Assessing Business Performance Chapter 6

Structure of Balance Sheet Current assets$100 Other assets500 Total assets$600 Page 127

Structure of Balance Sheet Current assets$100Current liabilities$75 Other assets500Other liabilities200 Total liabilities275 Equity325 Total assets$600 Total liabilities plus equity $600 Page 127

Structure of Balance Sheet Current assets$100Current liabilities$75 Other assets500Other liabilities200 Total liabilities275 Equity325 Total assets$600 Total liabilities plus equity $600 Balancing entry Page 127

Analysis of Balance Sheet Liquidity: Ability of the firm to convert its current assets to cash and retire all its current liabilities. The current ratio is a common measure of liquidity. Current ratio = current assets ÷ current liabilities = $100 ÷ $75 = 1.33 Greater than 1.0 Page 127

Analysis of Balance Sheet Liquidity: Ability of the firm to convert its current assets to cash and retire all its current liabilities. The current ratio is a common measure of liquidity. Current ratio = current assets ÷ current liabilities = $100 ÷ $75 = 1.33 Solvency: Ability of the firm to convert its total assets to cash and retire retire all its liabilities. The solvency ratio is a common measure of solvency. Solvency ratio = total assets ÷ total liabilities = $600 ÷ $275 = 2.18 Greater than 1.0 Greater than 1.0 Page 127

Structure of Income Statement Cash from sales$100. Other revenue25. Total revenue125. Page 129

Structure of Income Statement Cash from sales$100. Other revenue25. Total revenue125. Variable expenses50. Fixed expenses25. Total expenses75. Page 129

Structure of Income Statement Cash from sales$100. Other revenue25. Total revenue125. Variable expenses50. Fixed expenses25. Total expenses75. Income before taxes50. Page 129 $125 – $75 = $50

Structure of Income Statement Cash from sales$100. Other revenue25. Total revenue125. Variable expenses50. Fixed expenses25. Total expenses75. Income before taxes50. Page 129 $125 – $75 = $50

Structure of Income Statement Cash from sales$100. Other revenue25. Total revenue125. Variable expenses50. Fixed expenses25. Total expenses75. Income before taxes50. Page 129 $125 – $75 = $50

Structure of Income Statement Cash from sales$100. Other revenue25. Total revenue125. Variable expenses50. Fixed expenses25. Total expenses75. Income before taxes50. Provision for taxes10. Page 129

Structure of Income Statement Cash from sales$100. Other revenue25. Total revenue125. Variable expenses50. Fixed expenses25. Total expenses75. Income before taxes50. Provision for taxes10. Page % tax rate…

Structure of Income Statement Cash from sales$100. Other revenue25. Total revenue125. Variable expenses50. Fixed expenses25. Total expenses75. Income before taxes50. Provision for taxes10. Net income$40. Page 129

Structure of Income Statement Cash from sales$100. Other revenue25. Total revenue125. Variable expenses50. Fixed expenses25. Total expenses75. Income before taxes50. Provision for taxes10. Net income$40. Page 129 The bottom line…

Analysis of Income Statement Profitability: Two measures of profitability are net income appearing on the Bottom of the income statement and the rate of return on equity or ROE. This latter measure is defined as follows: ROE = net income ÷ equity = $40 ÷ $325 = or 12.3% Greater than zero Page 129

Analysis of Income Statement Profitability: Two measures of profitability are net income appearing on the Bottom of the income statement and the rate of return on equity or ROE. This latter measure is defined as follows: ROE = net income ÷ equity = $40 ÷ $325 = or 12.3% Efficiency: A measure of economic efficiency is the gross ratio which indicates The expenses per dollar of revenue. This measure is found by: Gross ratio = total expenses ÷ total revenue = $75 ÷ $125 = 0.60 Greater than zero Pre-tax profit margin is 40% Page 129

Accountant Vs. Economist Accounting profit: Limited to a measure of explicit costs appearing on the business’s income statement. Accounting profit = total revenue – total cost = $125 - $75 = $50 Page 136

Accountant Vs. Economist Accounting profit: Limited to a measure of explicit costs appearing on the business’s income statement. Accounting profit = total revenue – total cost = $125 - $75 = $50 Economic profit: Includes measure of implicit costs, which is an opportunity cost a business charges itself for using its existing resources that does not involve a payment of money. Economic profit = total revenue – total cost – implicit cost Page 136

Use of Financial Statements  Historical analysis of performance over time  Comparative analysis of performance with similar firms  Pro forma analysis  Internal uses (e.g., investment decisions  External uses (e.g., credit decisions

What Lies Ahead? What products should be produced, and how much should be produced? What level of specific inputs will be needed to produce these products? How should the acquisition of these inputs be financed? How large should the business become? Page 138

Problem 4 on Page 140 Given the following values, calculate the firm’s liquidity Solvency and profitability: Current assets$100 Other assets 500 Current liabilities 75 Total liabilities 275 Variable expenses 50 Provision for taxes 10 Total expenses 75 Total revenue 125

Problem 4 on Page 140 Given the following values, calculate the firm’s liquidity Solvency and profitability: Current assets$100 Other assets 500 Current liabilities 75 Total liabilities 275 Variable expenses 50 Provision for taxes 10 Total expenses 75 Total revenue 125 Current ratio = 100 ÷ 75 = 1.33 so the firm is liquid…. Current ratio = 100 ÷ 75 = 1.33 so the firm is liquid….

Problem 4 on Page 140 Given the following values, calculate the firm’s liquidity Solvency and profitability: Current assets$100 Other assets 500 Current liabilities 75 Total liabilities 275 Variable expenses 50 Provision for taxes 10 Total expenses 75 Total revenue 125 Total assets = = $600 Total liabilities = $275 Solvency ratio = 600 ÷ 275 = 2.18 so the firm is solvent…. Total assets = = $600 Total liabilities = $275 Solvency ratio = 600 ÷ 275 = 2.18 so the firm is solvent….

Problem 4 on Page 140 Given the following values, calculate the firm’s liquidity Solvency and profitability: Current assets$100 Other assets 500 Current liabilities 75 Total liabilities 275 Variable expenses 50 Provision for taxes 10 Total expenses 75 Total revenue 125 Net income = 125 – 75 – 10 = $40 Total assets = $600 Total liabilities = $275 Total equity = 600 – 275 = $325 ROE = 40 ÷ 325 =.123 or 12.3% so the firm is profitable…. Net income = 125 – 75 – 10 = $40 Total assets = $600 Total liabilities = $275 Total equity = 600 – 275 = $325 ROE = 40 ÷ 325 =.123 or 12.3% so the firm is profitable….