Financial Reports
LEARNING OBJECTIVES
1. Compare and contrast the fundamental objectives of a balance sheet
and an income statement.
2. Demonstrate the relationship between a balance sheet and an income
statement for a given year.
3. Describe the utility of financial ratios and interpret basic financial
ratios used in community pharmacy practice.
4. Describe and integrate the financial information depicted in a balance
sheet and an income statement in community pharmacy practice.
5. Define the flow of funds involved in community pharmacy practice,
including expenses, prescription adjudication, receipt of payment, and
revenue generation.
 Accounting is the language of business
 Accounting : “a service activity, whose function is to provide
quantitative information, primarily financial in nature, about
economic entities that is intended to be useful in making
economic decisions.”
 A major use of accounting is to track the flow of money (cash or
credit) between financing and investing activities
 Assets = owner’s equity + liabilities
ACCOUNTING PRINCIPLES
 pharmacy, just as any other type of organization, engages in
three fundamental activities:
 Obtaining financing
 Making investments
 Conducting a profitable operation
Obtaining Financing
 Financing activities to acquire assets involve obtaining funds
from
1- owners
2- creditors (i.e., banks).
 When owners fund the activities of a corporation, they
become shareholders of the corporation.
Making Investments
 In pharmacy settings, funds are invested in acquisition of
inventory, computer software and hardware, robotics,
buildings, and land.
 Acquiring the resources necessary to employ the appropriate
number of pharmacists, pharmacy technicians, and other staff
also can be viewed as an investment activity
Conducting a Profitable Operation
 Generally, the operating activities of pharmacy settings include:
 Purchasing
 Distribution (i.e., prescription-filling activities),
 Clinical activities
 Administration
 Marketing is also a significant operation activity, in that it is
required so that others can learn of the goods and services that
the pharmacy offers
THREE ESSENTIAL FINANCIAL
STATEMENTS
 The fiscal year is a unit of time—a year as the term
implies—that businesses use to record their financial
interactions.
The Balance Sheet
 Provides a snapshot of an organization’s assets, liabilities, and
shareholder equity at any particular point in time
 Balance sheet’s total assets must equal the total liabilities plus
shareholders’ equity at all times.
 It does not reveal much about what caused these values to
change over the course of the year
 does not tell us how income was generated and what types of
expenses during the accounting period.
The Income Statement
 Income statement is a dynamic document that provides
information about money coming into an organization
(income) and money necessary to obtain that income
(expenses).
 The difference between income and expenses is commonly
referred to as net income
The Statement of Cash Flows
 Throughout the fiscal year, the inflows and outflows of cash
are recorded in the statement of cash flows
 These recorded values generally fall into three categories:
1. Operating
2. Investing
3. Financing
FINANCIAL RATIOS
 Organizations, investors, creditors, and even individuals use
financial ratios to examine an organization’s financial
performance.
 Financial ratio is a financial analysis comparison in which
certain financial statement items are divided by one another
to reveal their logical interrelationships.
 Data are taken from the balance sheet and income statement
for calculating most ratios.
 They should not be used in isolation from other financial
reports
 In general, financial ratios allow users of financial
information to make comparisons between:
 A single organization and the entire industry average
 Differences within an organization over time (e.g., months,
quarters, years)
 Two or more units with a single organization (e.g.,
pharmacies within the same chain)
 Two or more organizations with each other (e.g.,
comparisons between chain pharmacy corporations)
Financial ratio analysis is only as valid as the financial
information on which it is based.
Profitability Ratios
 Profitability ratios provide a method to measure the overall
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financial success of a company
The most commonly used profitability ratios are the gross profit
margin and the net profit margin.
Gross profit margin = (sales − cost of goods sold) ÷ total sales
this ratio provides information on the company’s ability to
generate gross profits
Higher gross profit margin ratios are desirable because they
indicate the availability of funds for the company’s other
expenses
 Net profit margin = net income (after taxes) ÷ total sales
 Net profit margin indicates the fraction of net profit that is
generated for every riyal of sales
 Return on assets (ROA) = net income ÷ average total assets
 provides information on the company’s ability to generate profits
using the company’s assets
 profits can only be generated from the company’s assets.
Therefore, effective use of assets results in a high ROA ratio
 Return on equity (ROE) = net income ÷ average owner’s equity
 Return on equity, also known as return on investment (ROI), is a
measure of how well the company can make profits from funds
provided by owners or investors
 High ROE levels are desirable because investors— similar to
companies—are interested in maximizing their profits
 Managers who make better financial decisions are better able to
produce higher ROA and ROE ratios for their organizations.
