Financial analysis.docx

Unit 704:
Finance for Managers
(Managerial Accounting)
Facilitated By :
Dr. Ahmed Abdullah
SCM & Business Process Management Manager : Samsung Electronics
Ex. Finance A. Manager : Al-Muhaidib Group , KSA
Certified by Samsung as a Global Master Trainer
Business Support : KSA , South Korea , Russia , UAE , Vietnam
CSCP & SCM MBA , AASTMT

Economic
activities
Accounting
“links” decision
makers with
economic
activities  and
with the results of
their decisions.
Actions
(decisions)
Decision makers
The accounting
process
A
i
ccounting
nformation

Information System
Performance
evaluations
Stock
investments
Tax strategies
Labor relations
Resource
allocations
Lending
decisions
Borrowing
Decisions
Supported
Cash flows
Financial
position
Profitability
Financial
Information
Provided
Investors
Creditors
Managers
Owners
Customers
Employees
Information
Users

Types of Accounting
•Preparation
•Analysis
•Auditing
•Regulatory
•Consulting
•Planning
•Criminal
investigatio
n
Financial
•General accounting
•Cost accounting
•Budgeting
•Internal auditing
•Consulting
•Controller
•Treasurer
•Strategy
Managerial
•Preparation
•Planning
•Regulatory
•Investigations
•Consulting
•Enforcement
•Legal services
•Estate plans
Taxation
1-4

Managerial Vs Financial
Accounting

 Interpret and
record business
transactions.
 Classify similar
transactions into
useful reports.
 Summarize and
communicate
information to
decision makers.
Basic Functions of an Accounting System

Importance of Accounting
Accounting
is a
system that
information
that is
to help users make
better decisions.
1-7
Records
Reliable
Comparable
Communicates
Relevant
Identifies

1-8
Relevant
Information
Affects the decision of
its users.
Reliable Information Is trusted by
users.
Comparable
Information
Used in comparisons
across years & companies.
Generally Accepted Accounting
Principles
Financial accounting practice is governed by
concepts and rules known as generally accepted
accounting principles (GAAP).

Role of Financial Information
• Financial information pervades our economy
– It is the primary means of communication between profit seeking
organizations and their stakeholders
– For this reason organizations use financial measures internally as a broad
indicator of performance
• This financial information provides a signal that something is wrong, but
not what is wrong
• Financial information summarizes underlying activities
– But to explain financial results, managers need to dig deeper
– Detailed information provides additional insight into what is happening to
profits
1-9
 2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed.,

1-10
Users of Financial Information
External Users
•Lenders •Consumer Group
•Shareholders •ExternalAuditors
•Governments •Customers
Internal Users
s •Managers •Sales Staff
•Officers •Budget Officers
•Internal Auditors •Controllers

1-11
Users of Financial Information
External Users
Financial accounting provides
external users with financial
statements.
Internal Users
Managerial accounting provides
information needs for internal
decision makers.

Principles of Accounting
Objectivity Principle
Accounting information is
supported by independent,
unbiased evidence.
Going-Concern Principle
Reflects assumption that the
business will continue operating
instead of being closed or sold.
Future
Now
Cost Principle
Accounting information is
based on actual cost.

Monetary Unit Principle
Express transactions and events in
monetary, or money, units.
Revenue Recognition Principle
1. Recognize revenue when it is
earned.
2. Proceeds need not be in cash.
3. Measure revenue by cash
received plus cash value of items
received.
Business Entity Principle
A business is accounted for
separately from other business
entities, including its owner.

Going-concern means that
accounting information reflects a
presumption the business will
continue operating.
Business entity means that a
business is accounted for
separately from its owner or other
business entities.
Cost principle means that
accounting information is based
on actual cost.
Revenue recognition principle
provides guidance on when a
company must recognize
revenue.
Monetary unit means we can
express transactions in money.
Matching Principle prescribes that
a company must record its
expenses incurred to generate the
revenue.
1-14
Full disclosure principle requires a company to report the details behind
financial statements that would impact users’ decisions.

