The Nature of Accounting

Accounting is the identification, measurement and communication of financial information about economic entities to interested persons
Kieso and Weygandt

Arose from the need to communicate financial information Financial Accounting Standards Board (FASB) is authoritative rule making body
Finance is the Language of Business. Accounting is the Medium of Finance.
Management Simulations, Inc.

Underlying Assumptions
Key Assumptions Double entry Timing-matching principal Accrual accounting Historical cost FASB Standards applied to simulation reports.
Management Simulations, Inc.

Objectives of Financial Reporting

Know how effectively resources are obtained and appropriated Use information to inform investment and credit decisions Identify optimum time to take actions affected by cash flow Balance Sheet
Management Simulations, Inc.

P&L or Income Statement

Cash Flow

Balance Sheet
Identifies what the company owns and who owns it Snapshot of financial health Assets always equal liabilities and net worth combined Accurate for a specific date
Management Simulations, Inc.

Sample Capstone Balance Sheet from Annual Reports

Provides two years data Leverage = Total Assets / Total Equity. Ideal Leverage 1.81 to 2.80 from shareholders perspective Lenders prefer to examine Debt / Assets Managers favor Debt / Equity

Management Simulations, Inc.

The Analyst Report on the website provides coaching on Financial Structure

Capstone Balance Sheet Survey

The Capstone Courier provides each teams Balance Sheet summary on Page 3

Strategic intentions may be inferred based on profile

Management Simulations, Inc.

Example a team with a large Plant & Equipment line may be adopting a cost leadership, high volume position

Profit and Loss Statement or Income Statement

Compares revenues and expenses for a given period Movie of financial health Shows activity over a period of time Indicates the profitability of an organization

Management Simulations, Inc.

Income Statement Survey from Capstone Courier

Compare your team against competitors Is your variable costs to sales comparison above or below average? Do your SG&A expenses relative to sales reflect good rates of return?

Management Simulations, Inc.

Simulation Sample Proforma Income 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
Management Simulations, Inc.

Red number bad, black number - good

Cash Flow Statement

Shows movement of cash in and out of an organization over a given period Shows how much cash is available for use during a given period Reconciles net profit back to cash

Management Simulations, Inc.

Sample Capstone Cash Flow Statement

Provides two years data Common causes for emergency loans:
Excessive inventory resulting from poor sales forecasts Making Plant & Equip upgrades w/o raising sufficient capital Operating losses

1)

2)

3)
Management Simulations, Inc.

Introduction to Ratios
A financial ratio shows the relationship between two financial measures Developed by dividing one measure into another Provide insights into companys operations and strategy Four categories: liquidity, solvency, market value, profitability Used internally to evaluate performance and set goals Used externally to make investment decisions
Management Simulations, Inc.

Ratios Report Sample from Spreadsheet Proformas

Your spreadsheet program creates a Proforma Ratios Report based on your sales forecasts and tactical decisions.

Management Simulations, Inc.

Are your decisions maximizing the Success Measurements (ROE, ROS, ROA, Stock Price, Asset Turnover, Market Capitalization) you chose (or were

Asset Turnover

Reveals how effective assets are at generating sales revenue.

Asset Turnover =

sales assets

Management Simulations, Inc.

Return on Sales
ROS indicates the percentage of each sales dollar that results in net income.

Return on Sales =

net profit net sales

Management Simulations, Inc.

Return on Assets
ROA measures a companys ability to use all its assets to generate earnings.

Return on Assets =

net profit assets

Management Simulations, Inc.

Leverage
Leverage shows the debt level of the organization.

Leverage =

assets equity

Management Simulations, Inc.

Return on Equity
Return on Equity highlights for the stockholders the return on their investment.

Return on Equity =

net profit equity

Management Simulations, Inc.

Du Pont Formula
Value Chain

Return on Equity = net profit sales

Management Simulations, Inc.

net profit equity

sales assets

assets equity

Du Pont Formula
Value Chain

Return on Equity = net profit sales

Management Simulations, Inc.

net profit equity

sales assets

assets equity

Du Pont Formula
Value Chain

Return on Equity = net profit sales Return on Sales sales assets Asset Turnover

net profit equity

assets equity Leverage

Management Simulations, Inc.

Du Pont Formula TI vs. HP

Current Assets Fixed Assets Sales = 4.07 Net Income Shareholder Equity = 1.29 = 1.11 = .37 = 1.16

Management Simulations, Inc.

Texas Instruments

Hewlett Packard

Du Pont Formula TI vs. HP

Current Assets Fixed Assets Sales = 4.07 Net Income Shareholder Equity Turnover x ROS = ROA x Leverage = ROE
Management Simulations, Inc.

= 1.29 = 1.11 = .37 = 1.16 1.69 9.3% 15.7% 2.07 32.5%

Texas Instruments

Hewlett Packard

Du Pont Formula TI vs. HP

Current Assets Fixed Assets Sales = 4.07 Net Income Shareholder Equity Turnover x ROS = ROA x Leverage = ROE
Management Simulations, Inc.

= 1.29 = 1.11 = .37 = 1.16 1.69 9.3% 15.7% 2.07 32.5%

Current Assets Fixed Assets Sales = 3.09 Net Income Shareholder Equity

= 1.49 = .84 = .52 = 1.54

Texas Instruments

Hewlett Packard

Du Pont Formula TI vs. HP

Current Assets Fixed Assets Sales = 4.07 Net Income Shareholder Equity Turnover x ROS = ROA x Leverage = ROE
Management Simulations, Inc.

= 1.29 = 1.11 = .37 = 1.16 1.69 9.3% 15.7% 2.07 32.5%

Current Assets Fixed Assets Sales = 3.09 Net Income Shareholder Equity Turnover x ROS = ROA x Leverage = ROE

= 1.49 = .84 = .52 = 1.54 1.33 16.9% 22.4% 1.52 33.8%

Texas Instruments

Hewlett Packard