Managerial Analyzing Financial Statements Ratios

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Profitability ratios, turnover ratios and debt related ratios

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Managerial Accounting: 

Managerial Accounting Analyzing Financial Statements Ratios parkbenchtutors.com

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Ratios are useful to: Help control operations Determine whether vendors are likely to be able to supply Determine whether customers are likely to pay Assess whether another company is worth investing in Give potential investors and creditors a picture of the business

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Profitability Ratios These ratios comprise: Earnings per share Price-Earnings Ratio Gross Margin Percentage Return on total assets Return on stockholders equity

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We need information from Balance Sheets Balance Sheets December 31st 2012 2011 Assets Current Assets Cash 20300 58000 Receivables 62000 29800 Inventory 4700 14700 Prepaid insurance 1400 1700 Total current assets 88400 104200 Property, plant and equipment 143000 117000 Accumulated depreciation -43000 -28000 Total assets 188400 193200 Liabilities and Equity Current Liabilities Accounts payable 17600 14500 Accrued wages 6500 5900 Taxes payable 12500 11000 Total current liabilities 36600 31400 Long term debt 60000 100000 Total liabilities 96600 131400 Stockholders equity Common stock 45000 45000 Retained earnings 46800 16800 Total stockholders equity 91800 61800 Total liabilitiex and equity 188400 193200

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And from Income Statements Baa Baa Woollen Company Income statement Dec 31st 2012 2011 Sales 657000 440000 Cost of goods sold 452000 297000 Gross profit 205000 143000 Operating expenses Insurance 16000 14000 Wages 45000 40000 Depreciation 17000 12000 Loss on sale of equipment 2500 0 Income from operations 124500 77000 Interest expense 16000 8000 Income before taxes 108500 69000 Income taxes 27125 17250 Net income 81375 51750

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Earnings per share (Net income – Preferred Dividends) / Number of shares There has been no payment of a preferred dividend The number of shares is 45,000 (Each share for Baa Baa Woolens has a value of $1)

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And from Income Statements Baa Baa Woollen Company Income statement Dec 31st 2012 2011 Sales 657000 440000 Cost of goods sold 452000 297000 Gross profit 205000 143000 Operating expenses Insurance 16000 14000 Wages 45000 40000 Depreciation 17000 12000 Loss on sale of equipment 2500 0 Income from operations 124500 77000 Interest expense 16000 8000 Income before taxes 108500 69000 Income taxes 27125 17250 Net income 81375 51750

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We need information from Balance Sheets Balance Sheets December 31st 2012 2011 Assets Current Assets Cash 20300 58000 Receivables 62000 29800 Inventory 4700 14700 Prepaid insurance 1400 1700 Total current assets 88400 104200 Property, plant and equipment 143000 117000 Accumulated depreciation -43000 -28000 Total assets 188400 193200 Liabilities and Equity Current Liabilities Accounts payable 17600 14500 Accrued wages 6500 5900 Taxes payable 12500 11000 Total current liabilities 36600 31400 Long term debt 60000 100000 Total liabilities 96600 131400 Stockholders equity Common stock 45000 45000 Retained earnings 46800 16800 Total stockholders equity 91800 61800 Total liabilitiex and equity 188400 193200

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Profitability Ratio Earnings Per Share 2012 2011 Net income 81375 51750 Preferred Dividends 0 0 Number of shares 45000 45000 Ratio 1.808 1.150 Earnings per share have increased

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Price-Earnings Ratio Market price per share / Earnings per share The market price for shares was: 2012 $14.00 2011 $10.50

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Profitability Ratio Price-Earnings Ratio 2012 2011 Market price per share 14 10.5 Earnings per share 1.808 1.150 Ratio 7.74 9.13 There has been a small fall in this ratio

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Gross Margin Percentage Gross Margin / Net Sales This is an estimate of incremental profit generated by each dollar of sales

