Integrated Accounting Issues Winter 2006 Rodney K. Rogers, Ph.D., CPA School of Business Administration Portland State University

Traditional Stakeholders of Firm Operations/Investing Vendor Customer Goods $ $ CreditorsInvestors $ $ $ $ Financial Intermediaries Information Intermediaries

Expanded Stakeholders Firm Shareholders Creditors Employees Management Competitors Government Customers Vendors External Auditors Internal Auditors

Market EnvironmentOrganization Strategy Organization Activities Accounting System Financial Statements Accounting Environment Accounting Strategy From Business Activities to Financial Statements Organization Structure

Analysis of a Company Market Environment – “Context” –Macroeconomic, governmental, legal considerations, Organization Strategy Analysis – “Expectations” –Key profit drivers, business risks and profit potential Organization Structure – “Capabilities” –Current structure of organization Accounting Analysis –Evaluate the “quality” of the accounting numbers Financial Analysis –Evaluate performance using financial and non-financial information – (past and current results) Prospective Analysis –Forecasts and valuation

SWOT Analysis Internal –Strengths –Weaknesses External –Opportunities –Threats

Market Environment Interest Rates US and foreign GNP Growth Unemployment Levels Trends in Consumer savings/borrowing Others

Business Strategy Analysis Specific Industry Structure (Porter’s “five forces”) –Rivalry among existing firms Industry Growth, Concentration, Switching Costs, Fixed/Variable Costs, Excess Capacity –Threat of new entrants Scale Economies, First mover, Relationships –Threat of substitute products Price/Performance trade-off –Bargaining power of buyers and suppliers Switching cots, number and volume of buyers/suppliers Competitive Strategy –Cost Leadership –Differentiation

Competitive Strategy Cost Leadership –Same product or service at lower cost Economies of scale, efficient production, design Differentiation –Unique product or service at a premium price Product design, variety, customer service, brand, R&D, innovation How to maintain competitive status?

Business Strategy Analysis Quality of Management Regulatory Developments Social Issues Technology

Output: Basic Financial Statements Balance Sheet Income Statement Statement of Cash Flows Retained Earnings Statement Statement of Comprehensive Income

Analyzing a Firm Operations/Investing Vendor Customer Goods $ $ CreditorsInvestors $ $ $ $ Financial Intermediaries Information Intermediaries

Accounting Analysis Quality of Disclosures Quality of Numbers

Sales –Price vs. volume Charges –Real vs. nominal growth Cost of Goods Sold –Cost-flow assumptions –LIFO liquidation –Loss/Reserves on write-down of inventory

Quality of Numbers Operating Expenses –Discretionary expenses R&D Repair and Maintenance Advertising and Marketing –Depreciation Methods Estimates –Pension Accounting

Quality of Numbers Nonoperating Revenue and Expenses –Gains/Losses from Sales of Assets –Interest Income –Equity Income –Loss recognition on write-down of assets –Accounting changes –Extraordinary items –Reserves on restructuring charges

Financial Analysis: Levers for Value Creation Return on Equity = Net Income Shareholder’s Equity

Return on = Profit Margin x Asset Turnover x Financial Equity Leverage net income = net income x sales x assets owner’s equity sales assets owner’s equity Change revenues êhigher prices êgreater volume Change costs êproduct/process design êsupply relationships Reduce need for investment (capital intensity) Advantageous financing (external) Interrelationships of Ratios Managing Rev/ExpAssetsLiabilities/Equity

Managing Sales and Expenses Gross Profit Operating Profit Issues to Consider –Price vs. Volume Changes –Real vs. Nominal Growth –Inventory Issues

Many terms Net Income EBIDA EBIT or Operating Income (pre-tax) EBITDA FCF NOPAT or prefinancing operating earnings

Profitability Ratios Gross Profit Margin =Gross Profit Net Sales Operating Profit Margin = Operating Profit Net Sales Net Profit Margin = Net Earnings Net Sales

Profitability Ratios Return on Investment (ROI) = Net Earnings Total Assets SGA % = Selling, General and Admin. Expenses Net Sales Cash Flow Margin =Cash flow from operations Net Sales Return on Assets (ROA) = NOPAT Total Assets

Managing Assets Days in Receivables = Accounts Receivable Avg.Daily Sales A.R. Turnover = Net Sales Accounts Receivables Inventory Turnover = Cost of Goods Sold Inventory Fixed Asset Turnover = Net Sales Net Prop.Plant&Equip. Total Asset Turnover = Net Sales Total Assets

Managing Liabilities and Equity Current Ratio= Current Assets Current Liabilities Quick Ratio =Current Assets-Inventory Current Liabilities

Managing Liabilities and Equity Debt Ratio =Total Liabilities Total Assets L.T. Debt to Total Capital = LT Debt LT Debt + S.E. Debt to Equity = Total Liabilities Shareholders’ Equity Times Interest Earned =Operating Profit Interest Expense

Return on = Profit Margin x Asset Turnover x Financial Equity Leverage net income = net income x sales x assets owner’s equity sales assets owner’s equity Change revenues êhigher prices êgreater volume Change costs êproduct/process design êsupply relationships Reduce need for investment (capital intensity) Advantageous financing (external) Interrelationships of Ratios Managing Rev/ExpAssetsLiabilities/Equity (common earnings leverage) (capital structure leverage)

Market Ratios Earnings Per Share = Net Earnings Avg. Shares Outstanding Price to Earnings Ratio = Market Price of Common Stock Earnings Per Share Dividend Payout Ratio = Dividends Per Share Earnings Per Share Dividend Yield= Dividends Per Share Market Price of Common Stock

Financial Performance Measures by Area and Viewpoint