Chapter 17 Introduction to financial management

Current Assets = Cash + Accounts Receivable + Inventory

Fixed Asset  Non-current assets that a firm expects to hold longer than a year  e.g. building, equipment, machinery  DEPRECIATION: the allocation of the cost of a fixed asset over the periods in which it is used

EXAMPLE  Machine $10000  Useful Life: 5 years  STRIGHT LINE DEPRECIATION METHOD Depreciation per year = 10000/5 = $2000 per year  At the end of the second year, machine value shown in balance sheet: Machine Less: Accumulated Depreciation

Liability or Debt  Current Liability (short-term debt)  E.g. accounts payable (rent payable), Short-term bank loan,  Long Term Liability  Debts do not need to be paid within one year  E.g. long term bank loan

Current Liability = Short term bank loan + Account Payable

Owners’ equity or Net worth  The investment of the owners in the firm  E.g. capital, common stock (ordinary shares), retained earnings

Total Assets = Total Liabilities + Owners’ Equity or Net Worth

Current Assets + Fixed Assets = ( Current Liability + Long term ) Liability + ( Common Stock + Retained Earnings )

ABC Retailing Co., Ltd. Balance Sheet as at 31 December 1996 $$$ ASSETS Current assets Cash80,000 Accounts receivable60,000 Inventory 100,000 Prepaid expensives 10,000 Total current assets250,000 Fixed Assets Machinery Less: Accumulated depreciation20,000580,000 Buildings 610,000 Less: Accumulated depreciation 310,000300,000 Total fixed assets880,000 Total assets 1,130,000

LIABILITIES AND OWNERS’ EQUITY Current liabilities Accounts payable 40,000 Short-term bank loans 90,000 Accrued expenses 10,000 Total current liabilities 140,000 Long-term liabilities Long-term bank loans 600,000 Total liabilities 740,000 Owners’ equity Common stock 300,000 Retained earnings 90,000 Total owners’ equity 390,000 Total liabilities and owners’ equity 1,130,000 $$$

P.378 Case Study 2- Solution

Cash = C.A. – inventory – A/R = – – = 4000 Retained earnings = T.A. – T.L. – common stock – capital Total Assets = C.A. + F. A.= – = Total Current Liability = A/P + ST bank loans = = Total Liability =C.L. + LT. L. = = Total liability and owners’ equity = T.A. = Retained earnings = = 40000

Income Statement  Basic format of an income statement Sales - Cost of goods sold Gross profit - Operating expenses Earnings before interest and taxes - Interest Income before taxes - Taxes Net Income e.g. rent

P.377 Case Study 1- Solution

Net Worth = Capital + Reserve+ Retained earning+common stock Owners’ equity = net worth = total asset – total liability Working capital = current asset – current liability HINTS:

 (a)Sales = , Gross Profit =  (b) Cost of goods sold =  (c) Net income =  (d) Capital= , total assets =  (e) retained earnings = 70000, long-term liabilities=  (f) long-term liabilities = fixed assets = account payable =

P.378 Case Study 3- Solution

Case Study 3 - Solution Cost of goods sold$ Gross Profit Interest Operating expenses Sales = G.P. + C.O.G.S. = E.B.I.T. = G.P. – O.E = Net Income = E.B.I.T. – Interest =

Ratio Analysis  Compare the financial ratios with the industry average  Compare the financial ratios for the current period with those in the past  Compare the financial ratios with the management targets

Types of ratios  Liquidity ratio ( 流動資金比率 )  Profitability ratio ( 盈利能力比率 )  Activity ratio （活動比率）  Leverage ratio （槓桿比率）  Equity ratio （主榷比率）

Ratio Analysis  Refer to note “17FinancialRatioAnalysis” (word document)

Limitations of Ration Analysis 1. Financial statements are prepared by using different accounting policies and techniques in different companies. They may have different valuation methods or depreciation methods. It is difficult to compare the performance of different companies. 2. Differences in the backgrounds of the companies may also weaken the validity of inter-firm comparison. It is difficult to compare a firm which hires its plant with a firm which purchases its own plant.

3. The environment and external factors can affect the performance of a company difference. Differences in these factors may affect the inter- period comparison. 4. Changes in prices levels may also affect the validity of inter-period comparison.

5. Differences in the basis of data recording may also weaken the comparison of the return on capital employed between different periods. Most of the assets are recorded at historical cost, but the profit is recorded at the current price. 6. Accounting ratios act as indicators for financial assessment. However it is difficult to establish a proper standard for determining which result is good and which result is bad.

Exercise  E. Chiu Import & Export Co. Ltd. is a private limited company owned by Mr. Chiu. He has provided the following information for his company for the year ending December 31, 1987: (i) Debt/net worth= 1.5 (ii) Acid test ratio= 0.4 (iii) Total assets turnover= 1.5 times (iv) Days sales outstanding in accounts receivable= 20 (v) Gross profit margin = 25% (vi) Sales to inventory turnover = 5 times

 Using the above information, complete the following items in the balance sheet of E. Chiu Import & Export Co. Ltd. for the year ending December 31,  a) Cash _____________  b) Accounts receivable_____________  c) Inventories_____________  d) Plant and equipment_____________  e) Total assets_____________  f) Account payable_____________ Common stock$10000 Retained earnings$20000  g) Total Liabilities and capital_____________ Hint: net worth = common stock+ retained earnings

 Solution a) b) 6250 c) d) e) f) 4500 g) h) i)