14-1 analysis of operating activities electronic presentation by douglas cloud pepperdine university...
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Analysis of Analysis of Operating Operating ActivitiesActivities
Analysis of Analysis of Operating Operating ActivitiesActivities
Electronic Presentation by Douglas Cloud
Pepperdine University
Electronic Presentation by Douglas Cloud
Pepperdine University
Chapter Chapter F14F14
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1. Explain the relationship between product pricing and sales volume in creating revenues and profits.
2. Explain how operating strategy affects a company’s return on assets.
3. Define cost leadership and product differentiation and explain how companies use their strategies to create profits.
ObjectivesObjectivesObjectivesObjectives
Once you have Once you have completed this chapter, completed this chapter, you should be able to:you should be able to:
Once you have Once you have completed this chapter, completed this chapter, you should be able to:you should be able to:
ContinuedContinuedContinuedContinued
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4. Evaluate operating performance by using accrual and cash flow measures.
5. Examine the return on equity and explain how operating, investing, and financing activities are interconnected.
6. Describe the primary components of an accounting system and how they are useful for understanding business activities.
ObjectivesObjectivesObjectivesObjectives
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11ObjectiveObjectiveObjectiveObjective
Explain the relationship between product pricing and sales volume in creating revenues and profits.
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Operating DecisionsOperating DecisionsOperating DecisionsOperating Decisions
Net income = revenues – expenses
Return on assets
= total assets net income
OR
Return on assets
sales net income revenues
sales total assets= x
revenues
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Exhibit 1Exhibit 1Exhibit 1Exhibit 1 Summary of Expected Assets and Expected Operating Results for Mom’s Cookie Company
(in thousands)(in thousands) Assets Initial Investment Operating Results Year 1 Year 2Assets Initial Investment Operating Results Year 1 Year 2
Current assets $1,000 Sales revenues $3,000 $3,600Plant assets 4,000 Cost of ingredients (800) (960)Total assets $5,000 Depreciation (300) (300)
Wages and benefits (700) (700)Other operating exp. (1,000) (1,000)Operating income 200 640Interest expense (20) (20)Pretax income 180 620Income taxes (54) (186)Net income $ 126 $ 434
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22Explain how operating strategy affects a company’s return on assets.
ObjectiveObjectiveObjectiveObjective
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Developing an Developing an Operating StrategyOperating Strategy
Developing an Developing an Operating StrategyOperating Strategy
Profit margin =Net income
Sales revenue
Profit margin is a measure of a company’s ability to
create profit from its sales.
Profit margin is a measure of a company’s ability to
create profit from its sales.
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Developing an Developing an Operating StrategyOperating Strategy
Developing an Developing an Operating StrategyOperating Strategy
Asset turnover =Sales revenue
Total assets
Asset turnover is a measure of of a company’s ability to generate sales
from its investment in assets.
Asset turnover is a measure of of a company’s ability to generate sales
from its investment in assets.
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Developing an Developing an Operating StrategyOperating Strategy
Developing an Developing an Operating StrategyOperating Strategy
Return on assets =
Return on assets is the profit margin multiplied
by the asset turnover.
Return on assets is the profit margin multiplied
by the asset turnover.
Profit margin x Asset turnover
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Developing an Developing an Operating StrategyOperating Strategy
Developing an Developing an Operating StrategyOperating Strategy
If return on assets is low, a company must sell a lot of its
products to earn a reasonable profit.
If return on assets is low, a company must sell a lot of its
products to earn a reasonable profit.
