AG BUS EXAM 3
comparative statement analysis
Balance sheets and P&L statements from two periods are placed side by side and examined for any significant changes that could affect the financial condition of the firm
capital budgeting decision
evaluating profitability of potential investments by firm in new property, plant and equipment
ratio analysis
examines relationships of various components on balance sheet and P&L statement; compares changes over time
incremental cost
an increase in cost between two alternatives
average rate of return method of capital budgeting
annual return/investment
ex of current assets
cash, accounts receivable, inventory, and prepaid expenses
how is the break-even point calculated?
fixed cost/(price-variable cost); from the profit equation when profit is zero
advantages of ratio analysis
easy to calculate, easy to make comparisons, easily understood, and communicates financial position to interested parties
manager determines
economic order quantity (EOQ) and reorder point (ROP)
current assets
either cash now or will turn into cash within accounting period
break even analysis
helps managers find combination of costs, output, and selling price that permits firm to breakeven, no profits and losses
liquidity
the ability of the business to meet its cash commitments in a timely fashion
owners equity
the difference between a firm's assets and its liabilities
profits
total revenue - total costs
annuity
used to evaluate the present value of a series of equal-sized cash flows made over a number of periods (car payments, mortgages, student loans, lottery winnings, etc) usum of present value factors for period
compounding
what money put into a savings account today will be worth at a future date
reasons not to hold inventory
-High Maintenance Costs -High Protection Costs -Depreciation and Obsolescence -Taxes
reasons to hold inventory
-matching supply with demand -prevent stockouts -lower purchasing costs
balance sheet equation
Assets = Liabilities + Owner's Equity
uses of net working capital
DECREASE dividend payment, fixed assets purchase, investments payments, long term repayments, stock retirement
sources of net working capital
INCREASE fixed assets sale, investments sale, long-term loans taken, stock sale, depreciation, profits
solvency
a business is solvent if total assets exceed total liabilities
implicit cost
a non-monetary opportunity cost; does not involve explicit payments
advantages/disadvantages of payback method
advantage- quick and simple disadvantage- puts emphasis on recouping the investment and not based on profitability does not consider returns at end of period nor when the returns are received
advantages/disadvantages of average rate of return
advantages- simple uses returns over the entire life disadvantages- gives equal weight to all years does not consider time value of money size disparity problem measures rate of return not profit
explicit cost
cost for direct purchases of inputs and services which are directly traceable
Liquidity ratios
current, quick, and acid test ratio
current liabilities
debt must be paid within next accounting period
solvency ratios
debt to equity and times interest earned ratio
net working capital analysis (NWC)
difference between current assets and current liabilities tells managers how working capital is acquired
discounting
how much money do I have to put into a savings account today to have a certain amount at a specific time in future
activity ratios
inventory turnover, accounts receivable turnover, and accounts payable turnover
payback method of capital budgeting
investment/annual return
cost of goods sold (COGS)
represents the direct costs to business of just goods that are sold this period
4 categories of ratios
liquidity ratios, solvency ratios, activity ratios, and profitability ratios
limitations to ratio analysis
only indicates problems, not cause problems if you change accounting methods
net present value (NPV)
present value of benefits- present value of costs
benefit/cost ratio (B/C)
present value of benefits/present value of costs
financial objectives
profits, liquidity, and solvency
profitability ratios
return on investment (ROI), return on owners equity, profit as percentage of sales ratio
factors influencing BEP and profit
selling price, fixed cost, variable costs by becoming more efficient, selling more
contribution
selling price/unit - variable cost/ unit; what is available for paying overhead and profit
internal rate of return (IRR)
the discount rate that results in an NPV of zero; PV of cash inflows= PV of cash outflows
opportunity cost
the most desirable alternative given up as the result of a decision
Equivalent Annual Cost (EAC)
the present value of a project's costs calculated on an annual basis