Business 1220E- Finance.docx

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Department
Business Administration
Course
Business Administration 1220E
Professor
Eric Silverberg
Semester
Fall

Description
The Basics – Statement of Earnings, Balance Sheet and Statement of Retained Earnings Statement of Earnings (Income Statement)  How much money an organization is making over a period of time  Matches the revenue generated from selling goods or services against the expenses used to generate them – the difference will result in a net earnings or net loss  Cost of Goods Sold  Beginning Inventory + Purchases = COGAFS – Ending Inventory = COGS  Non-manufacturer- Includes the purchase and delivery costs  Manufacturer- Reflects all costs associated with the transformation of unprocessed raw materials into finished good available for sale  Serve organizations – No product, direct expenses of generating service revenue  Company name, statement name, date at top  Includes depreciation expense (how much the asset lost value just this year)  Only depreciate the asset for as long as it exists (Ex: New renovation, only depreciate it when it is finished)  If a year starts in January and the renovation is finished in March, only depreciate it for 9 mont  Do not have to pay interest on loans that have been paid off – minus current portion Balance Sheet  How much money an organization is making at a certain point in time  Assets = Debt + Equity  Assets – All physical goods and items of value owned by the company that will provide future benefits  Current assets will be converted into cash within a year and are listed in the level of liquidity  Includes intangibles (goodwill, organizational expenses, patents, copyrights)  Liabilities – Finance the company  A “demand note” indicates the lender may demand repayment at any time  Accrued expenses payable – A company may owe for various goods not yet delivered in full or for services not fully performed  First mortgage bonds – Bonds secured by the pledge of a company’s specific assets. The bondholders will have first claim if they cannot repay  Debentures – Unsecured certificates of debt, value resting on the general credit standing of the company  Shareholders equity  Capital Stock – The shares of ownership, which reflects the owners initial equity invested in the company  Sole proprietorship it is a single account, a partnership will show the different partners’ shares and a publicly traded company may have different kinds of shares (common and preferred stock)  Current portion is NOT an expense, we need to pay the $12,000 because it is a current liability  Only if a current portion is given do we have to add that onto the balance sheet  Double deduction – For a new loan in the first year you deduct the current portion twice because you are paying it once and because you are separating it  Accumulated depreciation – How much the asset has lost value since the day you first bought it  Depreciation expense has to be added to previous years accumulated depreciation  To calculate depreciation you divide how much you paid for the asset by its useful life  Will generally be 1- years if information is not given  PLUG = Working Capital Loan or Line of Credit – Like a credit card, taken out for day to day needs  Calculated by the difference between total assets and total liabilities/equity  Subsidiary – Another business under the same owners (ex: Owners of Elegance jewellers taking out loans on this company to fund other ones)  Parent company, more relaxed loan, flexibility Statement of Retained Earnings  Retained earning – Accumulated after tax profits which have not been paid out to the owners as dividends or drawings  Dividends is money taken out to pay the owners  Should not be paid out if the company is not making enough money Forms of Ownership 20/10/2012 4:15:00 PM Sole Proprietorship  A business owned and operated by a single individual  Takes ownership of the company’s profitability and full financial responsibility  Risky for creditors, owner is personally responsibly to pay debt  Must consider: risk, company size, provisions for succession, length of existence, historical relationships with creditors Partnership  Unincorporated enterprise owned by 2+ individuals  All partners are subject to unlimited financial liability  Partners’ liabilities are joint and personal (must repay if partners cannot) and legally responsible for one another Corporations  Created by law, separate from the people who own or manage them – ownership is represented by shares or stock  The owners elect a board of directors, which appoints company officers to set the companies objectives  Differences: Proprietorship VS Incorporated Owners Equity Shareholders Equity  Drawings  Dividends Money that you give to owners Money that you give to shareholders Capital Retained Earnings The money that has built up over time The money that has built up over time Statement of Capital Statement of Retained Earnings Taxed at personal level Taxed at corporate level - You and the business are the same, - Found on statement of earnings only personal accounts are taxed - No tax on statement of earnings  Statement of Cash Flows 20/10/2012 4:15:00 PM  Reveals how much cash has been generated and used by a company over a specified period of time  Where it spends its cash and where it receives its cash Operations  Describe how normal business operations have affected the flow off cash  Day-to-day activities  Adjusts the reported net earnings to a cash basis to determine cash flow  Ad back all non-cash expenses (ex: amortization, which is an accounting principle. You do not actually lose this cash), removing the impact of all transactions that are not normal operating items and differences in any current balance sheet accounts Analysis of Operations:  Are the operations generating cash?  Positive Cash flow – from stretching accounts payable, reducing inventory, tightening costs  Are these methods acceptable in this particular situation?  