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Business Arithmetic
In business, we use many different measurements to confirm our performance and to do comparisons. What follows are a series of
arithmetic calculations that are commonly used. I will be using the following Income Statement and Balance Sheet to illustrate the calculations.
Income Statement
Balance Sheet
Assets (Tools)
Sales
$
1,000,000
Liabilities (Outside Owners)
Cash
$
25,000
Accounts Payable
$ 45,000
Cost of Goods
$
550,000
Accounts Receivable
$
110,000
Payroll Payable
$ 20,000
Gross Profit
$
450,000
Inventory
$
125,000
Taxes Payable
$ 4,500
$
260,000
Total Current Assets
Less:
Selling
$
100,000
Gross Fixed Assets
$
250,000
General Expense
$
250,000
Less: Accum Deprec
$
(150,000)
Deprec Expense
$
35,000
Net Fixed Assets
$
100,000
Total Expense
$
385,000
Profit before Tax
$
65,000
Deps & Other Assets
$
Income Tax
$
26,000
Total Assets
$
Profit after Tax
$
39,000
Total Current Liabilities
$ 69,500
Bank & Other LTD
$ 75,000
Total Liabilities
$144,500
Equity (Inside Owners)
Cap Investment
$125,000
25,000
Retned Earn
$ 76,500
385,000
Current Period Earnings
$ 39,000
Total Equity
Total Liabilities and Equity
$240,500
$385,000
It is one thing to know how to do the arithmetic and another to know how to use the results. In the following Table, I will illustrate
common measurements used in business. I want you to write in the blank cells on the right hand side of the page how you think the results of the
calculation could be used to confirm performance or to compare performance between time periods or between companies. Do you think the
number values generated are “good” or “bad”? As a manager, what could you do to make them “better”? How could you use the information to
make business decisions?
If you look on the Internet you can find sites that show these same business measures. Some will even have explanations of how they are
used. Almost universally these sites merely show only definitions. If they show how to use the results it is almost always from the securities
analyst point of view, and not how a business manager would apply the information to improve the business You learn nothing by copying these
internet definitions into the blank cells. If this is what you choose to do, merely enter the URL and don’t bother copying the text from the site.
©William G. Donohoo 7/28/2014
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This is the Rosie Ruiz approach (look her up on Google). My desire is that you work out the meaning of each of these sets of calculations on your
own. Think it through. I am less worried about the correctness of the answer you derive than I am that you have to stretch your mind.
I encourage you to work through these calculations on your own. Note that values have been rounded so you will find trivial variations in
calculations as you check my work. This slight loss of precision is fine for our type of work. Generally, we are attempting to get close to the
“right” answer. All the values we work with are constantly moving so any calculation is only a close approximation.
Calculation
Results
Income Statement
(1.) Return on or % of X where X is any line entry on
the Income statement.
E.g. Profit Return on Sales = Net Profit/Sales = %
[You could use Pretax or Profit After Tax. Just use it
consistently from one period to another and from one
company to another]
This calculation can be done for every line item on the
Income Statement [I.E. line item/Sales = %]
39000/1000000
= 3.9%
If Sales and Return % are known, then Profit = Sales X
Return %
1000000 X 3.9% =
39000
If Profit and Return % are known then Sales = Profit/
Return %
39000/3.9% =
1000000
Balance Sheet
(2.) Allocation of Assets by Asset Title to Total Assets
E.g. Cash/Total Assets = %
25000/385000 = 6.5%
(3.) Allocation of (an account or account group in Total
Liabilities and Equity) to (Total Liabilities and Equity)
by Account Title = %
E.G. Current Liabilities/(Total Liabilities and Equity) =
%
69500/385000 = 18%
Equity/(Total Liabilities and Equity) = %
240500/385000 = 63%
Long Term Debt/(Total Liabilities and Equity) = %
75000/385000 =
19.5%
©William G. Donohoo 7/28/2014
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How do you think this can be used in business? Are each of the
values generated “good” or “bad”? How can they be improved?
.
.
Used to determine the percentage of the sales that is a profit to
the company. 3.9% is a bad value. It ca be made better by
decreasing the expenses and increasing the sales. It can be used
to find the sales or the profit of the company from the income
statement.
.
.
