Financial Management Two Separate Home Assignments

FIN 400

G. Travis Miller, MBA, M.Ed.

Sojourner-Douglass College

Friday, March 28, 2014

5 Activities that drive a

Company's Profits

1. Revenue derived from selling the company's product or service

2. Cost of producing or acquiring the goods or services to be sold

3. Operating expenses related to marketing or distributing the product or service and administering the business

4. Financing cost of doing business

5. Payment of taxes

The Income Statement

 What is it?  The statement of profit and loss for the period,

comprised of revenues less expenses for the period (Keown, 2005)

 Sales – expenses = profits  Revenue

 Cost of Goods Sold

 Operating Expenses

 Financing cost of doing business

 Tax expenses

 What does the Income Statement tell us about a company?

Basic Income Statement

2002 Sales $4,195,197

Cost of Goods Sold 2,673,129

Gross Profit 1,522,068

Selling, general and

administrative expenses

465,831

Depreciation 160,119

Total Operating

Expenses

$625,950

Operating Profit $896,118

Interest Expense 17,849

Earnings before taxes 878,269

Provisions for income

taxes

298,052

Net Income 580,217

Also called

earnings

before

interest and

taxes or

operating

income

Income from

operating

activities

Cost of

debt

financing

Income

resulting

from

operating

and

financing

activities

(Keown, 2005)

Balance Sheet

 What is it?

 A statement of financial position at a

particular date. The form of the statement

follows the balance sheet equation:

○ Total assets = total liabilities + owners equity

 What does it tell us about a company?

The Balance Sheet: An Overview Assets

Current Assets •Cash

•Marketable Securities

•Accounts Rec.

•Inventories

•Prepaid expenses

Fixed Assets •Machinery

•Buildings

•Land

Total Fixed Assets

Other Assets •Investments

•patents

Total Assets

Liabilities (Debt) and Equity

Current Liabilities (debt) •Accounts payable

•Other Payables

•Accrued Expenses

•Short Term Notes (less than one year term)

Total Current Debt

Long Term liabilities (debt) •Long Term notes (greater than 1 year term)

•Mortgages

Equity •Preferred Stock

•Common Stock

•Par value

+ Paid in Capital

- Treasury Stock

Retained Earnings

Total Stockholders Equity

Total Debt and Equity

(Keown, 2005) Finance.yahoo.com

Don’t forget about Taxes

 3 types of business entities

 Sole proprietors – Report their income in their

personal tax returns and pays what is owed.

 Partnerships – Each partner reports individual

income and pays taxes on that.

 Corporations – Separate legal entity, reports its

income and pays any taxes related to these

profits.

Principal 8 Taxes Bias Business Decisions

Financial Ratios

 Financial Ratios – Restating the accounting data in relative terms to identify of the

financial strengths and weaknesses of a

company.

 Ratios can be used to determine the

strength of a company and also

comparison to other firms.

○ The Income Statement and the Balance Sheet

are critical information sources to complete this

analysis.

4 question Approach to financial

ratios

1. How Liquid is the firm?

2. Is management generating adequate

operating profits on the firms assets?

3. How is the firm financing its assets?

4. Are the owners (stockholders) receiving

an adequate return on their

investment?

Liquidity ratios

 Current ratio= current asset/ current liabilities

 Ratio that compares cash and the assets that should

be converted to cash within a year with debt that is

due and payable within the year. - (high ratio number is better)

 Average collection period= accounts

receivable/ (sales/365)

 How many days it takes to collect on Accounts

Receivable? - (the lower the number the better)

Liquidity Ratios

 Accounts receivable turnover=credit

sales/ accounts receivable

 How many times during the year that A/R is

“turned over” - (the higher the number the better)

 Inventory turnover=cost of goods sold/

inventory

 How many times are we turning over our

inventory over the year? - (high ratio number is better)

More Ratios

 Operating Income Return On Investment

(OIROI)= operating income/ total assets

 Are the firms profits sufficient relative to the

assets being invested?

 OIROI = Operating Profit Margin X Total

Asset Turnover

○ OPM=operating income/ sales

○ TAT = sales/ Total Assets

- (high ratio number is better)

Operating Profit Margin (OPM),

part 1

 Measures the managements effectiveness in

managing the firms income statement as

measured by operating income to sales.

 OPM = operating income / Sales

 (Total sales – COGS – General and administrative

Expenses – marketing expenses)/ Sales - (high ratio number is better)

Operating Profit Margin (OPM),

part 1 (cont.)

 (Total sales – COGS – General and administrative Expenses – marketing expenses)

Driving force behind OPM

1. Number of units sold

2. Average selling price

3. Cost of manufacturing the product

4. Controlling general and administrative expenses

5. Cost in marketing and distribution

Operating Profit Margin (OPM)

part 2

 Total Asset Turnover = Sales / Total

assets

 How efficiently is a firm using its assets in

generating sales (For every dollar of assets, how many dollars of sales do we produce)

- (high ratio number is better)

Financing Decisions

 How does the company finance its assets?

 With debt (financing the assets)

 With equity (stocks, bonds, etc)

 Debt Ratio= Total Debt / Total Assets - (lower ratio number is better) – What does it mean to have

a low/high debt ratio?

- It measures the amount of debt your company uses to

finance its assets.

▪ i.e. – Municipal bond funded projects for buildings and stadiums