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Business Policy


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Business Policy

  1. 1. Business Policy & Strategy Chapter 8 Accounting and Finance Murdick, Moor, Babson & Tomlinson Sixth Edition, 2000
  2. 2. Financial Analysis For Nonfinanciers <ul><li>Who are Nonfinanciers? </li></ul><ul><ul><li>The large group of businesspeople who say, “I had some accounting and finance courses in school, but never liked them.” </li></ul></ul><ul><ul><li>business people who know something about the subject but want to learn more. </li></ul></ul>
  3. 3. Why Bother to Learn Financial Analysis <ul><li>It is one of the most important tools for analyzing the health of a business firm in its entirety or the subdivisions of the firm. </li></ul><ul><ul><li>It points out symptoms that help to pinpoint a problem within a firm. </li></ul></ul>
  4. 4. Just How Good Is Financial Analysis? <ul><li>Financial analysis is used as a beginning point in firm investigations by bankers, professional investors, and securities analysts. </li></ul><ul><ul><li>Study financial statements, trend analysis, and ratio comparisons to the appropriate industry. </li></ul></ul>
  5. 5. <ul><li>Advantages </li></ul><ul><ul><li>trends do persists </li></ul></ul><ul><ul><li>points up symptoms of basic problems that need to be improved </li></ul></ul><ul><ul><li>it is a quantitative appraisal </li></ul></ul><ul><ul><li>can help firms raise needed funds </li></ul></ul><ul><ul><li>figures are more precise than words and can often help the manager pinpoint exactly where problems lie. </li></ul></ul>Just How Good Is Financial Analysis?
  6. 6. <ul><li>Limitations </li></ul><ul><ul><li>accountants tend to focus on the past </li></ul></ul><ul><ul><li>financial trends may or may not portend the future </li></ul></ul><ul><ul><li>wide fluctuations in figures keep ratios from being useful or meaningful </li></ul></ul><ul><ul><li>accounting data represent what the accountants believe, or interpret as true </li></ul></ul><ul><ul><li>financial analysis is only mastered by few. </li></ul></ul>Just How Good Is Financial Analysis?
  7. 7. Major Sources of Financial Information <ul><li>General Sources </li></ul><ul><ul><li>Moody’s Manual </li></ul></ul><ul><ul><li>Standard & Poor’s Manuals and Surveys </li></ul></ul><ul><ul><li>Major brokerage houses </li></ul></ul><ul><ul><ul><li>i.e.. Merrill Lynch, Morgan Stanley Dean Witter </li></ul></ul></ul><ul><ul><li>Annual reports sent to stockholders - 10k – read the FINE print, boring but useful </li></ul></ul>
  8. 8. Major Sources of Financial Information <ul><li>Additional General Sources </li></ul><ul><ul><li>Trade Associations </li></ul></ul><ul><ul><ul><li>i.e.. National Retail Merchants Association </li></ul></ul></ul><ul><ul><li>Publications by Federal government agencies </li></ul></ul><ul><ul><ul><li>Current Industrial Reports, Statistical Abstract </li></ul></ul></ul><ul><ul><li>Internet </li></ul></ul>
  9. 9. Major Sources of Financial Information <ul><li>Ratio Reports </li></ul><ul><ul><li>Robert Morris Associates and Dun & Bradstreet </li></ul></ul><ul><ul><ul><li>supply industrywide ratios for manufacturing, wholesaling, and retailing firms </li></ul></ul></ul><ul><ul><li>Almanac of Business and Industrial Ratios </li></ul></ul><ul><ul><li>Annual Statement Studies </li></ul></ul>
  10. 10. Ratio Comparisons <ul><li>Be sure to use the appropriate industry category </li></ul><ul><li>Industry comparisons must be used with restraint </li></ul><ul><li>Why industry figures are used to compare companies? </li></ul><ul><ul><li>Relatively easy to get and can be used as a benchmark to give added meaning to the company being analyzed. </li></ul></ul>
  11. 11. How can Accounting help people in business make decisions? <ul><li>Accounting helps by answering five basic questions: </li></ul><ul><ul><li>How is the enterprise doing? </li></ul></ul><ul><ul><li>Which alternative plan is most attractive? </li></ul></ul><ul><ul><li>What is going wrong with the business and how do you remedy it? </li></ul></ul><ul><ul><li>How can all activities be coordinated? </li></ul></ul><ul><ul><li>How well does the firm deal with the environment? </li></ul></ul>
