The first slides are about trade
unions
• It is possible that there is a question in Paper 1
in October about trade unions
Who represents employees?
• A trade union (also known as a labour union
in the UK) – an organization that works to
protect the rights of the workers
• Idea is ¨strength in numbers¨ and also it s
cheaper and quicker for one person, one small
group to represent the many workers in the
union
Trade Unions
• Members pay dues ($) – goes towards legal
fees
Trade Unions
What do they want to get for their workers?
•
•
•
•
•
Higher pay
Better working conditions
Better benefits
Better training
Better equipment
Working Captial and CF
• Liquidity – how easily an asset can be
converted to cash (taking into consideration
speed and if some of its value will be lost in
the conversion)
• iIlliqud assets are things such as your building
or raw materials
Importance of Liquidity
• Insufficient working capital is the single
biggest cause of business failure (MORE THAN
LOW PROFITABILITY)
• PHRASE FROM THE USA
BUSINESS WORLD ¨CASH IS KING¨ ……
Other Point - Should have sufficient
liquidity, but not too much
• It is not the most efficient use of current
assets to have too much of them, why?
• Because they can earn a higher rate of return
being put in investments or to expand the
business
Importance of Liquidity
• A lack of working capital can lead to insolvency
(meaning that working capital is not sufficient to
meet current liabilities – money owed to others,
they are called creditors)
• This can lead to voluntary or compulsary closure
of a business, and a liquidation of the company
(SELLS ITS ASSETS IN ORDER TO TRY TO PAY AS
MUCH OF THE MONEY IT CAN OF WHAT IT OWES)
Measure of Liquidity – Current Ratio
• The ratio compares the current assets with the
value of current liabilities
Current Ratio
• Example: Current assets are $3 million and
Current Liabilities are $2 million, then the
current ratio is 1.5 to 1
•
$3 million/$2 million = 1.5
• If the ratio is below 1.0, then the company has
a liquidity problem and may not be able to
meet its short term liabilities
Review of the Working Capital
Cycle and Starting Cash Flow
• Working capital refers to the money that is
available for the daily operation of the business
(revenue expenditures, USA - called operating
costs), opposite is capital expenditures, like a
building or big Catepillar bulldozer
• Working capital is also known as net current
assets and is calculated the following:
Working Capital = Current Assets – Current Liabilities
Working Capital
• Assets are items owned or owed to a
company that have a monetary value, like a
building it owns, all its machinery, its logo (of
its brands), its inventory
Working Capital Cycle
Current Assets are the resources (or assets)
held by a business that will be used in the next
12 months …..
Current Assets = Liquid Assets
Examples of Current Assets
• Cash can either be held at bank or in your
hand (your wallet or in the cash register or
safe a business (like a bank has)
• Should use cash efficiently (cash you do not
need for the WC cycle, put into investments to
earn more money)
Current Assets
• Other Current Assets:
• Investments (held in a safe for instance in a
bank or placed in a bank account)
• Debtors (USA – accounts receivable)
• Stocks (USA – inventory)
Review - Current Assets
• Debtors – money owed to the business by customers for
goods purchased on credit, MOST WHOLESALE
TRANSACTIONS ARE ON CREDIT…
• ….FOR EXAMPLE WHEN SABMiller (WHICH SUPPLIES
BRAHMA BEER TO Wong) SELLS THE BEER TO THE
SUPERMARKET CHAIN, IT WOULD BE ON CREDIT, NOT
PAID FOR WITH CASH)
• Stocks (inventory) – all the unsold products, but include
raw materials, semi-finished goods, and finished goods
• Finished goods are liquid but the other two are not
Current Liabilities
• Current Liabilities refer to the money
that a company needs to repay to
others in the next 12 months, some
examples are:
Current Liabilities
• Accounts Payable = trade credit = creditors,
the financing of your purchase of raw
materials or anything else you will later sell
Current Liabilities
• Overdrafts – from banks, very short term
loans, with higher interest rates
• Or Taxes due, interest due, rent due, etc….
