Accounting for Decision Making.

1

• Accounting for Decision Making.
• Sect 1-4

2
Accounting is the process of
Topic 1 Accounting information managerial
decisions
Accounting is the link between business
activities and business decisions as illustrated
in the diagram below.
Ingram et al (200559)
3
Topic 1 Accounting information managerial
decisions
Source Jackson and Sawyers (2006 5)
4
Topic 1 Accounting information managerial
decisions

The Decision-making Model
Step 4 Select the best position
Step 3 Identify and analyse available options
Step 2 Identify objectives
Step 1 Define the problem
5
Topic 2 Financial Statements Accounting
concepts
The flow from transactions to financial
statements can be illustrated as follows
Transactions

Financial statements
Procedures for sorting, classifying, and
presenting (bookkeeping) Selection of
alternative methods of reflecting certain
transactions (accounting)
The financial statements and what they are
intended to report on are as follows
Financial Statement Reports on
Balance sheet Financial position on a certain date.
Income statement Financial performance for a particular period.
Statement of changes in equity Investments by and distributions to owners.
Statements of cash flows Cash flows during the period.
6
Topic 2 Financial Statements Accounting
concepts
MVN ENTERPRISES MVN ENTERPRISES
BALANCE SHEET AS AT 31 JANUARY 2011 BALANCE SHEET AS AT 31 JANUARY 2011
ASSETS Property, plant and equipment Inventory (merchandise) Accounts receivables Cash Total assets EQUITY AND LIABILITIES Equity Liabilities Non-current debt Accounts payables Total equity and liabilities R 247 000 19 000 28 500 151 400 445 900 220 650 100 000 125 250 445 900
7
Topic 2 Financial Statements Accounting
concepts
MVN ENTERPRISES MVN ENTERPRISES MVN ENTERPRISES
INCOME STATEMENT FOR THE YEAR ENDED 31 JANUARY 2011 INCOME STATEMENT FOR THE YEAR ENDED 31 JANUARY 2011 INCOME STATEMENT FOR THE YEAR ENDED 31 JANUARY 2011
R
Sales 300 000
Cost of sales (200 000)
Gross profit 100 000
Selling, general and administrative expenses (54 950)
Operating profit 45 050
Interest expense (15 000)
Net profit 30 050
8
Topic 2 Financial Statements Accounting
concepts
MVN ENTERPRISES STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31JANUARY 2011 MVN ENTERPRISES STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31JANUARY 2011
Balance at 31 January 2010 Additional capital contributed Profit for the year Drawings for the year Balance at 31 January 2011 R 0 211 000 30 050 (20 400) 220 650
9
Topic 2 Financial Statements Accounting
concepts
MVN ENTERPRISES CASH FLOW STATEMENT FOR THE YEAR ENDED 31 MARCH 20.6 MVN ENTERPRISES CASH FLOW STATEMENT FOR THE YEAR ENDED 31 MARCH 20.6 MVN ENTERPRISES CASH FLOW STATEMENT FOR THE YEAR ENDED 31 MARCH 20.6 MVN ENTERPRISES CASH FLOW STATEMENT FOR THE YEAR ENDED 31 MARCH 20.6
R
Cash flows from operating activities 135 800
Servicing of finance (15 000)
Interest paid (15 000)
Cash flows from investing activities (260 000)
Payment to acquire tangible non-current assets (260 000)
Net cash outflows (139 200)
Cash flows from financing activities 290 600
Net cash received from owner 190 600
Cash received from non -current loan 100 000
Increase in cash 151 400

10
Topic 2 Financial Statements Accounting
concepts
NOTES TO THE CASH FLOW STATEMENT Reconciliation of operating profit NOTES TO THE CASH FLOW STATEMENT Reconciliation of operating profit NOTES TO THE CASH FLOW STATEMENT Reconciliation of operating profit NOTES TO THE CASH FLOW STATEMENT Reconciliation of operating profit
R
Operating profit 45 050
Depreciation 13 000
Increase in inventory (19 000)
Increase in accounts receivable (28 500)
Increase in accounts payable 125 250
Net cash flows from operating activities 135 800