1-15
Business Entity Forms
Sole
Proprietorship
Partnership Corporation

1-16
Accounting Equation
Assets
Liabilities
& Equity
= + Equity
Liabilities
Assets

Assets
Accounts
Receivable
Vehicles
Cash
Notes
Receivable
Land
Store
Supplies
Equipment
Buildings
Resource
s owned
or
controlled
by a
company

1-18
Accounts
Payable
Creditors’
claims on
assets
Notes
Payable
Taxes
Payable
Wages
Payable
Liabilities

1-19
Contributed
Capital
Owner’s
claim on
assets
Equity
Retained
Earnings
Dividends

Assets = Liabilities + Equity
Liabilities
Expanded Accounting Equation
_ Dividends
+ Revenues
_
Retained Earnings
= +
1-20
Expenses
Common
Stock
Equity
Assets

Accounting and Financial statements
WHAT IS ACCOUNTING AND FINANCIAL STATEMENTS?
WHAT ARE TYPES OF FINANCIAL STATEMENTS?
Copyright © 2016 by McGraw-Hill Global Education LLC. All rights reserved.

Accounting and Financial Statements
• Financial statements arewritten
records that convey the business
activities and
the financial performance of a
company.
• Financial statements include
Balance sheet. Incomestatement.
Cash flow statement.
• income statement,
• statement of financial position,
• statement of change in equity,
• statement of cash flow,
• Noted (disclosure) tofinancial
statements.
•A balance sheet is a financial
statement that reports a
company's assets, liabilities and
shareholders' equity.
• Assets,
• liabilities,
• equity,
• revenue
• expenses.
What is a Balance Sheet
Types of accounts
What is accounting
and financial
statements?
What are the
major types of
financial
statements?

2-23
Balance Sheet
•The balance sheet is a snapshot of the firm’s assets and liabilities at a given point intime
•Assets = Liabilities + Stockholders’ Equity
•A number of ratios can be derived from the balance sheet, helping investors get a senseof
how healthy a company is.
•These include the debt-to-equity ratio and the acid-test ratio, along with manyothers
Balance Sheet formula
Definition of balance sheet
Rations

2-24
Example: U.S. Corporation Balance Sheet

2-25
Example: Balance sheet for Klingon
Corporation

2-26
Income Statement
An income statement or profit and loss account is one of the financial statements of a company and shows the
company's revenues and expenses during a particular period.
Income statement indicates how the revenues are transformed into the net income or net profit.
An income statement is one of the three (along with balance sheet and statement of cash flows) major financial
statements that reports a company's financial performance over a specific accounting period.
Net Income = (Total Revenue + Gains) – (Total Expenses + Losses)
Total revenue is the sum of both operating and non-operating revenues while total expenses include those incurred by
primary and secondary activities.
Revenues are not receipts. Revenue is earned and reported on the income statement. Receipts (cash received or paid
out) are not.
An income statement provides valuable insights into a company’s operations, the efficiency of its management, under-
performing sectors and its performance relative to industry peers.

2-27
Corporation Income Statement

What is the difference between Accounting income and cash flow
• Accounting income = revenue - expenses
• Cash flow represents cash in and cash out
• Net cash = Cash inflow –Cash outflow
• A cash flow statement shows the exact amount of a company's cash inflows and outflows over a period
of time.
• The income statement (accounting financial statement) is the most common financial statement and
shows a company's revenues and total expenses, including noncash accounting, such as depreciation
over a period of time
Cash flow
Accounting income
The difference between accounting income and cash flow

How to determine a firm’s cash flow from its financial statements
• Use the cash flow statement and balance sheet to obtain cash flow from
operations by adding net income, depreciation and amortization together
with income from other sources or charges, then subtract the net increasein
working capital (current assets minus current liabilities).
• Free Cash Flow = Net income + Depreciation/Amortization – (Change in
Working Capital – Capital Expenditure).
• Operating Cash Flow = Operating Income + Depreciation – Taxes + Changein
Working Capital.
• Cash Flow Forecast = Beginning Cash + Projected Inflows – ProjectedOutflows
= Ending Cash
Cash flow formula
Calculating Cash Flow from the Income Statement

4-30
© 2012 Pearson Prentice Hall. All rightsreserved.
Depreciation
• Depreciation is the portion of the costs of fixed assets
charged against annual revenues over time.
• Depreciation for tax purposes is determined by using the
modified accelerated cost recovery system (MACRS).
• On the other hand, a variety of other depreciation methods
are often used for reporting purposes.