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Expected Profit Margin for Expected Profit Margin for Mom’s Cookie CompanyMom’s Cookie Company
Expected Profit Margin for Expected Profit Margin for Mom’s Cookie CompanyMom’s Cookie Company
$126,000
$3,000,000= 4.2%
Year 1Year 1
Sales revenueProfit
Margin Net income
=
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Expected Profit Margin for Expected Profit Margin for Mom’s Cookie CompanyMom’s Cookie Company
Expected Profit Margin for Expected Profit Margin for Mom’s Cookie CompanyMom’s Cookie Company
Sales revenueProfit
Margin Net income
=
Year 2Year 2
$434,000
$3,600,000= 12.06%=
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Expected Asset Turnover for Expected Asset Turnover for Mom’s Cookie CompanyMom’s Cookie Company
Expected Asset Turnover for Expected Asset Turnover for Mom’s Cookie CompanyMom’s Cookie Company
Year 1Year 1
Total assetsAsset
TurnoverSales revenue
=
$3,000,000
$5,000,000= 0.60=
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Expected Asset Turnover for Expected Asset Turnover for Mom’s Cookie CompanyMom’s Cookie Company
Expected Asset Turnover for Expected Asset Turnover for Mom’s Cookie CompanyMom’s Cookie Company
Year 2Year 2
Total assetsAsset
TurnoverSales revenue
=
$3,600,000
$5,000,000= 0.72=
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Year 1Year 1
$126,000
$5,000,000= 2.52%=
Total assetsReturn on
assets Net income
=
Expected Return on Assets Expected Return on Assets for Mom’s Cookie Companyfor Mom’s Cookie CompanyExpected Return on Assets Expected Return on Assets
for Mom’s Cookie Companyfor Mom’s Cookie Company
or 4.2% x 0.60 = 2.52%
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Expected Return on Assets Expected Return on Assets for Mom’s Cookie Companyfor Mom’s Cookie CompanyExpected Return on Assets Expected Return on Assets
for Mom’s Cookie Companyfor Mom’s Cookie Company
or 12.06% x 0.72 = 8.68%
Year 2Year 2
Total assetsReturn on
assets Net income
=
$434,000
$5,000,000= 8.68%=
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33Define cost leadership and product differentiation, and explain how companies use these strategies to create profits.
ObjectiveObjectiveObjectiveObjective
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Exhibit 4Exhibit 4Exhibit 4Exhibit 4 Profit Margin, Asset Turnover, and Return on Assets for Krispy Kreme and Starbucks
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Cost Leadership and Product Cost Leadership and Product Differentiation StrategiesDifferentiation Strategies
Cost Leadership and Product Cost Leadership and Product Differentiation StrategiesDifferentiation Strategies
Companies that keep their prices low to generate high
sales volume use a cost leadership strategy.
Companies that keep their prices low to generate high
sales volume use a cost leadership strategy.
High profit margin companies use a product differentiation strategy.
High profit margin companies use a product differentiation strategy.
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Cost Leadership and Product Cost Leadership and Product Differentiation StrategiesDifferentiation Strategies
Cost Leadership and Product Cost Leadership and Product Differentiation StrategiesDifferentiation Strategies
They compete by offering products with special
features or qualities that customers are willing to buy.
They compete by offering products with special
features or qualities that customers are willing to buy.
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Cost Leadership and Product Cost Leadership and Product Differentiation StrategiesDifferentiation Strategies
Cost Leadership and Product Cost Leadership and Product Differentiation StrategiesDifferentiation Strategies
Starbucks is closer to using product
differentiation than is Krispy Kreme.
Starbucks is closer to using product
differentiation than is Krispy Kreme.
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Exhibit 5Exhibit 5Exhibit 5Exhibit 5 Cost Leadership and Product Differentiation as Alternative Operating Strategies
Operating Strategy Profit Margin Asset TurnoverOperating Strategy Profit Margin Asset Turnover Operating Strategy Profit Margin Asset TurnoverOperating Strategy Profit Margin Asset Turnover Cost Leadership Low High
Product Differentiation High Low
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Cost Leadership and Product Cost Leadership and Product Differentiation StrategiesDifferentiation Strategies
Cost Leadership and Product Cost Leadership and Product Differentiation StrategiesDifferentiation Strategies
Cost leadership companies typically buy and sell in
high volume.
Cost leadership companies typically buy and sell in
high volume.
Advertising often emphasizes low prices and convenient
one-stop shopping.
Advertising often emphasizes low prices and convenient
one-stop shopping.
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44Evaluate operating performance by using accrual and cash flow measures.