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And from Income Statements Baa Baa Woollen Company Income statement Dec 31st 2012 2011 Sales 657000 440000 Cost of goods sold 452000 297000 Gross profit 205000 143000 Operating expenses Insurance 16000 14000 Wages 45000 40000 Depreciation 17000 12000 Loss on sale of equipment 2500 0 Income from operations 124500 77000 Interest expense 16000 8000 Income before taxes 108500 69000 Income taxes 27125 17250 Net income 81375 51750

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Profitability Ratio Gross Margin Percentage 2012 2011 Gross Margin 205000 143000 Net Sales 657000 440000 Ratio 0.312 0.325 There has been little change in this ratio

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Return on total assets (Net income+(Interest expense X (1-Tax Rate)))/ Total Assets Net income is being adjusted for interest expense net of taxes Tax rate was assumed as 25% (Note tax rate may be altered from year to year, 25% was used to make calculation easier)

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And from Income Statements Baa Baa Woollen Company Income statement Dec 31st 2012 2011 Sales 657000 440000 Cost of goods sold 452000 297000 Gross profit 205000 143000 Operating expenses Insurance 16000 14000 Wages 45000 40000 Depreciation 17000 12000 Loss on sale of equipment 2500 0 Income from operations 124500 77000 Interest expense 16000 8000 Income before taxes 108500 69000 Income taxes 27125 17250 Net income 81375 51750

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Profitability Ratio Return on total assets 2012 2011 Net income 81375 51750 Interest Expense 16000 8000 1-Tax Rate 0.75 0.75 Total Assets 188400 193200 Ratio 0.496 0.299 The return here indicates a substantial increase

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Return on common stockholders’ equity (Net income – Preferred Dividends) / Common Stockholders Equity

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And from Income Statements Baa Baa Woollen Company Income statement Dec 31st 2012 2011 Sales 657000 440000 Cost of goods sold 452000 297000 Gross profit 205000 143000 Operating expenses Insurance 16000 14000 Wages 45000 40000 Depreciation 17000 12000 Loss on sale of equipment 2500 0 Income from operations 124500 77000 Interest expense 16000 8000 Income before taxes 108500 69000 Income taxes 27125 17250 Net income 81375 51750

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We need information from Balance Sheets Balance Sheets December 31st 2012 2011 Assets Current Assets Cash 20300 58000 Receivables 62000 29800 Inventory 4700 14700 Prepaid insurance 1400 1700 Total current assets 88400 104200 Property, plant and equipment 143000 117000 Accumulated depreciation -43000 -28000 Total assets 188400 193200 Liabilities and Equity Current Liabilities Accounts payable 17600 14500 Accrued wages 6500 5900 Taxes payable 12500 11000 Total current liabilities 36600 31400 Long term debt 60000 100000 Total liabilities 96600 131400 Stockholders equity Common stock 45000 45000 Retained earnings 46800 16800 Total stockholders equity 91800 61800 Total liabilitiex and equity 188400 193200

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Profitability Ratio Return on Common Stockholders Equity 2012 2011 Net income 81375 51750 Preferred dividends 0 0 Common Stockholders Equity 91800 61800 Ratio 0.886 0.837 This ratio also shows an increase

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Financial Leverage This is a measurement of the amount of the assets of the business that is financed by debt as opposed to equity The higher the leverage the more the assets are financed through debt

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Profitability Ratio Return on total assets 2012 2011 Net income 81375 51750 Interest Expense 16000 8000 1-Tax Rate 0.75 0.75 Total Assets 188400 193200 Ratio 0.496 0.299 Profitability Ratio Return on Common Stockholders Equity 2012 2011 Net income 81375 51750 Preferred dividends 0 0 Common Stockholders Equity 91800 61800 Ratio 0.886 0.837 The return on equity is greater than the return on assets Indicates good use of financial leverage

