0
goals of managers with the goals of shareholders
40
Lecture 8
Review of the Previous Lecture
Cash Flow Statement
Financial Statements Analysis
Significance
Common Size Analysis
Topics under Discussion
Financial Statements Analysis
Common Size Analysis (Cont.)
Ratio Analysis
Short-term solvency, or liquidity, ratios
Current Ratio
Acid Test (Quick) ratio
Cash ratio
Common-Size Statements
One very common and useful way of standardized comparison is to work with percentages
instead of dollars.
So, a standardized financial statement presenting all items in percentages is called a commonsize
statement.
Balance sheet items are shown as a percentage of total assets and income statement items as a
percentage of sales.
A2Z Inc., Balance Sheet
A2Z Inc.
Balance Sheet as of December 31
($ in millions)
Assets 20X1 20X2
Current Assets
Cash $ 84 $ 98
Accounts receivable 165 188
Inventory 393 422
Total $ 642 $708
Fixed assets
Net plant and equipment 2,731 2,880
Total assets $3,373 $3,588
A2Z Inc., Balance Sheet
Liabilities and equity 20X1 20X2
Current liabilities
Accounts Payable $ 312 $ 344
Notes payable 231 196
Total $ 543 $ 540
41
Long-term debt 531 457
Stockholders' equity
Common stock and paid-in surplus 500 550
Retained earnings 1,799 2,041
Total $2,299 $2,591
Total liabilities and equity $3,373 $3,588
A2Z Inc., Common-Size Balance Sheet
Assets 20X1 20X2
Current Assets
Cash 2.5% 2.7%
Accounts receivable 4.9 5.2
Inventory 11.7 11.8
Total 19.1% 19.7%
Fixed assets
Net plant and equipment 80.9% 80.3%
Total assets 100.0% 100.0%
A2Z Inc., Common-Size Balance Sheet
Liabilities and equity 20X1 20X2
Current liabilities
Accounts Payable 9.2% 9.6%
Notes payable 6.8 5.5
Total 16.0% 15.1%
Long-term debt 15.7% 12.7%
Stockholders' equity
Common stock and paid-in surplus 14.8% 15.3%
Retained earnings 53.3 56.9
Total 68.1 72.2
Total liabilities and equity 100.0% 100.0%
A2Z Inc., Common-Size Balance Sheet
More on Standardized Statements
Suppose we ask: "What happened to A2Z's net plant and equipment (NP&E) over the period?"
Based on the 20X1 and 20X2 B/S, NP&E rose from $2,731 to $2,880, so NP&E rose by
$149.
Did the firm's NP&E go up or down? Obviously, it went up, but so did total assets.
In fact, looking at the standardized statements, NP&E went from 80.9% of total assets to
80.3% of total assets.
A2Z Inc., Common-Size Balance Sheet
More on Standardized Statements
If we standardized the 20X2 numbers by dividing each by the 20X1 number, we get a
common base year statement. In this case, $2,880 / $2,731 = 1.0545, so NP&E rose by 5.45%
over this period.
42
If we standardized the 20X2 common size numbers by dividing each by the 20X1 common
size number, we get a combined common size, common base year statement. In this case,
80.3%/ 80.9% = 99.26%, so NP&E almost remained the same as a percentage of assets.
(. .) In absolute terms, NP&E is up by $149 or 5.45%, but relative to total assets, NP&E fell
by 2.6%.
A2Z Inc., Common-Size Balance Sheet
More on Standardized Statements
Current assets rose from 19.1% in 20X1 to 19.7% in 20X2
Current liabilities declined from 16.0% to 15.1% of total liabilities and equity over the same
time.
Total equity rose from 68.1% of total liabilities and equity to 72.2%.
Overall, A2Z's liquidity as measured by current assets compared to current liabilities,
increased over the year. Also, A2Z's indebtness diminished as a percentage of total assets.