ObjectiveObjectiveObjectiveObjective
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Comparing Accrual and Cash Flow Comparing Accrual and Cash Flow Measures of Operating PerformanceMeasures of Operating PerformanceComparing Accrual and Cash Flow Comparing Accrual and Cash Flow Measures of Operating PerformanceMeasures of Operating Performance
If a company does not convert its profits into cash, the profits are a misleading
performance indicator.
If a company does not convert its profits into cash, the profits are a misleading
performance indicator.
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Comparing Accrual and Cash Flow Comparing Accrual and Cash Flow Measures of Operating PerformanceMeasures of Operating PerformanceComparing Accrual and Cash Flow Comparing Accrual and Cash Flow Measures of Operating PerformanceMeasures of Operating Performance
The ratio of operating cash flow to total assets is useful for
comparing the operating cash flows of different companies.
The ratio of operating cash flow to total assets is useful for
comparing the operating cash flows of different companies.
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Exhibit 6Exhibit 6Exhibit 6Exhibit 6 A Comparison of Operating Cash Flows for Krispy Kreme and Starbucks
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Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Inventory turnover is the ratio of cost of good
sold to inventory. It measures the success of a
company in converting its investment in
inventory into sales.
Inventory turnover is the ratio of cost of good
sold to inventory. It measures the success of a
company in converting its investment in
inventory into sales.
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Exhibit 7Exhibit 7Exhibit 7Exhibit 7 Selected Financial Statement Information and Ratios
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Inventory turnover = Cost of goods sold
Inventories
$150,414,000
$12,031,000 12.50 =
Krispy Kreme—2001Krispy Kreme—2001
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
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Inventory turnover = Cost of goods sold
Inventories
$1,175,787,000
$221,253,000 5.31 =
Starbucks—2001Starbucks—2001
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
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Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
A ratio related to inventory turnover is day’s sales in
inventory, the ratio of inventory to average daily
cost of goods sold.
A ratio related to inventory turnover is day’s sales in
inventory, the ratio of inventory to average daily
cost of goods sold.
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Exhibit 7Exhibit 7Exhibit 7Exhibit 7 Selected Financial Statement Information and Ratios
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Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Day’s sales in inventory
Inventory
Cost of good sold ÷ 365
$12,031,000
$412,093 29.19 =
Krispy Kreme—2001Krispy Kreme—2001
=
$150,414,000$150,414,000÷ 365÷ 365
$150,414,000$150,414,000÷ 365÷ 365
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Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Day’s sales in inventory
Inventory
Cost of good sold ÷ 365
$221,253,000
$3,221,334 68.68 =
Starbucks—2001Starbucks—2001
=
$1,175,787,000$1,175,787,000÷ 365÷ 365
$1,175,787,000$1,175,787,000÷ 365÷ 365
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Accounts receivable turnover measures the success of a company’s
ability to convert revenues into cash.
Accounts receivable turnover measures the success of a company’s
ability to convert revenues into cash.
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
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Exhibit 7Exhibit 7Exhibit 7Exhibit 7 Selected Financial Statement Information and Ratios
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Sales revenueAccounts receivable
$300,715,000$19,855,000
15.15 =
=
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Krispy Kreme—2001Krispy Kreme—2001
Accounts receivable turnover
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Accounts receivable turnover
$2,648,980,000 $90,425,000
29.29 =
=
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Starbucks—2001Starbucks—2001
Sales revenueAccounts receivable
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Gross profit margin measures efficiency in the production or purchase of
goods for sale.
Gross profit margin measures efficiency in the production or purchase of
goods for sale.
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
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Exhibit 7Exhibit 7Exhibit 7Exhibit 7 Selected Financial Statement Information and Ratios
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Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Gross profitSales revenue
$150,301,000$300,715,000
50.0% =
=
Krispy Kreme—2001Krispy Kreme—2001
Gross profit margin
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Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Gross profitSales revenue
$1,473,193,000$2,648,980,000
55.6% =
=
Starbucks—2001Starbucks—2001
Gross profit margin
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Operating profit margin is an indicator
of a company’s efficiency in controlling
operating costs other than product costs.
