ROI/ROA: Net Profit/Avg Total Assets – Higher ratio
higher returns
Return on Sales: Net Income/ Net Sales
Debt Ratio: Liabilities/Assets – Higher ratio higher
risk
Profit Margin: Net Profit/Net Sales- Higher ratio
more future growth
Gross Margin: Gross Profit/Net Sales
Operating Profit Margin: Operating income/Net
Sales
AR Turnover = Net Sales/Avg AR – How many times
a year they convert AR into cash
Avg Collection Period: 365/AR Turnover – How
many days it takes to convert AR into cash
Inventory Turnover: COGS/Avg Inventory
Days’ Sales in Inventory: 365/Inventory Turnover –
How many days it takes to convert inventory into
cash/AR
Operating Cycle: Days’ Sales + Avg Collection
Period – How long it takes from buying Inv to
collecting cash
Day’s purchases in AP: 365/(Purchases/Avg AP) –
Avg time between purchases of Inv and cash
payment
Purchases = End Inv – Beg Inv + COGS
Excess temp capital = No of days purchases – Op
cycle
Current Ratio: Current Assets/ Current Liabilities –
Higher ratio higher liquidity
Acid Test Ratio: Quick Assets/Current Liabilities –
Quick Assets = cash +ST investment +AR (Without
Inv, prepaids)
Fixed Asset Turnover: Net Sales/Avg Fixed Assets –
Avg Fixed Assets = (Beg PPE – Final PPE) / 2
(Total) Asset Turnover: Net Sales/Avg Total Assets –
Measures ability to use total assets to generate
sales
EPS: (Net Profit – Preferred Dividends)/(Weighted
average Ordinary Shares Outstanding) – Measures
profitability per each ordinary share
P/E ratio: Market price per share/ EPS – What the
market is willing to pay for the company’s earning
stream
Dividend Payout Ratio: Cash Dividends/Net Income
– Percentage of NI paid out in the form of
dividends
Dividend Yield: Annual Div per share/ Price per
share – Amount of Div paid as compared to share
price of stock
ROE: (Net Income – Preferred Div)/Avg Ordinary
Shareholder’s Equity) or NI/Avg Equity
Times Interest Earned: EBIT/Interest Expense –
Indicates how many times its able to pay its
interest with its income before interest and tax
Cash Flow to Net Income: Cash Flow from
Operations/ Net Income
Cash Flow Adequacy: Cash Flow from
Operations/Cash paid for PPE
DuPont Analysis (ROE)= Profitability x Efficiency x
Leverage = Return on Sales x Asset turnover x
Assets to Equity Ratio
Profitability= Ability to generate net income per
sale
Efficiency= Ability to generate sales using assets
Leverage= Using borrowed funds instead of
invested
Financial accounting information helps investors
and creditors evaluate amount, timing, and
uncertainty of enterprise’s future cash flows
Quality of decision usefulness: Relevance
(predictive, confirmatory, materiality) and Faithful
representation(completeness, neutrality, free from
error), asses trends and crossref
Materiality: If information is significant, it is
material
Enhancing Characteristics:
Comparability (similar for diff companies)
Verifiability (diff measures obtain similar results)
Timeliness: quarterly financial reports
Understandability/ consistency
Assumptions: economic entity, monetary unit,
going concern, periodicity, accrual basis
Principles: measurement (historical cost v fair
value), revenue recognition, expense recognition
(matching principle), full disclosure
Closing entries (RE’s normal balance is credit):
Temporary accounts: revenue, expense, dividends,
gain and loss accounts
Debit balances are credited to RE, credit balances
are debited to RE
Liquidity: Meet short-term cash obligations
Current Assets/ Current Liabilities
Solvency: the ability to pay its debts
Total Liabilities/ Total Assets
Current Assets: Cash, Short-term investments,
Receivables, Inventories, Prepaid Expenses
Current Liabilities: Acc Payable, Unearned
Revenue, Liabilities due within the year
Higher Leverage(Solvency) Higher ROE
Income Statement
Pros: Help users evaluate past performance,
provides basis to predict future performance, help
users assess risk of achieving future CFs
Cons: Firms omit items they cannot measure
reliably, involves judgement and human error
Selling and administrative expenses: Salaries,
utility, depreciation.
Other Income and expense: Asset write-offs,
gains/loss from disposal, litigation settlement,
impairment, restructuring, Revenues unrelated to
the main business such as rent revenue, dividend
revenue, and interest revenue.
Discontinued Operations: Reported net of tax.
EPS = (NI–preferred DD)/weighted avg of OOS
Comprehensive Income: All changes in equity
during a period (e.g. revenues and gains, expenses
and losses in NI & gains and losses that affect
equity) except those resulting from investments by
owners and distributions to owners.
