The Nature of Accounting
“Accounting is the identification, measurement and
communication of financial information about
economic entities to interested persons”
Kieso and Weygandt
• Arose from the need to communicate financial
information
• Financial Accounting Standards Board (FASB) is
authoritative rule making body
Finance is the Language of Business. Accounting is the Medium of
Finance.
Management Simulations, Inc.
Underlying Assumptions
Key Assumptions
• Double entry
• Timing-matching principal
• Accrual accounting
• Historical cost
• FASB Standards applied to
simulation reports.
Management Simulations, Inc.
Objectives of Financial Reporting
• Know how effectively resources are obtained
and appropriated
• Use information to inform investment and
credit decisions
• Identify optimum time to take actions affected
by cash flow
Balance
Sheet
Management Simulations, Inc.
P&L
or Income
Statement
Cash
Flow
Balance Sheet
• Identifies what the company owns and who
owns it
• Snapshot of financial health
• Assets always equal liabilities and net worth
combined
• Accurate for a specific date
Management Simulations, Inc.
Sample Capstone ® Balance Sheet
from Annual Reports
•Provides two year’s data
•Leverage = Total Assets /
Total Equity. Ideal Leverage
1.81 to 2.80 – from
shareholder’s perspective
•Lenders prefer to examine
Debt / Assets
•Managers favor Debt /
Equity
The Analyst Report on the website provides coaching
on Financial Structure
Management Simulations, Inc.
Capstone ® Balance Sheet Survey
The Capstone ®
Courier provides
each team’s Balance
Sheet summary on
Page 3
Strategic intentions
may be inferred
based on profile
Management Simulations, Inc.
Example – a team
with a large Plant &
Equipment line may
be adopting a cost
leadership, high
volume position
Profit and Loss Statement or
Income Statement
• Compares revenues and expenses for a given period
• Movie of financial health
• Shows activity over a period of time
• Indicates the profitability of an organization
Management Simulations, Inc.
Income Statement Survey from
Capstone ® Courier
• Compare your team
against competitors
• Is your variable costs
to sales comparison
above
or
below
average?
• Do
your
SG&A
expenses relative to
sales
reflect good
rates of return?
Management Simulations, Inc.
Simulation Sample Proforma
Income Statement
Your spreadsheet
program creates a
Proforma Income
Statement using your
sales forecasts
reconciled to your
tactical decisions
The projected loss for
net profit in this
example tells the
management team
there is additional
work to be done in the
Strategy section
Management Simulations, Inc.
Red number – bad,
black number - good
Cash Flow Statement
• Shows movement of cash in and out of an
organization over a given period
• Shows how much cash is available for use
during a given period
• Reconciles net profit back to cash
Management Simulations, Inc.
Sample Capstone ® Cash Flow
Statement
Management Simulations, Inc.
•
Provides two
year’s data
•
Common causes
for emergency
loans:
1)
Excessive inventory
resulting from poor
sales forecasts
2)
Making Plant &
Equip upgrades w/o
raising sufficient
capital
3)
Operating losses
Introduction to Ratios
• A financial ratio shows the relationship between
two financial measures
• Developed by dividing one measure into another
• Provide insights into company’s operations and
strategy
• Four categories: liquidity, solvency, market value,
profitability
• Used internally to evaluate performance and set
goals
• Used externally to make investment decisions
Management Simulations, Inc.
Ratios Report Sample from
Spreadsheet Proformas
Your spreadsheet
program creates a
Proforma Ratios
Report based on your
sales forecasts and
tactical decisions.
Management Simulations, Inc.
Are your decisions
maximizing the
Success Measurements
(ROE, ROS, ROA,
Stock Price, Asset
Turnover, Market
Capitalization) you
chose (or were
assigned)?
Asset Turnover
“Reveals how effective assets are at generating
sales revenue.”
sales
Asset Turnover =
Management Simulations, Inc.
assets
Return on Sales
“ROS indicates the percentage of each sales
dollar that results in net income.”
net profit
Return on Sales =
Management Simulations, Inc.
net sales
Return on Assets
“ROA measures a company’s ability to use
all its assets to generate earnings.”
net profit
Return on Assets =
Management Simulations, Inc.
assets
Leverage
“Leverage shows the debt level of the
organization.”
assets
Leverage =
Management Simulations, Inc.
equity
Return on Equity
“Return on Equity highlights for the
stockholders the return on their
investment.”
net profit
Return on Equity =
Management Simulations, Inc.
equity
Du Pont Formula
Value Chain
net profit
Return on Equity =
net profit
sales
Management Simulations, Inc.
x
sales
assets
equity
x
assets
equity
Du Pont Formula
Value Chain
net profit
Return on Equity =
net profit
sales
Management Simulations, Inc.
x
sales
assets
equity
x
assets
equity
Du Pont Formula
Value Chain
net profit
Return on Equity =
net profit
sales
Return on
Sales
Management Simulations, Inc.
x
sales
assets
Asset
Turnover
equity
x
assets
equity
Leverage
Du Pont Formula · TI vs. HP
Current Assets
Fixed Assets
Sales
Net Income
Shareholder Equity
= 1.29
= 1.11
= 4.07
= .37
= 1.16
Texas Instruments
Management Simulations, Inc.
Hewlett Packard
Du Pont Formula · TI vs. HP
Current Assets
Fixed Assets
Sales
Net Income
Shareholder Equity
= 1.29
= 1.11
= 4.07
= .37
= 1.16
Turnover x
ROS
= ROA
x Leverage
= ROE
1.69
9.3%
15.7%
2.07
32.5%
Texas Instruments
Management Simulations, Inc.
Hewlett Packard
Du Pont Formula · TI vs. HP
Current Assets
Fixed Assets
Sales
Net Income
Shareholder Equity
= 1.29
= 1.11
= 4.07
= .37
= 1.16
Turnover x
ROS
= ROA
x Leverage
= ROE
1.69
9.3%
15.7%
2.07
32.5%
Texas Instruments
Management Simulations, Inc.
Current Assets
Fixed Assets
Sales
Net Income
Shareholder Equity
= 1.49
= .84
= 3.09
= .52
= 1.54
Hewlett Packard
Du Pont Formula · TI vs. HP
Current Assets
Fixed Assets
Sales
Net Income
Shareholder Equity
= 1.29
= 1.11
= 4.07
= .37
= 1.16
Current Assets
Fixed Assets
Sales
Net Income
Shareholder Equity
= 1.49
= .84
= 3.09
= .52
= 1.54
Turnover x
ROS
= ROA
x Leverage
= ROE
1.69
9.3%
15.7%
2.07
32.5%
Turnover x
ROS
= ROA
x Leverage
= ROE
1.33
16.9%
22.4%
1.52
33.8%
Texas Instruments
Management Simulations, Inc.
Hewlett Packard