Management Simulations, Inc. The Nature of Accounting “Accounting is the identification, measurement and communication of financial information about economic entities to interested persons” Kieso and Weygandt Arose from the need to communicate financial informationArose from the need to communicate financial information Financial Accounting Standards Board (FASB) is authoritative rule making bodyFinancial Accounting Standards Board (FASB) is authoritative rule making body Finance is the Language of Business. Accounting is the Medium of Finance.

Management Simulations, Inc. Underlying Assumptions Key Assumptions Double entryDouble entry Timing-matching principalTiming-matching principal Accrual accountingAccrual accounting Historical costHistorical cost FASB Standards applied to simulation reports.FASB Standards applied to simulation reports.

Management Simulations, Inc. Objectives of Financial Reporting Know how effectively resources are obtained and appropriatedKnow how effectively resources are obtained and appropriated Use information to inform investment and credit decisionsUse information to inform investment and credit decisions Identify optimum time to take actions affected by cash flowIdentify optimum time to take actions affected by cash flow BalanceSheet P&L or Income Statement CashFlow

Management Simulations, Inc. Balance Sheet Identifies what the company owns and who owns itIdentifies what the company owns and who owns it Snapshot of financial healthSnapshot of financial health Assets always equal liabilities and net worth combinedAssets always equal liabilities and net worth combined Accurate for a specific dateAccurate for a specific date

Management Simulations, Inc. Sample Capstone Balance Sheet from Annual Reports Sample Capstone ® Balance Sheet from Annual Reports Provides two year’s data Leverage = Total Assets / Total Equity. Ideal Leverage 1.81 to 2.80 – from shareholder’s perspective Lenders prefer to examine Debt / Assets Managers favor Debt / Equity The Analyst Report on the website provides coaching on Financial Structure

Management Simulations, Inc. Capstone Balance Sheet Survey Capstone ® Balance Sheet Survey The Capstone ® Courier provides each team’s Balance Sheet summary on Page 3 Strategic intentions may be inferred based on profile Example – a team with a large Plant & Equipment line may be adopting a cost leadership, high volume position

Management Simulations, Inc. Profit and Loss Statement or Income Statement Compares revenues and expenses for a given periodCompares revenues and expenses for a given period Movie of financial healthMovie of financial health Shows activity over a period of timeShows activity over a period of time Indicates the profitability of an organizationIndicates the profitability of an organization

Management Simulations, Inc. Income Statement Survey from Capstone Courier Income Statement Survey from Capstone ® Courier Compare your team against competitorsCompare your team against competitors Is your variable costs to sales comparison above or below average?Is your variable costs to sales comparison above or below average? Do your SG&A expenses relative to sales reflect good rates of return?Do your SG&A expenses relative to sales reflect good rates of return?

Management Simulations, Inc. Simulation Sample Proforma Income Statement Your spreadsheet program creates a Proforma Income Statement using your sales forecasts reconciled to your tactical decisions The projected loss for net profit in this example tells the management team there is additional work to be done in the Strategy section Red number – bad, black number - good

Management Simulations, Inc. Cash Flow Statement Shows movement of cash in and out of an organization over a given periodShows movement of cash in and out of an organization over a given period Shows how much cash is available for use during a given periodShows how much cash is available for use during a given period Reconciles net profit back to cashReconciles net profit back to cash

Management Simulations, Inc. Sample Capstone Cash Flow Statement Sample Capstone ® Cash Flow Statement Provides two year’s dataProvides two year’s data Common causes for emergency loans:Common causes for emergency loans: 1)Excessive inventory resulting from poor sales forecasts 2)Making Plant & Equip upgrades w/o raising sufficient capital 3)Operating losses

Management Simulations, Inc. A financial ratio shows the relationship between two financial measuresA financial ratio shows the relationship between two financial measures Developed by dividing one measure into anotherDeveloped by dividing one measure into another Provide insights into company’s operations and strategyProvide insights into company’s operations and strategy Four categories: liquidity, solvency, market value, profitabilityFour categories: liquidity, solvency, market value, profitability Used internally to evaluate performance and set goalsUsed internally to evaluate performance and set goals Used externally to make investment decisionsUsed externally to make investment decisions Introduction to Ratios

Management Simulations, Inc. Ratios Report Sample from Spreadsheet Proformas Your spreadsheet program creates a Proforma Ratios Report based on your sales forecasts and tactical decisions. Are your decisions maximizing the Success Measurements (ROE, ROS, ROA, Stock Price, Asset Turnover, Market Capitalization) you chose (or were assigned)?

Management Simulations, Inc. Asset Turnover “Reveals how effective assets are at generating sales revenue.” Asset Turnover = salesassets

Management Simulations, Inc. “ROS indicates the percentage of each sales dollar that results in net income.” Return on Sales Return on Sales = net profit net sales

Management Simulations, Inc. Return on Assets Return on Assets = net profit assets “ROA measures a company’s ability to use all its assets to generate earnings.”

Management Simulations, Inc. Leverage Leverage = assetsequity “Leverage shows the debt level of the organization.”

Management Simulations, Inc. Return on Equity Return on Equity = net profit equity “Return on Equity highlights for the stockholders the return on their investment.”

Management Simulations, Inc. Du Pont Formula Return on Equity = net profit equity salessalesassetsassetsequity xxxx Value Chain

Management Simulations, Inc. Du Pont Formula Return on Equity = net profit equity salessalesassetsassetsequity xxxx Value Chain

Management Simulations, Inc. Du Pont Formula Return on Equity = net profit equity salessalesassetsassetsequity xxxx Return on Sales Asset Turnover Leverage Value Chain

Management Simulations, Inc. Du Pont Formula · TI vs. HP Texas Instruments Hewlett Packard Current Assets= 1.29 Fixed Assets = 1.11 Sales = 4.07 Net Income =.37 Shareholder Equity = 1.16

Management Simulations, Inc. Du Pont Formula · TI vs. HP Texas Instruments Hewlett Packard Current Assets= 1.29 Fixed Assets = 1.11 Sales = 4.07 Net Income =.37 Shareholder Equity = 1.16 Turnover x1.69 ROS 9.3% = ROA15.7% x Leverage2.07 = ROE32.5%

Management Simulations, Inc. Du Pont Formula · TI vs. HP Texas Instruments Hewlett Packard Current Assets= 1.29 Fixed Assets = 1.11 Sales = 4.07 Net Income =.37 Shareholder Equity = 1.16 Current Assets= 1.49 Fixed Assets =.84 Sales = 3.09 Net Income =.52 Shareholder Equity = 1.54 Turnover x1.69 ROS 9.3% = ROA15.7% x Leverage2.07 = ROE32.5%

Management Simulations, Inc. Du Pont Formula · TI vs. HP Texas Instruments Hewlett Packard Current Assets= 1.29 Fixed Assets = 1.11 Sales = 4.07 Net Income =.37 Shareholder Equity = 1.16 Current Assets= 1.49 Fixed Assets =.84 Sales = 3.09 Net Income =.52 Shareholder Equity = 1.54 Turnover x1.69 ROS 9.3% = ROA15.7% x Leverage2.07 = ROE32.5% Turnover x1.33 ROS16.9% = ROA22.4% x Leverage1.52 = ROE33.8%