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Turnover Ratios Concerned with efficient use of assets Comprise: Asset Turnover Accounts Receivable Turnover Days Sales are in Receivables Inventory Turnover Days Sales are in Inventory

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Asset Turnover Net Sales / Total Assets Higher ratios show more efficient use of assets

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And from Income Statements Baa Baa Woollen Company Income statement Dec 31st 2012 2011 Sales 657000 440000 Cost of goods sold 452000 297000 Gross profit 205000 143000 Operating expenses Insurance 16000 14000 Wages 45000 40000 Depreciation 17000 12000 Loss on sale of equipment 2500 0 Income from operations 124500 77000 Interest expense 16000 8000 Income before taxes 108500 69000 Income taxes 27125 17250 Net income 81375 51750

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Balance Sheets December 31st 2012 2011 Assets Current Assets Cash 20300 58000 Receivables 62000 29800 Inventory 4700 14700 Prepaid insurance 1400 1700 Total current assets 88400 104200 Property, plant and equipment 143000 117000 Accumulated depreciation -43000 -28000 Total assets 188400 193200

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Turnover Ratio Asset Turnover 2012 2011 Net Sales 657000 440000 Total Assets 188400 193200 Ratio 3.487 2.277 The increase suggests a healthy improvement

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Accounts Receivable Turnover Net Credit Sales / Accounts Receivable There is an assumption here that all sales are credit sales. This would not be so for a retail business such as a supermarket

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And from Income Statements Baa Baa Woollen Company Income statement Dec 31st 2012 2011 Sales 657000 440000 Cost of goods sold 452000 297000 Gross profit 205000 143000 Operating expenses Insurance 16000 14000 Wages 45000 40000 Depreciation 17000 12000 Loss on sale of equipment 2500 0 Income from operations 124500 77000 Interest expense 16000 8000 Income before taxes 108500 69000 Income taxes 27125 17250 Net income 81375 51750

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Balance Sheets December 31st 2012 2011 Assets Current Assets Cash 20300 58000 Receivables 62000 29800 Inventory 4700 14700 Prepaid insurance 1400 1700 Total current assets 88400 104200 Property, plant and equipment 143000 117000 Accumulated depreciation -43000 -28000 Total assets 188400 193200

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Turnover Ratio Accounts Receivable Turnover 2012 2011 Net Credit Sales 657000 440000 Accounts Receivable 62000 29800 Ratio 10.60 14.77

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Days’ Sales in Receivables How many days the sales are in receivables gives an indication of how monies are being collected 365/Accounts receivable turnover

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Turnover Ratio Accounts Receivable Turnover 2012 2011 Net Credit Sales 657000 440000 Accounts Receivable 62000 29800 Ratio 10.60 14.77

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Turnover Ratio Days sales in receivables 2012 2011 365 days 365 365 Accounts Receivable Turnover 10.60 14.77 Ratio 34.44 24.72 If terms are payment in 30 days there is a warning sign here!

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Inventory Turnover Cost of goods sold / Inventory

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And from Income Statements Baa Baa Woollen Company Income statement Dec 31st 2012 2011 Sales 657000 440000 Cost of goods sold 452000 297000 Gross profit 205000 143000 Operating expenses Insurance 16000 14000 Wages 45000 40000 Depreciation 17000 12000 Loss on sale of equipment 2500 0 Income from operations 124500 77000 Interest expense 16000 8000 Income before taxes 108500 69000 Income taxes 27125 17250 Net income 81375 51750

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Balance Sheets December 31st 2012 2011 Assets Current Assets Cash 20300 58000 Receivables 62000 29800 Inventory 4700 14700 Prepaid insurance 1400 1700 Total current assets 88400 104200 Property, plant and equipment 143000 117000 Accumulated depreciation -43000 -28000 Total assets 188400 193200

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Turnover Ratio Inventory Turnover 2012 2011 Cost of goods sold 452000 297000 Inventory 4700 14700 Ratio 96.17 20.20

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Days Sales are in Inventory 365/ Inventory Turnover The longer this period becomes the less healthy a company may be If the period is too short then there may be a problem in meeting customer demand ahead

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Turnover Ratio Days' sales in Inventory 365 days 365 365 Inventory Turnover 96.17 20.20 Ratio 3.80 18.07 There has been a considerable drop in the days in inventory. This would usually be regarded as a healthy sign. It might also suggest a potential difficulty in keeping up with orders.

