You are on page 1of 22

# Formulas and Ratios 10/20/2014 1:20:00 AM

## - Gross Profit = Sales Revenue Cost of Goods Sold

- Net Profit = Gross Profit Other Expenses
Therefore: Net Profit = Sales Revenue Cost of Goods Sold
Other Expenses
- Assets = Liabilities Owners Equity
- Assets Liabilities = Owners Equity
- Profit (or Loss) = Revenue Expenses
- Return on Assets = net income 20x2 / total assets 20x1
- Gross Profit Margin = (Revenue COGS) [or Gross Profit] / Revenue
10/20/2014 1:20:00 AM

## Gross Profit = Sales Revenue Cost of Goods Sold

10/20/2014 1:20:00 AM
10/20/2014 1:20:00 AM

## Depreciation Everything except land is depreciated

Straight Line Same amount every year.
o EG. \$100 000 purchase
o Useful life of 4 years
o Residual Value \$20 000
o Ergo, \$20 000 per year, by 4 years, gives \$80 000
depreciation
Reducing Balance Depreciation Declines more earlier on
o Useful life (residual value / cost of asset)
o Usually use 1.5x or 2x straight line.
o EG. Depreciates over 10 yrs, loses \$100 000 (straight line
= \$10 000 p/yr
o Year 1 - \$100 000 x 15% - \$15 000 depr
o Year 2 - \$85 000 x 15% - \$12 750 depr etc.
Limited life depreciation = Amortisation
Useful Life
Potential
o Physical Life (wear and tear)
o Technical Life (motor vehicle lasts 10-15 yrs, only good for
5 yrs before no longer cost effective)
o Commercial Life (before becomes redundant)
o Legal Life (patents)
Units of Production Method ([cost - estimated residual value] /
estimated total units)
o Hours on a machine
o Kms on a vehicle
o Hours on plant machinery
o EG \$100 000 minus \$20 000 (\$80 000) over 8000 hours =
\$10 per machine hour
o EG \$30 000 - \$2 000 (\$28 000) over 100 000 kms = \$0.28
p/km

Assets
Installing, testing etc is all included in asset value (eg. Transport,
building, installation, interest costs-IF manufactured OVER 12
months)
o In a home and land purchase, they must be valued
separately, so that land stays put and house can be
depreciated.
o Fair Value
Where a valuation is scaled back (percentage wise)
due to mismatch between valuation and purchase
price.
Intangible Assets
Some software (office package yes, operating system no)
Patents
Franchises
Purchased Goodwill (ONLY when purchased difference between
net assets and purchase price [when \$\$\$ is OVER net assets])
Liabilities
A present obligation to another party, requiring the sacrifice of
future economic benefits, resulting from past transaction
o Recognised only when we can measure accurately
Non-Current Liabilities
o Loan
o Bonds
o Long Service Leave Payable
o Warranties Payable
o Finance Leases
Debtors, Creditors, Accurals and Prepayments10/20/2014 1:20:00
Difference between write-off method (when they go bad) and allowance
method (allowance set aside per sale or aged debtors method) for bad
debts
The matching principle. One allows for revenue/expence to be
matched in the same period, the write-off method does not
match sale and expense in the same period.
Allowance for doubtful debts is a contra-asset account as it reduces the
value of assets accounts receivable stays the same until debt is written
off, then goes down by amount
Prepayment an outlay you have not yet received the benefits from
Account is an asset paid through cash at bank or accounts
payable account, when used, asset goes down, appears in
expenses
Internal Control of Cash Statement of Cash Flows
and Other Issues 10/20/2014 1:20:00 AM
ACCRUAL ACCOUNTING
Accrual - expenses incurred and not yet paid
Unearned revenue paid in advance, without supplying goods/services
Statement of cash flow required as profit does not equal the cash