4-31
Baker Corporation acquired a new machine at a cost of
$38,000, with installation costs of $2,000. When the
machine is retired from service, Baker expects that it will
sell it for scrap metal and receive $1,000.
What is the depreciable value of the machine?
– Regardless of its expected salvage value, the depreciable value
of the machine is $40,000: $38,000 cost + $2,000 installation
cost.
Depreciation: An Example

4-32
• Under the basic MACRS procedures, the depreciable
value of an asset is its full cost, including outlays for
installation.
• No adjustment is required for expected salvage value.
• For tax purposes, the depreciable life of an asset is
determined by its MACRS recovery predetermined
period.
• MACRS property classes and rates are shown in
Table 4.1 on the following slides.
Depreciation: Depreciable
Value and Depreciable Life

4-33
Table 4.1 First Four Property
Classes under MACRS

Financial Analysis / Ratios Calculation
Sources and uses of cash and the Statement of Cash Flows
How to compute and interpret important financial ratios
Be able to compute and interpret the DuPont Identity
Understand the problems and pitfalls in financial statement analysis

Why Evaluate Financial Statements?
• Performance evaluation –compensation
and comparison between divisions
• Planning for the future – guide in
estimating future cash flow
• Creditors
• Suppliers
• Customers
• Stockholders
Internal uses
External uses
Evaluation of the statement of cash flows
helps in understanding the impact of the
firm's liquidity position from itsoperations,
investments and financial activities over
the period—in essence, where funds came
from, where they went, and how the
overall liquidity of the firm wasaffected.

Financial Ratios purposes
Financial
ratios are
grouped
into the
following
categories:
• Liquidity
ratios
• Leverage
ratios
• Efficiency
ratios
• Profitability
ratios
• Market value
ratios
Track company performance
• Determining individual financial ratios per
period and tracking the change in their values
over time is done to spot trends that may be
Ma
d
ke
evc
eo
lo
m
pp
in
a
g
ra
in
tiv
ae
co
ju
m
dp
gm
an
e
yn
. ts regarding
company performance
• Comparing financial ratios with that of major
competitors is done to identify whether a
company is performing better or worse than
the industry average.

Statement of Cash Flows
A cash flow statement is a
financial statement that summarizes
the amount
of cash and cash equivalents entering
and leaving a company.
The main components of the cash flow
statement are cash from operating
activities, cash from investing
activities, and cash from financing
activities

Developing the Statement of
Cash Flows
4-38
• The statement of cash flows summarizes the firm’s cash
flow over a given period of time.
• Firm’s cash flows fall into three categories:
– Operating flows: cash flows directly related to sale and
production of the firm’s products and services.
– Investment flows: cash flows associated with purchase and sale
of both fixed assets and equity investments in other firms.
– Financing flows: cash flows that result from debt and equity
financing transactions; include incurrence and repayment of
debt, cash inflow from the sale of stock, and cash outflows to
repurchase stock or pay cash dividends.
© 2012 Pearson Prentice Hall. All rights reserved.

How do you determine sources and uses of
cash
• existing cash on the balance sheet,
revolver, new debt issuances, new equity
issuances.
• purchasing the target's equity, repaying
the target's debt or refinancing the
target's debt, as well as the financingand
transaction expenses.
Uses of cash include:
Sources of cash include:
Sources of cash are things that
yield cash and uses of cash drain
the cash balance.
Assets are typically
liabilities are uses of cash as they
turn into an expense down the line
either paying accrued expenses or
long-term liabilities.