Used to determine the profitability of the assets owned by a
company. The value is quite good and can be improved by
maximizing the potential of the company’s assets.
This shows a company’s ability to service its debts. If this
value is high, then the company is able to pay off its debts. In
this case, the value is good, meaning that the company can pay
off the debtors. However, it can be improved by borrowing
less. These values can be used to determine the company’s
liabilities, debts or equity.
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Total Liabilities (both Current Liabilities and Long
Term Debt)/(Total Liabilities and Equity) = %
144500/385000 =
37.5%
Note:
1. Both Assets and Liabilities are subtotaled as
“Current” and “Fixed” or “Long Term”.
Current refers to items that turn into cash (for
example, Collecting Accounts Receivable) or
require cash (for example, paying Accounts
Payable) to be paid out in the next 12 months.
2. Total Liabilities and Equity finance the Assets.
(4.) Long Term Debt to Equity = %
75000/240500 = 31%
If Long Term Debt and Long Term Debt as a % of
Equity is known, Equity = Long Term Debt/Long Term
Debt as a % of Equity
75000/31% =240500
If Equity and Long Term Debt as a % of Equity is
known , Long Term Debt = Equity X Long Term Debt
as a % of Equity
(5.) Current Ratio = Current Assets/Current Liabilities
240500 X 31% =
75000
If Current Assets and Current Ratio is known, Current
Liabilities = Current Assets/Current Ratio
250000/3.6 = 69500
If Current Liabilities and Current Ratio is known,
Current Assets = Current Liabilities X Current Ratio
(6.) Working Capital = Current Assets – Current
Liabilities
(7.) Non-cash Working Capital = (Accounts Receivable
+ Inventory) – Current Liabilities
69500 X 3.6 = 250000
Income Statement and Balance Sheet
(8.) Working Capital Turnover = Sales/Working Capital
250000/69500 = 3.6
It is a comparison between a company’s long term debt and the
equity. The values in this case are bad. They can be improved
by reducing the borrowing. Can be used to determine the
equity and long term debt of the company.
Used to measure a company’s ability to service the liabilities.
3.6 is a good value but cab be improved by lowering the value
of the liabilities or increasing the assets.
250000 – 69500 =
190500
110000+12500069500=165000
1000000/190500 =
5.25
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.
.
This is the amount of money a company uses to run its
everyday business. The value given in this case is quite good
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If Working Capital and Working Capital Turnover are
known, Sales = Working Capital X Working Capital
Turnover
If Sales and Working Capital Turnover are known,
Working Capital = Sales/Working Capital Turnover
(9.) Asset Turnover = Sales / Assets
and can be improved by increasing the assets.
190500 X 5.25 =
1000000
1000000/5.25 =
190500
1000000/385000 = 2.6
If Sales and Asset Turnover are known, Assets =
Sales/Asset turnover
1000000/2.6 = 385000
If Assets and Asset Turnover are known, Sales = Assets
X Asset Turnover
(10.) Days Cash Usage on Hand = Cash/(Sales/365)
385000 X 2.6 =
1000000
25000/(1000000/365)
= 9.13
110000/(1000000/365)
= 40.15
(11.) (DSO) Accounts Receivable Days Outstanding =
Accounts Receivable/(Sales/365)
If Accounts Receivable and Accounts Receivable Days
Outstanding are known, Sales = Accounts
Receivable/Accounts Receivable Days Outstanding X
365
110000/40.15 X 365 =
1000000
If Sales and Accounts Receivable Days Outstanding
are known, Accounts Receivable = Sales/365 X
Accounts Receivable Days Outstanding
(12.) Inventory Turnover = Cost of Goods
Sold/Inventory
1000000/365 X 40.15
= 110000
If Inventory and Inventory Turnover are known, Cost
of Goods Sold = Inventory X Inventory Turnover
125000 X 4.4 =
550000
If Cost of Goods Sold and Inventory Turnover are
known, Inventory = Cost of Goods Sold/Inventory
Turnover
(DIO) Inventory Days on Hand = Inventory/(Cost of
550000/125000 = 4.4
550000/4.4 = 125000
110000/(550000/365)
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It is the efficiency of a company’s assets in producing sales.
Can be used to calculate the sales or assets of a company. The
value given is good but could be improved by increasing the
sales.