Liquidity Ratios
 Provide information on the business’s ability to meet its
short-term financial obligations
 The current ratio is the ratio of current assets to current liabilities.
 Current ratio = current assets ÷ current liabilities
 An organization with a high current ratio is taking fewer risks
in meeting its financial obligation
 High values greater than 5 This might be a sign of a
company that is too conservative, leaving too much of its
money in the bank rather than investing it in ways that could
help the organization grow (e.g., building new pharmacies or
expanding existing services).
 A low current ratio (<2.0) indicates that the organization has
low current assets (especially cash) relative to its current
liabilities (often bills that are due in 30 to 60 days).
 quick ratio
 quick assets are defined as assets that are easily converted to cash
 it provides a better picture of a company’s liquidity and its ability to
meet its financial obligations.
 Quick ratio = (current assets − inventories − prepaid expenses) ÷
current liabilities
 The standard quick ratio that any organization strives to obtain is at
least 1.0 less means not enough money to pay obligations
Turnover Ratios
 Turnover ratios measure the efficiency with which an organization uses its
assets
 Inventory turnover ratio = cost of goods sold ÷ average inventory
(at cost)
 The inventory turnover ratio measures how quickly, on average, an
organization’s inventories are sold
 Low inventory turnover ratios (6.0 or below) indicate that the
organization’s inventory is too large for its operations and that cash
that could be better spent elsewhere is tied up in inventory
 High inventory turnover ratios are generally desirable
because this means that the organization was able to sell and
replace its inventory with high efficiency and therefore
generate higher revenues and profits
 Receivables turnover ratio = credit sales ÷ average accounts
receivable
 This ratio measures how quickly receivables (money owed to
the organization by others) are turned into cash
Quiz
 What are the three types of financial statements .
 Definition of 'Equity '
1. A stock or any other security representing an ownership interest.
2. On a company's balance sheet, the amount of the funds contributed
3.
4.
5.
by the owners (the stockholders) plus the retained earnings (or
losses). Also referred to as "shareholders' equity".
In the context of margin trading, the value of securities in a margin
account minus what has been borrowed from the brokerage.
In the context of real estate, the difference between the current
market value of the property and the amount the owner still owes on
the mortgage. It is the amount that the owner would receive after
selling a property and paying off the mortgage.
In terms of investment strategies, equity (stocks) is one of the
principal asset classes. The other two are fixed-income (bonds) and
cash/cash-equivalents. These are used in asset allocation planning to
structure a desired risk and return profile for an investor's portfolio.
 Definition of 'Liability‘ A company's legal debts or
obligations that arise during the course of business
operations. Liabilities are settled over time through the
transfer of economic benefits including money, goods or
services.
 Definition of 'Asset'
1. A resource with economic value that an individual,
corporation or country owns or controls with the
expectation that it will provide future benefit.
2. A balance sheet item representing what a firm owns.
 Definition of 'Return On Assets - ROA'
An indicator of how profitable a company is relative to its total
assets. ROA gives an idea as to how efficient management is
at using its assets to generate earnings. Calculated by dividing
a company's annual earnings by its total assets, ROA is
displayed as a percentage. Sometimes this is referred to as
"return on investment”
Note: Some investors add interest expense back into net
income when performing this calculation because they'd like
to use operating returns before cost of borrowing.
 ROA tells you what earnings were generated from invested capital (assets).
ROA for public companies can vary substantially and will be highly dependent
on the industry. This is why when using ROA as a comparative measure, it is
best to compare it against a company's previous ROA numbers or the ROA of a
similar company.
The assets of the company are comprised of both debt and equity. Both of these
types of financing are used to fund the operations of the company. The ROA
figure gives investors an idea of how effectively the company is converting the
money it has to invest into net income. The higher the ROA number, the better,
because the company is earning more money on less investment. For example,
if one company has a net income of $1 million and total assets of $5 million, its
ROA is 20%; however, if another company earns the same amount but has total
assets of $10 million, it has an ROA of 10%. Based on this example, the first
company is better at converting its investment into profit. When you really
think about it, management's most important job is to make wise choices in
allocating its resources. Anybody can make a profit by throwing a ton of money
at a problem, but very few managers excel at making large profits with little
investment.
 http://www.investopedia.com/video/play/return-on-assets/