Current Assets and Current
Liabilities
• Quiz yourself:
SABMiller has a __________(?), the money
owed to it by Censosud, so it has a debtor
or account receivable
Censosud has a _____________(?), the
money it owes SAB Miller, so it has a
creditor (account payable)
Putting together Current Assets and Current
Liabilities….the Working Capital Cycle
• THE TIME BETWEEN THE CASH PAYMENTS FOR
THE COSTS OF PRODUCTION AND RECEIVING
MONEY FROM THE CUSTOMERS THAT BUY
YOUR PRODUCTS
Cash
Production Costs
Sales
Cash
---A company must manage the cycle well to
make sure it can complete the circle
Why is WC important?
• Working Capital is essential for all parts of a
company
• HR – you have to have sufficient WC to pay your
employees or they will lose their trust in the
company, lose motivation immediately!
• Marketing – This can only be funded if their is
adequate CF. Sometimes companies use some of
their cash cows to finance advertising of other,
less profitable segments of the company
Another Practice Exercise
What is the working capital?
Accounts Receivable $4,000
Cash $70,000
Inventory $50,000
Overdrafts $25,000
Accounts Payable $30,000
Taxes owed $3,000
Answer
$124,000 - $58,000 = $66,000
Forecasting Cash Flows
Important Point - there is a difference
between profit and cash
• The profit of a company is sales
(revenues) minus costs..
• …..but the cash is the net of
cash inflows and cash
outflows = net cash flow
Cash and Profit are Different
Things
• SO….
IT IS POSSIBLE TO BE PROFITABLE BUT CASH
DEFICIENT AND ITS ALSO POSSIBLE TO BE
UNPROFITABLE BUT HAVE A LOT OF CASH
Forecasting Cash Flows
• Vs. Cash Flow Forecasts – A cash flow
statement is a historical statement that shows
the actual cash inflows and outflows of a
company over a 12 month period
• A Cash Flow Forecast is an internal company
document that shows the expected cash
inflows and outflows over a period of time
Cash Flow Forecasts
• Cash Flow Forecasts have:
• Cash inflows (receipts) – mainly from the
money you get from customers when they pay
for your product, but also from things like:
debtor pays you, receipt of interest payments,
sell your building, sell a subsidiary, win a
lawsuit against another company, etc…
Cash Outflows
• Cash outflows can be from other sources too,
like paying off accounts payable, long term
debts, interest, or advertising
expenses)….called payments and expenses
Net Cash Flow
• Is the difference between
cash inflows and cash
outflows
Reasons for Cash Flow Forecasts
• Banks and other lenders require cash flow
forecasts to make decisions on a loan
• CF forecasts can help managers to anticipate
and identify periods of potential cash
difficulties – and may adjust the timing of cash
inflows or cash outflows as a result
Cash Flow Forecasts
• CF forecasts help the planning process, and
can be compared with actual results to plan
better in the future
Constructing CF Forecasts
Month of July
Opening Balance
5,000
Inflows
Cash sales revenues
Other income
Total Cash Inflows
6,000
0
6,000
Constructing Cash Flows
Outflows
Stocks
Labor Costs
Other costs
Total Cash Outflows
2,500
3,500
2,000
8,000
Net Cash Flow
(2,000)
Closing Balance
3,000
Complete Cash Flow Forecast
Opening Balance
5,000
Inflows
Cash sales revenues
Other income
6,000
0
Total Cash Inflows
6,000
Outflows
Stocks
Labor Costs
Other costs
Total Cash Outflows
2,500
3,500
2,000
8,000
Net Cash Flow
(2,000)
Closing Balance
3,000
Constructing Cash Flows
Practice -
January
Cash sales
2,000
Stock purchases
600
Rent
1,000
Other costs
600
Opening Cash Balance 1,000
Net Cash Flow
?
Closing Cash Balance
?
February
2,000
60
0
600
?
