4 chapter 4 maintain and analyze financial records · maintain and analyze financial records 4 ......
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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
Essentials of Accounting
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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
Essentials of Accounting
source document
original record of a transaction
journals
business records
journal entry
identifies key information for the transaction
All financial transactions must be
recorded.
Essentials of Accounting
specific reports prepared according to
accepted accounting principles
balance sheet
income statement
cash flow statement
financial statements
Essentials of Accounting
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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
Profitability Ratios
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This ratio evaluates the efficiency of the assets of
the company.
Profitability Ratios
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
Market Performance Ratios
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anticipated earnings on investments
help investors decide what price to pay for a
company’s stock
Market Performance Ratios
when this ratio is greater than 1, investors are
willing to pay more for the stock than it is valued
by the company
Market Performance Ratios
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