing Shares as An Investment

  30. Current Market Price Per ShareEarnings Per Share P/E Ratio = $43.95$2.80 P/E Ratio = = 15.7 Price/Earnings (P/E) Ratio A recent price for Home Depot common share was $43.95 per share. This ratio measures the relationship between the current market price of the stock and its earnings per share.

  31. Dividend Yield Dividends Per Share Market Price Per Share = Dividend Yield $0.75$43.95 = = 1.7% Dividend Yield Ratio Home Depot paid dividends of $0.75 per share when the market price was $43.95 per share. This ratio is often used to compare the dividend-paying performance of different investment alternatives.

  32. Ratios may be interpreted by comparison with ratios of other companies or with industry average ratios. Ratios may vary because of the company’s industry characteristics, nature of operations, size, and accounting policies. Interpreting Ratios

  33. In addition to financial ratios, special factors might affect company analysis: Rapid growth. Uneconomical expansion. Subjective factors. Other Financial Information

  34. A securities market in which prices fully reflect available information is called an efficient market. In an efficient market, a company’s stock reacts quickly when new, relevant information is released about the company. Efficient Markets

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