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Management Simulations, Inc.
The Nature of AccountingThe Nature of Accounting
““Accounting is the identification, measurement and Accounting is the identification, measurement and communication of financial information about communication of financial information about economic entities to interested persons”economic entities to interested persons”
Kieso and WeygandtKieso and Weygandt
• Arose from the need to communicate financial Arose from the need to communicate financial informationinformation
• Financial Accounting Standards Board (FASB) is Financial Accounting Standards Board (FASB) is authoritative rule making bodyauthoritative rule making body
Finance is the Language of Business. Accounting is the Medium of Finance.
Management Simulations, Inc.
Underlying AssumptionsUnderlying Assumptions
Key AssumptionsKey Assumptions
• Double entryDouble entry
• Timing-matching principalTiming-matching principal
• Accrual accountingAccrual accounting
• Historical costHistorical cost
• FASB Standards applied to FASB Standards applied to simulation reports.simulation reports.
Management Simulations, Inc.
Objectives of Financial ReportingObjectives of Financial Reporting
• Know how effectively resources are obtained Know how effectively resources are obtained and appropriatedand appropriated
• Use information to inform investment and Use information to inform investment and credit decisionscredit decisions
• Identify optimum time to take actions affected Identify optimum time to take actions affected by cash flowby cash flow
BalanceBalanceSheetSheet
P&L P&L or Income or Income StatementStatement
CashCashFlowFlow
Management Simulations, Inc.
Balance SheetBalance Sheet
• Identifies what the company owns and who Identifies what the company owns and who owns itowns it
• Snapshot of financial healthSnapshot of financial health
• Assets always equal liabilities and net worth Assets always equal liabilities and net worth combinedcombined
• Accurate for a specific dateAccurate for a specific date
Management Simulations, Inc.
Sample Capstone Sample Capstone ® Balance Sheet Balance Sheet from Annual Reportsfrom 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 Capstone ® Balance Sheet Survey Balance Sheet Survey
The Capstone ® Courier provides each team’s Balance Sheet summary on Page 3
Strategic intentions may be inferred based on profile
Example – a team with a large Plant & Equipment line may be adopting a cost leadership, high volume position
Management Simulations, Inc.
Profit and Loss Statement or Profit and Loss Statement or Income StatementIncome Statement
• Compares revenues and expenses for a given periodCompares revenues and expenses for a given period
• Movie of financial healthMovie of financial health
• Shows activity over a period of timeShows activity over a period of time
• Indicates the profitability of an organizationIndicates the profitability of an organization
Management Simulations, Inc.
Income Statement Survey from Income Statement Survey from Capstone Capstone ® Courier Courier
• Compare your team Compare your team against competitorsagainst competitors
• Is your variable costs Is your variable costs to sales comparison to sales comparison above or below above or below average?average?
• Do your SG&A Do your SG&A expenses relative to expenses relative to sales reflect good sales reflect good rates of return? rates of return?
Management Simulations, Inc.
Simulation Sample Proforma Simulation Sample Proforma Income StatementIncome 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
Red number – bad, black number - good
Management Simulations, Inc.
Cash Flow StatementCash Flow Statement
• Shows movement of cash in and out of an Shows movement of cash in and out of an organization over a given periodorganization over a given period
• Shows how much cash is available for use Shows how much cash is available for use during a given periodduring a given period
• Reconciles net profit back to cashReconciles net profit back to cash
Management Simulations, Inc.
Sample Capstone Sample Capstone ® Cash Flow Cash Flow StatementStatement
• Provides two Provides two year’s datayear’s data
• Common causes Common causes for emergency for emergency loans:loans:
1)1) Excessive inventory Excessive inventory resulting from poor resulting from poor sales forecastssales forecasts
2)2) Making Plant & Making Plant & Equip upgrades w/o Equip upgrades w/o raising sufficient raising sufficient capitalcapital
3)3) Operating lossesOperating losses
Management Simulations, Inc.
• A financial ratio shows the relationship between A financial ratio shows the relationship between two financial measurestwo financial measures
• Developed by dividing one measure into anotherDeveloped by dividing one measure into another
• Provide insights into company’s operations and Provide insights into company’s operations and strategystrategy
• Four categories: liquidity, solvency, market value, Four categories: liquidity, solvency, market value, profitabilityprofitability
• Used internally to evaluate performance and set Used internally to evaluate performance and set goalsgoals
• Used externally to make investment decisionsUsed externally to make investment decisions
Introduction to RatiosIntroduction to Ratios
Management Simulations, Inc.
Ratios Report Sample from Ratios Report Sample from Spreadsheet ProformasSpreadsheet Proformas
Your spreadsheet program creates a Proforma Ratios Report based on your sales forecasts and tactical decisions.
Are your decisions maximizing the Success Measurements (ROE, ROS, ROA, Stock Price, Asset Turnover, Market Capitalization) you chose (or were assigned)?
Management Simulations, Inc.
Asset TurnoverAsset Turnover
““Reveals how effective assets are at generating Reveals how effective assets are at generating sales revenue.”sales revenue.”
Asset Turnover =Asset Turnover =salessales
assetsassets
Management Simulations, Inc.
