Return on Assets

Profitability Ratios

 Net income

Average total assets

How well are you using Assets to generate earnings. 

Profit Margin

Profitability Ratios

Net Income
Net Sales 

Measures how much profit the company earns from each sales dollar.

Asset Turnover

Profitability Ratios

Sales
Average Total Assets

How well are you creating sales from Assets 

ROA = PM  * AT

Profitability Ratios

NI           =          NI    *     Sales

Avg Asst          Sales      Avg Asst

Return on Equity

Net Income
Avg Shareholder's Equity 

Return on Equity = Profit Margin Ratio * Asset Turnover Ratio * Equity Multiplier

ROE =        NI     *         Sales           *   Avg Tot Asst
                Sales         Avg Tot Asst              Avg Eq

ROE - Measures the profit generated from the resources owner provided

 Current Ratio

Liquidity Ratios

Current Ratios = Current Assets
                           Current Liabilities 

Quick Ratio

Liquidity Ratios

 Cash + Marketable Securities + A/R

Current Liabilities 

If you couldn't sell Inventory, wil you still be able to pay all your liability.

Debt-to-Equity Ratio

Solvency/Leverage Ratios

Total Liabilities

Shareholders' Equity 

Times Interest Earned Ratio

Solvency/Leverage Ratios

Earnings Before Interest & Taxes
Interest Expense 

Receivables Turnover Ratio

 Net Sales

Avg Accounts Receivable 

Reveals how many times receivables have turned (been collected) during the period.

Average Collection Period

365
Receivables Turnover Ratio 
 

Receivable Turover Ratio = Net Sales / Avg Account Receivables

Reveals how many days on average it takes the company to collect their A/R

Inventory Turnover Ratio

 COGS

Average Inventory 

how many times inventory turned (was sold) during the period.

Payables Turnover Ratio

Inventory Purchases

Average Accounts Payable 

Beg Inv + Inventory Purchases - COGS = End Inv

How many times payable turned (were paid) during the period

Average Days Payables

365
Payables Turnover Ratio 

How many days on average the firm waited to pay their receivables.

Days in Financing

Days in Inv + Days in A/R - Days in Payables

Tells you how many days of working capital required

All intangible values that are not identifiable.

GAAP Limitations of Ratio Analysis

Non-Capitalized Costs

GAAP Limitations of Ratio Analysis

Historical Costs

Only when the transaction is recorded.  Example, Land value increases.

Liquidity

Refers to cash: how much we have, how much is expected, and how much can be raised on short notice.

Current Assets

Current Liabilities

Those liabilities that come due within the next year.

Net Working Capital

or

Working Capital

An excess of current assets over current liabilities.

Current Assets - Current Liabilities

• Solvency/Leverage Ratios (Define)
• Solvency (Define)
• Leverage (Define)

• Ability of the company to pay its long-term obligations.
• Company's ability to meet its debt obligations
• describes how a company is financed

Average Days Inventory Held

365
Inventory Turnover Ratio

how many days on average it takes the company to sell inventory.

Accrual Accounting

A system of accounting in which revenues and expenses are recorded as they are earned and incurred, not necessarily when cash changes hands

• Accounting splits business into time-periods
• Make NI a better measure of a firm’s profitability

Revenue Recognition

Revenues are recorded when two main criteria are met

• The earnings process is substantially completed
• Cash has either been collected or its collectability is reasonably assured

Four Types of Adjusting Entries

1. Unrecorded Receivables
2. Unrecorded Liability
3. Prepaid Expense
4. Unearned Revenue

Unrecorded Receivables

Earned revenue, not yet recorded

Example: Contract to provide limo service from November 1 to February 28.  You get paid $3,000 for whole contract once you fulfill the contract.

Unrecorded Liability

Expense incurred, not yet recorded

Example: Used $800 of electricity in December.  You will get a bill in January.

Prepaid Expense

Paid $, but you haven’t used the service/good yet

Example: Paid 6-month premium of $600 for insurance up front on November 1.

Unearned Revenue

Got paid $ up front, but you haven’t done the work yet.

Example: Received $1,000 deposit from a customer for a product to be sold and delivered next month.

Trial Balance

• The trial balance is a listing of all accounts and their balances at a point in time. 
   
• Its purpose is to prove the mathematical equality of debits and credits, provide a useful tool to uncover any accounting errors, and help prepare the financial statements.

Closing Process

• The closing process refers to the ‘zeroing out’ of revenue and expense accounts (the temporary accounts) by transferring their ending balances to retained earnings. 
   
• Balance sheet accounts carry over from period to period and are called permanent accounts.
   
• The result is that all income statement accounts begin the next period with zero balances. 

Statement of cash flows

The financial statement that describes an entity’s cash inflows and cash outflows during a period.  

• Designed to show information about the change in the cash balance from first balance sheet to second balance sheet. 
• One of the 4 required financial statements
• Only required since 1983
• Cash is defined as “Cash and cash equivalents.”  Includes bank account balances, cash, coin, and short-term liquid investments

Operating Activities

Statement of Cash Flow

Cash transactions that enter into the determination of net income

• Two methods- direct/ indirect

Investing Activities

Statement of Cash Flow

Cash transactions involved in the purchase and sale of PPE, other long-term assets and making/collecting loans (an investment to our firm)

Financing Activities

Statement of Cash Flow 

Cash transactions whereby resources are obtained or repaid to owners and creditors

Receipts from customers for sales made or services rendered.

Receipts of interest and dividends

Other receipts that are not related to investing or financing activities, such as lawsuit settlements and refuncs received from suppliers.

Payments to employees or suppliers.

Payments to purchase inventories.

Payments of interest to creditors.
 

Payments of taxes to government.

Other payments that are not related to investing or financing activities, such as contributions to charity.

Receipts from sales of PPE assets and intangible assets.

Receipts from sales investments in stocks, bonds, and other securities (other than cash equivalents).

Receipts from repaymeents of loans by borrowers.

Payments to purchase PPE assets and intangible assets.

Payments to purchase stocks, bonds, and other securities (other than cash equivalents).

Payments made to lend money to borrowers.

Receipts from issuances of common stock and preferred stock and from sales of treasury stock.

Receipts from issuance of bonds payable, mortgage notes payable, and other notes payable.

Payments to acquire treasury stock.

Payments of dividends.

Payments to settle outstanding bonds payable, mortgage notes payable, and other notes payable.

Two ways of creating the statement of cash flows

• Analyzing the cash account
• Must have detailed information about all transactions associated with the cash account
• With computers this is possible if you code each transaction by type
   
• Analyzing the balance sheet and income statement
• If specific information about cash is not available then this is the way to do it
• Most information needed to create the statement of cash flows is in the balance sheet and income statement
• Undo accrual basis accounting

Information from Balance Sheet

Operating Activities

Current Assets

Current Liabilities

Long-term Assets

Long-term Liabilities

Stockholders' Equity

Stakeholders for Financial Acct

Shareholders

Debt Holders

Managers

Employees

Investment Analyst

Customers and Strategic Partner

Required Financial Statements

Income Statement

Balance Sheet

Statement of Cash Flow

Statement of Shareholder Equity

Balance Sheet

describes the sources and uses of funds at a point in time.

Assets        =         Liability + Owner's Equity
use of funds           Source of funds 

Assets

Economic resources that are owned or controlled by a company that have future economic benefits

Example: Cash, A/R, Inventory, Land, Building, Equipment, Copyrights, and Investments.

Liabilities

Future obligations to pay cash, transfer assets or provide services to another party.

Example: Account Payable, Notes Payable, Wages Payable.