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Debt Related Ratios These ratios are concerned with: How much debt a company has The ability to repay the debt Comprise: Current Ratio Acid Test or Quick Ratio Debt to Equity Ratio Times Interest Earned

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Current Ratio Current Assets / Current Liabilities Guide to whether company can meet current obligations Any ratio of 1 or greater is seen as healthy

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Balance Sheets December 31st 2012 2011 Assets Current Assets Cash 20300 58000 Receivables 62000 29800 Inventory 4700 14700 Prepaid insurance 1400 1700 Total current assets 88400 104200 Liabilities and Equity Current Liabilities Accounts payable 17600 14500 Accrued wages 6500 5900 Taxes payable 12500 11000 Total current liabilities 36600 31400

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Debt Related Ratio Current Ratio 2012 2011 Current Assets 88400 104200 Current Liabilities 36600 31400 Ratio 2.42 3.32 Although there has been a fall the ratio is still greater than 1

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Acid Test or Quick Ratio (Cash + Marketable Securities + Receivables) / Current Liabilities Only includes the most liquid assets A ratio of less than 1 could mean potential difficulties Inventory not included since this requires sales

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Balance Sheets December 31st 2012 2011 Assets Current Assets Cash 20300 58000 Receivables 62000 29800 Inventory 4700 14700 Prepaid insurance 1400 1700 Total current assets 88400 104200 Liabilities and Equity Current Liabilities Accounts payable 17600 14500 Accrued wages 6500 5900 Taxes payable 12500 11000 Total current liabilities 36600 31400

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Debt Related Ratio Acid Test / Quick Ratio 2012 2011 Cash 20300 29800 Marketable Securities 0 0 Short Term Receivables 62000 29800 Current Liabilities 36600 31400 Ratio 2.25 1.90 The ratio is still above 1 which is healthy

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Debt to Equity Ratio Total Liabilities / Stockholders Equity The higher the ratio the more debt there is High ratios mean greater risk Creditors may refuse further financing

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Liabilities and Equity Current Liabilities Accounts payable 17600 14500 Accrued wages 6500 5900 Taxes payable 12500 11000 Total current liabilities 36600 31400 Long term debt 60000 100000 Total liabilities 96600 131400 Stockholders equity Common stock 45000 45000 Retained earnings 46800 16800 Total stockholders equity 91800 61800 Total liabilities and equity 188400 193200

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Debt Related Ratio Debt to Equity Ratio 2012 2011 Total Liabilities 96600 131400 Stockholders Equity 91800 61800 Ratio 1.05 2.13 The fall in the ratio is a healthy sign

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Times Interest Earned Operating Income / Interest Expense High ratios are healthy

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And from Income Statements Baa Baa Woollen Company Income statement Dec 31st 2012 2011 Sales 657000 440000 Cost of goods sold 452000 297000 Gross profit 205000 143000 Operating expenses Insurance 16000 14000 Wages 45000 40000 Depreciation 17000 12000 Loss on sale of equipment 2500 0 Income from operations 124500 77000 Interest expense 16000 8000 Income before taxes 108500 69000 Income taxes 27125 17250 Net income 81375 51750

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Debt Related Ratio Times Interest Earned 2012 2011 Operating Income 124500 77000 Interest Expense 16000 8000 Ratio 7.78 9.63

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facebook.com/david.hopcoft.9 parkbenchtutors.com Narrated by David Hopcroft