So we may conclude that balance sheet as grown stronger
A2Z Inc., Income Statement
For the Year 20X2
($ in millions)
Net sales $2,311
Cost of goods sold 1,344
Depreciation 276
Earnings before interest and taxes $ 691
Interest 141
Taxable income 550
Taxes 187
Net income $ 363
Dividends $121
Retained earnings 242
A2Z Inc., Common-Size Income Statement
Net sales 100.0 %
Cost of goods sold 58.2
Depreciation 11.9
Earnings before interest and taxes 29.9
Interest 6.1
Taxable income 23.8
Taxes 8.1
Net income 15.7 %
Dividends 5.2%
Retained earnings 10.5
A2Z Inc., Common-Size Income Statement
This statement tells us what happened to each dollar in sales.
For A2Z interest expense eats up 6.1% of sales, while taxes take another 8.1% of sales figure.
Following this, 15.7% of revenues from sales flow down to bottom as net income; one-third of
which is paid in dividends and remainder two-thirds is taken as retained earnings for busniess.
As far as cost is concerned, 58.2% of revenues are spent on the goods sold
43
Standardized Financial Statements
Although an organization's common-size statements provide a better analytical insight into the
it's strength and standing, yet it's performance and efficiency can be better judged by
comparing these with those of the firm's competitors.
Ratio Analysis
Another way of avoiding the problems involved in comparing companies of different sizes, is
to calculate and compare financial ratios.
One problem with ratios is that different people and different sources frequently don't
compute them in exactly the same way.
While using ratios as a tool for analysis, you should be careful to document how you calculate
each one, and, if you are comparing your numbers to those of another source, be sure you
know how their numbers are computed.
Ratio Analysis
For each of the ratios we discuss, several questions come to mind:
How is it computed?
What is it intended to measure, and why might we be interested?
What is the unit of measurement?
What might a high or low value be telling? How might such values be misleading?
How could this measure be improved?
Ratio Analysis
Financial ratios are traditionally grouped into the following categories:
Short-term solvency, or liquidity, ratios
Ability to pay bills in the short-run
Long-term solvency, or financial leverage, ratios
Ability to meet long-term obligations
Asset management, or turnover, ratios
Intensity and efficiency of asset use
Profitability ratios
Ability to control expenses
Market value ratios
Going beyond financial statements
Short-Term Solvency, or Liquidity Measures
The primary concern to which these ratios relate, is the firm's ability to pay its bills over the
short run without undue stress. So these ratios focus on current assets and current liabilities.
Liquidity ratios are particularly interesting to short-term creditors. Since financial managers
are constantly working with banks and other short-term lenders, an understanding of these
ratios is essential
44
Short-Term Solvency, or Liquidity Measures
Current assets and liabilities
Their book values and market values are likely to be similar.
They can and do change fairly rapidly, hence unpredictable
Current Ratio
Current Assets
Current Ratio= ------------------------
Current Liabilities
Because current assets and liabilities are converted into cash over the following 12 months, the
current ratio is a measure of short run liquidity.
The unit of measurement is either dollars or times.
Current Ratio
For A2Z Corporation, the 20X2 current ratio is
$708
Current Ratio= ---------- = 1.31 times
$540
We can say that
A2Z has a $1.31 in current assets for every $1 in current liabilities OR
A2Z has its current liabilities covered 1.31 times over.
Current Ratio
To a creditor (particularly a short-term creditor like supplier), the higher the current ratio, the
better
To firm, high current ratio indicates liquidity, but it may also indicate an inefficient use of cash
and other short-term assets.
We would expect to see a current ratio of at least 1, because a current ratio of less than 1
would mean that net working capital is negative
Current Ratio
Like any other ratio, current ratio is effected by various transactions.
If a firm borrows over long-term,
The short run effect would be an increase in cash as well as in long term liabilities.
Current liabilities would not be affected, so the current ratio would rise.
An apparently low current ratio may not be a bad sign for a company with a large reserve of
unlimited borrowing power.
45
Current Ratio
Current Events
A firm wants to payoff some of its suppliers and creditors. What would happen to current
ratio?
Current ratio moves away from 1. if it is greater than 1 it will get bigger. But if it is less
than 1, it will get smaller.