Estimation of the number of days a company can run with the
cash at hand currently. The value is good.
This is the number of days a company takes to get all the
account receivables. The value is bad. Can be improved by
effective correction of credits.
This is the number of days that a stock takes to be fully sold
out. The value is good but can be improved by promoting the
sales.
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Goods Sold/365)
= 73
If Inventory and Inventory Days on hand are known,
Cost of Goods Sold = Inventory/Inventory Days on
Hand X 365
110000/73 X 365 =
550000
If Cost of Goods Sold and Inventory Days on Hand are
known, Inventory = Cost of Goods Sold/365 X
Inventory Days on Hand
550000/365 X 73 =
125000
(13.) (DPO) Accounts Payable Days Outstanding =
Accounts Payable/(Cost of Goods Sold/365)
45000/(550000/365) =
29.86
If Accounts Payable and Accounts Payable Days
Outstanding are known, Cost of Goods Sold =
Accounts Payable/Accounts Payable Days Outstanding
X 365
45000/29.86 X 365 =
550000
If Sales and Accounts Payable Days Outstanding are
known, Accounts Payable = Cost of Goods Sold/365 X
Accounts Payable Days Outstanding
550000/365 X 29.86 =
45000
(14.) Return on Total Assets = Net Profit/Total Assets =
%
39000/385000 =
10.1%
If Net Profit and Return on Total Assets are known,
Total Assets = Net Profit/Return on Total Assets
39000/10.1% =385000
If Total Assets and Return on Total Assets are known,
Net Profit = Total Assets X Return on Total Assets
385000 X 10.1% =
39000
(15.) Return on Investment = Net Profit/(Long Term
Debt + Equity) = %
39000/(75000 +
240500) = 12.36%
If Net Profit and Return on Investment are known,
(Long Term Debt + Equity) = Net Profit/Return on
Investment
39000/12.36% =
315500
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Good. It is a measure of the number of days a company takes to
repay the loans. Less borrowing can assist in improving the
value.
Measure of how good the assets are returning profits to the
company. The value is good and can be improved by
investment in better assets.
It is the profits from the investments made by the company.
This value is good but can be improved by using better
methods of investment.
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Note: In performing this calculation to determine the
combined value of Long Term Debt and Equity, we
will not know the breakout between Long Term Debt
and Equity from the information given.
If (Long Term Debt + Equity) and Return on
Investment are known, Net Profit = (Long Term Debt +
Equity) X Return on Investment
315500 X 12.36% =
39000
(16.) Return on Equity = Net Profit/ Equity = %
39000/240500 =
16.2%
If Net Profit and Return on Equity are Known, Equity
= Net Profit/Return on Equity
39000/16.2% =
240500
If Equity and Return on Equity are known, Net Profit =
Equity X Return on Equity
(17.) Breakeven (in dollars) = Fixed Costs[defined
here in the Income Statement as Total Expenses]/
Gross Margin %
240500 X 16.2%
=39000
This is the return a company makes from a dollar of a
shareholder’s equity. Improvements through better investment
methods.
Good value. A point at which a business is Making no losses
nor profits. Improvement by lowering the cost of goods.
Gross Margin = Sales – Cost of Goods Sold = 1000000
– 550000 = 450000
Gross Margin % = Gross Margin/Sales =
450000/100000 = 45%
385000/45% = 856000
Measures the company’s financial capability. The values in this
case is good and can be improved by increasing sales.
(18.) (CCC) Cash Conversion Cycle = Days Inventory
on Hand + Days Accounts Receivable outstanding –
Days Payable Outstanding
Accounts Receivable Days Outstanding = Accounts
Receivable/(Sales/365)
110000/(1000000/365)
= 40.15
Inventory Days on Hand = Inventory/(Cost of Goods
Sold/365)
110000/(550000/365)
= 73
©William G. Donohoo 7/28/2014
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7
Accounts Payable Outstanding = Accounts Payable/
(Cost of Goods Sold/365)
45000/(550000/365) =
29.86
CCC = DSO + DIO - DPO
40.15+73 - 29.86 =
83.29
©William G. Donohoo 7/28/2014
This study source was downloaded by 100000873581897 from CourseHero.com on 11-19-2023 13:08:51 GMT -06:00