Part VI: Financial Management Introduction to Business 3e 15 Copyright © 2004 South-Western. All rights reserved. Accounting and Financial Analysis

Copyright © 2004 South-Western. All rights reserved.15–2 Financial Management

Copyright © 2004 South-Western. All rights reserved.15–3 Learning Goals Explain how firms use accounting. Explain how to interpret financial statements. Explain how to evaluate a firm’s financial condition.

Copyright © 2004 South-Western. All rights reserved.15–4 Accounting and Financial Analysis

Copyright © 2004 South-Western. All rights reserved.15–5 Accounting Accounting involves the summary and analysis of a firm’s financial condition How firms use accounting –In the reporting of accurate financial information to shareholders and creditors (financial accounting)  Bookkeeping records financial transactions.  Publicly owned firms must have their financial statement audited and certified as accurate.

Copyright © 2004 South-Western. All rights reserved.15–6 How Firms Use Accounting Use financial information to support decisions—managerial accounting –Use historical revenue and cost information to support budgeting decisions –Use sales information to evaluate impact of promotion strategy –Use seasonal sales information to determine future production level

Copyright © 2004 South-Western. All rights reserved.15–7 business online

Copyright © 2004 South-Western. All rights reserved.15–8 Uses of Accounting Use financial information to maintain control: –Monitor performance of individuals, divisions, and products. –Monitor production efficiency. –Identify firm’s strengths and weaknesses. –Audit records to ensure accuracy.

Copyright © 2004 South-Western. All rights reserved.15–9 Interpreting Financial Statements Income statement –Indicates firm’s revenue, costs, and earnings over a period of time. Balance sheet –Reports book value of all the firm’s assets, liabilities, and owner’s equity at a given point in time.

Copyright © 2004 South-Western. All rights reserved.15–10 Income Statement Net sales Cost of goods sold Gross profit Operating expenses Earnings before interest and taxes Earnings before taxes Net income (earnings after taxes)

Copyright © 2004 South-Western. All rights reserved.15–11 Example of Income Statement: Taylor, Inc. Exhibit 15.1

Copyright © 2004 South-Western. All rights reserved.15–12 Income Statement Items as a Percentage of Net Sales for Taylor, Inc. Exhibit 15.2

Copyright © 2004 South-Western. All rights reserved.15–13 Balance Sheet Items Assets Liabilities Owner’s equity

Copyright © 2004 South-Western. All rights reserved.15–14 Assets Assets are anything owned by the firm –Current assets are those that will be converted into cash within a year  Cash, marketable securities, accounts receivable, and inventories –Fixed assets will be used for more than a year  The value of plant and equipment is depreciated to reflect the reduced value (useful life) of the assets over time.

Copyright © 2004 South-Western. All rights reserved.15–15 Liabilities Liabilities include all of the firm’s debts –Current (short-term) Liabilities  Will be repaid within a year. –Accounts payable –Notes payable –Long-term liabilities (debt)  Will not to be fully repaid within a year.

Copyright © 2004 South-Western. All rights reserved.15–16 Liabilities and Owner’s Equity Owner’s equity –Par (stated) value of all common stock issued, additional paid-in capital, and retained earnings.

Copyright © 2004 South-Western. All rights reserved.15–17 Example of Balance Sheet for Taylor, Inc.

Copyright © 2004 South-Western. All rights reserved.15–18 Breakdown of Balance Sheet for Taylor, Inc. Exhibit 15.4

Copyright © 2004 South-Western. All rights reserved.15–19 Basic Accounting Equation Assets = Liabilities – Owner’s Equity

Copyright © 2004 South-Western. All rights reserved.15–20 Responsible Financial Reporting Accounting methods that provide the most accurate indication of a firm’s financial condition –Helps gain credibility with existing and potential stockholders –Makes it easier for managers to detect and correct deficiencies

Copyright © 2004 South-Western. All rights reserved.15–21 Financial Reporting Role of Auditors –Certify that financial reports are accurate and within generally accepted reporting guidelines. Role of Board of Directors

Copyright © 2004 South-Western. All rights reserved.15–22 Ratio Analysis Evaluate the relationships between financial statement variables –Compare ratios with other companies in the same industry –Assess change in ratios over time –Common ratios  Liquidity  Efficiency  Financial leverage  Profitability

Copyright © 2004 South-Western. All rights reserved.15–23 Measures of Liquidity The firm’s ability to meet short-term obligations

Copyright © 2004 South-Western. All rights reserved.15–24 Measures of Efficiency

Copyright © 2004 South-Western. All rights reserved.15–25 Measures of Financial Leverage The degree to which firm uses borrowed funds to finance its assets

Copyright © 2004 South-Western. All rights reserved.15–26 Measures of Profitability

Copyright © 2004 South-Western. All rights reserved.15–27 Ratio Analysis Comparing ratios –Evaluate how a firm’s financial condition compares to other firms in the industry. Limitations of ratio analysis –Firms might operate in more than one industry - makes comparisons difficult. –Accounting practices vary among firms –Seasonality can impact ratios

Copyright © 2004 South-Western. All rights reserved.15–28 Ratio Analysis Sources of information on ratios –Robert Morris Associates –Dun and Bradstreet

Copyright © 2004 South-Western. All rights reserved.15–29 Chapter Summary Firm’s financial condition is important to financial managers, creditors and stockholders. Income statement and balance sheet are the most important financial statements used to evaluate a firm’s financial condition. Financial ratios help evaluate a firm’s liquidity, efficiency, profitability, and financial leverage.