1. Memorial University of Newfoundland
Financial Accounting: Tools for Business Decision-Making Fourth Canadian Edition
Prepared by:
Peggy Coady
Memorial University of Newfoundland
&
Catherine Seguin
University of Toronto
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2. Performance Measurement
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Performance Measurement

3. Sustainable Earnings
Likely level of future cash flows is generated by earnings
Sustainable earnings is net earnings adjusted for irregular items
Discontinued operations
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4. Discontinued Operations
Disposal, or availability for sale, of an identifiable operating segment
Operating segment
Separate business unit with its own financial elements (e.g., revenues, expenses, and cash flows) distinguishable from the rest of the company.
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5. Discontinued Operations
Statement of earnings:
Earnings (loss) from operations
Gain (loss) on disposal of the segment
Both components are reported net of applicable taxes in a section entitled Discontinued Operations, which follows Earnings from Continuing Operations
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6. Discontinued Operations
Balance sheet
Assets (net of liabilities) held for sale segregated and reported at lower of carrying amount and fair value
No further depreciation taken
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7. Change in Accounting Principle
When the principle used in the current year is different from the one used in the preceding year
Voluntary: Permitted, when new principle results in more reliable and relevant presentation
Mandatory: Required by standard setters
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8. Change in Accounting Principle
Reporting effects
Cumulative effect of change reported as adjustment to opening retained earnings in statement of shareholders’ equity
New principle used to report current results
Prior period statements restated
Effects of change detailed in notes
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9. Discussion Question
Discuss the adoption of international financial reporting standards (IFRS) as a change in accounting policy.
Discussion points:
Mandatory change
Restatement of opening balances to comply with new standards
Note some exemptions permitted where benefit does not exceed cost. Prospective application allowed in those cases.
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10. Comparative Analysis Three types of comparisons: Intracompany basis
Intercompany basis
Industry averages
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11. Comparative Analysis Three tools: Horizontal analysis
Percentage of base-period amount
Percentage change for the period
Vertical analysis
Ratio analysis
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12. Analysis-period amount % of base-period amount
Horizontal Analysis
Analysis-period amount
Base-period amount
% of base-period amount
127% % % % %
ANY COMPANY INC.
Assumed Net Sales (in thousands)
2009
2008
2007
2006
2005
$ 6,562.8
$ 6,295.4
$ 6,190.6
$ 5,786.6
$ 5,181.4
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13. $ amount of change for period
Horizontal Analysis
$ amount of change for period
Base-period amount
% change for period
Note that the base-period amount changes each year. That is, it is 2005 for the purposes of calculating the change between 2006 and It becomes 2006 for the purposes of calculating the change between 2007 and 2006; and so on.
4.2% % % % n/a
ANY COMPANY INC.
Assumed Net Sales (in thousands)
2009
2008
2007
2006
2005
$ 6,562.8
$ 6,295.4
$ 6,190.6
$ 5,786.6
$ 5,181.4
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14. Vertical Analysis
Expresses each item in a financial statement as a percent of a base amount (total assets or net sales)
ANY COMPANY, INC.
