CHAPTER 23 Evaluating Firm Performance

Transcription

1 Part 6 Understanding What the Numbers Mean CHAPTER 23 Evaluating Firm Performance Longenecker Moore Petty Palich 2008 Cengage Learning. All rights reserved. PowerPoint Presentation by Charlie Cook The University of West Alabama

2 Looking AHEAD After you have read this chapter, you should be able to: 1. Identify the basic requirements for an accounting system. 2. Explain two alternative accounting options. 3. Describe the purpose of and procedures related to internal control. 4. Evaluate a firm s ability to pay its bills as they come due. 5. Assess a firm s overall profitability on its asset base. 6. Measure a firm s use of debt and equity financing. 7. Evaluate the rate of return earned on the owners investment Cengage Learning. All rights reserved. 23 2

3 Accounting Activities in Small Firms Basic Requirements for Accounting Systems Provide an accurate picture of operating results. Permit a quick comparison of current data with prior years operations. Furnish financial statements for use by management, bankers, and prospective creditors. Facilitate prompt filing of reports and tax returns to regulatory and tax-collecting agencies. Reveal employee fraud, waste, and record-keeping errors Cengage Learning. All rights reserved. 23 3

4 The Record-Keeping System Major Types of Internal Accounting Records Accounts receivable records Accounts payable records Inventory records Payroll records Cash records Fixed asset records Other accounting records 2008 Cengage Learning. All rights reserved. 23 4

5 Small Business Accounting Resources Computer Accounting Software Packages Checkbook functions Automatic financial statements preparation Cash budget tracking Subsidiary journal accounts preparation Outside Accounting Services Convenience Competence Cost 2008 Cengage Learning. All rights reserved. 23 5

6 Alternative Accounting Options Cash Versus Accrual Accounting Cash method Revenues and expenses are recognized only when payments are received or expenses are paid. Accrual method Revenue and expenses are reported when they are incurred, regardless of when they are received or paid Cengage Learning. All rights reserved. 23 6

7 Accounting Method Alternatives Single-Entry Versus Double-Entry Systems Single-entry system A checkbook system of accounting reflecting only receipts and disbursements. Double-entry system A self-balancing accounting system that uses journals and ledgers Cengage Learning. All rights reserved. 23 7

8 Internal Accounting Controls Internal Control A system of checks and balances that safeguards assets and enhances the accuracy and reliability of financial statements. Types of internal controls: Identify transactions requiring owner authorization Ensure checks have supporting documentation Limit access to accounting records and computers Send bank statements directly to the owner Safeguard blank checks Require employees to take vacations 2008 Cengage Learning. All rights reserved. 23 8

9 Evaluating The Firm s Financial Performance Can a Firm Meet Its Financial Commitments? Can it pay its bills when they come due? Is it making a good return on your assets? How much debt is it using, and what are the implications for the firm s future? Is it creating a good return on equity investments? Financial Ratios Restatements of selected income statement and balance sheet data in relative terms 2008 Cengage Learning. All rights reserved. 23 9

10 23-1 Financial Ratios for Retail Computer and Software Stores, *Not applicable. Firms in this group have a negative equity on average, preventing computation of return on equity. Note: RMA cautions that the Studies be regarded only as a general guideline and not as an absolute industry norm. This is due to limited samples within categories, the categorization of companies by their primary Standard Industrial Classification (SIC) number only, and different methods of operations by companies within the same industry. For these reasons, RMA recommends that the figures be used only as general guidelines in addition to other methods of financial analysis. Source: Adapted from RMA Annual Statement Studies, published by Robert Morris Associates, Philadelphia, Pa. Copyright Robert Morris Associates, Cengage Learning. All rights reserved

11 23-2 Income Statement for Trimble & Associates Leasing, Inc., for the Year Ending December 31, Cengage Learning. All rights reserved

12 23-3 Balance Sheet for Trimble & Associates Leasing, Inc., for December 31, Cengage Learning. All rights reserved

13 Can the Firm Pay Its Bills as They Come Due? Current Ratio Comparing cash and near-cash current assets against the debt (current liabilities) coming due and payable within one year. Current ratio Current assets Current liabilities Current ratio $350,000 $100, Industry norm for current ratio = Cengage Learning. All rights reserved

