Accounting 110 Week 7 - Lecture notes 7 PDF

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Accounting 110 Professor Mary Copeland
The following information is from the video lecture and powerpoint for Accounting 110. The yellow highlights are what I think are important. The highlights of different colors are to make it easier to find definitions that came out previously.
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Accounting 110 The following information is from the video lecture and powerpoint for Accounting 110. They ellow highlights are what I think are important. The highlights of different colors are to make it easier to find definitions that came out previously.

Accounting 110 Week 7 Financial Statement Analysis 

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Factors in Communicating Useful Information - The primary  objective of accounting is to provide information useful for decision making - To provide information that supports this objective, accountants must consider the following - Users - Who uses this information? - Stakeholders - Managers - People that will invest in the company - Types of Decision - Add a branch? - Go international? - Information Analysis - Is a sale necessary? - Need more/get rid of inventory?

Differentiate between horizontal and vertical analysis -

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Method of Analysis - Horizontal - Focuses on trends - Studies the behavior of individual financial statement items over several periods of time - Percentage - Computing the relationship between two amounts and what they mean to each other - Vertical - Also called common  size on income statements - Percentages compared on individual components against key statement figure - Ratio - Used to find ratios  compared to previous performances Horizontal and Percentage Analysis - Horizontal analysis refers to studying the behavior of individual financial statement items over several accounting periods - Also called trend  analysis - Absolute amounts

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- Percentage analysis Horizontal Analysis

Vertical analysis - Uses percentages to compare individual components of financial statements to a key statement figure - A common  size financial statement is a vertical analysis in which each financial statement item is expressed as a percentage Vertical Analysis of the Income Statement - All items are usually  expressed as a percentage of sales Vertical Analysis

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Vertical Analysis of the Balance Sheet - In balance sheets, all items are usually expressed as a percentage of total assets

Ratio Analysis - Involves studying various relationships between different items reported in a set of financial statements

Calculate ratios for assessing a company’s liquidity -

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Liquidity Ratios - Indicate a company’s  ability to pay short-term debts - Focus on current  assets and current liabilities - Looks at - Working capital - Current ratio - Accounts receivable ratios - Inventory ratios Working Capital - Excess of current assets - current liabilities

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Current Ratio - Current assets / Current liabilities - Measures a company’s  short-term debt paying ability - A declining ratio may be a sign of deteriorating financial condition, or it might result from eliminating obsolete inventories

Accounts Receivable Turnover - Net credit sales / Average accounts receivable - The ratio measures how  many times a company converts  its receivables into cash each year

Average Days to Collect Receivables - 365 days / Accounts Receivable Turnover - (from example above) Average Collection Period = 365/16.98 = 21 days - The ratio measures how many days it takes on average to collect an accounts receivable Inventory Turnover - Cost of goods sold / Average inventory

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Ratio measures how  many times a company’s inventory has been sold and replaced during the year

Average Days to Sell Inventory - 365 / Inventory turnover - (from example above) Average Sale Period = 365/10.8 times = 34 days - The ratio measures how many days it takes on average to sell the inventory

Calculate ratios for assessing a company’s solvency -

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Solvency Ratios - Used to analyze  a company’s long-term debt-paying ability and its financing structure - Two ratios used - Debt to assets ratio - Debt to equity ratio Debt to Assets Ratio - Total Liabilities / Total Assets - Ratio measures the percentage of a company’s assets that are financed by debt Debt to Equity Ratio - Total Liabilities / Total Stockholders’ Equity - Ratio indicates the relative  proportions of debt to equity on a company’s balance sheet - Stockholders like a lot of debt if the company can take advantage of positive financial leverage - Creditors prefer less debt and more equity because equity represents a buffer of protection

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Calculate ratios for assessing company management’s effectiveness -

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Profitability Ratios - Measure a company’s ability to generate earnings - Net profit margin (return on sales) - Return on equity Net Profit Margin - Net Income / Net Sales - Describes the percent remaining of each sales dollar after subtracting other expenses as well as cost of goods sold

Return on Equity - Net Income / Average Total Stockholders’ Equity - Often used to measure  the profitability of the stockholders’ investment

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Calculate ratios for assessing a company’s position in the stock market -

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Stock Market Ratios - Analyze the earnings and dividends of a company - Earnings per share Earnings per Share - Net Earnings Available for Common Stock / Average Number of Outstanding Common Shares - Indicates how much income was earned for each share of common stock outstanding

Limitations of FInancial Statement Analysis - Different Industries - Can’t really compare companies in different industries on an equal platform - Changing economic environment - Accounting Principles Benchmarking and Trend Analysis for Ratios - What are the industry averages? - What are the competitors’ ratios? - What are the ratio goals of the managers? - What has occurred over time with the ratios? - What is the forecast for the ratios? - What else?...