800
1,600
Constructing Cash Flows
Practice Cash sales
Stock purchases
Rent
Other costs
Opening Cash Balance
Net Cash Flow
Closing Cash Balance
January
2,000
600
1,000
600
1,000
(200)
800
February
2,000
60
0
600
800
800
1,600
Causes of Cash Flow Problems
• Growing too fast - a company attempts to
expand too quickly
• Overborrowing – Companies that are highly
geared (USA term = highly leveraged) have
high interest payments and possibly principal
payments too
Causes of Cash Flow Problems
• Overstocking – Buy too much stocks
(inventories)
• Poor Credit Control – Too many customers are
buying on credit, or the credit terms are not
strict enough, or customers are not paying in
time
Causes of Cash Flow Problems
• Unforseen Changes - unexpected changes in
demand (specific to the company or due to
the economy) or a machinery breakdown
lengthens the working capital cycle
Management of Cash Flow and
Working Capital
• Dealing with Cash flow problems:
1. Seeking Alternative Forms of Finance
(example, overdrafts)
2. Improving Cash Inflows (example, fewer days
for ARs)
3. Reducing Cash Outflows (example, fire a
redundant worker)
Other Alternative Forms of Finance
• Overdrafts
• Sale and Leaseback
• Selling off Fixed Assets
• Debt factoring
• Government Assistance
• Growth strategies or Equity Infusion
Dealing With CF Problems
Improving cash inflows…
• Tighter Credit Control (remember, this is how
you are managing your debtors)
• Cash Payments Only (from customers, don´t
even allow debtors!)
• Or find a way to increase sales…..examples?
Dealing With
Liquidity Problems
• Change Pricing Policy (to get rid of excess
inventory) – works for price elastic products
• Improved Marketing Planning – for example,
through market research a company can
improve its sales
Dealing With
Liquidity Problems
Final Way to Deal with them – Reducing cash
outflows
• Seek Preferential Credit Terms
• Seek Alternative Suppliers – raw materials at
lower prices from different source
• Cut revenue expenditures – fire a redundant
worker
Other ways
• Better Stock Control – Have raw materials
ordered just before they are needed
• To repeat! Reduce Expenses! – examples are
Airlines that stopped providing snacks or
meals on many flights, or eliminating many
unecessary perks for Senior Executives
Dealing With
CF/WC/Liquidity Problems
• In the real world, companies use a
combination of all three methods to deal with
liquidity problems
Alternative Approach to Liquidity
Problems
• Minimize the risks (being proactive)
• Wider consumer base (spreading the risks)
• Send out demands for part-payments
• Establish systems for large due amounts to be
paid in installments
• Ensuring that quality management systems
are in place (for example, deliveries)
Limitations of Cash Flow Forecasting
• Marketing – Inaccurate or poor market research
• Human Resources – Unproductive workforce?
• Operations Management – Machinery failure? Airbus
break-even point for Airbus production went up 70%
because of production delays
• Competitors – Aggressive marketing by competiton (or
superior products) can destroy your sales forecasts
Limitations of Cash Flow Forecasting
• Changing fashions and tastes – Causes changes in
demand, some products will not sell, others may
become unexpectedly popluar, etc..
• Economic changes – What stage in the economic cycle
are we in? Consumer confidence is extremely
important for consumer purchases Did we get an
exogenous shock that threw us into a recession
unexpectedly?
• External shocks - Did we get an exogenous shock that
threw us into a recession unexpectedly?
Reminder: Profit vs. Cash flow
• Be aware of the trade offs between managing
profitability and cash flow, sometimes they
are at conflict
• Example – offering credit to low end
customers
More tips about Cash Flow
Bank Interest
• If you start building your cash balance, then
your money in the bank will start to pay you
interest, helping your cash flow - virtuous
circle
Bank Overdrafts
• Try to avoid this kind of short term financing,
it costs the company (high interest rates)
which hurts the cash flow - vicious circle
Reducing Expenses
• Remember, any reduction in expenses is the
most direct and best way to help cash flow
• For example, having less workers, or paying
them less, or re-negotiating your rent
agreement, or renting less space to save on
rent expense!
Management of Stocks (inventories)
• Do not buy more stocks than you need for
your production, and do not pay cash for
them, buy them on credit (using your
accounts payable)
Taxes Owed
• You have to pay these amounts to the
government
• But you can do it in payments (installments),
you do not have to pay it all at once.
• By paying in installments you are delaying
cash outflows, helping cash flow…..
Starting Cash Balance
• If you are starting a business and you start
with too little cash you may be setting
yourself up for failure in case in takes some
time to build up cash flow…..
