Financial Accounting and Ratio Analysis (Corporate fin. N2&3)
Accrual accounting:
The general idea is that economic events are recognized by matching revenues to expenses (the matching principle) at the time in which the transaction occurs rather than when payment is made or received.
-recognize revenue when the earnings process is virtually complete and the value of an exchange of goods or services is known.
- not at the time of collection but at the time of sale
Recognize revenues when
-delivery has occurred or services have been rendered
-there is persuasive evidence of an arrangement for customer payment.
- the price is fixed or determinable.
- collection is reasonably assured.
matching concept:
Cash basis accounting can distort the measurement of net income because it soemtimes fails to properly match revenus with expenses.
The problem is that cash is not always received or paid in the period when the revenue is earned or when the expense is incurred.
The objective of accrual accounting is to improve matching of revenues with expenses.
Networking capital is usually positive for a healthy firm
Market value is the true value and is the price at which the assets, liabilities, or equity can actually be bought or sold.
Taxes is one of the largest cash outflows
Marginal vs. Average tax rates-> tax bracket
1) marginal - the percentage paid on the next dollar earned
2) average: tax bill/ taxable income
Marginal tax rate is relevant for financial decision making : issue of how much tax for an addiitional profit
Operating cash flow: the cash flow from the firm's business activities
Net capital spending: net spending on fixed assets (purchases of fixed assets less sales of fixed assets)
Change in Net Working Capital: net increase in current assets over current liabilities.
Types of ratios:
1. Liquidity ratios: Short-term solvency
2. Financial leverage ratios or Long-term solvency ratios
3. Asset management or Turnover ratios
4. Profitability ratios
Dupont Identity: ROE= PM * TAT *EM
Internal Growth rate is defined as the maximum growth a company can attain without relying on external sources of finance
Sustainable Growth rate: how much the firm can grow by using internally generated funds and issuing debt to maintain a constant debt ratio.
Determinants of growth:
1. profit margin - operating efficiency
2. Total asset turnover - asset use efficiency
3. financial leverage - choice of optimal debt ratio
4. Dividend policy - choice of how much to pay to shareholders versus reinvesting in the firm
Current ratio = CA/CL
708/540 = 1.31 times
Quick Ratio = (CA- Inventory)/ CL
"acid test"
- (708-422)/540 = 0.53 times
Cash ratio = Cash/CL
98/540 = .18 times
Total Debt Ratio = (TA- TE)/TA
= (3,588-2,591)/3588 = 0.28 times
Debt/Equity = TD/TE
= (997/2591)= 0.38 times
Equity Multiplier = TA/TE = 1+ D/E
Times Interest Earned = EBIT/Interest
= 4.9 times
Cash Coverage = (EBIT+ Depreciation)/Interest
= (691+276)/141 = 6.9 times
Inventory Turnover = COGS/ Inventory
Days' Sales in Inventory = 365/ Inventory Turnover
Payables Turnover = COGS/ AP
Days' Costs in Payables = 365/ Payables Turnover
Total Asset Turnover = Sales/ Total Assets
Capital Intensity ratio = 1/TAT
Profit margin = NI/Sales
Return on Assets = NI/TA
Return on Equity = NI/TE
Enterprise Value = Total market value of the stock + Book value of all liabilities - Cash
1. You have the following information:
Leverage ratio (assets/equity)= 2.2
Total Asset Turnover = 2.0
Net Profit Margin = 5.5%
Dividend Payout ratio = 31.8%
ROE= PM* TAT* Leverage= 5.5 * 2 * 2.2= 24.2%
2. tax burden ratio = .75
leverage ratio = 1.25
interest burden = .6
return on sales = 10%
Asset turnover = 2.4
ROE= tax burden * interest burden * margin * turnover * leverage
=
The general idea is that economic events are recognized by matching revenues to expenses (the matching principle) at the time in which the transaction occurs rather than when payment is made or received.
-recognize revenue when the earnings process is virtually complete and the value of an exchange of goods or services is known.
- not at the time of collection but at the time of sale
Recognize revenues when
-delivery has occurred or services have been rendered
-there is persuasive evidence of an arrangement for customer payment.
- the price is fixed or determinable.
- collection is reasonably assured.
matching concept:
Cash basis accounting can distort the measurement of net income because it soemtimes fails to properly match revenus with expenses.
The problem is that cash is not always received or paid in the period when the revenue is earned or when the expense is incurred.
The objective of accrual accounting is to improve matching of revenues with expenses.
Networking capital is usually positive for a healthy firm
Market value is the true value and is the price at which the assets, liabilities, or equity can actually be bought or sold.
Taxes is one of the largest cash outflows
Marginal vs. Average tax rates-> tax bracket
1) marginal - the percentage paid on the next dollar earned
2) average: tax bill/ taxable income
Marginal tax rate is relevant for financial decision making : issue of how much tax for an addiitional profit
Operating cash flow: the cash flow from the firm's business activities
Net capital spending: net spending on fixed assets (purchases of fixed assets less sales of fixed assets)
Change in Net Working Capital: net increase in current assets over current liabilities.
Types of ratios:
1. Liquidity ratios: Short-term solvency
2. Financial leverage ratios or Long-term solvency ratios
3. Asset management or Turnover ratios
4. Profitability ratios
Dupont Identity: ROE= PM * TAT *EM
Internal Growth rate is defined as the maximum growth a company can attain without relying on external sources of finance
Sustainable Growth rate: how much the firm can grow by using internally generated funds and issuing debt to maintain a constant debt ratio.
Determinants of growth:
1. profit margin - operating efficiency
2. Total asset turnover - asset use efficiency
3. financial leverage - choice of optimal debt ratio
4. Dividend policy - choice of how much to pay to shareholders versus reinvesting in the firm
Current ratio = CA/CL
708/540 = 1.31 times
Quick Ratio = (CA- Inventory)/ CL
"acid test"
- (708-422)/540 = 0.53 times
Cash ratio = Cash/CL
98/540 = .18 times
Total Debt Ratio = (TA- TE)/TA
= (3,588-2,591)/3588 = 0.28 times
Debt/Equity = TD/TE
= (997/2591)= 0.38 times
Equity Multiplier = TA/TE = 1+ D/E
Times Interest Earned = EBIT/Interest
= 4.9 times
Cash Coverage = (EBIT+ Depreciation)/Interest
= (691+276)/141 = 6.9 times
Inventory Turnover = COGS/ Inventory
Days' Sales in Inventory = 365/ Inventory Turnover
Payables Turnover = COGS/ AP
Days' Costs in Payables = 365/ Payables Turnover
Total Asset Turnover = Sales/ Total Assets
Capital Intensity ratio = 1/TAT
Profit margin = NI/Sales
Return on Assets = NI/TA
Return on Equity = NI/TE
Enterprise Value = Total market value of the stock + Book value of all liabilities - Cash
1. You have the following information:
Leverage ratio (assets/equity)= 2.2
Total Asset Turnover = 2.0
Net Profit Margin = 5.5%
Dividend Payout ratio = 31.8%
ROE= PM* TAT* Leverage= 5.5 * 2 * 2.2= 24.2%
2. tax burden ratio = .75
leverage ratio = 1.25
interest burden = .6
return on sales = 10%
Asset turnover = 2.4
ROE= tax burden * interest burden * margin * turnover * leverage
=
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