CASH FLOW STATEMENT Shows where the money came from and
where its going. (net cash flow will be positive or negative)
Indicates companys ability to:
Meet obligations (liabilities etc)
Prosper and grow
Obtain external financing
If unable to keep this, business fails
Bills paid with cash not profit, profitable business can struggle to pay bills
Cash represents cash on hand and demand deposits (something to be
converted into cash within 3 months)
Owed \$10 at start
Owed \$15 at the end
Acc. Rec has gone up \$5, so they paid \$5 less then what they bought
10 + 20 -15 = 15
Same in reverse
Cash collected = sales revenue increase in acc. Rec.
OR
Cash collected = sales revenue + decrease in acc. Rec.
Profit and Loss as well as Balance Sheet required to calculate Cash Flow!!!
OPERATING ACTIVITIES Strictly Cash
taxes, supplier payments, rent etc.
INVESTING ACTIVITIES
FINANCING ACTIVITIES
Issue of shares, debentures share buybacks, dividends paid,
redemption of debentures etc.
Cash Flow Statement = Change in Cash at Bank Account on Balance
Sheet
Cash paid to suppliers
Inventory = cost of goods sold + increase in inventory OR
= cost of goods sold decrease in inventory
Cash paid for inventory
Cash paid = inventory purchased + decrease in accounts payable OR
= inventory purchased increase in accounts payable
Handling of cash and recording of said cash should be kept separate and
completed by different people

EXAMPLES
Cash from Customer Operating
Paid wages Operating
4 Year lease car non cash
paid interest operating
issued debentures financing
issued shares financing
sold long term investments investing
paid dividends financing
redeemed debentures financing
issued preference share financing
sold equipment for gain investing (buying/selling non-current assets is
investing)
purchased patents investing
loss on disposal of non-current asset loss (non-cash)
When selling the extra cash comes in, so you have a cash
transaction, when making a loss this is a non cash transaction
Increase in inventory operating
Ar start 200000
Ar end 250000
Sales - 500000
Cash paid 450000

## Land is revalued from 130 000 to 200 000

As the value is unrealized, sits under other comprehensive. (not sold
yet) this is under owners equity
Balance sheet land increases 70 000 and reserve increases 70 000
Comp income re-eval surplus increases 70 000
Cash flows nothing, no cash
Paid back loan of 80 000
Reduce loan payable 80 000
Cash down 80 000
Financial Statement Analysis 10/20/2014 1:20:00 AM

## Profits need to be compared to other values to be put in perspective.

Straight dollar values do not show progression or efficiency.
Profits are often compared to sales, previous profits etc.
Why?
Identify problems
Investment decisions
Compare against
Itself over time
Industry
Benchmarks
Competitors
Horizontal analysis - Goes across the statements years to years
Eg. 200 000 to 280 000 80 000 / 200 000 x 100 = 40%
increase (change over original value)
(280 000 x 100) / 200 000 = 140
new year times 100%, divided by base year = percentage of sales
compared to base year. Eg. 140%

Vertical
List total assets then express everything as a percentage of total assets

Trend Analysis
When 3 or more years exist, trend is used to show growth prospects

Ratios
Profitability
o Net profit margin before interest and taxes
Measures profits PRIOR to tax and debts
Net profit margin = (net profit before interest and
taxes x 100) / sales
o Net profit margin
(Net profit x 100) / Sales
o Gross profit margin
Efficiency of management turning over goods for
profit
((Net sales cost of goods sold) x 100) / net sales
o Interest cost as a percentage of sales
(Interest expense x 100) / sales
o Asset turnover
How efficient assets used to generate sales
Assets turnover = sales / average total assets
Returns (on assets, shares etc.)
o Return on assets
o Return on equity
Net profit after tax preference dividend x 100 /
average ordinary shareholders equity
o Earnings per share
Efficiency
o Debtors turnover
Net sales /average debtors
o Average days sales uncollected
Net sales / debtors turnover
Liquidity shows ability to pay debt
o Current ratio
1.5 to 1 or 2 to 1 are good ratios (rule of thumb)
= current assets / current liabilities
o Quick ratio (acid test)
Excludes inventory as this cannot be quickly turned
into cash
= (current assets inventory) / current liabilities
1 to 1 is ok, as inventory will increase that in time
o Cash flows from operations to current liabilities
= operating cash flows / current liabilities
Solvency ratios measures risk associated with how the
o Debt to equity
Total liabilities / total shareholders equity
o Debt to total assets shows assets financed by debt
Total liabilities / total assets
o Leverage Ratio
Total assets / total shareholders equity
o Interest coverage
(Net profit + income tax + interest) / interest
expense
o Cash flow from operations to total liabilities shows ability
to pay debt from operating cash flow
Operating cash flow / total liabilities
Market based ratios
o Price/Earnings ration
Market price per ordinary share / earnings per share
o Earnings yield
Earnings per share / market price per ordinary share
o Dividend yield
Dividends per ordinary share / market price per
ordinary share
Others
o Net tangible asset backing
Net tangible assets / number of ordinary shares
issued
Gearing
Investment