• Have enough capital to get you through the
start up phase !
Something to Watch Out For –
stop spending on inventory!
• A company´s sales start to decline, but it is still
spending the same amount on stocks! This
creates a cash flow problem
• This will lead to high cash outflow for
payments and high accounts payable account
that needs to be paid later
New Chapter -Accounting
Fundamentals
• All companies must keep a
record of their finances,
including who owns
everything (BS), how much
was made or lost (IS), where
the money went (CF)….etc…
Financial statements
• A set of financial accounts consist of three statements
• INCOME STATEMENT (how much money made or
lost)
• BALANCE SHEET (snapshot in time, assets liabilities
and equity)
• CASH FLOW STATEMENT ( where are you getting
cash from and what are you spending it on) vs.
FORECAST, which we already learned about)
Financial Statements Paint a Picture
• And it is up to Financial Analysts, Investors,
Shareholders to analyze them to see what
they mean
• Remember, that trends are more important
to look at than just one month or one
year……
Financial Accounts, why have
them?
• Companies must produce final accounts as an
obligation (legal and owners)
• They are also vital for strategic planning
Imagine a company without them…
Management Accounting vs. Financial
Accounting
• Management accounting is internal and
confidential, it is what you will focus on if you
are hired as an accountant in a company
• The rest of us focus on Financial Accounting
(we are analyzing the final accounts that the
company produced)
So who looks at Financial statements
• Shareholders
• Employees
• Managers
• Competitors
Who looks at Financial statements?
• Government
• Financiers
• Potential investors
Companies want them to look good
• As the book states, there is pressure on the
company to make them look good……for
almost all of the aforementioned groups
• Term from book – profit quality
• Later we will talk about ¨window dressing¨
Start with Income Statement
• Top (1st) part of the income statement
• Sales = Revenues = Sales revenues = money
received from customers for goods or services
sold
• Gross Profit is the difference between the
sales revenue and the cost of sales
Gross Profit
• Top (1st) part of the profit and loss account
• Sales = Revenues = Sales revenues = money
received from customers for goods or services
sold
• Gross Profit is the difference between the
sales revenue and the cost of sales
Gross Profit
• Gross Profit = sales revenue – Cost of goods
sold (COGS) = cost of sales
Sales revenue $50,000
COGS
($45,000)
Gross Profit
$5,000
Cost of sales calculation
• Opening stock + purchases – closing stock
(book) $1,000 + $2,000 - $1,800 = $1,200 COGS
If sales were $3,600, then gross profit = $2,400
or
$5,000 + $2,000 - $4,000 = $3,000 COGS
If sales were $10,000, then gross profit = $7,000
Calculate the gross profit – for a
distributor of cocoa beans
• Beginning inventory: $10,000 (of cocoa
beans)
• Purchases of cocoa beans: $33,000
• Ending inventory: $13,000
• Sales: $50,000
answer
• 10k + 33k – 13k = 30,000 (Cost of goods sold)
Sales 50,000
COGS (30,000)
GP
20,000
GROSS PROFIT MARGIN
Gross margin divided by sales
20,000
50,000
=
40%
How to improve GP margin
• Use cheaper suppliers
• Increase selling price
• Marketing strategies
• NOTE to AS Students- If they cut
salaries, or lower rent, etc..those are
NOT to do with GP….they are revenue
expenditures (operating costs)….which
we see next
Now, the full income statement
• Operating profit =
gross profit – revenue expeditures (operating
expenses)
• Examples of revenue expenditures:
administrative expenses… utility bills, interest
on bank loans, rent, repairs, supplies,
marketing expenses, all salaries and bonuses,
transportation and distribution costs, etc…
To summarize
• GP minus (-) expenses = operating profit
• A company can try to increase operating profit
by lowering expenses or from non-operating
income
• for example, higher bank interest expense, or
renting out one of their properties, or
dividends received from investments……
So, after operating profit is…..