  12. 12. How the enterprise is doing <ul><li>Financial accounting provides reports on: </li></ul><ul><ul><li>Profit </li></ul></ul><ul><ul><li>ROI (return on investment) </li></ul></ul><ul><ul><li>Growth of assets and equity </li></ul></ul><ul><ul><li>Market Share/ growth of market share </li></ul></ul><ul><ul><li>Debt levels, turnover ratios </li></ul></ul>
  13. 13. Choosing the most attractive alternative plan: <ul><li>Accounting provides managers with enough information to choose between alternatives </li></ul><ul><li>Accounting focuses on past events which helps managers predict the future of the business </li></ul><ul><li>This enables managers to choose the best alternative for the company </li></ul>
  14. 14. Coordinating Activities: <ul><li>Information that is needed to coordinate activities can be transmitted with accounting procedures </li></ul><ul><li>Provides reports for managerial appraisal of results </li></ul><ul><li>Enables predictions to be made for the consequences of proposed plans </li></ul>
  15. 15. How well the firm deals with its environment: <ul><li>Accounting information is essential for effective management dealings with the environment </li></ul><ul><li>For example, </li></ul><ul><ul><li>Internal Revenue Services </li></ul></ul><ul><ul><li>SEC </li></ul></ul><ul><ul><li>FCPA (Multinational firms) </li></ul></ul>
  16. 16. How to start an Analysis? <ul><li>Every business activity is derived from the combination of the sales forecast and the business plan </li></ul><ul><li>To analyze a business’ trends it is best to start with the five most recent years </li></ul><ul><li>Information found in certain ratios will tell you what state your business is in. </li></ul><ul><ul><li>(information found in: balance sheet and profit-and-loss statements, statement of cash flows also) </li></ul></ul>
  17. 17. Key Information of the Profit-and Loss Statement <ul><li>What is the Profit-and-Loss statement? </li></ul><ul><ul><li>A financial summary of the operations of a company by sales, costs, expenses, income, etc. for a specific period of time. </li></ul></ul><ul><li>From the Profit-and-Loss statement you can figure out the profit percentage on sales for each of the past years. </li></ul><ul><li>Enables a company to compare the trends in profits (or losses) </li></ul>
  18. 18. Ratios <ul><li>Profitability Ratios </li></ul><ul><ul><li>Measures the total effectiveness of a company’s management in generating profits </li></ul></ul><ul><li>Liquidity Ratios </li></ul><ul><ul><li>Indicate a firm’s ability to meet short-term financial obligations (current and quick ratios) </li></ul></ul><ul><li>Financial Leverage Management Ratios </li></ul><ul><ul><li>Measure the degree to which a firm is financing its assets with fixed-charge sources of funds such as debt, preferred stock, or leases </li></ul></ul><ul><li>Asset Management Ratios (Turnover) </li></ul><ul><ul><li>Indicate how efficiently a firm is utilizing its assets to generate sales </li></ul></ul>
  19. 19. Profitability Ratios <ul><li>Net profit margin </li></ul><ul><ul><li>NPAT/ Sales </li></ul></ul><ul><ul><li>- Shaft it was 5.53% profit earned per dollar of sales </li></ul></ul><ul><li>Net profit per share of common stock </li></ul><ul><li>Net profit to net worth (ROI) </li></ul><ul><li>-measure of business relative to other opportunities for investing money </li></ul><ul><li>Net profit before taxes may be more useful sometimes </li></ul>
  20. 20. Liquidity Ratios <ul><li>Quick Ratio (acid test) </li></ul><ul><ul><ul><li>Current assets – Inventories / Current Liabilities </li></ul></ul></ul><ul><ul><li>Degree of assurance a company can offer its creditors </li></ul></ul><ul><li>Current Ratio </li></ul><ul><ul><ul><ul><li>Current Assets / Current Liabilities </li></ul></ul></ul></ul><ul><ul><li>Shaft example: </li></ul></ul><ul><ul><ul><ul><ul><li>$169,400/ $11,400 = 15.4 </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>$1.00/ 15.4 = .0649 </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Convert each $1 of assets to .07 cents to cover their debt </li></ul></ul></ul></ul></ul><ul><ul><li>To what extent CA cover your CL </li></ul></ul>