11
Topic 2 Financial Statements Accounting
concepts
Direct Method Shows the major classes of gross
cash receipts and payments. This method starts
with Revenues and Expenses while also including
Current Assets as well as Current Liabilities.
Indirect Method Shows the net profit or loss as a
starting point and makes adjustments for all
transactions of a non-cash items.
12
Topic 3 Accounting Presentation
Balance Sheet
Current assets Inventories Notes receivable Accounts receivable Short-term marketable securities Cash and cash equivalents Non-current assets Land Buildings and equipment Assets acquired by lease Intangible assets Natural resources Other non-current assets

13
Topic 3 Accounting Presentation
Balance Sheet
Owners equity Ordinary shares Preference shares Retained income Current liabilites Accounts payable Short-term debt Current maturities of long-term debt Non-current liabilities Long-term debt Other long-term liabilities
14
Topic 3 Accounting Presentation
15
Periodic LIFO of Corner Shelf Bookstore
Number of Books Cost per Book Total Cost
Inventory at 12-31-09 1 _at_ 85  85
First purchase (January 2010) 1 _at_ 87 87
Second purchase (June 2010) 2 _at_ 89 178
Third purchase (December 2010) 1 _at_ 90     90
Total goods available for sale 5 440
Less Inventory at 12-31-10 4   350
Cost of goods sold 1 _at_ 90  90
16
Perpetual LIFO of Corner Shelf Bookstore
Number of Books Cost per Book Total Cost
Inventory at 12-31-09 1 _at_ 85  85
First purchase (January 2010) 1 _at_ 87 87
Second purchase (June 2010) 2 _at_ 89 178
Third purchase (December 2010) 1 _at_ 90     90
Total goods available for sale 5 440
Less Inventory at 12-31-10 4   351
Cost of goods sold 1 _at_ 89  89
17
Topic 4 Income statement Cashflow
The following table represents a framework of the
main items that are reported in an Income
Statement.
Income statement
Sales Cost of sales Gross profit Other operating expenses Income from operations Interest expense Interest income Gains (losses) on sale of assets Income tax expense Net profit Earnings per share
18
Cost of goods sold in arriving at gross profit
Sales Cost of goods sold Inventory (1/1/06) Purchases Direct labour Less Inventory (31/12/06) Net cost of goods sold Gross profit on sales R 5,000 45,000 30,000 R 80,000 10,000 R 100,000 70,000 30,000
Gross profit margin is simply the gross profit
expressed as a percentage of sales. This ratio
is determined as follows
Gross profit margin