• Profit before taxes – taxes are then deducted
to get Net Profit
Taxes
Taxes – what you owe to the government
--Usually it is converted to a liability on the
Balance Sheet (unless you pay it all
immediately)
Last Part of the Income Statement
• Final part is the Appropriation Account
• Shows how the net profit was distributed
It has two parts Dividends, and Retained
Profit
Sample Income statement with the appropriation account
Sales revenues
Cost of Sales
Gross Profit
$400,000
($200,000)
$200,000
Less: Operating Expenses
Operating Profit
($160,000)
$40,000
Plus non-operating income
Profit before interest and taxes
$5,000
$45,000
Interest Expense
Profit before taxes
$1,500
$43,500
Taxes
Net Profit
($3,500)
$40,000
Dividends paid
Ending Retained Profit
$ 2,000
$ 72,000
Gross Profit Margin 50%
Net Profit margin 10%
(beginning retained profit was $70,000)
Practice / calculate GP, GP margin operating profit and net
income, net income margin and ending retained profits
•
•
•
•
•
•
•
•
Beginning inventory $80,000
Purchases of stock $55,000
Ending inventory balance $10,000
Sales $160,000
Wages $12,000
Rent $4,000
Interest $4,000
Taxes $2,000 Non-operating income $2,500
•
Dividends $1,000
Beginning retained profit $345,000
Answer to 1st Practice
• In student notes
Practice Question 2 – 2011 and 2012 Income Statements
•
Sales for 2011 were $35,000 per month for Jan to April,
and $45,000 per month for May to December. Total sales increased 20% in 2012
•
Gross margin is 70% for the whole year 2011. In 2012 COGS is 40%
•
Operating expenses are 17% of total sales in 2011, but 22% of total sales in 2012
•
There is $15,000 of non-operating income i 2011, and interest expense is $5,000 in
2011, but in 2012, there is $1,000 of non-operating income, and $14,000 of interest
expense
•
Tax rate is 25%, pay taxes on the amount of income before taxes , both years
•
Dividends paid to shareholders in 2011: $3,000, in 2012 , are 0
•
The retained profit balance at 12/31/10 was $100,000 (appropriation account!)
Analysis: What kind of story can you tell about this story for what happened in 2012
based on the results you see?
Income statement assessment
•
Sales for 2011 were $450,000. Total sales decreased 23% in 2012
•
Gross margin is 60% for the whole year 2011. In 2012 Cost of sales is 55%
•
Operating expenses are 17% of total sales in 2011, but 29% of total sales in 2012
•
There is $13,000 of non-operating income in 2011, and interest expense is $5,000 in 2011, but in 2012,
there is $1,000 of non-operating income, and $14,000 of interest expense
•
Tax rate is 35%, pay taxes on the amount of income before taxes , both years
•
Dividends paid to shareholders in 2011: $3,000, in 2012 , are $1,000
•
The retained profit balance at 12/31/10 was $100,000 (appropriation account)
•
Analyze what happened in 2012 based on the results you see, mention any ratios or increases or
decreases from one year to the next
Income Statement Practice
2011
2012
Sales
Cost of Sales___________________________________ __ ____________ _
Gross Profit
GP Margin
%
%
Less: Operating Expenses __________________________ _______________
Operating Profit
Plus non-operating income__________________________ ______________
Profit before interest and taxes
Interest expense___________________________________ _______________
Earnings before taxes
Taxes ____________________________________________ _______________
Net Profit
Net profit margin
%
%
Appropriation Account
Beginning Retained Profits
+Net Income
- Dividends paid
= Ending Retained Profit
Do you pay taxes now?
Profit before Interest and Taxes $100,000
Less (minus) Taxation
$15,000
Profit after tax
$85,000
And on the Balance Sheet:
Current Liabilities:
Taxes Payable
$15,000
Appropriation Account
• Dividends – is the amount of the net profit
that is distributed back to the owners of the
business (shareholders if it is a public
company)
• The amount is converted to a liability on the
balance sheet in current liabilties as dividends
payable
Appropriation Account - Continued
• Retained profit – this is what is left
from net profit after interest and tax,
and after you have deducted the
dividends.