  21. 21. Liquidity Ratios <ul><li>Fixed assets to net worth </li></ul><ul><ul><li>Portion of Net Worth covered by assets </li></ul></ul><ul><ul><li>Preferably a low number </li></ul></ul><ul><li>Funded debt to net working capital </li></ul><ul><li>Current liabilities to net worth </li></ul><ul><li>Current liabilities to Inventory </li></ul><ul><li>Total Liabilities to net worth </li></ul>
  22. 22. Leverage Ratios <ul><li>Current debt to net worth </li></ul><ul><li>Total debt to net worth </li></ul><ul><ul><li>These two ratios indicate the proportion of total debt and current debt to the equity of the owners </li></ul></ul><ul><ul><li>amount of equity required to finance the company’s debt </li></ul></ul><ul><ul><li>It it’s too high, additional funds will be hard to raise </li></ul></ul>
  23. 23. Asset Management Ratios (Turnover) <ul><li>Accounts Receivable – money owed to firm A/R </li></ul><ul><ul><ul><li>Accounts Receivable/Credit Sales/365 </li></ul></ul></ul><ul><ul><li>Quality of receivables of a company </li></ul></ul><ul><li>Bad Debts – percent written off, age the A/R </li></ul><ul><li>Net sales/ net worth </li></ul><ul><li>Assets to Sales </li></ul><ul><ul><li>Total investment needed to generate sales </li></ul></ul><ul><li>Net Sales to Inventory </li></ul><ul><ul><li>Good to compare this result with other industries </li></ul></ul><ul><ul><li>Inventory maintenance can be costly </li></ul></ul>
  24. 24. Breakeven Analysis Total Revenue = Total Costs Total Costs = Fixed Costs + Variable Costs Consider Economies of Scale
  25. 25. How Breakeven is helpful… <ul><li>Whether or not to add SALES or ADVERTISING expense in order to INCREASE VOLUME </li></ul><ul><li>Merits of DECREASING PRICES to increase VOLUME </li></ul><ul><li>How advisable is it to borrow capital improvements needed to INCREASE CAPACITY </li></ul><ul><li>Whether to AUTOMATE PRODUCTION -or- OFFICE WORK </li></ul>
  26. 26. Depreciation and Valuation of Inventories <ul><li>Direct deduction from profits </li></ul><ul><ul><li>Rapid Depreciation vs. Slower depreciation </li></ul></ul><ul><li>Valuating inventories can overstate and understate your inventories which affects the taxes the firm pays </li></ul><ul><ul><li>LIFO vs. FIFO </li></ul></ul><ul><ul><li>LIFO may deflate the firm’s reported earnings, but it also reduces the firm’s income taxes </li></ul></ul>
  27. 27. LIFO and FIFO <ul><li>FIFO – first inventory to arrive, is the first inventory to be sold. </li></ul><ul><li>LIFO – last inventory in is the first out to be sold. </li></ul><ul><li>A high valuation on year end inventories (which may be less than book value) will reduce the cost of goods sold, which increases profits (and taxes paid). </li></ul>
  28. 28. Problems Encountered on the Income Statement <ul><li>Poor sales trend </li></ul><ul><li>Bad products </li></ul><ul><li>High prices </li></ul><ul><li>Production problems </li></ul><ul><ul><li>Develop better products </li></ul></ul><ul><ul><li>Find the problem areas in production and fix them </li></ul></ul>
  29. 29. <ul><li>High number of returned goods </li></ul><ul><ul><ul><ul><li>Poor quality </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Product does not meet the consumers expectations </li></ul></ul></ul></ul><ul><li>Increasing trend of COGS percentage </li></ul><ul><ul><ul><ul><li>Retailers might be charging too much </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Set up pricing standards </li></ul></ul></ul></ul></ul>
  30. 30. <ul><li>Material Cost Increasing </li></ul><ul><ul><li>Waste in the production process </li></ul></ul><ul><ul><li>Price of material increasing </li></ul></ul><ul><ul><li>Transportation prices increasing </li></ul></ul><ul><li>Increasing percentage of direct labor </li></ul><ul><ul><li>Wages are increasing without increasing productivity </li></ul></ul><ul><ul><li>Poor labor market </li></ul></ul>
  31. 31. <ul><li>Increasing Sales Expense </li></ul><ul><ul><li>Sales management problems </li></ul></ul><ul><ul><li>High advertising cost </li></ul></ul><ul><ul><li>Increased warehouse or shipping expense </li></ul></ul><ul><li>Increasing inventory percentage to sales turnover </li></ul><ul><ul><li>Poor marketing policy </li></ul></ul><ul><ul><li>Poor manufacturing-marketing coordination </li></ul></ul><ul><ul><li>Poor manufacturing policy </li></ul></ul>