Using%20Accounting%20Information%20for%20Business%20Control

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• Using Accounting Information for Business Control
• BS PL statement assist mgers control the
  financial health performance of their
  operation.
• This section focuses 3 main areas of financial
  analysis
• Comparative statements analysis,
• Net working capital analysis,
• Ratio analysis
• that are employed to evaluate past financial
  performances of businesses.
• 1. Comparative Statements Analysis
• 1st first step in comparative statements analysis
  is to
• examine balance sheets P L statements for 2
  consecutive periods
• ook for any changes that may indicate a shift in
  the financial condition of the firm.

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• Let's examine the comparative B/S of AgBiz Corpn.
  
• Current AssetsThere is a fall in cash
  inventories plus a large increase (500) in
  accounts receivable.
• This signal problems for the firm as reflects a
  reduction in the firm's liquidity or ability to
  pay its bills on time.
• Fixed AssetsUnchanged except for a 160,000
  (40) rise in buildings eqpmt which may imply
  a reduction liquidity
• Total Assets There is an increase in the value
  of total assets of 12 ( 109,200) since last
  year.
• Current LiabilitiesHas increase by 116.7 from
  last year, mainly from accounts payable
  installment payments may reflect a decrease in
  the firm's liquidity.
• Total Liabilities Has risen slightly since last
  year.
• Total owners' equity Has increased by the amount
  of net income (42,300 from PL).
• Total Liabilities Owners' Equity Has risen by
  109,200.
• Note equation assets liabilities owners'
  equity, or
• 1,020,000 410,000
  610,000.

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• Let's examine the comparative PL of AgBiz Corpn
• RevenueThere is a 17.2 increase in sales
  revenues
• Cost of Goods Sold Rose just by 10 from last yr
  to meet the 17.2 increase in sales.
• Operating Expenses There is over 50 (i.e.51.65)
  increase in operating expenses.
• Net Income Has risen by 41 from last year. This
  is partly explained by cost of goods sold staying
  almost the same.
• Expenditure Pattern (where each was spent)
• Year 1 For each of sales taken in, 0.821 was
  spent on COGS (1,026,000/1,250,000), leaving
  0.179 to contribute to operating expenses
  profits.
• Year 2 Amount spent on COGS was reduced to
  0.771 (i.e. 1,129,000 /1,105,000), leaving
  0.229 for operating expenses profits. This
  extra 0.050 per sales dollar may reflect good
  mgmt.

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• Operating Expenses as of SalesIt rose 4.5
  from 15 of sales to 19.5, with largest from
  salaries wages, promotion, utilities. These
  require scrutiny as rising operating expenses can
  reduce level of profits
• Income Before TaxesRose from 2.9 of sales to
  3.5. Thus the increases in expenses are well
  spent, as net income rose from 2.4 to 2.9 of
  sales.
• 2. Net Working Capital Analysis
• It measures liquidity by computing the that
  will remain after selling all current assets
  paying all current liabilities i.e. measures
  availability of cash or "near cash" items to pay
  bills as they come due.
• It is thus the money used to meet the day-to-day
  expenses of the firm to meet any emergency
  expenses.

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• NWC difference btwn current assets current
  liabilities as shown on balance sheet. NWC CA -
  CL
• CA items that will turn to cash within next
  acctg period
• CL debt items that must be paid within next
  acctg period.
• NWC current assets (CA) current liabilities
  (CL)
• Includes Cash IncludesNotes
  payable Securities Accounts
  payable Accounts receivable Taxes
  payable Inventory etc. Dividends
  payable etc.