• It is the money that the company
will keep, and add to the balance
sheet as added capital
Appropriation Account
So, the following IN GREEN will be seen in the
the Consolidated Statement of Shareowners’
Equity
Net Profit after interest and tax $100,000
Minus dividends
$5,000
= an amount that is left over….to go to retained profit
Appropriation Account
Retained Profit as of 12/31/10
Retained profit for the year ended 12/31/11
New retained profit balance
$,5,500,000
$100,000
$5,600,000
Appropriation Account
The company has a reconciliation account for
shareholder´s equity and it would show up
there
It is called the Consolidated Statement of
Shareowners’ Equity. (THIS WILL NOT BE A
PART OF THE COURSE).
One other item in the Income
statement
• Sometimes we see exceptional items (in USA
callled extraordinary gain or loss)
• They are not expected to repeat, so they are
put at the very bottom of the profit and loss
account (to reflect that they are not a regular
part of the operations of the company)
Example, exceptional item
Net profit after interest and tax
Exceptional item – loss of building in hurricane
Net profit and loss
$500,000
$145,000
$355,000
Finishing thoughts on the income
statement
• It shows historical performance
• There is no guarantee that this will be the
performance in the future (that is the job of
Analysts and investors to analyze what may
happen in the future)
Finishing thoughts on the Income
Statement
• Window dressing – legal manipulation of the
P&L account or balance sheet to make it look
better at year end
• Example: selling fixed assets on December
5th, and you receive the money December
30th,so that you show a large cash balance on
December 31 (and show higher working
capital and higher current ratio)
Balance Sheet
• A ¨SNAPSHOT IN TIME¨ that shows everything
the company owns (its assets) and who it
owes (its liabilities), and who owns the assets
(equity, or capital).
Assets
• Assets are items owned by a business or owed
to a business which hold a monetary value
• Assets are either current or fixed
Types of Assets
• Tangible fixed assets - physical assets such as
equipment, machinery, property (land and
buildings), trucks, etc..
• Tangible fixed assets will depreciate over time
(THEY WILL LOSE THEIR VALUE AS THEY GET
OLDER)
Types of Assets
• Intangible Fixed Assets – non-physical fixed
assets such as brand names, trademarks,
copyrights, and patents, and also goodwill
• Many times have very high value, but it is
difficult process how to value them……
More on intangible assets
• Patents – form of legal protection for inventors for a limited time, usually
20 years. So that company has exclusive rights to produce the product for
that period, making its investment pay off
(Example, compact discs were patented by Philips)
• Copyrights – legal protection to original artistic work (Example, you want
to copy a Black Eyed Peas song, get permission from them first)
• Goodwill - value of an organization´s image, reputation, or its customer
base, or even its employees´ loyalty to the company from having treated
them well over the years.
• Registered Trademarks – distinctive signs that uniquely identifty a brand,
Coca Cola brand image, the Nike swoosh, etc…
• Intellectual property - a term that often describes all of the above
Coca Cola´s Intangible Assets – but it is
hard to measure these!
Value and their percent of Coca Cola´s total assets
IN BILLIONS OF $US DOLLARS
Value of Assets
Goodwill
$ 12,219
Bottlers’ franchise rights with indefinite lives
$ 7,770
Trademarks with indefinite lives
$ 6,430
Definite-lived intangible assets, net
$1,137
Other intangible assets not subject to amortization $113
Total $ 27,669
Pct (%)
15%
10%
8%
1%
less than 1%
35%
When is the only time we can really
put a dollar value on goodwill?
When there is a takeover (merger) and the cost
of buying the target company (one being
purchased) includes an extra amount ABOVE
the value of its assets………that extra amount
is the goodwill being paid….
More Types of Assets
• Investments – medium to long term financial
investments that the company holds, they can
be debentures (debt of other company or
government) or shares in a company
• Can be held because they are profitable or as
part of a joint venture, etc…
Total Assets
= current assets + long term assets
Liabilities
• A liability is a legal obligation of a business to
repay its lenders or suppliers = debts
• For review! -- Current Liabilities are debts
due within the next 12 months (as we learned
in 3.3)
Liabilities
• Long term liabilities are debts that can be paid
after 12 months.