Suppose a firm has $4 in current assets and $2 in current liabilities for a current ratio of 2.
and uses $1 in cash to reduce current liabilities, then new current ratio is ($4-2) / ($2-1) = 3
Reversing the situation to $2 in current assets and $4 in current liabilities, the change will
cause current ratio to fall to 1/3 from 1/2
Current Ratio
Current Events
Suppose a firm buys some inventory. What would happen in this case?
Nothing happens to current ratio. Because in this scenario, one current asset (cash) goes
down while another current asset (inventory) goes up. Total current assets are unaffected.
Current Ratio
Current Events
What happens if a firm sells some merchandise?
Current ratio would usually rise because inventory is shown at cost and sale would
normally be at something greater than cost (difference is markup).
So, the increase in either cash or receivables is greater than the decrease in inventory.
This increases current assets and current ratio rises.
Quick (or Acid-Test) Ratio
Inventory is often the least liquid current asset. And its book values are least reliable as
measures of market value since the quality of inventory isn't considered. Some of the
inventory may turn out to be damaged, obsolete or lost.
Relatively large inventories are often a sign of short-term trouble.
The firm may have overestimated sales and overbought or overproduced as a result, hence tied
up a substantial portion of its liquidity in slow moving inventory
Quick (or Acid-Test) Ratio
It is computed just like current ratio, except inventory is omitted.
Current Assets - Inventory
Quick Ratio= ------------------------------------
Current Liabilities
For A2Z, this ratio in 20X2 was
$708 - 422
Quick Ratio= ----------------- = 0.53 times
$540
46
Quick (or Acid-Test) Ratio
The quick ratio here tells a somewhat different story than the current ratio, because inventory
accounts for more than half of A2Z's current assets
If the same figure is for an aircraft manufacturing corporation, then this would certainly be a
cause for a BIG concern.
Cash Ratio
A very short-term creditor may be interested in the cash ratio
Cash
Cash Ratio= -----------------------
Current Liabilities
Current ratio for A2Z in 20X2 was 0.18
Summary
Financial Statements Analysis
Common Size Analysis (Cont.)
Ratio Analysis
Short-term solvency, or liquidity, ratios
Current Ratio
Acid Test (Quick) ratio
Cash ratio
Upcoming topics
Ratio Analysis (cont.)
Long Term Solvency, or Liquidity ratios
Asset management, or turnover, ratios
Profitability ratios
Market value ratios
goals of managers with the goals of shareholders
40
Lecture 8
Review of the Previous Lecture
Cash Flow Statement
Financial Statements Analysis
Significance
Common Size Analysis
Topics under Discussion
Financial Statements Analysis
Common Size Analysis (Cont.)
Ratio Analysis
Short-term solvency, or liquidity, ratios
Current Ratio
Acid Test (Quick) ratio
Cash ratio
Common-Size Statements
One very common and useful way of standardized comparison is to work with percentages
instead of dollars.
So, a standardized financial statement presenting all items in percentages is called a commonsize
statement.
Balance sheet items are shown as a percentage of total assets and income statement items as a
percentage of sales.
A2Z Inc., Balance Sheet
A2Z Inc.
Balance Sheet as of December 31
($ in millions)
Assets 20X1 20X2
Current Assets
Cash $ 84 $ 98
Accounts receivable 165 188
Inventory 393 422
Total $ 642 $708
Fixed assets
Net plant and equipment 2,731 2,880
Total assets $3,373 $3,588
A2Z Inc., Balance Sheet
Liabilities and equity 20X1 20X2
Current liabilities
Accounts Payable $ 312 $ 344
Notes payable 231 196
Total $ 543 $ 540
41
Long-term debt 531 457
Stockholders' equity
Common stock and paid-in surplus 500 550
Retained earnings 1,799 2,041
Total $2,299 $2,591
Total liabilities and equity $3,373 $3,588
A2Z Inc., Common-Size Balance Sheet
Assets 20X1 20X2
Current Assets
Cash 2.5% 2.7%
Accounts receivable 4.9 5.2
Inventory 11.7 11.8
Total 19.1% 19.7%
Fixed assets
Net plant and equipment 80.9% 80.3%
Total assets 100.0% 100.0%
A2Z Inc., Common-Size Balance Sheet
Liabilities and equity 20X1 20X2
Current liabilities
Accounts Payable 9.2% 9.6%
Notes payable 6.8 5.5
Total 16.0% 15.1%
Long-term debt 15.7% 12.7%
Stockholders' equity
Common stock and paid-in surplus 14.8% 15.3%
Retained earnings 53.3 56.9
Total 68.1 72.2
Total liabilities and equity 100.0% 100.0%
A2Z Inc., Common-Size Balance Sheet
More on Standardized Statements
Suppose we ask: "What happened to A2Z's net plant and equipment (NP&E) over the period?"
