1. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Saturday, November 16th Midterm Topic: Accounting & Finance Quiz #5 Extra Credit #1

2. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Accounting and Financial Analysis Earnings of Firm Value of Firm Accounting Function Summary and Analysis of a Firm’s Financial Condition Management decisions such as how much to produce and how many employees to hire Marketing decisions such as pricing and the amount of promotion necessary Finance decisions such as the amount of debt financing versus equity financing that is appropriate

3. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Accounting Firms use accounting to: Process of: Report financial conditions Support decisions Control business operations Process of: Report financial conditions Support decisions Control business operations

4. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Guideline Establishment GAAP (Generally Accepted Accounting Principles) FASB (Financial Accounting Standards Board) SEC (Securities and Exchange Commission) IRS (Internal Revenue Service) GAAP (Generally Accepted Accounting Principles) FASB (Financial Accounting Standards Board) SEC (Securities and Exchange Commission) IRS (Internal Revenue Service)

5. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Two Types of Accounting Managerial: concerned with preparing information for review by those on the inside of the firm. Financial: concerned with preparing information for review by those on the outside of the firm.

6. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Audit for Control Is a formal evaluation of the records used to prepare a firm’s financial statement. Internal Auditors External Auditors Employees who analyze and evaluate the company. Public accountants who work for an independent accounting firm.

7. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Two Major Financial Statements Income Balance Sheet Reports the book value of assets, liabilities, and owner’s equity of a firm at a given point in time. Indicates the revenue, costs, and earnings of a firm over a given time frame.

8. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Sample Income Statement Net sales$20,000 Cost of goods sold 16,000 Gross profit $ 4,000 Selling expense$1,500 General & administrative 1,000 Total operating expense 2,500 Earnings before interest and taxes 1,500 Interest expense 500 Earnings before tax $1,000 Income tax (at 30%) 300 Net income $ 700 Net sales$20,000 Cost of goods sold 16,000 Gross profit $ 4,000 Selling expense$1,500 General & administrative 1,000 Total operating expense 2,500 Earnings before interest and taxes 1,500 Interest expense 500 Earnings before tax $1,000 Income tax (at 30%) 300 Net income $ 700

9. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Assets(in thousands) Current assets Cash $ 200 Marketable securities 300 Accounts receivable 500 Inventory 1,000 Total current assets $ 2,000 Fixed assets Plant and equipment $10,000 Less accumulated depreciation 2,000 Net fixed assets 8,000 Total assets$10,000 Liabilities & Owner’s Equity(in thousands) Current liabilities Accounts payable $ 600 Notes payable 400 Total current liabilities $ 1,000 Long-term debt$ 5,000 Common stockholder’s equity Common stock$ 1,000 Additional paid-in capital 2,000 Retained earnings 1,000 Total owner’s equity$ 4,000 Total liabilities and owner’s equity $10,000 Assets(in thousands) Current assets Cash $ 200 Marketable securities 300 Accounts receivable 500 Inventory 1,000 Total current assets $ 2,000 Fixed assets Plant and equipment $10,000 Less accumulated depreciation 2,000 Net fixed assets 8,000 Total assets$10,000 Liabilities & Owner’s Equity(in thousands) Current liabilities Accounts payable $ 600 Notes payable 400 Total current liabilities $ 1,000 Long-term debt$ 5,000 Common stockholder’s equity Common stock$ 1,000 Additional paid-in capital 2,000 Retained earnings 1,000 Total owner’s equity$ 4,000 Total liabilities and owner’s equity $10,000 Balance Sheet

10. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Ratio Analysis Liquidity Efficiency Leverage Profitability Liquidity Efficiency Leverage Profitability A quantitative measurement used to evaluate a firm’s financial performance.

11. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Three Profitability Ratios Indicates a firm’s overall performance in terms of its ability to generate revenue in excess of expenses. Return on Assets = Net Income/ Total assets Net Profit Margin = Net Income/Net Sales Return on Equity = Net Income/ Total Owners’ Equity

12. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Liquidity Measures a firm’s ability to meet its short term obligation. Current Ratio = Current Assets/Current Liabilities Acid-Test Ratio or Quick Ratio = Quick Assets/Current Liabilities

13. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Measures of Efficiency Inventory Turnover = Costs of Goods Sold/Average Value of Inventory For A Period of Time Asset Turnover = Net Sales/Total Assets Used to analyze how well the firm is managing its assets.

14. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Leverage or Debt Ratios The degree to which a firm is relying on debt financing. Debt to Owners’ Equity = Long-Term Debt/Owners’ Equity Times Interest Earned = Earnings Before Interest & Taxes/Annual Interest Expense

15. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Debt vs Equity Financing Firm’s Financing Decisions Firm’s cost of capital (funds) used to support business operations Firm's Earnings Firm's Value

16. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Four Factors in Determining Creditworthiness The planned use for the borrowed funds. Financial condition of the firm. Outlook of the industry and environment of the firm. Available collateral.

17. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Major Types of Financing  Debt financing Act of borrowing funds.  Equity financing Act of receiving investment from owners (by issuing stock or retaining earnings).

18. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Methods of Debt Financing Borrowing From Financial Institutions Fixed-rate loans Floating-rate loans Issuing Bonds Secured Unsecured Call Feature Issuing Commercial Paper

19. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Three Interest Rate Charge Scenarios I 1 (Fixed rate) I 2 (Floating rate while interest rates are rising) I 3 (Floating rate while interest rates are declining) Interest Rate

20. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Prime Rates

21. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Methods of Equity Financing Retaining Earnings Keep earnings after taxes for expansion. Issuing Stock Common. Preferred. The act of receiving investment from owners by retained earning or issuing stock.

22. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Initial Public Offering (IPO) Advantages of IPOs: Gain access to more funds. Obtain funds without increasing existing debt level. Disadvantages of IPOs: Must inform shareholders of their financial condition. Expenses associated with reporting of information must be filed with SEC. Difficulty in encouraging stock purchase. Ownership structure is diluted. Investment banks charge high fees.

23. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Issuing of Securities Origination Investment bank advises firm on amount of stock and bonds to issue. Underwriting Investment bank guarantees a price to the issuing firm. Distribution Prospectus is distributed to investors.

24. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Capital Structure Use of Debt Interest payments are tax deductible. Can claim interest payments during year as expense. Increased risk of default. May result in high interest payments. Creditors may not be willing to provide additional credit. Equity Financing Eliminates many of the above concerns. The composition of debt versus equity financing.

25. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Return on Equity & Financial Leverage Proportion (%) of Assets Financed with Equity Percent

26. MultiMedia by Stephen M. Peters© 2001 South-Western College Publishing Interest Expense & Financial Leverage Proportion (%) of Assets Financing with Equity Dollars (thousands)