Inflows and Outflows of Cash
4-40
© 2012 Pearson Prentice Hall. All rights reserved.

How to compute and interpret important financial ratios
Financial ratios are created with the use of numerical values taken
from financial statements to gain meaningful information about a
company
By understanding what each key financial ratio is assessing, we can
more easily derive the ratios with a quick look at the financial
statements.
A ratio takes one number and divides it into another number to
determine a decimal that can later be converted to a percentage>
The numbers found on a company’s financial statements – balance
sheet, income statement, and cash flow statement – are used to
perform quantitative analysis and assess a company’s liquidity,
leverage, growth, margins, profitability, rates of return

Liquidity ratios
Financial ratios that measure a company’s ability to repay both short- and long-
term obligations.
The current ratio measures a company’s
ability to pay off short-term liabilities with
current assets
Current ratio = Current assets /
Current liabilities
The acid-test ratio measures a company’s
quick assets
Acid-test ratio = Current assets –
Inventories / Current liabilities
The cash ratio measures a company’s
cash and cash equivalents
Cash ratio = Cash and Cash
equivalents / Current Liabilities
The operating cash flow ratio is a measure
of the number of times a company can pay
off current liabilities with the cash
generated in a given period:

Operating cash flow ratio = Operating
cash flow / Current liabilities

Example of acid test ratio
• Company A: ($95,125 – $5,412) /
($75,231 – $45,232) = 2.99
• Company B: ($102,343 – $6,454) /
($85,010 – $34,142) = 1.89
• Company C: ($152,342 – $10,343) /
($95,010 – $53,434) = 3.42
Acid Test Ratio:

Computing Liquidity Ratios
Current Ratio = CA / CL 2,256 / 1,995 = 1.13 times
Quick Ratio = (CA – Inventory) / CL (2,256 – 301) / 1,995 = .98
times
Cash Ratio = Cash / CL 696 / 1,995 = .35 times
NWC to Total Assets = NWC / TA (2,256 – 1,995) / 5,394 = .05
Interval Measure = CA / average daily
operating cost
2,256 / ((2,006 + 1,740)/365)
= 219.8 days

Leverage Financial Ratios
Leverage ratios measure the amount of capital that comes from debt.
The debt ratio measures the relative amount of
a company’s assets that are provided from debt Debt ratio = Total liabilities / Total
assets
The debt to equity ratio calculates the
weight of total debt and financial liabilities
against shareholders’ equity:
Debt to equity ratio = Total
liabilities / Shareholder’s equity
The interest coverage ratio shows how
easily a company can pay its interest
expenses
Interest coverage ratio = Operating
income / Interest expenses
The debt service coverage ratio
reveals how easily a company can pay
its debt obligations:
Debt service coverage ratio =
Operating income / Total debt
service

Efficiency Ratios
Efficiency ratios, also known as activity financial ratios, are used to measure how well a company is utilizing its
assets and resources.
The asset turnover ratio measures a
company’s ability to generate sales from
assets:
Asset turnover ratio = Net sales / Average
total assets
The inventory turnover ratio measures
how many times a company’s inventory
is sold and replaced over a given period:
Inventory turnover ratio = Cost of goods
sold / Average inventory
The accounts receivable turnover ratio
measures how many times a company
can turn receivables into cash over a
given period:
The days sales in inventory
ratio measures the average number of
days that a company holds on to
inventory before selling it to customers:

Receivables turnover ratio = Net
credit sales / Average accounts
receivable
Days sales in inventory ratio = 365 days /
Inventory turnover ratio

Profitability Ratios
Profitability ratios measure a company’s ability to generate income relative to revenue, balance sheet assets,
operating costs, and equity.
The gross margin ratio compares the gross profit of a
company to its net sales to show how much profit a
company makes after paying its cost of goods sold:
Gross margin ratio = Gross profit / Net
sales
The operating margin ratio compares the operating
income of a company to its net sales to determine
operating efficiency:
Operating margin ratio = Operating
income / Net sales
The return on assets ratio measures how efficiently a
company is using its assets to generate profit: Return on assets ratio = Net income /
Total assets
The return on equity ratio measures how efficiently
a company is using its equity to generate profit: Return on equity ratio = Net income /
Shareholder’s equity