30
19
Consolidated statements of income (R millions) Consolidated statements of income (R millions) Consolidated statements of income (R millions) Consolidated statements of income (R millions)
Years ended Dec 2010 2010 2009 2008
Net income Less Cost of sales Gross profit Less Research and development Marketing, general, and admin Impairment of goodwill Amortization and impairment of acquisition-related intangibles Purchase in-process RD Operating expenses Operating income 34,209 14,463 19,746 4,778 4,659 ------ 179 ------- 9,616 10,130 30,141 13,047 17,094 4,360 4,278 617 301 5 9,561 7,533 26,764 13,446 13,318 4,034 4,334 ------ 548 20 8,936 4,382
20
Indirect Method
Statement of Cash Flows Statement of Cash Flows
Cash Flows From Operations Net income Add (subtract) adjustments Depreciation Deferred taxes Gain on the sale of machinery Equity in long-term investment Accounts receivable (use) Inventory (source) Accounts payable (source) Net cash flow from operations Investing Cash Flows Purchase fixed assets (use) Sale of old machine (source) Net cash flow from investing Financing Cash Flows 10 year note (source) Sale of common stock (source) Dividends paid (use) Repayment of mortgage note (use) Net cash flow from financing Net cash flow (increase) R 70 100 10 (10) (2) (80) 100 20 208 (100) 30 (70) 100 10 (6) (50) 54 192
21
Direct Method
Operating cash flows Direct method Operating cash flows Direct method
Cash inflows Sales Increase in A/R (use) Cash collections Cash inputs Cost of goods sold Decrease in inventory (source) Increase in A/P (source) Cash inputs Other cash outflows Current income taxes Interest paid Other cash outflows Cash Flow From Operations Investing Cash Flows Purchase fixed assets (use) Sale of old machine (source) Net cash flow from investing Financing Cash Flows 10 year note (source) Sale of common stock (source) Dividends paid (use) Repayment of mortgage note (use) Net cash flow from financing Net cash flow (increase) R 1600 (80) 1520 (1350) 100 20 (1230) (35) (47) (82) 208 (100) 30 (70) 100 10 (6) (50) 54 192
22
Question. You are presented with the following
information. IQUAD Ltd Trading and profit and
loss statement for the year ended 31 December 2010
R000 R000
Sales 1 000
Less Cost of goods sold
Opening stock 200
Purchases 700
900
Less Closing stock 300 600
Gross profit 400
Operating expenses (240)
Operating profit 160
Debenture interest (10)
Net profit before tax 150
Taxation (50)
Net profit after taxation 100
Dividends (60)
Retained profit for the year 40
23
IQUAD Ltd Balance sheet at 31 December 2010
2009 2010
R000 R000 R000 R000
Fixed assets at cost 900 1000
Less Accumulated depreciation 150 750 255 795
Current assets
Stock 200 300
Trade debtors 120 150
Cash 20 45
340 495
Less Current liabilities
Trade creditors 70 90
Taxation 40 50
Proposed dividend 30 60
140 200 200 295
950 1090
Capital and reserves
Ordinary shares of R1 each 750 750
Profit and loss account 200 240
950 990
Loans
Debenture stock (10 issued 1 Jan 2006) ------ 100
950 1090
Required Prepare the cash flow statement for the
year to 31 December 2010. (20)
24
IQUAD Ltd Cash flow statement for the year ended
31 December 2010
R000
Cash receipts
Sale of goods (R1000 R120 R150) 970
Issue of debenture stock (R100 R0) 100
1070
Cash payments
Purchases (R700 R70 R90) (680)
Operating expenses (R240 (R255 R150)) (135)
Debenture interest paid (10)
Taxation (40)
Dividends (30)
Purchases of fixed assets (R1050 R900) (150)
(1045)
Increase in cash during the year 25
Cash at 1 January 2010 20
Cash at 31 December 2010 45
25

• The following information applies to Trustworthy
  Enterprises for November 2010
• 02 The owner of Trustworthy Enterprises commenced
  business by investing R65, 000 cash.
• 06 Purchased equipment for R15, 000 cash.
• 10 The owner obtained a long-term loan of R30,
  000 from the bank.
• 14 Purchased merchandise on credit for R40, 000.
• 28 Sold merchandise that cost R15, 000 for R26,
  000 on credit.
• 31 Paid salaries to the employees, R6000.
• Required
• Prepare the Balance sheet of Trustworthy
  Enterprises as at end November 2010.
• Prepare the Cash Flow Statement for the month
  ended November 2010.

26
a)
Balance sheet of Trustworthy Enterprises as at 30 November 2010

ASSETS R
Property, plant and equipment 15 000
Inventory 25 000
Accounts receivable 26 000
Cash 74 000
140 000

EQUITY AND LIABILITIES
Equity 70 000
Liabilities
Long-term debt 30 000
Accounts payable 40 000
Total equity and liabilities 140 000
27
(b)
Cash flow statement of Trustworthy Enterprises for the month ending 30 November 2010 R
Cash flows from operating activities (6000)
Net profit 5 000
Increase in inventory (25 000)
Increase in accounts receivable (26 000)
Increase in accounts payable 40 000
Cash flows from investing activities (15 000)
Purchase of plant, property and equipment (15 000)
Cash flows from financing activities 95 000
Capital contributed 65 000
Cash received from long-term loan 30 000
Net increase in cash for the year 74 000
Cash (Opening balance) 0
Cash (Closing balance) 74 000
28
Good luck with your studies
29

• Accounting for Decision Making.
• Sect 5-8

30

• Sect 5 Cost-volume-profit relationships.
• Using CVP analysis, managers would be able to get
  information to use in decision-making relating
  to
• How profits are affected by a change in costs.
• What effect a change in sales volume will have on
  profit.
• The profit that is expected from a certain sales
  volume.
• How many units need to be sold to achieve a
  targeted profit.
• At what output of production will the income and
  costs be the same.
• Setting selling prices.
• Selecting the mix of products to sell.

