4 chapter 4 maintain and analyze financial records · maintain and analyze financial records 4 ......

BUS291-Business Finance 12/17/13

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Maintain and Analyze Financial Records

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4.1 Accounting Principles and Practices

4.2 Maintain and Use Financial Records

4.3 Financial Analysis Management Tools

4.4 Financial Analysis and Decision Making

Chapter 4

Terms

accounting

equities

fundamental accounting equation

accounts

accounting transaction

accounting cycle

accrual accounting

due care

Accounting Principles and Practices

Finance and Accounting

accounting

organizes a system of financial records

records financial data

prepares, analyzes and interprets financial

statements

work is guided by Generally Accepted Accounting

Principles (GAAP)

finance

saving, investing, and using money by individuals,

businesses, and governments

is broader than accounting


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money and capital markets

determining monetary needs and obtaining adequate cash

investments

analyzing and choosing among investment alternatives while considering returns and risks

financial management applies management principles to financial decision-

making for organizations

Finance consists of three interrelated areas

Accounting focuses on history.

Finance focuses on the future.

Decision-makers must understand the financial

past to plan for the financial future.

Essentials of Accounting

equities

the financial claims on a company’s

resources

fundamental accounting equation

Assets = Liabilities + Owner’s Equity

resources used by a business in its operations

liabilities

claims against the business resources by those to whom the business has financial obligations

owner’s equity

financial interest in the business held by all owners

assets



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the financial records for each of the specific assets, liabilities, and categories of owner’s equity

accounting transaction

the act of recording a financial activity that results in a change in the value of an organization’s resources

financial activities are recorded as entries in the accounts

accounts


source document

original record of a transaction

journals

business records

journal entry

identifies key information for the transaction

All financial transactions must be

recorded.


specific reports prepared according to

accepted accounting principles

balance sheet

income statement

cash flow statement

financial statements



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The Accounting Cycle

accounting cycle

a series of steps performed to

ensure the completeness and accuracy of

accounting records

prepare summary financial statements

Accounting Professional Practices

Accuracy is critical in accounting work.


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Assumptions

Single Economic Entity

an identifiable, independent business

Going Concern

for an on-going business

Monetary Unit

reflects the use of one stable currency

Periodic Reporting

information recorded in regular time periods

Accounting Principles

Historic Costs

Revenue Recognition

accrual accounting

recognizing revenue and expenses when they are incurred rather than when cash is received or spent

Expense and Revenue Matching

Full Disclosure

Standard Practice and Conservatism

Professional Practices

Professional Competence

Due Care and Sufficient Data

due care

a commitment to completing all tasks

thoroughly and with the highest level of quality

Independence and Integrity


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Terms

information system

information integrity

annual report

Maintain and Use Financial Records

Develop and Maintain a Business

Records System

information system

a structured set of processes, people, and

equipment for converting data into

information

Types of Financial Information

Common types of financial information

include

data

records

reports


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Information Integrity

information integrity

Information remains unchanged from its

source and has not been accidentally or

maliciously modified, altered, or destroyed.

When an organization’s information

integrity is compromised, people loose

confidence in the organization.

Maintaining

Financial

Records

Developing

and

maintaining a

financial

records

system that

has integrity

requires

decisions in

several areas.

Using Financial Records

Information must be organized to be

meaningful and usable.


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Users And Uses

Each user of financial information has

specific concerns.

Managers need to operate a profitable business

and maximize shareholder value.

Investors want to maximize the value of their

investment.

Creditors want to be sure the company has assets

sufficient to cover debt.

The government requires accurate financial

disclosure and tax payments.

Private and Public Records and Reports

Privately owned companies are not required to

disclose financial information.

Public companies must report financial

information.

annual report

a statement of a company’s operating and

financial performance issued at the end of its

fiscal year

Form 10-K

a form required by the SEC that may be even

more detailed than an annual report

Terms

chief executive officer (CEO)

chief operating officer (COO)

chief financial officer (CFO)

equity financing

debt financing

retained earnings

solvency

Financial Management Analysis Tools


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Financial Management Activities

The primary objective of financial

management is to maximize the wealth of

owners.

The Structure of Financial Management

board of directors

provide business oversight

establish corporate policy

hire key executives

review major business decisions

chief executive officer (CEO)

the top manager of a corporation

executes the strategy and the policy of board

of directors

leads management and employees

sets long-term operational direction

directs business operations

chief financial officer (CFO)

plans and manages financial resources

chief operating officer (COO)

The Structure of Financial Management

treasurer

manages cash, investments, and other

financial resources

manages relationships with investors and

creditors

controller

in charge of accounting and financial records


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Financial Management Decisions

Three major decisions define the work

of financial managers:

what investments need to be made

how investments should be financed

how to efficiently manage investments

Asset Planning

decisions must be made regarding the best

mix of assets to effectively support business

objectives

equity financing

offers investors an ownership interest in the

company

debt financing

obtaining assets by borrowing money

short term financing methods include:

trade credit

operating loans

commercial paper

Asset Financing

Financial Management Decisions

Asset Management

assets, both fixed and liquid, need to be

efficiently managed

Financial Analysis Tools

Long-term financing decisions focus on

capital assets.