Based on the 20X1 and 20X2 B/S, NP&E rose from $2,731 to $2,880, so NP&E rose by
$149.
Did the firm's NP&E go up or down? Obviously, it went up, but so did total assets.
In fact, looking at the standardized statements, NP&E went from 80.9% of total assets to
80.3% of total assets.
A2Z Inc., Common-Size Balance Sheet
More on Standardized Statements
If we standardized the 20X2 numbers by dividing each by the 20X1 number, we get a
common base year statement. In this case, $2,880 / $2,731 = 1.0545, so NP&E rose by 5.45%
over this period.
42
If we standardized the 20X2 common size numbers by dividing each by the 20X1 common
size number, we get a combined common size, common base year statement. In this case,
80.3%/ 80.9% = 99.26%, so NP&E almost remained the same as a percentage of assets.
(. .) In absolute terms, NP&E is up by $149 or 5.45%, but relative to total assets, NP&E fell
by 2.6%.
A2Z Inc., Common-Size Balance Sheet
More on Standardized Statements
Current assets rose from 19.1% in 20X1 to 19.7% in 20X2
Current liabilities declined from 16.0% to 15.1% of total liabilities and equity over the same
time.
Total equity rose from 68.1% of total liabilities and equity to 72.2%.
Overall, A2Z's liquidity as measured by current assets compared to current liabilities,
increased over the year. Also, A2Z's indebtness diminished as a percentage of total assets.
So we may conclude that balance sheet as grown stronger
A2Z Inc., Income Statement
For the Year 20X2
($ in millions)
Net sales $2,311
Cost of goods sold 1,344
Depreciation 276
Earnings before interest and taxes $ 691
Interest 141
Taxable income 550
Taxes 187
Net income $ 363
Dividends $121
Retained earnings 242
A2Z Inc., Common-Size Income Statement
Net sales 100.0 %
Cost of goods sold 58.2
Depreciation 11.9
Earnings before interest and taxes 29.9
Interest 6.1
Taxable income 23.8
Taxes 8.1
Net income 15.7 %
Dividends 5.2%
Retained earnings 10.5
A2Z Inc., Common-Size Income Statement
This statement tells us what happened to each dollar in sales.
For A2Z interest expense eats up 6.1% of sales, while taxes take another 8.1% of sales figure.
Following this, 15.7% of revenues from sales flow down to bottom as net income; one-third of
which is paid in dividends and remainder two-thirds is taken as retained earnings for busniess.
As far as cost is concerned, 58.2% of revenues are spent on the goods sold
43
Standardized Financial Statements
Although an organization's common-size statements provide a better analytical insight into the
it's strength and standing, yet it's performance and efficiency can be better judged by
comparing these with those of the firm's competitors.
Ratio Analysis
Another way of avoiding the problems involved in comparing companies of different sizes, is
to calculate and compare financial ratios.
One problem with ratios is that different people and different sources frequently don't
compute them in exactly the same way.
While using ratios as a tool for analysis, you should be careful to document how you calculate
each one, and, if you are comparing your numbers to those of another source, be sure you
know how their numbers are computed.
Ratio Analysis
For each of the ratios we discuss, several questions come to mind:
How is it computed?
What is it intended to measure, and why might we be interested?