LIMITATIONS
Quality of information can be average
Ratios shown from balance sheet will not represent period as
balance sheet is at not at end
Too summarized
Looking at past data

PROBLEMS
Price changes
Tech changes
Commercial environment
Accounting policies
Base year

## AVERAGE VALUES = (Beginning of period + end of period) / 2

Financing and Business Structures 10/20/2014 1:20:00 AM

## Short Term Finance

o Buys on credit, interest free, may offer discount if paid on
time
Factoring
o Finance company collects accounts receivable company
may be aggressive towards customers and you may lose
them
Eg. GE for Harvey Norman
Bank Overdrafts
o Random borrowing, not set timeframe and bank may
require security over assets
Medium Term Finance
Loans
o More structured form of overdraft
Hire Purchase
o Finance company buys the asset and hires it to the
Leasing
o Operating Lease like leasing a car for two months
o Finance Lease very similar to borrowing then buying the
car
Long Term Finance
Long Term Loans
o Loan from sole entity
Debentures
o Multiple loans from different entities
o Eg. 10M for 5 years at 10%
o Interest is then paid each period

## Working Capital = Current Assets Current Liabilities

Equity Finance
o Limited equity
o Debt financing if owner doesnt have the equity, if
downturn situation is very risky
Partnership
o If one partner cannot pay, other partners pay
Limited Companies
o

## Financing Structures and Financial Risk

Gearing
Summary
Capital Investment Decisions 10/20/2014 1:20:00 AM

## Main User Groups

Shareholders
Management (Top Level Employees)
Banks / Investors
ASIC
Mid-Low Level Employees (mildly)
Financial reports contain standard information which users pick out of it
what they would like. Standard users cannot demand information out of a
business like CEOs etc. can. Some bankers are the exception (auditor
role).
Chairmans Statement summarises the years activities, future predictions
and commonly emphasis the positives.
Ratios
Pre-Set ie. Might have to stick to it
Determined ie. Worked out from figures

## Capital Investment Decisions

Should we invest in a new machine?
Should we buy a new factory?
o Often involves large investments
o Difficult to bail out of once decision is made
o A number of methods available to help assess and make
the decision

## NET PRESENT VALUE - Will be worth 10 million in 10 years time,

backtrack inflation etc. to work out what that is worth today (might be
9.5 million).

## Methods of Project Evaluation

Accounting Rates of Return
o Is measured by the average profit from an investment,
expressed as a percentage of the average investment
Easy to understand
Managers are familiar with the key concepts
Ignores the time value of money
Uses accounting measures of profit rather than
cash flows (USE NET CASH FLOW NOT NET
PROFIT TO GET AROUND THIS)
Two methods may lead to different decisions
(ie. 80% v. 40% in example)
o Formula 1 ARR = (average net profit x 100) / average
book value of investment
o Formula 2 ARR = (average net profit x 100) / total initial
investment value
The two formulas will produce different results. As long as
the one formula is used throughout the project, as well as
competing projects.
Payback Period time required to cover initial investment
o A risk-related measure used in practice to supplement
other techniques
o Other things being equal, if two competing investments
offered similar expected benefits, the one with the shorter
payback period would be preferred.
Internal Rate of Return (not in lecture)
Net Present Value
Recognises the time value of money
Dollars can be added, as they are in present value
Correct ranking of mutually exclusive projects
Dependent on forecast cash flows and opportunity
cist of capital, rather than arbitrary guess by
management
How do we determine the minimum rate of return?
How accurate are forecast cash flows?
Qualitative Factors