Short-term financial planning focuses

on working capital.


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Using Financial Records and Reports

Managers study financial reports to asses

the following information:

the current values of important financial

elements of the business

the relationships among the current values

determine their company’s performance

relative to comparable companies

Balance Sheet

retained earnings

profits earned by a company that are not paid to

shareholders as dividends

working capital (current assets)

Net working capital = current assets – current

liabilities

shareholder’s equity

the value of all classes of stock and retained

earnings

Income Statement

Comparing income statements over

multiple time periods provides a strong

assessment of a company’s

performance.

improvements in efficiencies of generating

revenues

cost containment


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Cash Flow Statement

Cash flow is the movement of cash into

and out of a business.

solvency

the ability of a company to meet its

financial obligations as they become due

A company with an increasing positive

cash flow is a healthy company.

revenues from the primary work of the

business

cash from investing activities

revenues earned from purchasing or selling

assets

cash from financing activities

cash from the sale of stock and from taking

on long- or short-term debt

cash from operating activities

Cash Flow Statement

Terms

financial ratios

financial leverage

benchmark company

ratio analysis

operating income

Financial Analysis and Decision Making


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Understanding Financial Ratios

financial ratios

comparisons of financial data used to

evaluate business performance

ratio analysis

the study of relationships in a company’s

finances in order to understand and

improve financial performance

Liquidity Ratios An important measure of a company’s health

is its ability to pay debts on time.

need a favorable liquid position

The current ratio shows how well the

company is prepared to pay current

liabilities.

due within a year

A ratio of 2:1 represents a strong position

in most industries.

Inventory is a particular problem in some

industries.

A ratio of 1:1 is acceptable in many

industries.


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Asset Management Ratios

Asset management ratios compare the

value of key assets to sales

performance.

fixed assets turnover ratio

examines the efficiency of land, buildings,

and major equipment

A company doesn’t earn money until its

inventory is sold.

If a business has a low inventory ratio:

inventory should be reviewed to determine if it

is obsolete

Used to determine if a company has a

reasonable amount of assets for the sales

being produced.

A low value suggests assets are not being

used efficiently.


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Higher ratios mean that accounts

receivable are collected quickly.

Lower ratios might indicate losses.

when older accounts are not paid

(accounts receivable) ÷ (average daily sales)

identifies how many days on average it takes

to collect accounts receivable

a small number of days shows effective

credit procedures

average collection period ratio

Debt Management Ratios

financial leverage

using debt financing to increase the rate of

return on assets

The appropriate ratio is guided by

the industry in which the company operates

the financial stability of the company


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A high ratio means the company has a high

margin of safety in being able to pay creditors.

Debt Management Ratios

Profitability Ratios

Ratios are used to track bottom-line

performance.

useful for comparison with competitors

a tool to asses performance relative to

other possible investments

gross profit margin ratio

(gross profit) ÷ (net sales)

operating profit margin ratio

(operating income) ÷ (net sales)

operating income

earnings before interest and taxes



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This ratio evaluates the efficiency of the assets of

the company.


Market Performance Ratios

Market performance ratios serve a

variety of functions

examine the overall financial performance

of a business in contributing to

shareholder value

a metric of the effectiveness of executive

leadership

helps compare multiple companies

if preferred stock is issued

the dividends paid to preferred stockholders are

subtracted from net income

before dividing by the number of shares of common

stock issued



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anticipated earnings on investments

help investors decide what price to pay for a

company’s stock


when this ratio is greater than 1, investors are

willing to pay more for the stock than it is valued

by the company


Use Financial Ratios

Comparing ratios over several time

periods provides a better picture of the

company’s financial condition.

Industry trends can also be analyzed

using financial ratios.


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Develop a Financial Analysis Plan

1. Organize financial records.

2. Determine key financial ratios.

3. Develop baseline data.

4. Identify comparative information sources.

5. Identify benchmark companies.

benchmark company

a competitor with outstanding performance

6. Calculate ratios regularly.

7. Use ratio analysis as a tool to establish

financial goals.

Sources of Comparative Information

Financial information is relatively easy to

obtain for public corporations.

can compare company’s to one another

can analyze performance for investing decisions

Information provided by trade associations

may be provided only to members

may have a usage fee

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