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Chap 002

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86 views38 pages

Chap 002

jh

Uploaded by

Keith Joanne Santiago
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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2

Review of
Accounting

Chapter

McGraw-Hill/Irwin
Copyright 2009 by The McGraw-Hill Companies, Inc. All

Chapter Outline

Income Statement
Price-earnings Ratio
Balance Sheet
Statement of Cash Flows
Tax-free Investments (Deprecation)

2-2

Basic Financial Statements


Income Statement
Balance Sheet
Statement of Cash Flows

2-3

Income Statement
Device to measure the profitability of a firm
over a period of time
It covers a defined period of time
It is presented in a stair-step or progressive
fashion to examine profit or loss after each type
of expense item is deducted

2-4

Income Statement (contd)


Sales Cost of Goods Sold (COGS)
= Gross Profit (GP)
GP Expenses = Earnings Before Interest and Taxes
(EBIT) or Operating Income (OI)
EBIT Interest = Earnings Before Taxes (EBT)
EBT Taxes = Earnings After Taxes (EAT) or Net
Income (NI)
2-5

Income Statement (contd)

2-6

Return to Capital
Three primary sources of capital:
Bondholders
Preferred stockholders
Common stockholders

Earnings per share


Interpreted in terms of number of outstanding
shares
May be paid out in dividends or retained by
company for subsequent reinvestment

Statement of retained earnings


Indicates disposition of earnings
2-7

Statement of Retained Earnings

2-8

Price-Earnings (P/E) Ratio


Multiplier applied to earnings per share to
determine current value of common stock
Some factors that influence P/E:
Earnings and sales growth of the firm
Risk (volatility in performance)
Debt-equity structure of the firm
Dividend payment policy
Quality of management
2-9

Price-Earnings (P/E) Ratio (contd)


Allows comparison of the relative market
value of many companies based on $1 of
earnings per share
Indicates expectations about the future of a
company

Price-earnings ratios can be confusing

2-10

Price-earnings Ratios
for Selected US Companies

2-11

Limitations of the Income Statement


Income gained/lost during a given period is
a function of verifiable transactions
Stockholders, hence, may perceive only a much
smaller gain/loss from actual day-to-day
operations

Flexibility in reporting transactions might


result in differing measurements of income
gained from similar events at the end of a
time period
2-12

Balance Sheet
Indicates what the firm owns and how these
assets are financed in the form of liabilities
or ownership interest
Delineates the firms holdings and obligations
Items are stated on an original cost basis rather
than at current market value

2-13

Balance Sheet Items


Liquidity: Asset accounts are listed in order
of liquidity
Current assets
Items that can be converted to cash within 12 months

Marketable securities
Temporary investments of excess cash

Accounts receivable
Allowance for bad debts to determine their anticipated
collection value

Inventory
Includes raw materials, goods in progress, or finished
goods
2-14

Balance Sheet Items (contd)


Prepaid expenses
Represent future expense items that are already paid
for

Investments
Long-term commitment of funds
Includes stocks, bonds, or investments in other
companies

Plant and equipment


Carried at original cost minus accumulated
depreciation
Accumulated depreciation
Sum of past and present depreciation charges on currently
owned assets

2-15

Balance Sheet Items (contd)


Depreciation expense is the current years charge

Total assets: Financed through liabilities or


stockholders equity

Short-term obligations
Accounts payable
Notes payable
Accrued expense

2-16

Stockholders Equity
Represents total contribution and ownership
interest of preferred and common
stockholders
Preferred stock
Common stock
Capital paid in excess of par
Retained earnings

2-17

Statement of Financial Position


(Balance Sheet)

2-18

Concept of Net Worth


Net worth/book value = Stockholders equity
preferred stock component
Market value is of primary concern to the:
Financial manager
Security analyst
Stockholders

2-19

Limitations of the Balance Sheet


Most of the values are based on
historical/original cost price
Troublesome when it comes to plant and
equipment inventory

FASB ruling on disclosure of inflation


adjustments no longer in force
It is purely a voluntary act on the part of the
company

2-20

Limitations of the Balance Sheet


(contd)
Differences between per share values may
be due to:
Asset valuation
Industry outlook
Growth prospects
Quality of management
Risk-return expectations

2-21

Comparison of Market Value


to Book Value per Share

2-22

Statement of Cash Flows


Emphasizes critical nature of cash flow to
the operations of the firm
It represents cash/cash equivalents items easily
convertible to cash within 90 days

Cash flow analysis helps in combating


discrepancies faced through accrual method
of accounting

2-23

Statement of Cash Flows (contd)


Advantage of accrual method
Allows matching of revenues and expenses in
the period in which they occur to appropriately
measure profits

Disadvantage of accrual method


Adequate attention not directed to actual cash
flow position of firm

2-24

Concepts Behind the Statement of


Cash Flows

2-25

Determining Cash Flows from


Operating Activities
Translation of income from operations from
an accrual to a cash basis
Direct method
Every item on the income statement is adjusted
from accrual to cash accounting

Indirect method
Net income represents the starting point
Required adjustments are made to convert net
income to cash flows from operations
2-26

Indirect Method

2-27

Comparative Balance Sheets

2-28

Cash Flows from Operating


Activities

2-29

Determining Cash Flows from


Investing Activities
Investing activities:
Long-term investment activities in mainly plant
and equipment
Increasing investments represent a use of funds
Decreasing investments represent a source of funds

2-30

Determining Cash Flows from


Financing Activities
Financial activities apply to the
sale/retirement of:
Bonds
Common stock
Preferred stock
Other corporate securities
Payment of cash dividends
Sale of firms securities is a source of funds
Payment of dividends and repurchase of securities is
a use of funds
2-31

Overall Statement
Combining the Three Sections

2-32

Analysis of the Overall Statement


How are increases in long-term assets being
financed?
Preferably, adequate long-term financing
and profits should exist
Short-term funds may be used to carry longterm needs could be a potential high-risk
situation
Example: trade credit and bank loans
2-33

Depreciation and Funds Flow


Depreciation
Attempt to allocate the initial cost of an asset
over its useful life

Charging of depreciation does not directly


influence the movement of funds

2-34

Comparison of Accounting
and Cash Flows

2-35

Free Cash Flow


Free Cash Flow = Cash flow from operating
activities Capital expenditures Dividends
Capital expenditures
Maintain productive capacity of firm

Dividends
Maintain necessary payout on common stock and to
cover any preferred stock obligations

Free cash flow is used for special financing


activities
Example: leveraged buyouts
2-36

Income Tax Considerations


Corporate tax rates
Progressive: the top rate is 40% including state
and foreign taxes if applicable. The lower bracket
is 1520%

Cost of a tax-deductible expense

2-37

Depreciation as a Tax Shield


Not a new source of fund
Provides tax shield benefits measurable as
depreciation times the tax rate
Corporation A Corporation B
Earnings before depreciation and taxes
Depreciation
_________ _________
Earnings before taxed
Taxes (40%)
_________ _________
Earnings after taxes
+Depreciation charged without cash outlay
_________ _________
Cash flow
Difference

$400,000 $400,000
100,000
0
300,000
120,000

400,000
160,000

180,000
100,000

240,000
0

$280,000 $240,000
$40,000

2-38

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