31
Calculation of operating profit.
Selling price per crate Variable costs per crate Fixed costs in respect of the product Sales volume in crates R30 R18 R80, 000 8000 crates
Applying these figures in the model results in
the following operating profit
Per unit x Volume Total
Sales Variable costs Contribution margin Fixed costs Operating profit R30 R18 R12 x 8 000 R96 000 (80 000) R16 000 40
32
Drop in selling price by R6 and increase in sales
volume to 12000 units. The operating profit will
be
Per unit x Volume Total
Sales Variable costs Contribution margin Fixed costs Operating loss R24 18 R6 12 000 R72 000 (80 000) (R8 000) 25
33
Decrease in selling price by R6 accompanied by an
increase in advertising expense of R6 000 and an
expected increase in sales volume of 19 000
units. Operating profit is expected to be
Per unit x Volume Total
Sales Variable costs Contribution margin Fixed costs Operating profit R24 18 R 6 x 19 000 R114 000 (86 000) R 28 000 25
34
Calculating the volume of sales required to
achieve a target level of operating profit of R46
000.
Per unit x Volume Total
Sales Variable costs Contribution margin Fixed costs Operating profit R30 18 R 12 x ? R126 000 (80 000) R 46 000 40
The required sales volume is 10 500 units (R126
000 / R12).
35
Greystone CC manufactures one product. The
following details relating to the product
applies
Variable costs per unit Total fixed cost Selling price per unit Number of units sold R 72 R 32 000 R 82 6 000

• Required
• Calculate the break-even quantity and the
  break-even value.
• Calculate the margin of safety in terms of units
  and value.

Per unit x Volume Total
Sales Variable costs Contribution margin Fixed costs Operating profit R82 72 R 10 x 6000 6000 6000 R492 000 (432 000) R 60 000 (36 000) R 24 000 12,195
36

• Break-even quantity Fixed costs / Contribution
  margin per unit
• R36 000 / R10
• 3 600 units
• Total revenue at break-even Fixed costs
  / contribution margin ratio
• R36 000 / 12,195
• R295 200 (or 3
  600 x R82)
• Margin of safety Sales units Break-even
  sales units
• (in terms of units) 6 000 3 600
• 2 400 units
• Margin of safety Sales Break-even
  sales
• (in terms of value) R492 000 R295 200
• R196 800

37
Operating leverage is calculated as
follows Operating leverage
The formula for the margin of safety
is Margin of safety
38

• Cost analysis for planning, control and
  decision-making.
• Cost analysis for planning.
• Planning is the management process of identifying
  and quantifying the goals of the organisation.
• Strategic planning involves an identification of
  the long-term goals and drawing up plans to
  achieve them.
• A budget is a plan in financial terms that
  extends for a period in the future.
• Budgeting process. The first step in the
  budgeting process is to develop and communicate a
  set of broad assumptions about the economy,
  the industry and the entitys strategy for the
  budget period.
• The operating budget is a collection of related
  budgets comprising the sales forecast (or revenue
  budget), the purchase/production budget, the
  operating expense budget, the income statement
  budget, the cash budget, and the budgeted balance
  sheet. The operating budget is also called the
  master budget.

39

• Cost analysis for decision making.
• Net Present Value
• The difference between the market value of a
  project and its cost.
• How much value is created from undertaking an
  investment?
• The first step is to estimate the expected future
  cash flows.
• The second step is to estimate the required
  return for projects of this risk level.
• The third step is to find the present value of
  the cash flows and subtract the initial
  investment. This is to determine whether the
  project is viable.

• Computing NPV for the Project
• You are looking at a new project and you have
  estimated the following cash flows
• Year 0 CF -165,000 (original investment)
• Year 1 CF 63,120
• Year 2 CF 70,800
• Year 3 CF 91,080
• Your required return for assets of this risk is
  12.
• Using the formulas NPV

NPV 63,120/(1.12) 70,800/(1.12)2
91,080/(1.12)3 165,000 12,627.42
40
Another way of determining NPV is as follows
Year Cash Flow PV
1 63,120.00 56,363.39
2 70,800.00 56,453.16
3 91,080.00 64,845.76

NPV _at_ 12 177,662.91
Original Investment -165,000.00
NPV 12,662.91

• Decision rule.
• If the NPV is positive, accept the project. A
  positive NPV means that the project is expected
  to add value to the firm and will therefore
  increase the wealth of the owners.
• Since our goal is to increase owner wealth, NPV
  is a direct measure of how well this project will
  meet our goal.
• So, do we accept or reject the project?
• NPV is positive at 12 - we can accept the
  investment!