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• Examination of AgBiz NWC shows a decrease from Y1
  to Y2 but still able to pay all its expected
  bills.
• Current assets - Current liabilities NWC
• Yr 1 205,000 - 41,500
  163,500
• Yr 2 174,000 - 89,500
  84,050
• A decrease
  79,450
• Activities that Impact BS and NWC
• 1. Cash purchase of inventory inventory value
  rises, cash falls by similar amount, CA remains
  same. CL are unchanged. Thus NWC remains
  unchanged.
• CA - CL
  NWC
• cash inventory - no change
  no change

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• 2. Short-term Credit Purchase of Inventory
• CA - CL
  NWC
• inventory - accounts payable
  no change
• Long-term credit purchase of inventory
• CA - CL NWC
• inventory - no change rise by amt of
  inventory change
• 3. Long-term loan payment next year
• CA - CL NWC
• cash - no change fall by amt of
  change in cash
• i.e. if CA or CL is used to meet non-current
  balance sheet item, then NWC changes. This is so
  cos the accounting equation (assets liabilities
  owners' equity) is always true

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• Sources and Uses or Application of Net Working
  Capital
• Document valuable to mger/shareholders alike, cos
  it shows where working capital came from where
  it was spent.
• Sources of NWC Uses of NWC
• Profits Payment of dividends
• Sale of fixed assets Purchase of fixed
  assets
• Sale of investments Purchase of investments
• Over 1 yr loans Repayment of debt
• Sale of stock Retirement of stock
• Depreciation
• Building sources uses NWC statement requires 2
  consecutive BS plus a PL statements in a 3-step
  process
• Step One Calculate NWC for each yr change in
  NWC. In our example yr 1 NWC 163,500 yr 2
  NWC 84,050. NWC Change 163,500 - 84,050
  79,450

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• Step two Determine sources uses of NWC items.
  In our example uses of NWC (160,200) gt the
  sources of NWC (80,000) by 79,450 this is
  equal to the change in NWC btwn yr1 yr 2 as
  shown in step one.
• Step three Examine changes CA CL by
  calculating the net changes in CA CL their
  difference. Which should give same amount as
  change in NWC (i.e. - 79,450).
• Purpose of sources uses statement is to show
  items that are source of NWC or used for NWC
  during the year.
• In our example, Profits long-term borrowings
  were main sources of NWC btwn yr 1 yr 2 main
  of NWC was to the purchase of new fixed assets
  (buildings eqpmt).
• To accomplish this, cash inventories were
  reduced, while accounts receivable, accounts
  payable, current portion of long-term debt all
  rose.
• Mgers like to have major source of funds be
  profits major use of funds be fixed assets,
  since this would reflect a healthy, growing firm.

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• Figure Developing Sources Uses of Net
  Working Capital Statement
• 1. Determine the Change in the Net Working
  Capital
• Year Current Assets - Current
  Liabilities Net Working Capital
• 1 205,000 -
  41,500 163,500
• 2 174,000 -
  89,950 84,050
• Change in Net Working
  Capital 79,450
• 2. Determine the Sources and Uses of Net Working
  Capital
• Sources of NWC
  Uses of NWC
• Profits (Retained Earnings) 42,300
  Dividends
  0
• Sale of Fixed Assets 0
  Purchase of Fixed Assets 160,000
• Long-Term Borrowings 18,450
  Repay Debt
  0
• Sale of Stock
  0 Retirement of Stock
  0
• Depreciation 20,000
  Other Investments
  200 Total Sources 80,750
  Total Uses
  160,200
• 80,750 - 160,200
  -79,450
• 3. Determine the Changes within Current Assets
  and Current Liabilities
• Change in Current Assets - Change in Current
  Liabilities Change in NWC
• -32,000 Cash
  33,000 Accounts Payable
• 25,000 Acct. Rec.
  250 Taxes Pay,
• -24,000 Inventories
  15,200 Current Part of long term Debt