What is the unit of measurement?
What might a high or low value be telling? How might such values be misleading?
How could this measure be improved?
Ratio Analysis
Financial ratios are traditionally grouped into the following categories:
Short-term solvency, or liquidity, ratios
Ability to pay bills in the short-run
Long-term solvency, or financial leverage, ratios
Ability to meet long-term obligations
Asset management, or turnover, ratios
Intensity and efficiency of asset use
Profitability ratios
Ability to control expenses
Market value ratios
Going beyond financial statements
Short-Term Solvency, or Liquidity Measures
The primary concern to which these ratios relate, is the firm's ability to pay its bills over the
short run without undue stress. So these ratios focus on current assets and current liabilities.
Liquidity ratios are particularly interesting to short-term creditors. Since financial managers
are constantly working with banks and other short-term lenders, an understanding of these
ratios is essential
44
Short-Term Solvency, or Liquidity Measures
Current assets and liabilities
Their book values and market values are likely to be similar.
They can and do change fairly rapidly, hence unpredictable
Current Ratio
Current Assets
Current Ratio= ------------------------
Current Liabilities
Because current assets and liabilities are converted into cash over the following 12 months, the
current ratio is a measure of short run liquidity.
The unit of measurement is either dollars or times.
Current Ratio
For A2Z Corporation, the 20X2 current ratio is
$708
Current Ratio= ---------- = 1.31 times
$540
We can say that
A2Z has a $1.31 in current assets for every $1 in current liabilities OR
A2Z has its current liabilities covered 1.31 times over.
Current Ratio
To a creditor (particularly a short-term creditor like supplier), the higher the current ratio, the
better
To firm, high current ratio indicates liquidity, but it may also indicate an inefficient use of cash
and other short-term assets.
We would expect to see a current ratio of at least 1, because a current ratio of less than 1
would mean that net working capital is negative
Current Ratio
Like any other ratio, current ratio is effected by various transactions.
If a firm borrows over long-term,
The short run effect would be an increase in cash as well as in long term liabilities.
Current liabilities would not be affected, so the current ratio would rise.
An apparently low current ratio may not be a bad sign for a company with a large reserve of
unlimited borrowing power.
45
Current Ratio
Current Events
A firm wants to payoff some of its suppliers and creditors. What would happen to current
ratio?
Current ratio moves away from 1. if it is greater than 1 it will get bigger. But if it is less
than 1, it will get smaller.
Suppose a firm has $4 in current assets and $2 in current liabilities for a current ratio of 2.
and uses $1 in cash to reduce current liabilities, then new current ratio is ($4-2) / ($2-1) = 3
Reversing the situation to $2 in current assets and $4 in current liabilities, the change will
cause current ratio to fall to 1/3 from 1/2
Current Ratio
Current Events
Suppose a firm buys some inventory. What would happen in this case?
Nothing happens to current ratio. Because in this scenario, one current asset (cash) goes
down while another current asset (inventory) goes up. Total current assets are unaffected.
Current Ratio
Current Events
What happens if a firm sells some merchandise?
Current ratio would usually rise because inventory is shown at cost and sale would
normally be at something greater than cost (difference is markup).
So, the increase in either cash or receivables is greater than the decrease in inventory.
This increases current assets and current ratio rises.
Quick (or Acid-Test) Ratio
Inventory is often the least liquid current asset. And its book values are least reliable as
measures of market value since the quality of inventory isn't considered. Some of the
inventory may turn out to be damaged, obsolete or lost.
Relatively large inventories are often a sign of short-term trouble.
The firm may have overestimated sales and overbought or overproduced as a result, hence tied
up a substantial portion of its liquidity in slow moving inventory
Quick (or Acid-Test) Ratio
It is computed just like current ratio, except inventory is omitted.
Current Assets - Inventory
Quick Ratio= ------------------------------------
Current Liabilities
For A2Z, this ratio in 20X2 was
$708 - 422
Quick Ratio= ----------------- = 0.53 times
$540
46
Quick (or Acid-Test) Ratio
The quick ratio here tells a somewhat different story than the current ratio, because inventory
accounts for more than half of A2Z's current assets
If the same figure is for an aircraft manufacturing corporation, then this would certainly be a
cause for a BIG concern.