Market Value Ratios
Market value ratios are used to evaluate the share price of a company’s stock. Common market
value ratios include the following:
The book value per share ratio
calculates the per-share value of a
company based on the equity
Book value per share ratio =
(Shareholder’s equity – Preferred equity)
/ Total common shares outstanding
available to shareholders:
The dividend yield ratio measures the
amount of dividends attributed to
shareholders relative to the market
Dividend yield ratio = Dividend per share
/ Share price
value per share:
The earnings per share ratio measures
the amount of net income earned for
each share outstanding:
Earnings per share ratio = Net earnings /
Total shares outstanding
The price-earnings ratio compares a company’s share price to its earnings per

share: Price-earnings ratio = Share price /
Earnings per share

Benchmarking
• Used to see how the firm’sperformance
is changing through time
• Internal and external uses
• Compare to similar companies
or within industries
• SIC and NAICS codes
3-49
Time-Trend Analysis
Peer Group Analysis
Ratios are not very
helpful by
themselves; they
need to be compared
to something

Capital Budgeting Techniques
CAPITAL BUDGETING TECHNIQUES / METHODS
Payback period
Non discount methods
Accounting rate of return method ( ROI
).
Discounted method includes NPV method
profitability index method
IRR.
Capital
budgeting
Capital budgeting, and investment appraisal, is the planning process used to
determine whether an organization's long term investments such as new
machinery, replacement of machinery, new plants, new products, and research
development projects are worth the funding of cash through the firm's
capitalization structure

Non-Discount Method in capital budgeting
• The payback method simply computes the number of years it will take for an
investment to return cash equal to the amount invested.
• For example, if an investment of $100,000 is made and it generates cash of
$50,000 for two years followed by $10,000 per year for four additional years, its
payback is two years ($50,000 + $50,000).
• If another investment of $100,000 generates cash of $20,000 per year fortwo
years and then provides cash of $40,000 per year for six additional years, its
payback is approximately 3.5 years ($20,000 + $20,000 + $40,000 + 0.5 times
$40,000).
A non-discount method of capital budgetingdoes not explicitly consider the time
value of money.
In other words, each dollar earned in the future is assumed to have the same value
as each dollar that was invested many years earlier.
The payback method is one of the techniques used in capital budgeting thatdoes
not consider the time value of money.

Payback Period
• Payback period in capital
budgeting refers to the time
required to recoup thefunds
expended in an investment,
• For example, a $1000investment
made at the start of year 1 which
returned $500 at the end of year
1 and year 2 respectively would
have a two-year payback period
•A longer payback period indicates
capital is tied up.
•Focus on early payback can
enhance liquidity.
•Investment risk can beassessed
through payback method.
•Shorter term forecasts.
•This is more reliable technique.
•Ignores the time value of
money:
•Cash flows received
during the early years of
a project get a higher
weight than cash flows
received in later years.
Definition Advantages of Payback Method Disadvantages of
the Payback Method

Accounting Rates of Return
Accounting Rate of Return (ARR)
is the percentage rate of
return that is expected from an
investment or asset compared to
the initial cost of investment.

Accounting Rate of Return advantages and disadvantage
• ARR is based on accounting information,
therefore, other special reports are not
required for determining ARR.
• ARR method is easy to calculate and
simple to understand.
• ARR method is based on accountingprofit
hence measures the profitability of
investment.
• ARR ignores the time value of money.
• ARR method ignores the cash flow
from investment
• ARR method does not consider
terminal value of the project.
Advantages Of Accounting Rate
Of Return (ARR)
Disadvantages Of Accounting
Rate OF Return (ARR)

Net Present Value
CAPITAL BUDGETING TECHNIQUES / METHODS
The Discounted Payback
The Internal Rate of Return
There are different methods
adopted for capital budgeting. The
traditional methods or nondiscount
methods include: Payback period
and Accounting rate of return
method. The discounted cash flow
method includes the NPV method,
profitability index method and IRR.