MANAGEMENT ACCOUNTING
Present Value Tables
Bring future \$\$\$ back to what its worth today
Future Value Tables
Take todays \$\$\$ into futures value
Annuity
Where each year payments are brought back
Single Amount
One single value (lump sum payment)
Cost Information and Decision Making10/20/2014 1:20:00 AM
Use of Cost Information
Why???
o Control Costs
o Aid Planning
o Value Inventories
o Aid the setting of product prices
Issues with Costing
Two Main issues
o
Cost Objects
Objects can be
o Product
o Customer
o Department
o Project
o Activity (eg. Setting up equipment)
Direct and Indirect Costs
Direct Cost
o Can be traced easily and accurately to a product/service
Indirect Cost
o Not accurately and easily traced to a product/service, eg.
Factory equipment used for multiple products, electricity,
rent etc.
Period Costs and Product Costs
Period Cost
o All costs that are not part of the product costs, eg. Selling,
marketing, electricity of office etc.
Product Costs
o Direct Labour, materials etc. that are all required for the
product directly.
All of our costs (indirect as well) into our product, aims to share
all the costs across all the products equally.
Traditional Volume-Based v. Activity-Based Costing (ABC)
TVB
o Volume based drivers such as machine hours or labour
units.
ABC
o Looks at finer detail with regard to the activities and
relating back to that.
o Usually requires computer software as rather complex!
Absorption v. Variable Costing
Absorption
o Includes variable and fixed costings into product
Variable
o Only variable production costs included
Summary
10/20/2014 1:20:00 AM

Fixed Cost
Cost is fixed and does not change in response to changes in the
level of activity
o EG. Rent, depreciation, salaries etc.
Variable Cost
Cost changes in response to change in activity
o EG. Commissions, hourly labour rates, raw materials

P = Sx [FC + VCx]
P = Expected Profit
S = Selling Price Per Unit
x = Number of Units Sold
FC = Fixed Costs
VC = Variable Costs per Unit

## Contribution Margin = Sales price Variable Costs

Break Even = Contribution Margin Fixed Cost

28000 = 6x
x = 4,666.67

P = 4000

P = 5600

P = 5800 (3,800)

## Contribution Margin Ratio

If CM Ratio is 40% and sales increase \$10000, net profit should increase
\$4000 (if fixed costs remain the same) [60% is the variable cost amount
from each item]
Budgets 10/20/2014 1:20:00 AM

## What are Budgets

Formal written statement of managements plan in specific
financial terms
Planning establishing short and long term objectives
Control Ensuring objectives are achieved
Can also express financial aspects of training etc.
When are Budgets Developed
Yearly, Quarterly, Rolling, can be broken down to time periods
different to the original budget
Who Develops Budgets
Top down free from employee bias
Bottom up Employee empowerment
Why are Budgets Developed
Plans gives direction and gets people thinking about the future
Defines financial objectives provides people with goals
Could shed light on areas that require attention
Gives managers an idea of amount of \$\$\$ to spend
How are Budgets Developed
Incorporate different sections, sections vary based on type of
business, ie. manufacturer, retailer, service based company etc.
Responsibility Accounting
Where company is structured into business units
Should only have responsibility over figures they can control
Preparing Sales Budget

Preparing Cash Collection Budget

Summary
Exam Review / Notes 10/20/2014 1:20:00 AM

## Cash Flow Statements

Operating Involved in normal business activities
Financing Debentures etc
Investing - Buying and Selling Assets

Cash Flows
Budgets
Cost Volume Profit