RSM100Y1 Chapter Notes - Chapter 15: Debt Ratio, Financial Ratio, Accrual

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Published on 21 Apr 2013
School
UTSG
Department
Rotman Commerce
Course
RSM100Y1
Professor
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Chapter 15
The Income statement
- Income statement: A financial record of a company’s
revenues, expenses and profits over a specific period of
time
- Summarizes a firm’s financial performance over a specific
time period, usually a quarter (three months) of a year
- Helps decision makers focus on overall revenues and the
costs needed to generate these revenues
- Not-for-profit organization use the income statement to
check whether the revenues from contributions and other
sources will cover the organization’s operating costs
- Provides many basic data to calculate the financial ratios
that managers use in planning and controlling activities
- Also called a profit-and-loss statement, P&L statement,
statement of comprehensive income (under IFRS)
- Begins with total sales or revenues generated during a year,
quarter, or month, then deduct all of the costs related to
producing the revenues (operating expenses, interest, and
taxes), the remaining net income may be distributed to the
firm’s owners (the shareholders, proprietors, or partners)
or reinvested in the company as retained earnings
- Bottom-line: The final figure on the income statement
net income after taxes
- Keeping costs under control is important part of running a
business
Statement of Changes in Equity
- Statement of changes in equity: a record of the change in
equity from the end of one fiscal period to the end of the
next fiscal period
- Uses information form both the balance sheet and the
income statement
- Begins with the shareholders’ equity shown on balance
sheet at the end of prior year, then net income is added,
and cash dividends paid to owners are subtracted
- Additional capital added to equity, withdrew capital,
equity is reduced
- All additions and subtractions equal the change in owners’
equity from the end of the previous fiscal year to the end
of the current fiscal year
- New amount of owners’ equity is reported on the balance
sheet for the current year
The Statement of cash flows
- Statement of cash flows: a record of the sources and uses
of cash during a period of time, provides investors and
creditors with information about a firm’s cash receipts
and cash payments for its operations, investments, and
financing during an accounting period
- Accrual accounting: an accounting method that records
revenues and expenses when they occur, not when cash
actually changes hand, companies prepare a statement of
cash flows due to the wide use of this method
- The amounts may differ between what is reported as sales,
expenses, and profits and the amount of cash that
actually flows into and out of a business during a period of
time
- Can help to prevent financial distress for otherwise
profitable firms
- Can provide investors and others with vital information
Financial ratio analysis
- Accounting professionals also help managers interpret the
statements by comparing data on the firm’s current
activities to data for previous periods and to data on
other companies in the same industry
- Ratio analysis: measures a firm’s liquidity, profitability,
reliance on debt financing, and how effectively
management uses the firm’s resources, allows comparisons
with other firms and with the firm’s own past performance
- Ratio interpret actual performance and making
comparisons to what should have happened
- Managers compare their firm’s ratios with ratios similar
companies to understand their firm’s performance
compared with competitors’ result
- These industry standards are important measures and help
focus on problem area and areas of excellence
- Ratios for the current accounting period can be
compared with similar calculations for previous periods to
spot developing trends
- Can be classified according to specific purposes
Liquidity ratios
- Liquidity ratios: measures a firm’s ability to meet its
short-term obligations, such as loans, when they are due
- An increase in liquidity reduces the likelihood that a firm
will need to raise funds to repay loans
- Firms with low liquidity may have to choose between
defaulting (failing to pay) and borrowing fro high-cost
lending sources to meet short term financial obligations
- Current ratio: Current assets/Current liabilities
Compares current assets to current liabilities
Provides information about the firm’s ability to pay its
current debts as they mature, or as payments are due
Must be considered along with factors such as nature
of the business, the season, and the quality of the
company’s management team
- Acid-test ratio (quick ratio): (Current assets Inventory) /
Current liabilities
Measures the ability of a firm to meet its debt
payments on short notice
Compares quick assets (the most liquid current assets)

Document Summary

Income statement: a financial record of a company"s revenues, expenses and profits over a specific period of time. Summarizes a firm"s financial performance over a specific time period, usually a quarter (three months) of a year. Helps decision makers focus on overall revenues and the costs needed to generate these revenues. Not-for-profit organization use the income statement to check whether the revenues from contributions and other sources will cover the organization"s operating costs. Provides many basic data to calculate the financial ratios that managers use in planning and controlling activities. Also called a profit-and-loss statement, p&l statement, statement of comprehensive income (under ifrs) Bottom-line: the final figure on the income statement net income after taxes. Keeping costs under control is important part of running a business. Statement of changes in equity: a record of the change in equity from the end of one fiscal period to the end of the next fiscal period.