Financial Accounting Week 2

Debt Ratio

Comparing the amount of liabilities with the amount of assets indicates the extent to which a company has borrowed money to leverage the owner's investments and increase the size of the company Debt ratio measures leverage = total liabilities divided by total assets Banks lending money want lower debt ratios to be repaid quickly and stockholders want higher debt ratios so the company can expand the business, generally around

Preventative controls

Control activities that are designed to prevent the occurrence of errors and fraud

Common size Financial Statements

Dividing all the financial statement numbers by sales for the year in order to standardize them when a company may be growing and earning more sales year to year

Number of days' sales in inventory

365/ Inventory Turnover

Liquidity

A company's ability to pay its debts in the short run

Allowance for bad debt

A contra account to accounts receivable Used because the company does to yet know which receivables will not be collected

Sales returns and allowances

A contra revenue account in which the return of or allowance for reduction in the price of merchandise previously sold is recorded Debit this account and credit cash and/or accounts receivable

Overall company performance

A function of both the profitability of each sale measured by return of sales and the ability to use assets to generate sales measured by asset turnover If there is a profitability problems shown in a dupont analysis then you can use the common size income statement to look at expenses, if there is an efficiency problem look at the assets on the common size balance sheet

Sarbanes Oxley Act

A law passed by Congress in 2002 that gives the SEC significant oversight responsibility and control over companies issuing financial statements and their external auditors

Asset Turnover

A measure of company efficiency equal to sales divided by total assets Answers whether assets are being used efficiently e.g. .83 means that for each dollar of assets the company is able to generate 83 cents in sales

Return on Equity

A measure of the amount of profit earned per dollar of investment Net income/Stockholders's Equity e.g. 47% ROE means for each dollar invested 47 cents of profit was earned

Average collection period

A measure of the average number of days it takes to collect a credit sale 365/Accounts receivable turnover

Current Ratio

A measure of the liquidity of a business measured by current assets/current liabilities Generally if it is below 2 then there is the possibility of liquidity problems but now IT advances have made it so company's have a reduced need to hold cash

Debt to Equity Ratio

A measure of the number of dollars of borrowed funds for every dollar invested by owners Total Liabilities / stockholder's equity

Segregation of duties

A strategy to provide an internal check on performance through separation of authorization of transactions from custody of related assets (approving the sale of a building or land), operational responsibilities from record keeping responsibilities (recording the transactions in the accounting records) and custody of assets from accounting personnel (having physical possession of or control over the assets involved in transactions including operational responsibility like having the key to the safe) no one department or individual should be responsible for handling all or conflicting phases of a transaction

DuPont Framework

A systematic approach for breaking down return on equity into three ratios: Return on Sales (Net Income/Sales) is the Profitability Asset Turnover (Sales/Assets) is the Efficiency Assets to Equity Ratio (Assets/Equity) is the Leverage-number of dollars of assets acquired for each dollar invested by stockholders

Debt to Equity vs Debt ratio vs Assets to Equity

All show the relationship between the amount of a company's borrowing and the amount of a company's stockholder investment 1.0 ratio for Debt to Equity means that total liabilities and total stockholders equity are equal 1.0 for debt ratio means that all of the company's financing has come from debt not stockholder equity 1.0 for Assets to equity means that total assets and total stockholders equity are equal to each other implying that there are no liabilities

Bad debt

An uncollectible account receivable

Assets to Equity Ratio

Assets to Equity Ratio (Assets/Equity) is the Leverage-number of dollars of assets acquired for each dollar invested by stockholders

Average Collection Period

Average number of days it takes to collect a credit sale (accounts receivable ) equal to 365/ Accounts Receivable Turnover

Income smoothing

Carefully timing the recognition of revenues and expenses to even out the amount of reported earnings from one year to the next, also can be used with Accounts Receivable and Allowance for bad debts, increasing AFBD estimates when income is high and decreasing AFBD estimates when income is low which can disrupt consistency and not accurately portray future cash flows

Net Sales

Gross Sales less sales discounts and sales returns and allowances

Inventory Efficiency

How many times a company replenishes its inventory during a year, how many times you sell all of your inventory a year provides a measure of the efficiency with which inventory is managed equal to COGS / Average Inventory

Accounts Receivable Turnover

How many times during the year old receivables are collected and replaced by new receivables A measure used to indicate how fast a company collects its receivables equal to sales / average accounts receivable value

Gross sales

total sales before sales discounts and returns and allowances

Detective controls

Internal control activities that are designed to detect the occurrence of errors and fraud

Price Earnings Ratio

Market value of shares / Net income Generally Range between 5 and 30 in the US and high PE ratios are associated with firms that are expected to have high growth in the future but do not necessarily have high net income now

Audit Committee

Members of a company's board of directors who are responsible for dealing with the external and internal auditors

Return on Sales

Net income/ Sales measure of the amount of profit earned per dollar of sales

Internal Control Structure

Policies and procedures established to provide management with reasonable assurance that the objectives of an entity will be achieved If they don't find the errors then internal auditors will come before external auditors come and nail them

Financial Ratios

Relationships between financial statement amounts e.g. Net income divided by sales is a financial ratio called return on sales

The allowance method

Satisfies the matching principle because it accounts for uncollectible during the same period in which the sales occurred, firm estimates the amount of receivabl es arising from this year's credit sales that will become uncollectible

Control Environment

The actions policies and procedures that reflect the overall attitudes of top management about control and its importance to the entity

Fixed asset Turnover (PP&E)

Value the appropriateness of the level f a company's property plant and equipment Sales / Average fixed assets A measure of the number of dollars in sales generated by each dollar of fixed assets

Accounts receivable turnover

a measure used to indicate how fast a company collects its receivables sales revenue / average accounts receivable (Balance of A/R end of last year + Balance of A/R for end of this year /2) want to be at least 12, getting paid every month

Sales Discount

cash discounts, a reduction in the selling price allowed if payment is received within a specified period e.g. 2/10 n/30 means that a buyer will receive a 2% discount from the selling price if payment is made within 10 days of the date of purchase and the full amount must be paid within 30 days or it will be past due Sales discount is a contra account which means it is deducted from sales revenue on the income statement, contra revenue account so it is considered revenue but is a debit balance Debit this and credit accounts receivable

cash flow adequacy ratio

cash from operations divided by expenditures for fixed asset additions and acquisitions of a new business

Financial Statement Analysis

the examination of both the relationships among financial statement numbers and the trends in those numbers over time Both a Diagnosis of how the company is doing and a prognosis of how it will do in the future

CashFlow to Net Income Ratio

the extent to which accrual accounting assumption and adjustments have been included in computing net income generally the value is greater than one because of significant non cash expenses like depreciation that reduces net income but has no impact on cash flows

Times Interest Earned Ratio

the interest that is available for interest payments to annual interest expenses Operating Profit (Income before interest and taxes)/Annual interest expense

Net realizable value of accounts receivable

the net about that would be received if all receivables considered collectible were collected equal to total accounts receivable - allowance for bad debts

Aging accounts receivable

the process of categorizing each account receivable by the number of days it has been outstanding