Operating profit margin is an indicator
of a company’s efficiency in controlling
operating costs other than product costs.
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
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Exhibit 7Exhibit 7Exhibit 7Exhibit 7 Selected Financial Statement Information and Ratios
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Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Operating incomeSales revenue
$23,507,000$300,715,000
7.8% =
=
Krispy Kreme—2001Krispy Kreme—2001
Operating profit margin
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Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
Further Evaluation of Further Evaluation of Operating StrategyOperating Strategy
=Operating profit
margin
$281,094,000$2,648,980,000
10.6% =
Starbucks—2001Starbucks—2001
Operating incomeSales revenue
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55Examine return on equity and explain how operating, investing, and financing activities are interconnected.
ObjectiveObjectiveObjectiveObjective
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Net income
Equity
Net income
Equity
Linking Operating and Investing Linking Operating and Investing Activities with Financing ActivitiesActivities with Financing ActivitiesLinking Operating and Investing Linking Operating and Investing
Activities with Financing ActivitiesActivities with Financing Activities
Return on Equity
Return on Equity
Profit Margin
Profit Margin
Financial Leverage
Financial Leverage
Asset Turnover
Asset Turnover= x x
Sales Revenues
Total Assets
Sales Revenues
Total Assets
Net income
Sales Revenues
Net income
Sales Revenues
Total Assets
Equity
Total Assets
Equity
= x x
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Linking Operating and Investing Linking Operating and Investing Activities with Financing ActivitiesActivities with Financing ActivitiesLinking Operating and Investing Linking Operating and Investing
Activities with Financing ActivitiesActivities with Financing Activities
Another ratio to measure financial risk is times
interest earned.
Another ratio to measure financial risk is times
interest earned.
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Exhibit 7Exhibit 7Exhibit 7Exhibit 7 Selected Financial Statement Information and Ratios
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Linking Operating and Investing Linking Operating and Investing Activities with Financing ActivitiesActivities with Financing ActivitiesLinking Operating and Investing Linking Operating and Investing
Activities with Financing ActivitiesActivities with Financing Activities
Operating incomeInterest expense
$23,507,000$607,000
38.73 =
=
Krispy Kreme—2001Krispy Kreme—2001
Times interest earned
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Linking Operating and Investing Linking Operating and Investing Activities with Financing ActivitiesActivities with Financing ActivitiesLinking Operating and Investing Linking Operating and Investing
Activities with Financing ActivitiesActivities with Financing Activities
$281,094,000$2,087,000
134.71* =
Starbucks—2001Starbucks—2001
Times interest earned
Operating incomeInterest expense
=
*Rounded
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66Describe the primary components of an accounting system and how they are useful for understanding business activities.
ObjectiveObjectiveObjectiveObjective
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The Big PictureThe Big PictureThe Big PictureThe Big Picture
A business is a transformation process in which—
(1) financial resources are obtained through financing activities,
(2) financial resources are used to acquire other resources through investing activities, and
(3) resources are used to produce and sell goods and services through operating activities.
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Exhibit 8Exhibit 8Exhibit 8Exhibit 8 Accounting and Business Decisions
Transformation Process
ActivitiesActivitiesInvestingInvesting
FinancingFinancing OperatingOperating
Accounting System
InformationInformationInvestingInvesting
FinancingFinancing OperatingOperating
Decision Makers
DecisionsDecisionsInvestingInvesting
FinancingFinancing OperatingOperating
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Exhibit 9Exhibit 9Exhibit 9Exhibit 9 The Accounting Information System
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The Accounting CycleThe Accounting CycleThe Accounting CycleThe Accounting Cycle
1. Examining business activities2. Recording transactions3. Updating account balances4. Making end-of-period adjustments5. Preparing financial statements6. Closing revenue and expense
accounts
Steps in the accounting cycle include:
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Exhibit 10Exhibit 10Exhibit 10Exhibit 10 Using Accounting Information to Make Decisions About Company Value
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THE ENDTHE END
CCHAPTERHAPTER F14 F14
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