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• Ratio Analysis
• Looks at the relationship (or ratio) btwn
  components of BS and PL statement. There are 4
  main categories of ratios
• 1. Liquidity ratios mainly from BS statement
• 2. Solvency ratios mainly from BS statement
• 3. Activity ratios - from both BS and PL
  statements
• 4. Profitability ratios mainly from PL.
• Ratios from Balance Sheets
• A. Liquidity Ratios Measures ability to meet the
  day-to-day cash needs of a firm it concentrates
  on CA (sources) CL (uses) three (3) ratios
  have been developed.
• 1. Current RatioMeasures CA relative to CL. A
  value of 1 means CL CA. Like NWC, it shows the
  firm's ability to meet its bills in the next
  period. The larger the ratio ratio the more
  liquid the firm vice versa
• Current Ratio Year 1 CA 205,000 4.94
  CL 41,500
• Current Ratio Year 2 CA 174,000 1.93
  CL 89,950

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• 2. Quick RatioMeasures CA less inventories
  relative to CL shows the firm's ability to pay
  bills quickly if inventories cannot be sold. The
  larger the ratio ratio the more quickly the the
  firm can pay its bills.
• Quick Ratio Year 1 CA - inventories 205,000
  151,000 1.30 CL 41,500
• Quick Ratio Year 2 CA - inventories 174,000
  127,000 0.52 CL 89,950
• 3. Acid Test RatioMeasures ability to pay bills
  tomorrow if inventories accounts receivable
  cannot be turned to cash.
• Acid Test Ratio Year 1 Cash 49,000
  1.18 CL 41,500
• Acid Test Ratio Year 2 Cash 17,000
  0.19 CL 89,950
• In yr 1 AgBiz is extremely liquid, as it had
  1.18 in cash for each it owed in coming year
  but this reduced to 0.19 in yr 2.

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• B. Solvency Ratios Measures ability to pay debt
  its relationships btwn assets, liabilities
  equity. Analyzes if firms debt or liabilities
  can be paid off by sale of all assets. Assetsgt
  liabilities solvent
• 1. Debt to Equity Ratio or Leverage Ratio.
  Compares the proportion of financing provided by
  lenders with that provided by firm owner i.e.
  it determines the relative size of creditors'
  claims to owners' or stockholders claim its
  the ratio of total debt (total liabilities) to
  owners' equity.
• Debt to Equity Ratio Yr 1 Total debt
  (liabilities) 343,100 0.60
  Owners equity 567,700
• Debt to Equity Ratio Yr 2 Total debt
  (liabilities) 410,000 0.67
  Owners equity 610,000
• When leverage ratio 1, lenders owners are
  providing equal portion of financing. Smaller
  values are preferred to larger ones thus very
  large leverage ratios result from small equity,
  meaning an increasing chance of insolvency

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• 2. Debt to Asset Ratio Measure what part of
  total assets is owned to lenders. It shd have a
  value less than 1 smaller values are
  preferred.Thus ratios gt 1 means insolvency.
• Debt to Asset Ratio Yr 1 Total debt
  (liabilities) 343,100 0.38
  Total Assets 910,800
• Debt to Asset Ratio Yr 2 Total debt
  (liabilities) 410,000 0.40
  Total Assets
  1,020,000
• 3. The Times Interest Earned Ratio Lenders are
  concerned with the level of risk they are
  assuming when they loan money to firms. One
  measure of risk is the size of the firms pretax
  earnings relative to the interest payment. These
  figures can be obtained from the PL statement.
• Int. Earned Ratio Yr 1 Income before tax
  interest 36,0004000 10.0
  Interest paid 4000
• Int. Earned Ratio Yr 1 Income before tax
  interest 51,0005000 11.2
  Interest paid 5000
• In yr 1, there was 10 of income for each of
  interest due but this rose to 11 in yr 2. Thus,
  interest payment is not in jeopardy cos as
  interest rose, income has risen more.

