Accounting & Financial Reporting

BUSG 503Michael Dimond

Michael DimondSchool of Business Administration

Financial Accounting for MBAs

• Course Overview• Introductions

• Schedule

• Resources

• How do I get an A in this class?

Michael DimondSchool of Business Administration

Financial Accounting for MBAs

• Accounting Information• Who uses it?

• What does it contain?

• How is it presented?

Michael DimondSchool of Business Administration

Financial Statements

Michael DimondSchool of Business Administration

Basic Financial Analysis

• Financial figures are related, and they can reveal many details about a company, its performance, and its value

• Accounting figures are prepared according to specific rules and certain distortions exist.

• There are so many numbers… where shall we begin?

Michael DimondSchool of Business Administration

Meaningful Ratio Analysis

• Analysis means to break something down to understand it.• Ratio analysis should be used to answer a specific question

or set of questions.

• If you were examining the financial statements for a company, you might start with this basic question:

“Is this a good use of investors’ money?”

• What financial ratio would answer this question?

How about Return on Equity?

• How do you compute Return on Equity (ROE)?

Michael DimondSchool of Business Administration

Analyzing ROE

• ROE = NI ÷ Equity and answers the question, “is this a good use of investors’ money?”

• If you were to break this down, there are three basic questions to answer:

How profitable is this business?

How efficiently are assets being used?

How much does financial leverage help the investors?

• What financial ratios would answer these questions?

Profit Margin (PM)

Total Asset Turnover (TAT)

Equity Multiplier (EM)

Michael DimondSchool of Business Administration

Drivers of ROE

• Profit Margin (PM) = NI ÷ Sales and answers the question, “How profitable is this business?”

• Total Asset Turnover (TAT) = Sales ÷ Total Assets and answers the question, “How efficiently are assets being used?”

• Equity Multiplier (EM) = Total Assets ÷ Equity and answers the question, “How much does financial leverage help the investors?”

Michael DimondSchool of Business Administration

The DuPont Identity

• ROE is directly driven by profitability, efficiency and leverage.

• ROE = PM x TAT x EM

How does that work?

• The numerators and denominators cancel to reduce the equation to NI ÷ Equity

ROE = PM x TAT x EM

NI NI Sales Total AssetsEquity Sales Total Assets Equity

NI NI Sales Total AssetsEquity Sales Total Assets Equity

= x x

= x x

Michael DimondSchool of Business Administration

A word about ROA

• ROA = Return on Assets• What’s the difference between Equity & Assets?

• Leverage

• What’s the difference between ROE & ROA?• Leverage

• ROE = PM x TAT x EM• EM represents leverage

• ROA = PM x TAT• No leverage

Michael DimondSchool of Business Administration

Digging Deeper with Financial Ratios

• How would you analyze profitability, efficiency and leverage?• How do profitability, efficiency and leverage relate?

• What affects profitability?

• What drives sales?

• What is the composition of assets?

• How were assets paid for?

• How are liabilities managed?

• Where shall we begin?

Michael DimondSchool of Business Administration

Common-Size Financial Statements

• Shows each line item as a percent of an appropriate total.• Common-size balance sheet

• % of Total Assets

• Shows the composition of assets

• Liabilities & equity items are also shown as % of total assets

• Debt Ratio = Total Liabilities ÷ Total Assets

• Common-size income statement• % of Sales

• PM = Net Income as % of Sales

Michael DimondSchool of Business Administration

Common-Size Income Statement

100%

5.77%7.19%

Michael DimondSchool of Business Administration

Common-Size Balance Sheet

100%

44.34%45.68%

Michael DimondSchool of Business Administration

We don’t make a common-size CF Statement

There are other ways to examine

relevant information which would be

more helpful

Michael DimondSchool of Business Administration

Vertical & Horizontal Analysis

• Vertical Analysis compares figures as a percent of a relevant total (“common size” financial statements)

• Horizontal Analysis compares the same figure over a series of periods (showing % change or % growth)

Michael DimondSchool of Business Administration

Measuring growth

• Financial figures change from year to year• To find the % change (“% growth”) over a 1-year period,

divide the difference of the two figures by the first year’s value:• [ending – beginning] / [beginning]

OR

• [ending] / [beginning] - 1

• Measuring growth over more than one period means we need to find the average growth during that time.

Michael DimondSchool of Business Administration

Using the SEC website for information