Financial Calculator and a Spreadsheet to Solve Time Value
of Money Problems
Financial
Calculato
r
Excel (and other spreadsheet programs) is the greatest
financial calculator ever made. There is more of a learning
curve than a regular financial calculator, but it is much more
powerful.

Net Present Value
1. Net present value (NPV)
• is the difference between
the present value of cash inflows
and the present value of cash
outflows over a period of time.
• NPV is used in capital budgeting
and investment planning to
analyze the profitability of a
projected investment or project.
• net present value is nothing but
net off of the present value
of cash inflows and outflows by
discounting the flows at a
specified rate
NPV = ∑(CFn / (1 + i)n) – Initial
Investment
•n = Period which takes values from
0 to the nth period till the cash flows
ending period
•CFn = Cash flow in the nth period
•i = Discounting rate
Q1. Assuming the initial cash flow
for a project is $10,000 invested for
a project and subsequent cash
flows for each year for 5 years is
$3,000. The discount rate is
assumed to be 10%. Calculate Net
Present Value.

Net Present Value
Q1. Assuming the initial cash flow for a project is $10,000 invested
for a project and subsequent cash flows for each year for 5 years
is $3,000. The discount rate is assumed to be 10%. Calculate Net
Present Value.
`NPV= $ (10,000) +$2,727.27+ $2,479.34 +$2,253.94+ $2,049.04 $+1,862.76
=$1,372.36

The Discounted Payback
Payback period : 3.4 years
Discounted payback: 4.4 years
The discounted
payback period is a
modified version of
the payback period
that accounts for
the time value of
money.
Both metrics are used
to calculate the amount
of time that it will take
for a project to “break
even,” or to get the
point where the net
cash flows generated
cover the initial cost of
the project.
Both the payback
period and the
discounted payback
period can be used to
evaluate the
profitability and
feasibility of a specific
project.

The Internal Rate of Return
The internal rate of return is a metric used
in financial analysis to estimate the
profitability of potential investments.
The internal rate of return is a
discount rate that makes the net present
value (NPV) of all cash flows equal to zero
in a discounted cash flow analysis
IRR= $(10,000) +$ 5,000 +$7,500 +$ 10,000 + $12,500 +$15,000 = 71%

Summary – DCF Criteria
• Difference between
market value and cost
• Take the project if the
NPV is positive
• Has no serious problems
• Preferred decision
criteria
Net present value Internal rate of return
• Discount rate
that makes
NPV = 0
• Take the project
if the IRR is
greater than the
required return
• Same decision
as NPV with
conventional
cash flows

References
1. R. Baker, P. Wallage: The Future of
Financial Reporting in Europe: Its
Role in corporate Governance, The
International Journal of Accounting,
Vol. 35, No. 2, 2000.
2. B. Elliot, J. Elliot: Financial
Accounting and Reporting, 10th
edition, Pearson Education Limited,
Essex, 2006.
3. D. Gulin, F. Spajic, V. Vasicek, and K.
Zager: Influence of Stock
Manipulations on Financial
Statements, AIESA – Building of
Society based on knowledge,
International Scientific Conference,
Bratislava, 2005.
4. D. Gulin, L. Zager, B. Tusek: The Role of Accounting
in Corporate Governance, MicroCAD 2005,
International Scientific Conference, University of
Miskolc (UM) & Innovation and Technology Transfer
Centre (ITTC), Miskolc, 2005
5. “International Financial Reporting Standards”,
International Accounting Standards Committee
Foundation, London, 2004.
6. P. Miller, P. Bahnson: Quality Financial Reporting,
Mcgraw-Hill, New York, 2002.
7. M.B. Romney, P.J. Steinbart, B.E. Cushing:
Accounting Information Systems, AddisonWesley
Publishing Company, 1997.

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