Condensed Balance Sheets
December 31 (in thousands)
2009
2008
Assets
Amount
Percent
Current assets
Property, plant, and equipment
Other assets
Total assets
$1,496.5
2,888.8
666.2
$5,051.5
29.6%
57.2%
13.2%
100.0%
$1,467.7
2,733.3
636.6
$4,837.6
30.1%
56.9%
13.0%
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15. Ratio Analysis
Liquidity Ratios: Measure short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash
Solvency Ratios: Measure the ability of the company to survive over a long period of time
Profitability Ratios: Measure the earnings or operating success of a company for a given period of time
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16. Liquidity Ratios Working capital Current ratio Inventory turnover
Days in inventory
Receivables turnover
Average collection period
Cash current debt coverage
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17. Working Capital Measures short-term debt paying ability
Working Capital = Current Assets – Current Liabilities
Higher is better
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18. Current Ratio Measures short-term debt paying ability
Current Ratio = Current Assets
Current Liabilities
Higher is normally (but not always) better. Be cautious about influences of slow moving inventory and receivables on this ratio
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19. Inventory Turnover Measures liquidity of inventory Inventory Turnover=
Cost of Goods Sold
Average Inventory
Higher is better
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20. Days in Inventory Measures number of days inventory is on hand=
365 Days
Inventory Turnover
Lower is better
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21. Average Gross Receivables
Receivables Turnover
Measures liquidity of receivables
Receivables Turnover =
Net Credit Sales
Average Gross Receivables
Higher is better
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22. Average Collection Period
Measures number of days receivables are outstanding
Average Collection Period =
365 Days
Receivables Turnover
Lower is better
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23. Cash Current Debt Coverage
Measures short-term debt-paying ability (cash basis)
Cash Current Debt Coverage =
Cash Provided (Used) by Operating Activities
Average Current Liabilities
Higher is better
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24. Solvency Ratios Debt to total assets Free cash flow
Times interest earned
Cash total debt coverage
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25. Debt to Total Assets Ratio
Measures % of total assets provided by creditors
Debt to Total Assets =
Total Liabilities
Total Assets
Lower is better
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26. Free Cash Flow
Measures cash available for paying dividends or expanding operations
Cash Provided (Used) by Operating Activities 
Net Capital Expenditures
Dividends Paid =
Free Cash Flow
Higher is better
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27. Earnings Before Interest Expense and Income Tax Expense (EBIT)
Times Interest Earned
Measures ability to meet interest payments as they come due
Times Interest Earned =
Earnings Before Interest Expense and Income Tax Expense (EBIT)
Interest Expense
Higher is better
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28. Cash Total Debt Coverage
Measures long-term debt-paying ability (cash basis)
Cash Total Debt Coverage =
Cash Provided (Used) by Operating Activities
Average Total Liabilities
Higher is better
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29. Profitability Ratios Corporate Measures Investor Measures
Gross profit margin
Profit margin
Return on assets
Asset turnover
Return on common shareholders equity
Investor Measures
Earnings per share (EPS)
Price-earnings (P-E) ratio
Payout ratio
Dividend yield
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30. Discussion Question
Why are profitability ratios are subdivided into corporate measures and investor measures?
Discussion points:
Both investors and creditors are interested in evaluating profitability
The investor measures are used by investors to determines whether to purchase the company’s shares for income or growth.
The corporate measures relate to the company’s past profitability.
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31. Gross Profit Margin
Measures margin between selling price and cost of goods sold
Gross Profit Margin =
Gross Profit
Net Sales
Higher is better
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32. Profit Margin Measures net earnings generated by each dollar of sales
Net Sales
Higher is better
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33. Return on Assets Measures overall profitability of assets Net Earnings
Average Total Assets
Higher is better
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34. Asset Turnover
Measures how efficiently assets are used to generate sales
Asset Turnover =
Net Sales
Average Total Assets
Higher is better
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35. Return on Common Shareholders’ Equity
Measures overall profitability of shareholders’ investment
Return on Common Shareholders’ Equity =
Net Earnings – Preferred Dividends
Average Common Shareholders’ Equity*
*Common shareholders’ equity = Total shareholders’ equity – Preferred shares
Higher is better
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36. Earnings per Share (EPS)
Measures net earnings earned on each common share
Earnings Per Share =
Net Earnings – Preferred Dividends
Weighted Average Number of Common Shares
Not comparable between companies
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37. Price-Earnings (P-E) Ratio
Measures relationship between market price per share and earnings per share
Price-Earnings Ratio =
Share Price
Earnings Per Share
Higher indicates investors expect favourable earnings in future
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38. Higher is better for investors seeking income
Payout Ratio
Measures % of earnings distributed in the form of cash dividends
Payout Ratio =
Cash Dividends
Net Earnings
Higher is better for investors seeking income
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39. Higher is better for investors seeking income
Dividend Yield
Measures earnings generated by each share, based on the market price per share
Dividend Yield =
Dividend per Share
Market Price per Share
Higher is better for investors seeking income
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40. Limitations of Financial Analysis
Can be impacted by
Alternative accounting principles
Inflation
Diversification
Professional judgment
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41. Copyright © 2009 John Wiley & Sons Canada, Ltd. All rights reserved
Copyright © 2009 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.
Kimmel, Weygandt, Kieso, Trenholm Financial Accounting : Tools for Business Decision-Making, Fourth Canadian Edition © 2008 John Wiley & Sons Canada, Ltd.
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