41

• Internal Rate of Return
• Internal rates of return (IRR).
• This is the most important alternative to NPV.
• It is often used in practice and is intuitively
  appealing.
• It is based entirely on the estimated cash flows
  and is independent of interest rates found
  elsewhere.
• Definition IRR is the return that makes the NPV
  0.
• Another way of putting it is that the IRR is the
  discount rate that equates the PV of cash inflows
  with the initial investment associated with the
  project.
• Decision Rule Accept the project if the IRR is
  greater than the required return.

42
Example The management of Tiger Engineering are
considering the following investment project. The
following data is available Cost of plant and
equipment 60 000 Salvage value nil Expected
profit/loss Yr 1 (15 000) Yr 2 10
000 Yr 3 35 000 Tiger Engineering uses the
straight-line method of depreciation for all
fixed assets. The estimated cost of capital is
10 p.a.
43
Cash flows. ARR ARR
Year Profit/loss Depreciation Cash flow
1 2 3 (15 000) 10 000 35 000 20 000 20 000 20 000 5 000 30 000 55 000

x100
x 100
33.33 NPV
Year Cash flow I Discount factor 10 PV I
0 1 2 3 (60 000) 5 000 30 000 55 000 1 0.9091 0.8264 0.7513 (60 000) 4 546 24 792 41 321
NPV 10 659
44
IRR
Year Cash flow Disc fact 17 PV Disc fact 18 PV
0 1 2 3 (60 000) 5 000 30 000 55 000 1 0.8547 0.7305 0.6244 (60 000) 4 273 21 915 34 342 1 0.8475 0.7182 0.6086 (60 000) 4 237 21 546 33 473
NPV 530 (744)
(Where do I get 1274 from? The diff between PV _at_
17 and 18.)
IRR 17.42
45

• Quick example.
• Suppose an investment will cost 90,000 initially
  and will generate the following cash flows
• Year 1 132,000
• Year 2 100,000
• Year 3 -150,000
• The required return is 15.
• Should we accept or reject the project?
• Hurdle rate is 15.

Year 0 -90,000
Year 1 132,000
Year 2 100,000
Year 3 -150,000

IRR 10.11 Reject

NPV fx 15 91,769.54
Less initial investment -90,000.00
NPV at 15 1,769.54 Accept
46
EC Industrials manufactures a product, Brainagra
that sells for R126 each. The cost of producing
and selling 240 000 units are estimated as
follows Variable costs per unit Direct
materials R30 Direct labour R18 Factory
overhead R12 Selling and administrative
expenses R15 R75 Fixed costs Factory
overheads R3 200 000 Selling and
administrative expenses R1 200 000 In the
current year, to date 180 000 units were
manufactured and sold. An additional 45 000 units
are expected to be sold on the domestic market
during the remainder of the year. EC Industrials
received an offer from Namibia Wholesalers for 12
000 units of Brainagra at R84 each. Namibia
Wholesalers will market the product in Namibia
with its own name brand and no additional
expenses will be incurred by EC Industrials. The
sale to Namibia Wholesalers is not expected to
affect domestic sales of the product and the
additional units could be produced during the
current year using excess capacity. As the
Marketing Manager you are requested to make a
decision to either accept or reject the above
proposal and to motivate the decision you have
made. (15)
47
A comparison of the sales offer of R84 with the
selling price of R126 indicates that the offer
should be rejected. EC Industrials, however, has
excess capacity and the focus should be on the
relevant cost, which is the variable cost. The
difference in the profit from accepting the offer
is calculated as follows Differential Revenue
from accepting the offer 12 000 units _at_ R84 R
1 008 000 Differential cost by accepting the
offer 12 000 units _at_ R60 (R30 R18 R12) (R
720 000) Differential profit from accepting the
offer 288 000 The offer should
therefore be accepted.
48
The following information relates to two
projects, Project A and Project B from which one
must be chosen by Construction International. Aft
er-tax cash flows Year Project A Project B
1 0 36 000 2 18 500 36 000
3 36 200 36 000 4 123 000 36 000 Both
projects require an initial investment of R117
700 As the project manager of Construction
International you are required to 3.1 Calculate
the Net Present Value (NPV) for each project
using a discount rate of 12. Which project would
you use choose? Why? 3.2 Calculate the
Internal Rate of Return (IRR) for both projects.
Which project should be chosen? Why (20)
49