Look at industry, environment, economic climate, production stage  Example: It is not uncommon for a company to have a negative cash flow if they are expanding their product line or in growth Financing Activities  Changes in level of financing in the business (repayments or borrowings) Analysis of Financing:  Match the type of investment to the length of financing  Sound financial practice involves matching short-term uses with short-term sources and long-term uses with long-term sources  Example: Long term loan for purchase of fixed assets or short-term loan for day to day needs  Reveals how much debt/equity has been acquired/retired over the year  There can be discrepancies between long term sources and uses  Example: If sources exceed, balance must be filled with short-term uses  Short-term financing should be used to supplement periodic cash requirements for operations Investing Activities  All cash movements relating to the acquisitions or disposals of non-current assets Analysis of Investments:  Periodic purchases and sales of assets are common  Newer equipment becomes available, expansion or growth  Fixed assets should be acquired from funds from operations and long-term debt  Investments can offer insight to the direction taken by a business  Example: Investment in new equipment may indicate it’s intent to maintain or increase capacity General Analysis of Cash Flows: - If assets decrease in value, it is a source of cash. It increases on the statement of cash flows as you are gaining cash from these sales - If your assets go up, it is a use of cash. Your assets are increasing because you are spending cash - If liabilities increase you are taking out ASSETS LIABILITIES AND money so it is a source of cash OWNERS EQUITY - If your liabilities are lower, you are paying  SOURCE  SOURCE these loans off, so it will be a use of cash - So what, why that number is happening,  USE  USE how it effects the decision - Needs sources to meet obligations and expand Interpreting the Standard Cash Flow 1. Was cash generated from operations?  If cash is negative, none is generated from operations and the “engine” of the company is not working, we are not making money from day-to-day activities  Normal that a new business will lose money at first – however trends should still demonstrate that profit is increasing 2. Is the net income a source of cash? What does this tell us?  Making profit or not? Why? How?  If it is a source of cash, sales are more than operations 3. What are the sources and uses of cash from operations? What do they mean?  Look at the OPERATIONS section (Depreciation, accounts receivable, inventory, accounts payable)  Activity (purchased etc)…assess risk (high or low) (include considerations such as depreciation or trends)…as a creditor…  HOW DOES THIS AFFECT OUR DECISION?  Trade debt is never preferable, especially to fund fixed assets  What would we like to see in the future? Look at major sources and uses: funding, matching  If accounts payable is a consistent source of cash, they are making regular payments on their loans – a good thing for a creditor to see  Investigate consistency to ensure these payments are not just a one-time thing to impress creditors and get a better rating 4. What are the remained money of sources and uses? What do they mean?  Look at FINANCING and INVESTMENT activities  [Long-term and short-term] Sources and uses should match up  Paying off debt with debt is never a sustainable practice  Paying off consistent portions of long-term debt is a food practice and proves the company is reliable in their payments  Should not pay off dividends or drawings if the company is new and does not have enough trends to support itself 5. Recommendations for the Future?  If there is good activity and visible growth, recommend that the company continues these practices  Only need real and thorough recommendations if the company has unsounds practices  Net Cash Flow – The sum of the three components and equals the difference between the cash balance on the balance sheet at the beginning of the accounting periods  Bankrupt – When you run out of cash, not related to your profits  Why is this happening, what it tells us as an investor Ratio Analysis 20/10/2012 4:15:00 PM  Industry ratios are always an excellent point of reference for comparison (better or worse than industry average)  If a ratio is n/a, there is a reason and this must be analyzed  Example: Lawsons, there was no equity or investment in the company (it was all liabilities), so there cannot be a return on this equity  There was no equity, the company was completely financed with debt Vertical Analysis  Statement of earnings, expenses are expressed as a percentage of net sales  Question large expenses Profitability  Corresponding with an increase in operating income  it is a desirable trend if cogs is decreasing and gross profit is increasing - better at managing costs and expenses and becoming more efficient  Compare the numbers  Example: In Maple Leaf Hardware rent is becoming a smaller percentage of their vertical analysis. Upon examining the statement of earnings we can see that in fact the cost of rent is going up, but it is a smaller portion of their profits  Analyze the biggest numbers (percentage-wise) or numbers that have great changes as well as cogs, gross margin, total expenses (if increasing or decreasing) and net earnings  Return on Equity – The income generated as a percentage of the company’s equity, the amount of money you get back from each dollar you put in the company  Justifies risk and shareholders return on investment Efficiency  How well does the company use its resources to generate a return  Age of receivables (how many days it takes to collect money from customers)  If it takes longer and their goods are more expensive, this number will be higher  Preferable if smaller than age of payables – receiving money before you pay money is a better practice  Will not be an important ratio for companies who do the majority of their sales in cash  Age of payables (how long it takes to pay their suppliers)  If suppliers are paid back faster, the company will have a better relationship with them in the future and may be able to arrange deals (extending credit terms)  Age of inventory (how long before inventory is sold)  Appropriateness will depend on the product, if it is something perishable it cannot “sit on the shelf” for many days Liquidity  Can a company meet its short term obligations?  Must consider the industry- service industry does not have inventory and will generally have lower ratios  The difference between the current ratio and acid test is generally inventory and how reliant we are on it  Companies who provide a service are less reliant vs. manufacturers and retailers who are  The idea difference should be approximately 1  Example: 1.75:1 – For every $1 of liabilities they have $1.75 of current assets  If they need to liquidate today they can over assets  The lower the ratio, the more illiquid the company is  2:1 is the ideal current ratio  1:1 is the idea acid test  Able to pay off all liabilities with current assets that are not inventory  If the current ratio is too high, it indicates that you can invest somewhere else Liabilities ASSETS Equity Stability  Assess financial risk of the company  Net worth to total assets – Portion of assets paid for by owner vs. liabilities  In most situations you want this relatively even  Interest coverage- MUST be over 1, you only have to pay this fee once over the operating period  This information is essential to the creditor  Can correspond to the amount of loans taken out (ex: Interest coverage will decrease if a new loan is taken out and you have more interest to pay)  Debt to equity – how are you financing your company? Lower = safer for crediots Growth  Growth in Assets - - Growth in Profit - Growth in Equity  You buy more assets to make money  There should be money in the piggy b
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