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Lecture Financial accounting (10th edition): Chapter 5 - Pratt, Peters

Chapter 5 - Using financial statement information. In this chapter students will be able to: Describe the two basic uses of financial statements, describe the four elements of successful companies and how they link to the company’s overall financial performance. | 2 Chapter 5: Using Financial Statement Information 3 Describe the two basic uses of financial statements. Learning Objective 1 4 Control and Prediction Financial accounting numbers are useful in two fundamental ways: They help investors and creditors influence and monitor the business decisions of a company’s managers. They help to predict a company’s future earnings and cash flows. 5 Financial Accounting Numbers as Prediction Aids Financial statements do not reflect the company’s prospects within its business environment Statements are backward looking, not focusing on the future prospects. Financial statements are inherently limited Statements leave out some current and historical information such as human resources and the effects of inflation. Management prepares the financial statements in a biased manner Managers often choose accounting methods and estimates that make them look good. 6 Concept Practice 1 7 Describe the four elements of successful companies and how they link to | 2 Chapter 5: Using Financial Statement Information 3 Describe the two basic uses of financial statements. Learning Objective 1 4 Control and Prediction Financial accounting numbers are useful in two fundamental ways: They help investors and creditors influence and monitor the business decisions of a company’s managers. They help to predict a company’s future earnings and cash flows. 5 Financial Accounting Numbers as Prediction Aids Financial statements do not reflect the company’s prospects within its business environment Statements are backward looking, not focusing on the future prospects. Financial statements are inherently limited Statements leave out some current and historical information such as human resources and the effects of inflation. Management prepares the financial statements in a biased manner Managers often choose accounting methods and estimates that make them look good. 6 Concept Practice 1 7 Describe the four elements of successful companies and how they link to the company’s overall financial performance. Learning Objective 2 8 Overall Financial Performance Leverage Looks at capital structure Using borrowed funds (debt) to produce revenues for the shareholders. Solvency The ability to meet payments as they come due Asset Quality The extent to which assets generate revenues Expense Control Expenses must be managed and minimized where possible 9 Figure 5-3 Capital Flows 10 Using borrowed funds to generate returns for shareholders is called a. leverage. b. profitability. c. taking a bath. d. solvency. 11 Identify a financial ratio package for each of the four elements of successful companies and use the ratios to analyze company performance. Learning Objective 3 12 Analyzing the Financial Statements Comparisons across time Comparisons within the industry Comparisons within the financial statements: common-size statements and ratio analysis Leverage ratios Solvency ratios Asset quality ratios Expense control ratios Overall performance ratios .