• PROJECT A
• Year Cash Inflow Discount Factor Present Value
• 1 0 0.8929 0
• 2 18 500 0.7972 14 748
• 3 36 200 0.7118 25 767
• 123 000 0.6355 78 611
• Total Present Value 119 126
• Investment 117 700
• NPV (positive) 1 426
• PROJECT B
• Net Inflow R 36 000
• Discount factor x 3.0373
• Total Present Value 109 342
• Investment 117 700
• NPV (negative) 8 358
• DECISION
• Project A should be chosen because the NPV is
  positive. Reject Project B because it has a
  negative NPV.

50

• PROJECT A
• Choosing the discount factor
• Step 1
• Since we know the NPV is positive and above zero,
  although by a small margin, pick a higher
  discount rate e.g. 13 (Trial and error is used
  to obtain the higher rate).
• Step 2
• Year Cash Discount Discount
  Present Present
• Inflow Factor Factor
  Value Value
• 12 13
  12 13
• 1 0 0.8929
  0.8850 0 0
• 2 R 18 500 0.7972 0.7831
  R14 748 R14 487
• 3 R 36 200 0.7118 0.6931
  R25 767 R25 090
• 4 R123 000 0.6355 0.6133
  R78 166 R75 435
• Total PV
  R118 681 R115 012
• Investment
  (R117 700) (R117 700)
• NPV
  R 981 (R2 688)

51
Step 3 Interpolation The IRR is between 12
and 13 IRR 12 ____981__
981 2 688 12 981_ 3669
12.27
52
PROJECT B Choosing the discount factor Step
1 Since we know the NPV is negative, pick a lower
discount rate e.g. 10 (Trial and error is used
to obtain the lower rate). Step 2 Year Cash
Inflow Discount Discount Discount
Present Present Present
p.a. Factor Factor
Factor Value Value Value
10
9 8 10 9
8 1-4 36 000 3.1699
3.2397 3.3121 114 116
116629 119235 Investment

117 700 117700 117700 NPV
(R3 584) (R1071) R1535
53
Step 3 Interpolation The IRR is between 8 and
9 IRR 8 __1535___ 10711535 8
1535 2606
8.59 Decision Project A must be chosen because
it has a higher IRR (20)
54
Payback Period
Project A Project B
Initial investment R42, 000 R45, 000
Year Operating CFs Operating CFs
1 14, 000 28, 000
2 14, 000 12, 000
3 14, 000 10, 000
4 14, 000 10, 000
5 14, 000 10, 000
Average 14, 000 14, 000
For project A, which is an annuity, the payback
period is 3.0 years. Since project B generates a
mixed stream of cash inflows, the calculation of
the payback period is not quite as clear cut. In
year 1 the firm will recover R28, 000 of its
initial investment. In yr 2 R40, 000 will be
recovered (28k 12k). At the end of year 3, R50,
000 will be recovered. Since the amount received
at the end of year 3 is greater than the initial
investment, the payback period is somewhere
between 2 3 years. Only R5, 000 must be
recovered during year 3. However R10, 000 was
recovered. Thus the payback period is 2.5yrs
(2yrs R5, 000/10, 000). If the maximum
acceptable payback period is 2.75yrs, project A
would be rejected and project B accepted.
55

• Analysis and interpretation of financial
  statements.
• Ratio analysis consists of five major categories,
  namely
• Liquidity ratios which indicate the ability of
  the organization to meet its short-term
  obligations.
• Profitability ratios which express the
  effectiveness of the company in earning profits
  and return on capital invested.
• Financial leverage ratios which show the
  relative extent to which capital employed has
  been provided by shareholders and providers of
  debt.
• Market ratios which reflect the performance of
  the share price on the stock exchange and the
  implications for the shareholders of that share.
• Efficiency ratios reflect the management ability
  of the company with regard to its turnover and
  working capital. This is also known as Activity
  Ratios.

