The Accounting Equation

ASSETS = LIABILITIES + EQUITY

ASSETS Liabilities Equity

DR CR DR CR Combined Capital Retained Earnings
NB NB
Stock - Dividends + Revenues - Expenses
DR CR DR CR DR CR DR CR
NB NB NB NB
 Cash  Accounts payable Positive Negative Positive Negative
 Receiveables  Notes Payable
 Notes Receivable  Accrued Liability
 Prepaid Expenses  Unearned Revenue
 Equipment,
Furniture, Fixtures
 Building
 Land

Debt Ratio: total liabilities/total assets

ROA = net income/avg total assets
Avg total assets = beginning total assets/ending total assets
Current Ratio = total current assets/total current liabilities
INCOME STATEMENT BALANCE SHEET

COMPANY NAME COMPANY NAME

INCOME STATEMENT Balance Sheet
Month Ending ______________ Date (last day of the month)
Revenues:
Service Revenues ________________ ASSETS Liabilities
Cash ________ Accounts Payable _______
Expenses: Accounts Receivable ________ Unearned Revenue _______
Rent Expenses ________________ Office Supplies ________
Salaries Expenses ________________ Furniture ________ Total Liabilities ________
Utilities Expenses ________________ Equipment ________
TOTAL Expenses _________________ Land ________ Stockholders Equity
Common Stock ________
Net Income _________________ Retained Earnings ________
Total Stockholder Equity ________

Total Assets ________ Total Liabilities & Stockholder Equity ________

 STATEMENT OF RETURNED EARNINGS
COMPANY NAME
Statement of Returned Earnings
Month Ending ______________ Sales Revenue IS/CR
Sales Returns and Allowances IS/DB
Retained Earnings, (beginning date) _________
Net income for month _________ ( + ) Sales Discounts IS/DB
_________ Cost of Goods Sold IS/DB
Dividends _________ ( - )
Returned earnings (end date) _________

ADJUSTED TRIAL BALANCE

INCOME SHEET BALANCE SHEET

Debit Credit Debit Credit Debit Credit
Cash * *
Accounts Recievable * *
Office Supplies * *
Equipment * *
Accumulated Depreciation Equipment * *
Furniture * *
Accumulated Depreciation Furniture * *
Land * *
Accounts Payable * *
Unearned Revenue * *
Salaries Payable * *
Common Stock * *
Dividends * *
Service Revenue * *
Rent Expense *
Utilities Expense * *
Supplies Expense * *
Salaries Expense * *
Depreciated Equipment * *
Depreciated Furniture * *
* *
TOTAL

Must be equal Must be equal Must be equal Must be equal

USING RATIOS TO ANALYZE A BUSINESS

NORM
Evaluating the Working Capital. Working capital = Current Ratio (ability to pay current CR = Total current High ratio means business has sufficient current 1.5 – 1.9
Measures ability to Current assets – liabilities with current assets) assets/Total current liabilities assets to maintain normal business operations
ability to pay current liabilities
meet short term Cash Ratio (determines a company’s CR = Cash + Cash Too high means not enough cash invested in less 1 but
current liabilities obligations with equivalents / Total current company. To low doesn’t give investors’
ability to meet its short-term obligations) greater than
current assets liabilities confidence the company has the ability to repay
short term debts 0
Acid Test Ratio (can they pay if all = Cash + short term Target is 0.9 to 1.0
liabilities came due immediately) investments + net current
receivables/total current
liabilities
Evaluating the Inventory # of times company sells its avg level of = COGS/Average merchandise High number means ease of turning over
merchandise in a year inventory (beg merch inv+end inventory. Low number means problems
ability to sell turnover merch inv/2)
merchandise Day’s sales in Average # of days merchandise inventory 365/inventory turnover Must be compared against industry standard
inventory and is held by the company
inventory
collect Gross profit AKA Gross margin Reflects the ability to earn a profit on = gross profit/net sales Increase signals growth decrease signals
receivables goods sold. revenue trouble
Percentage
Accounts Number of times a company collects the = net credit sales/average net High ratio means fast cash collections but too
average receivables balance in a year account receivables. (beg acct high means credit is too tight.
receivable receiavalbe + end acct
turnover ratio receivable/2)
Day’s sales in AKA collection Number of days it takes to collect avg = 365 / accounts receivable This number should be close to the # of days
period level of receivables. turnover ratio customers have to pay their bill.
receivables
Evaluating the Debt ratio Proportion of assets financed with debt = Total liabilities / total assets Higher the ratio, higher the financial risk of the 57 – 67 is avg
company
ability to pay Financial leverage Proportion of total liabilities vs total = total liabilities / total equity Higher number = greater financial risk
Debt to equity
long-term debt equity
ratio
Times interest AKA interest- Measures the companies ability to pay = net income + income tax High means ease in paying interest. Low means 2 – 3 is avg.
coverage ratio interest expense expense + interest expense / difficulty paying interest and therefore
earned ratio interest expense problems
Evaluating Profit margin How much net income earned on each = net income / net sales Higher the number, the more profits are made
dollar of sales
profitability ratio
Rate of return Measures success is using assets to earn = net income + interest Higher is better and must be compared to
profit expense / avg total assets industry standard
on total assets (beg + end / 2)
Asset turnover How well the company is using its assets = net sales / avg total assets Want this to be fairly high. Look at industry
to generate sales revenue (beg + end / 2) standards also.
ratio
Rate of return AKA return on How much income is earned for every = net income – preferred This number is compared to interest rates to 15 – 20%
equity dollar invested by stockholders dividends / avg common determine which way is better for growth.
on common stockholders equity (beg +
Stockholders end / 2)
equity
Earnings per EPS Amount of net income for each share of = net income – preferred Compare year to year for increase of this # Look for 15 –
outstanding common stock dividends / weighted avg # of 20% increase
share common shares outstanding
Evaluating stock Price/Earnings P/E Ratio of the market price of a share of = market price per share of Compare year over year and look for upward
common stock to the company’s common stock / earnings per trends against industry standards.
as an investment Ratio earnings per share share
Dividend Yield Measures the percentage of a stock’s = annual dividend per share / Watch for value of return and also growth of
market value that is returned annually to market value per share overall stock price. Both are values.
stockholder’s as dividends
Dividend Payout Measures the percentage of earnings = annual dividend per share / Compare year to year.
paid out annually to common earnings per share
stockholders as cash dividends

RED FLAGS Movement of Sales, These should all move together. Increased sales lead to higher receivables and may require more merchandise inventory (or a higher inventory turnover) to meet
merchandise inventory demand. Unexpected or inconsistent movements among sales, merchandise inventory and receivables make the financial statements look suspect.
and receivables
Earning Problems Has net income decreased significantly for several years in a row? Did the company report net income inprevious years but now is reporting net loss? Most
companies cannot survive losses year after year.
Decreased cash flow Cash flow validates net income. Is net cash flow from operating activities consistently lower than net income? If so, the company is in trouble. Are the sales of plant
assets a major source of cash? If so, the company may face a cash shortage.
Too much debt How does the company’s debt ratio compare to that of major competitors? If the debt ratio is too high, the company may be unable to pay it debts.
Inability to collect Are days’ sales in receivables frowing faster than for competitors? If so, a cash shortage may be looming.
receivables
Buildup of Is inventory turnover too slow? If so, the company may be unable to sell goods, or it may be overstating merchandise inventory.
merchandise
inventories