• Examples include debentures (issued by the
company), bank loans or mortgages
Equity
• This section, which appears at the bottom of
the balance sheet, shows the ownership of
the company
• It is broken down into sub-sections
Equity
• Shareholder´s Equity – is the amount of
money raised through the sale of shares
+
• Retained Earnings (the profit the company
has kept in the company)
Retained Profits
• Retained Profits – What is left over from the
profit after interest and tax and dividends –
this money is REINVESTED IN THE COMPANY,
and adds to Equity
Simple Balance Sheet
Cash
15
AR
25
Inventory 40
AP
10 yr. Bank loan
Building
Total Assets
20
100
Equity
Tot Liab´s + Equity
15
35
50
100
Total Assets = Total Liabilities + Equity
Note!
• USA puts current assets first
• UK (AS/CIE) put fixed assets first
• Important to know the US accounting
(method), it is more universal
• For now, use US format
Use of Balance Sheets
• We can analyze working capital
• Asset structure (an increase in fixed assets may
indicate they are expanding)
• Capital structure (leveraged or not leveraged,
etc..), and
• Total assets (giving an idea of its size)
Limitations of Balance Sheets
• A balance sheet can change quickly
• Book value, which is what we mostly see on
balance sheets for assets, can be very
different than the true or market value of an
asset
• No detailed breakdown of the assets
Limitations of Balance Sheets
• Intangible assets…..they are not really reflected
• Manchester United, a PLC, how can goodwill
reflect the real value of each of the players
(businessweek.com)
• Any company that says that its people are its
most valuable asset might be having their
balance sheet undervalue the company´s true
value
One more ratio before Balance
Sheet Practice
• Acid Test Ratio (also called Quick Ratio)
• Same as current ratio, but do not include
inventory (stocks) because sometimes they
are not so easy to sell
Acid ratio tells you how liquid the company is,
only considering very liquid assets
Review
Liquidity Ratios
Current Ratio, Acid Test Ratio
Profitability Ratios
Gross Margin, Net Profit margin
Balance Sheet Practice
Now, Practice - Create a balance sheet, also
calculate the current ratio and acid test ratio
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Chevrolet 4 x 4 Trucks $121,000
Accounts Payable $35,000
Cash $15,000
Warehouse $664,000
Overdrafts $4,000
20-year loan $100,000
Retained Earnings $203,000
Capital from issuance of shares $330,000
Accounts Receivable $54,000
11-month Investment in CD $12,000
Inventory (stocks) $130,000
Taxes payable $11,000
Interest payable $13,000
Final Practice, Balance Sheet – Inka Food Supply
Company
Create a balance sheet, also calculate the current ratio and acid test ratio
Capital from issuance of shares $212,000
Overdrafts $2,000
Warehouse $15,000
Administration building $124,000
Creditors $44,000
Cash $15,000
6-month loan $4,000
Inka Food Supply 5% debentures, due 2032 $100,000
Holdings of 20-year Chilean Government Bonds $142,000
Retained Earnings $88,000
Debtors $57,000
Stocks $110,000
Interest payable $15,000
Short term investments $2,000
Answer Key – Inka Food Supply B/S
Current Assets
Cash
15,000
Short term investments 2,000
Debtors
57,000
Stocks
110,00
Total Current Assets 184,000
Current Liabilities
Creditors
Interest Payable
Overdrafts
Six-month loan
Total Current Liabilities
44,000
15,000
2,000
4,000
65,000
Fixed (Long-Term Assets)
Warehouse
15,000
Administration building
124,000
20-year Chilean Bonds
142,000
Total Long-term Assets
281,000
Long-Term Liabilities
20-year debentures
Total Long-Term Liabilties
$100,000
$100,000
Shareholder´s Equity
Capital Stock issued
Retained Earnings
Total Shareholder´s Equity
212,000
88,000
300,000
TOTAL LIABILITIES AND SHAREHOLDER´s EQUITY
$465,000
TOTAL ASSETS
Current Ratio
Acid Test Ratio
$465,000
2.83
1.13
The company has good liquidity as evidenced by the almost 3x current ratio and Acid test ratio above 1x
Fedex example
• Non-operating income – gambling?
• If it is true, founder Smith had only $5,000 left
and flew to Las Vegas and turned it into
$32,000 and kept the company running long
enough to get an $11 million investment
IBM´s capital structure
• http://quicktake.morningstar.com/stocknet/b
onds.aspx?symbol=ibm