56

• The three basic measures of liquidity are
• Net working capital CA CL
• Current ratio CA/CL
• Quick (acid-test) ratio CA inventory / CL

57

• Activity ratios.
• i) Inventory T/O Cost of goods sold / Inventory
• Fixed asset Turnover Sales / Net fixed assets
• Accounts receivable T/O Ann cr sales / Accs
  rec
• iv) Ave collection period A/cs rec / Ave sales
  per day
• (A/cs rec / Ann sales)/360

58

• Profitability ratios.
• i) Gross prof margin Sales cost of goods sold
  / sales gross profs / sales
• ii) Operating prof margin EBIT / Sales
• Operating profs / Sales
• iii) Return on Total Assets (ROA) Net profs
  after tax / owners equity
• iv) Return on Equity (ROE) Net profs after
  taxes / Owners equity
• v) Earnings per share (EPS) Earnings available
  for common shareholders / no of shares of common
  stock outstanding

59
4) Leverage ratios. i) Debt ratio Tot
liabilities / tot assets ii) Debt-to-equity
ratio Long-term debt / owners equity iii)
Times interest earned ratio EBIT /
Interest iv) Fixed-payment coverage ratio
EBIT lease payments / int lease payments
((principal payments pref
stock divs) x (1/(1-T)))
60
5) Other ratios. i) Price / Earnings (P/E)
ratio Mkt P per share of common stock / after
tax earnings per share ii) Dividend payout
ratio Ann divs per share/ After tax earnings per
share
61
Barlow Company Income Statement for the year ended 31 December 2010 Barlow Company Income Statement for the year ended 31 December 2010 Barlow Company Income Statement for the year ended 31 December 2010
2010 (R,000) 2009 (R,000)
Sales revenue 3,074 2,567
Less Cost of goods sold 2,088 1,711
Gross profits 986 856
Less Operating expenses
Selling expenses 100 108
General admin expenses 194 187
Lease expense 35 35
Depreciation expense 239 223
Total operating expense 568 553
Operating profits 418 303
Less Interest expense 93 91
Net profits before taxes 325 212
Less Taxes (rate 29) 94 64
Net profits after taxes 231 148
Less preferred stock dividends 10 10
Earnings available for common shareholders 221 138
62
Barlow Company Balance Sheet for the year ended 31 December 2010 Barlow Company Balance Sheet for the year ended 31 December 2010 Barlow Company Balance Sheet for the year ended 31 December 2010
Assets 2010 (R,000) 2009 (R,000)
Current assets
Cash 363 288
Marketable securities 68 51
Accounts receivable 503 365
Inventories 289 300
Total current assets 1,223 1,004
Gross fixed assets
Land and buildings 2072 1903
Machinery and equipment 1,866 1,693
Furniture and fixtures 358 316
Vehicles 275 314
Other 98 96
Total fixed assets 4,669 4,322
Less Accumulated depreciation 2,295 2,056
Net fixed assets 2,374 2,266
Total assets 3,597 3,270
63
Liabilities and stockholders equity 2010 (R,000) 2009 (R,000)
Current liabilities
Accounts payable 382 270
Notes payable 79 99
Accruals 159 114
Total current liabilities 620 483
Long-term debt 1,023 967
Total liabilities 1,643 1,450
Stockholders equity
Preferred stock cumulative 5, R100 par, 2,000 shares authorized and issued 200 200
Common stock R2.50 par, 100,000 shares authorized, shares issued and outstanding in 2006 76,262 in 2005 76,244 191 190
Paid-in capital in excess of par on common stock 428 418
Retained earnings 1,135 1,012
Total stockholders equity 1,954 1,820
Total liabilities and stockholders equity 3,597 3,270
64

• Required Calculate the following for Barlow
  Company for 2010.
• The acid-test ratio. (2)
• The average collection period. (2)
• The fixed asset turnover. (2)
• The debt ratio. (2)
• Operating profit margin. (2)
• Net profit margin. (2)
• Return on equity. (2)
• Price/earnings ratio. (2)

65

1. Acid-test ratio

1.51

1. Average collection period

58.9 days

1. Fixed asset turnover

1.29

1. Debt ratio

45.7
66

1. Operating profit margin

13.6

1. Net profit margin

7.5

1. Return on equity

6.4

1. P/E ratio

11.1
67
Good luck with your studies