basic equations

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Basic Equations

The Accounting Equation Assets = Liabilities + Equity

This equation tells us two things, 1) Assets (the things a businesshelp it generate profit are either owned by the business (equity) oby the business (liabilities) !) "inancial Accounting is not concerwith re#enues and profit $ts purpose is to %eep accurate records ofinancial transactions that ha#e transpired

The "inancial Equation(s)&e#enue = 'rice olu*e ost = "ied +

ariable $nco*e = &e#enue - ost

The foundation of the "inancial Equation is. $nco*e = &e#enue -/owe#er, in order to perfor* this equation, we *ust first calculat&e#enue ('rice olu*e) and ost ("ied + ariable) $t is therethe 0ob of financial *anagers (and all *anage*ent) to concernthe*sel#es with re#enues, costs and profits Though e*phasis frodepart*ent to depart*ent *ay #ary, *anage*ent *ust concernthe*sel#es with all three enerally spea%ing, both re#enues and*ust increase o#er the *ediu* and long ter*s while costs *ost o*ust be *aintained or decreased o#er the sa*e period

The Financial Statements

2alance 3heetAssets = Liabilities + Equity (a 4snapshot5*o*ent in ti*e)

A financial state*ent that su**ari6es a co*pany7s assets, liabilitiand shareholders7 equity at a specific point in ti*e These three basheet seg*ents gi#e in#estors an idea as to what the co*pany owowes, as well as the a*ount in#ested by the shareholders

$nco*e 3tate*ent$nco*e = &e#enues - ost (o#er a period ofti*e)

A financial state*ent that *easures a co*pany7s financial perforo#er a specific accounting period "inancial perfor*ance is assessgi#ing a su**ary of how the business incurs its re#enues and epthrough both operating and non-operating acti#ities $t also showsnet profit or loss incurred o#er a specific accounting period, typico#er a fiscal quarter or year

ash "low 3tate*entash in and out (o#er a period of ti*e) andadded to (or subtracted fro*) the opening cash#alue

2ecause public co*panies tend to use accrual accounting, the incstate*ents they release each quarter *ay not necessarily reflect cin their cash positions This docu*ent pro#ides aggregate data

regarding all cash inflows a co*pany recei#es fro* both its ongoioperations and eternal in#est*ent sources, as well as all cash outhat pay for business acti#ities and in#est*ents during a gi#en qu

3tate*ent of 3hareholders8Equity

hanges in equity due to such things as netinco*e (or loss), sale (or repurchase) of stoc%and changes in asset #alues since the lastreporting period

Also %nown as 9equity9 and 9net worth9, the shareholders7 equityto the shareholders7 ownership interest in a co*pany $t is co*pris'referred stoc%, Additional contributed (paid-in) capital, o**ostoc%, &etained earnings, :ther ite*s (such as #aluation allowanc

Liquidity Ratios

;or%ing apital &atio urrent Assets < urrent Liabilities The wor%ing capital ratio (urrent Assets


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whether a co*pany has enough short ter* assets to co#er its shordebt Anything below 1 indicates negati#e ; is sufficient%nown as 9net wor%ing capital9

?uic% &atio (Acid Test) (urrent Assets - $n#) < urrent Lliabilities

An indicator of a co*pany8s short-ter* liquidity The quic% ratio*easures a co*pany8s ability to *eet its short-ter* obligations w*ost liquid assets "or this reason, the ratio ecludes in#entoriescurrent assetsThe quic% ratio *easures the dollar a*ount of liquiassets a#ailable for each dollar of current liabilities Thus, a quic%of 1@ *eans that a co*pany has 1@> of liquid assets a#ailable tco#er each 1 of current liabilities The higher the quic% ratio, thethe co*pany7s liquidity position Also %nown as the 4acid-test rati9quic% assets ratio9

Bebt &atios Total Bebt < Total Assets

The debt ratio is the ratio of total debt to total assets, epressed inpercentage, and can be interpreted as the proportion of a co*pan

assets that are financed by debtThe higher this ratio, the *orele#eraged the co*pany and the greater its financial ris% Bebt rati#ary widely across industriesash for its sale Thus, this *etric ada#erage days in in#entory to a#erage days of accounts recei#ablearri#e at a final nu*ber (of days) that co*bines the two

Bebt to Equity &atio Total Liabilities < 3hareholder7s Equity 3ee Asset anage*ent &atios

Asset Turnover Ratios

$n#entory Turno#er

3ales < $n#entory or :3 < A#e $n#entory or(1! *onths ost of &e#enue < ($n#entoriesfro* current year + $n#entories fro* prioryear) < !))

Although the first calculation is *ore frequently used, :3 (cogoods sold) *ay be substituted because sales are recorded at *ar#alue, while in#entories are usually recorded at cost Also, a#eragin#entory *ay be used instead of the ending in#entory le#el to*ini*i6e seasonal factors This ratio should be co*pared againstindustry a#erages A low turno#er i*plies poor sales and, thereforecess in#entory A high ratio i*plies either strong sales or ineffebuying /igh in#entory le#els are unhealthy because they represein#est*ent with a rate of return of 6ero $t also opens the co*pantrouble should prices begin to fall

Accounts &ecei#ableollection 'eriod

A#erage Accounts &ecei#able


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A


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3ales rowth F((Total &e#enue for the current period < Total&e#enue for the last period) - 1) 1>>

Hields period to period sales growth

ross 'rofit rowth F((ross 'rofit for the current period < ross'rofit for the last period) - 1) 1>>

Hields period to period gross profit growth

:perating $nco*e rowth((:perating $nco*e for the current period >

Hields period to period operating inco*e growth

Break Even Analysis

2rea% E#en Analysis in

Inits 2rea% E#en Analysisin 3ales

"ied ost < ontribution per Init (ie 'rice

-ariable ost) "ied ost Epresses ross argin as a percentage of et 3ales

Epenses to &e#enues (Epenses < &e#enues) 1>>This ratio can be perfor*ed for total epenses or for a specific eaccount

Epenses to et 3ales F (Epenses < et 3ales) 1>> This ratio can be perfor*ed for total epenses or for a specific e


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account

The !uPont Pyramid

Bu'ont 'yra*id'rofit argin = 'rofitF profit *argin, for ea*eans the co*pany has a net inco*e of >!> for each dollar of s

Total Asset Turno#er = 3ales


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per share are usually easily found on quote pages as the di#idendin the *ost recent quarter which is then used to calculate the di#iyield Bi#idends o#er the entire year (not including any specialdi#idends) *ust be added together for a proper calculation of B'including interi* di#idends 3pecial di#idends are di#idends whionly epected to be issued once so are not included The total nuof ordinary shares outstanding is so*eti*es calculated using theweighted a#erage o#er the reporting period "or ea*ple. A2co*pany paid a total of !C,>>> in di#idends o#er the last year owhich there was a special one ti*e di#idend totalling @J,!@> A! *illion shares outstanding so its B'3 would be (!C,>>>-@J,!@>)>>,>>> = >>MMJ per share

'rice Earning &atio ('


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;eighted A#erage ost ofapital (;A)

A calculation of a fir*7s cost of capital in which each category ofcapital is proportionately weighted All capital sources - co**onpreferred stoc%, bonds and any other long-ter* debt - are include;A calculation All else equal, the ;A of a fir* increasesbeta and rate of return on equity increases, as an increase in ;Anotes a decrease in #aluation and a higher ris%

;here.

&e = cost of equity &d = cost of debt E = *ar%et #alue of fir*7s equity

B = *ar%et #alue of fir*7sdebt

= E + B E

basic equations

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