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• C. Activity RatiosDeals with activity of firm
  with respect to inventory levels, credit
  payments, own bill paying.
• 1. Inventory Turnover Ratio Assist mgers
  determining how much inventory to be kept on
  hand. One way to measure inventory activity is to
  calculate number of times inventory is used up or
  turned over in the year. Its done by dividing
  COGS (from PL) by the level of inventory shown
  on BS.
• Inventory Turnover Ratio Yr 1 COGS 1,026,000
  6.79 inventory level 151,000
• Inventory Turnover Ratio Yr 2 COGS 1,129,000
  8.89 inventory level 127,000
• In yr 1 inventory turned over 6.79 times in yr
  2 it turned over 8.89 times, thus, the inventory
  turned over more quickly in year 2 than in year 1

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• 2. Accounts Receivable Turnover Ratio. Measures
  length of time a firm has to wait to get its
  money from credit sales. It calculated by
  dividing credit sales (10 of Sales in our
  example) by value of accounts receivable
• Ac Rec Turnover Ratio Yr 1 credit
  Sales 125,000 25
  accounts receivables 5,000
• Ac Rec Turnover Ratio Yr 2 credit
  Sales 146,500 4.88
  accounts receivables 30,000
• In yr 1the accounts receivable turned over 25
  times or once every 14.6 days, 4.88 times or
  once every 74.8 days in yr 2.
• Thus, there was a substantial increase in the
  length of time (14.6 to 74.8 days) required to
  get money from credit sales. Such a jump requires
  managers to examine the firms credit policies,
  which may be a source of the liquidity problem.

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• 3. The Accounts Payable Turnover Ratio Measures
  how fast the firm pays its own bills. It
  calculated by dividing credit purchases e.g.
  25 of purchases assumed to be on credit (from
  PL statement) by level of accounts payable
  (from BS)
• Ac Payable T/Ratio yr 1credit purchases
  269,250 13.5 accounts
  payables 20,000
• Ac Payable T/Ratio yr 1credit purchases
  276,250 5.21 accounts
  payables 53,000
• Thus, in yr 2 it took over 2.5 times as long for
  the firm to pay its bills. This is a serious
  increase deserves some mgmt attention as it
  could have been caused by its liquidity problems.

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• D. Profitability Ratios Measures how efficient
  the firm is in using its resources to produce
  profit. 3 ratios are presented
• 1. Return on Investment Ratio (ROI). Also called
  return on capital or return on asset. The ROI
  ratio measures the profit, or return on money
  invested in the firm, its relationship btwn
  before-tax profit (from PL) total assets (from
  BS).
• ROI in yr 1 before-tax profit x 100 36,000
  x 100 3.95 total assets
  910,800
• ROI in yr 2 before-tax profit x 100 51,000
  x 100 5.00 total assets
  1,020,000
• In vr 1 there was a return of 3.95 on monev
  invested in yr 2 this rose to 5.00. Thus, it
  shows that the firm was using its resources more
  efficiently in year 2.

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• 2. Return on Owners' Equity Ratio (ROE). The ROI
  ratio can be misleading as it is a mixture of
  both debt equity capita,thus, ROE may be a more
  appropriate measure of return. It is the ratio of
  before-tax profit (from PL) to owners' equity
  (from BS)
• ROI in yr 1 before-tax profit x 100 36,000
  x 100 6.34 owners
  equity 567,700
• ROI in yr 2 before-tax profit x 100 51,000
  x 100 8.36 owners
  equity 610,000
• ROE rose from 6.34 in yr 1 to 8.4 in yr 2. This
  higher return may reflect a good job on the part
  of mgmt.

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• 3.Profit as a Percentage of Sales RatioMeasures
  the profit earned from sales revenue. Its the
  relationship btwn the before-tax profit total
  sales (from PL)
• PPS Ratio yr 1 before-tax profit 36,000
  2.88 total sales
  1,250,000
• PPS Ratio yr 2 before-tax profit 51,000
  3.48 total sales
  1,465,000
• This ratio shows improvement as profit from each
  dollar of sales revenue rose from 0.0288 in yr 1
  to 0.0348. This may reflect good management.