““ROS indicates the percentage of each sales ROS indicates the percentage of each sales dollar that results in net income.”dollar that results in net income.”
Return on SalesReturn on Sales
Return on Sales =Return on Sales =net profitnet profit
net salesnet sales
Management Simulations, Inc.
Return on AssetsReturn on Assets
Return on Assets =Return on Assets =net profitnet profit
assetsassets
““ROA measures a company’s ability to use ROA measures a company’s ability to use all its assets to generate earnings.”all its assets to generate earnings.”
Management Simulations, Inc.
LeverageLeverage
Leverage =Leverage =assetsassets
equityequity
““Leverage shows the debt level of the Leverage shows the debt level of the organization.”organization.”
Management Simulations, Inc.
Return on EquityReturn on Equity
Return on Equity =Return on Equity =net profitnet profit
equityequity
““Return on Equity highlights for the Return on Equity highlights for the stockholders the return on their stockholders the return on their investment.”investment.”
Management Simulations, Inc.
Du Pont FormulaDu Pont Formula
Return on Equity =Return on Equity =net profitnet profit
equityequity
net profitnet profit
salessales
salessales
assetsassets
assetsassets
equityequityxxxx xxxx
Value Chain
Management Simulations, Inc.
Du Pont FormulaDu Pont Formula
Return on Equity =Return on Equity =net profitnet profit
equityequity
net profitnet profit
salessales
salessales
assetsassets
assetsassets
equityequityxxxx xxxx
Value Chain
Management Simulations, Inc.
Du Pont FormulaDu Pont Formula
Return on Equity =Return on Equity =net profitnet profit
equityequity
net profitnet profit
salessales
salessales
assetsassets
assetsassets
equityequityxxxx xxxx
Return on Return on SalesSales
Asset Asset TurnoverTurnover
LeverageLeverage
Value Chain
Management Simulations, Inc.
Du Pont Formula · TI vs. HPDu Pont Formula · TI vs. HP
Texas InstrumentsTexas Instruments Hewlett PackardHewlett Packard
Current AssetsCurrent Assets = 1.29= 1.29
Fixed Assets Fixed Assets = 1.11= 1.11
Sales Sales = 4.07= 4.07
Net Income Net Income = .37= .37
Shareholder Equity Shareholder Equity = 1.16= 1.16
Management Simulations, Inc.
Du Pont Formula · TI vs. HPDu Pont Formula · TI vs. HP
Texas InstrumentsTexas Instruments Hewlett PackardHewlett Packard
Current AssetsCurrent Assets = 1.29= 1.29
Fixed Assets Fixed Assets = 1.11= 1.11
Sales Sales = 4.07= 4.07
Net Income Net Income = .37= .37
Shareholder Equity Shareholder Equity = 1.16= 1.16
Turnover xTurnover x 1.691.69
ROS ROS 9.3% 9.3%
= ROA= ROA 15.7%15.7%
x Leveragex Leverage 2.072.07
= ROE= ROE 32.5%32.5%
Management Simulations, Inc.
Du Pont Formula · TI vs. HPDu Pont Formula · TI vs. HP
Texas InstrumentsTexas Instruments Hewlett PackardHewlett Packard
Current AssetsCurrent Assets = 1.29= 1.29
Fixed Assets Fixed Assets = 1.11= 1.11
Sales Sales = 4.07= 4.07
Net Income Net Income = .37= .37
Shareholder Equity Shareholder Equity = 1.16= 1.16
Current AssetsCurrent Assets = 1.49= 1.49
Fixed Assets Fixed Assets = .84= .84
Sales Sales = 3.09= 3.09
Net Income Net Income = .52= .52
Shareholder Equity Shareholder Equity = 1.54= 1.54
Turnover xTurnover x 1.691.69
ROS ROS 9.3% 9.3%
= ROA= ROA 15.7%15.7%
x Leveragex Leverage 2.072.07
= ROE= ROE 32.5%32.5%
Management Simulations, Inc.
Du Pont Formula · TI vs. HPDu Pont Formula · TI vs. HP
Texas InstrumentsTexas Instruments Hewlett PackardHewlett Packard
Current AssetsCurrent Assets = 1.29= 1.29
Fixed Assets Fixed Assets = 1.11= 1.11
Sales Sales = 4.07= 4.07
Net Income Net Income = .37= .37
Shareholder Equity Shareholder Equity = 1.16= 1.16
Current AssetsCurrent Assets = 1.49= 1.49
Fixed Assets Fixed Assets = .84= .84
Sales Sales = 3.09= 3.09
Net Income Net Income = .52= .52
Shareholder Equity Shareholder Equity = 1.54= 1.54
Turnover xTurnover x 1.691.69
ROS ROS 9.3% 9.3%
= ROA= ROA 15.7%15.7%
x Leveragex Leverage 2.072.07
= ROE= ROE 32.5%32.5%
Turnover xTurnover x 1.331.33
ROSROS 16.9%16.9%
= ROA= ROA 22.4%22.4%
x Leveragex Leverage 1.521.52
= ROE= ROE 33.8%33.8%