OCI: unrealised gains/losses on non-trading equity
security; translation gains/losses on foreign
currency
Gross margin = Gross Profit/ Sales
Five-Step Process for Revenue Recognition
1.Identify the contract with the customer:
Agreement between two or more parties that
creates enforceable rights or obligations
Criteria: Commercial substance, parties approved,
rights are established, collection is probable
2. Identify the separate performance obligations:
Count the number of distinct and independent
obligations. If you can buy separately: Independent
3. Determine the transaction price: Use fair value
4. Allocate transaction price
5. Recognize revenue when PO is satisfied: Over a
period of time if: the customer receives and
consumes the benefits as the seller performs,
Customer controls the asset, the company does
not have an alternative use for the asset.
Sales Discount from past experience: Recognize
revenue after discount, if no discount: Cr Sales
Discount Forfeited
Sales Returns and Allowance:
Record returns: Dr Sales Returns and Allowance Cr
Acc Receivable, Dr Returned Inventory Cr COGS.
Record Expected Sales Returns: Dr Sales Returns
and Allowance Cr Refund Liabilities, Dr Estimated
Inventory Returns Cr COGS
Long Term Contracts:
Usually a single PO
Spanning several reporting periods, Seller bill
purchaser at interval
Revenue Estimation Methods:
Percentage of Completion:
+amortisation of intangibles
+ Increase in liabilities
- decrease in accrued expense
Contract asset: when seller provides G&S on
account, has the right to consideration
from customer
Contract liability: seller’s obligation to transfer
G&S since consideration already received from
customers (i.e. unearned revenue)
CIP: an inventory account used to accumulate
costs as incurred in project (i.e., material, labor,
and overhead), plus any recognized gross profit; 
contract asset
Billings on Construction: A contra-asset account to
accumulate billings sent to clients for periodic
“progress payment”  contract liability
Journal Entries
1. Construction in Progress: Dr CIP Cr Cash,
Material, Labour
2. Billings: Dr Acc Rec Cr Billings on Construction
3. Revenue Recognition: Dr CIP(Gross Profit) Dr
Cost of Construction Cr Revenue from LT contract
Cost Recovery Method: When reasonable
estimate revenue: Cost = Revenue, current period
profit = 0, recognize revenue at completion
Journal Entry:
Dr Cost of Construction, Cr Revenue from LT C
Statement of Cash Flows
To provide information about cash receipts and
cash disbursements during a period
-To complement the Income Statement and
Balance Sheet
-Information about cash flows from operating
activities, when combined with information about
cash flows from other activities, can provide
information helpful in assessing future profitability,
liquidity, and long-term solvency
Free Cash Flow =
+CF from Operating Activities
+ Interest Expense
- CAPAX(Capital expenditure)
- Dividends paid
Net cash flow from operating activities is
determined by eliminating noncash expenses and
noncash revenues from net income.
Financing:
- Dividends paid
+ increase in bond/note payable
Balance Sheet
Income Statement
Historical Cost
Change in accounting
methods
Use estimates
Management
discretion: fraud
Values omitted
Values Omitted
Expenses: Decreases in economic benefits during
the accounting period in the form of
- outflows or depletions of assets or
- incurrence of liabilities
Common Reasons for Discontinued Operations:
- Closure of Redundant Division Post-Merger
- Cutting Off Unprofitable Division
- Discontinuation of Product/Service with Limited
Market Demand
- Fire Sale for Liquidity (i.e. Urgent Need for Cash)
- Mismatch of Business Division with Core
Operations
Change in contract terms while it is ongoing:
-Companies determine whether a new contract
(and performance obligations) results or
whether it is a modification of the existing
contract.
-Account for as a new contract if:
Promised goods or services are distinct, and
The company has the right to receive an amount of
consideration that reflects the standalone selling
price of the promised goods or services.
Companies provide a range of disclosures:
-Disaggregation of revenue.
-Reconciliation of contract balances.
-Remaining performance obligations.
-Cost to obtain or fulfil contracts.
Other qualitative disclosures:
Significant judgments and changes in them.
Minimum revenue not subject to variable
consideration constraint.
ASSURANCE WARRANTY: Straight away revenue
When incur cost for assurance warranty, debit to
expense
Payables causes an increase in liabilities and a
decrease in expense thus it decreases income
statement but there is no cash outflow yet so we
have to increase CFO
Only affects Operating Cash Flows, so only
Operating Cash Flows section looks different, but
that too will result in same number in cash flow
from operations
Indirect method provides more direct links to I/S