14 Can the Firm Pay Its Bills as They Come Due? (cont d) Account Receivable Turnover Ratio The number of time accounts receivable roll over during a year. Accounts receivable turnover Credit sales Accounts receivable Accounts receivable turnover $850,000 $80, Industry norm for accounts receivable turnover = Cengage Learning. All rights reserved

15 Can the Firm Pay Its Bills as They Come Due? (cont d) Inventory Turnover The number of times inventories roll over during the year. Inventory turnover Cost of goods Inventory sold Inventory turnover $550,000 $220, Industry norm for inventory turnover = Cengage Learning. All rights reserved

16 Can the Firm Pay Its Bills as They Come Due? (cont d) Acid-Test Ratio (Quick Ratio) A measure of a company s liquidity that excludes inventories. Acid-test ratio Current assets - Inventories Current liabilities Acid-test ratio $350,000 - $220,000 $100, Industry norm for acid-test ratio = Cengage Learning. All rights reserved

17 Can the Firm Pay Its Bills as They Come Due? (cont d) Average Collection Period The average time it takes a firm to collect its accounts receivable. Average collection period Accounts receivable Daily credit sales Average collection period $80,000 $850, days Industry norm for average collection period = 35 days 2008 Cengage Learning. All rights reserved

18 23-4 Return on Assets: An Overview 2008 Cengage Learning. All rights reserved

19 23-5 Return on Equity: An Overview 2008 Cengage Learning. All rights reserved

20 Is the Business Providing a Good Return on Its Assets? Return on Assets A measure of operating profits relative to total assets Industry norm for OIROI: 13.20% 2008 Cengage Learning. All rights reserved

21 Is the Business Providing a Good Return on Its Assets? (cont d) Operating Profit Margin The ratio of operating profits to sales, showing how well a firm manages its income statement. Operating profit margin Operating profit margin Operating profits Sales $100,000 $850, % Industry norm for operating profit margin: 11.0% 2008 Cengage Learning. All rights reserved

22 Is the Business Providing a Good Return on Its Assets? (cont d) Total Asset Turnover A ratio of sales to total assets, showing the efficiency with which the firm s assets are used to generate sales. Total asset turnover Sales Total assets Total asset turnover $850,000 $920, Industry norm for total asset turnover = Cengage Learning. All rights reserved

23 Is the Business Providing a Good Return on Its Assets? (cont d) Operating Income Return on Assets Return on Assets = Operating profit margin X Total asset turnover =.1176 x 0.92 = 10.82% Industry ROA = 11.0% x 1.2 = 13.20% 2008 Cengage Learning. All rights reserved

24 Turnover Ratios Accounts receivable turnover Credit sales Accounts receivable $850,000 $80, Industry Norm Inventory turnover Cost of goods Inventory sold $550,000 $220, Fixed asset turnover Sales Fixed assets $850,000 $570, Cengage Learning. All rights reserved

25 How Much Debt Is the Firm Using? Financial Leverage The use of debt in financing a firm s assets Debt-Equity Ratio The ratio of total debt to total assets Debt ratio Total debt Total Assets Debt ratio $300,000 $920, , or 33.0% Industry norm for debt ratio = 40.0% 2008 Cengage Learning. All rights reserved

26 How Much Debt Is the Firm Using? (cont d) Times Interest Earned Ratio The ratio of operating income to interest charges Times interest earned Operating income Interest Expense Times interest earned $100,000 $20, Industry norm for time interest earned = Cengage Learning. All rights reserved

27 Are the Owners Getting a Good Rate of Return on Their Equity Investment? Return on equity The rate of return that owners earn on their investment. Return on equity Net income Common Equity Return on equity $60,000 $620, , or 9.7% Industry norm for return on equity = 12.5% 2008 Cengage Learning. All rights reserved

28 23-6 Financial Ratio Analysis for Trimble & Associates Leasing, Inc Cengage Learning. All rights reserved

29 Key TERMS single-entry system double-entry system internal control financial ratios accounts receivable turnover inventory turnover operating profit margin total asset turnover fixed asset turnover financial leverage times interest earned ratio 2008 Cengage Learning. All rights reserved