Ratios Calculate specific values that give some measure to financial performance Calculate specific values that give some measure to financial performance Types Types –Liquidity – can they pay the bills as they come due? –Solvency – can they survive for a long period of time –Profitability – can they earn a satisfactory rate of return –Market indicators – is the company a good investment? –Activity – indicate efficiency and effectiveness of operations and asset management

Ratios Ratios –Asset turnover – total sales for every dollar of assets a company owns –Accounts receivable turnover – ability to collect cash from credit customers –Working capital – not a ratio – ability to meet short- term obligations –Current ratio – ability to pay current liabilities with current assets –Quick ratio – only the very liquid assets –Debt to equity – compares debt to owner’s investment –Times interest earned – compares amount of income that has been earned with the interest obligation

–Gross margin percentage – measure company’s profitability – one of the most carefully watched –Return on assets – success in using its assets to earn income, interest is return to creditors – added back –Return on common equity – how much is earned with common shareholder’s investment Horizontal analysis – previous year Horizontal analysis – previous year Vertical analysis Vertical analysis Profit margin – increase revenues? Profit margin – increase revenues? –Increase prices – price elasticity, lose sales? –Decrease prices - increase volume enough –Grant credit - costs?

–Extend uses of product - I.e. baking soda as a deodorize –Find new products - is market big enough?, take sales from existing products –Open new geographic areas - profitable –Elasticity formula: Percentage change in quantity/percentage change in price Percentage change in quantity/percentage change in price Percentage change in price: (P2-P1)/P1 Percentage change in price: (P2-P1)/P1 Percentage change in quantity: (Q2-Q1)/Q1 Percentage change in quantity: (Q2-Q1)/Q1 If over 1 – elastic and price sensitive If over 1 – elastic and price sensitive If less than 1 – inelastic and price insensitive If less than 1 – inelastic and price insensitive I.e. price increase from $1.25 to $1.50, decrease in quantity from 1,000 to 900 I.e. price increase from $1.25 to $1.50, decrease in quantity from 1,000 to 900 Same price increase, decrease in quantity from 1,000 to 500 Same price increase, decrease in quantity from 1,000 to 500

Revenue Recognition General rule General rule –Revenue is earned –High probability of collection –3 situations Methods Methods –Point of sale - checkout - hw and sw, retail –When work completed but no cash received –Consignment - placing in hand of another, retaining ownership until sold –Proportional performance –Specific performance - contracted to perform –Cost recovery - high degree of uncertainty of collection

Long term construction project worth $15,000 in revenue. Costs of the project are $10,000. How much revenue does the firm recognize each year. Long term construction project worth $15,000 in revenue. Costs of the project are $10,000. How much revenue does the firm recognize each year. At end of first year the project is 30% complete. At end of first year the project is 30% complete. At end of second year project is 70% complete. At end of second year project is 70% complete. At end of third year the project is complete. At end of third year the project is complete.

Download Financial Statement Analysis, Dupont Formula; Download Financial Statement Analysis, Dupont Formula; Download Target 05 and Target 06 and Target07 (don't print)‏ Download Target 05 and Target 06 and Target07 (don't print)‏ Assign #2 - horizontal and vertical analysis of income statement and balance sheet of Target (due 1/25, 1/28). Assign #2 - horizontal and vertical analysis of income statement and balance sheet of Target (due 1/25, 1/28). – Income statement – horizontal – 07-05, vertical – – Balance sheet – horizontal – 07-05, vertical – 07-05; one paragraph – thoughts, concerns, comments. Download ABC Costing and ABC Costing Problem, Download ABC Costing and ABC Costing Problem, Read Introduction to Financial Ratios and Financial Statement Analysis Read Introduction to Financial Ratios and Financial Statement Analysis Read Introduction to Activity-Based Costing Read Introduction to Activity-Based Costing