Cash Ratio
A very short-term creditor may be interested in the cash ratio
Cash
Cash Ratio= -----------------------
Current Liabilities
Current ratio for A2Z in 20X2 was 0.18
Summary
Financial Statements Analysis
Common Size Analysis (Cont.)
Ratio Analysis
Short-term solvency, or liquidity, ratios
Current Ratio
Acid Test (Quick) ratio
Cash ratio
Upcoming topics
Ratio Analysis (cont.)
Long Term Solvency, or Liquidity ratios
Asset management, or turnover, ratios
Profitability ratios
Market value ratios
Add your answer:
Earn +20 pts
What is the function of technostructure?
Technostructure is a term coined by the economist John Kenneth Galbraith in "The New Industrial State" (1967) to describe the group of technicians within an enterprise (or an administrative body) with considerable influence and control on its economy. It usually refers to managerialcapitalism where the managers and other company leading administrators, scientists, or lawyers retain more power and influence than the shareholders in the decisional and directional process.Since the technostructure is composed of an hierarchical system of influential employees inside the enterprise, its primary goal is not to maximize their profits but rather survival, continuous growth and maximal size. While it must maintain acceptable relations with their shareholders, hegemonic growth is more beneficial to the technostructure.
Give example of goal you set in life and how you achieved it?
My goal was to make as much money doing what I love to do and work less then 20 hours a week and average over $250 per hr . I did achieve it by becoming a licensed Master plumber as everyone needs the service industry
What is the noun form of word target?
The word 'target' is a noun as a word for a mark to shoot at; a goal to be achieved; a person or thing that is talked about, criticized, or laughed at.The noun form of the verb to target is the gerund, targeting.
What is the goal and purpose of statistics?
what is the goal of statistics
When was The Million Dollar Goal created?
The Million Dollar Goal was created in 2003.
What is goal congruence and how can it be achieved?
this focusing on achieving the objecting of the organization
How would you describe goal congruence in a business setting?
Goal congruence occurs when the goals of the employees and the goals of the company become intertwined and meshed together.
When can there arise a conflict between shareholders and managers goal?
conflicts between a shareholders goals ana a managers goal may arise when the shareholder decides to by-pass the principle of agency theory which states that the mangers and shareholders should have equal rights of financial decision making unless one via the other is made to be clearly resolved through devastating financial effects. the conflict from here then oon arises.
How organizational reputation affect goal congruence?
6
What is the relationship between shareholders and managers?
When you hold a share of a company, you are an investor in the company. You have invested your money in the company and it is the prime goal of the company's management to ensure that they earn sufficient revenue and profit for you "the investor" who has invested in the company. Ideally speaking, shareholders can be considered as owners of the company and the managers can be considered as employees working for the company.
What affects the probability of goal congruence?
Full sharing of facts and vision.
How are cost accounting and financial accounting similar?
Simple answer: They both provide useful information to users. Thus is the true goal of accounting. Cost accounting users= managers Financial accounting user= shareholders
How does responsibility accounting system foster goal congruence?
Responsible accounting ensures that the business is accurately reporting their financial position. This supports congruence because they are transparent in their business dealings.
What is intermediate goal?
a goal which must be achieved in order to accomplish your ultimate goal
Did FerinadadMagellan achieved his goal?
Magellan died before cirumnavigation was achieved by the his few surviving crewmen, thus he did not achieve his goal.
Why is goal congruence important to an organization?
so that both the employee and the organization could work efficiently and effectively
What is the difference between goal conflict and goal congruence?
Goal conflict is when we have alternative goals including both Minimization and Maximization of problem .And Goal congruence is when we have alternative goals of same type , either maximizatioin or minimization. Example: Minimizing distance and maximizating closeness ratio in facility layout problem are two conflict goals. Minimizing flow and minimizing risky transpot are congruent goals.
