1. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 1-1 Understanding Accounting and Financial Statements

2. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 1-2 Making Comparisons ●Consider these two cars ●How do you compare the two cars? –Miles per hour –Miles per gallon –# repairs per mile –Cost per repair ●These are ratios Car ACar B Miles driven 10003000 Elapsed Time 20 hrs.50 hrs Gas used 50 gal.200 gal. # of repairs 25 Cost of repairs $2000$4000

3. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 1-3 Financial Ratio Analysis ●Ratio analysis—one of the most commonly used tools for measuring the firm’s liquidity, profitability, and reliance on debt financing, as well as the effectiveness of management’s use of its resources –Allows comparisons with other firms and with the firm’s own past performance

4. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 1-4 Financial Ratio Analysis ●Financial Ratios and What They Measure

5. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 1-5 Financial Ratio Analysis ●Liquidity Ratios –Firm’s ability to meet its short-term obligations Current ratio = current assets / current liabilities

6. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 1-6 Financial Ratio Analysis ●Profitability Ratios –Profitability ratios—compare the firm’s earnings with total sales or investments –Five important profitability ratios are:  Return on sales (ROS) = profit / sales  Return on assets (ROA) = profit / assets  Return on equity (ROE) = profit / owners equity  Earnings per share (EPS) = profit / # of shares

7. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 1-7 Financial Ratio Analysis ●Leverage ratios—measures the extent to which a firm relies on debt financing –Debt ratio = total liabilities / total assets –Leverage ratio = total assets / owners’ equity ●Activity ratios—measure the effectiveness of management’s use of the firm’s resources –Inventory turnover ratio—indicates the number of times merchandise moves through a business = COGS / inventory

8. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 1-8 Budgeting ●Budget—a planning and controlling tool that reflects the firm’s expected sales revenues, operating expenses, and cash receipts and outlays –Quantifies the firm’s plans for a specified future period –Serves as a financial blueprint –Standard for comparison against actual performance ●Cash Budget

9. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 1-9 In Class ●Compare the financials of: –Anheuser-Busch –Apple –Microsoft