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Financial Performance Measurement chapter 16
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Foundations of Financial Performance Measurement
OBJECTIVE 1: Describe the objectives, standards of comparison, sources of information, and compensation issues in measuring financial performance.
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Exhibit 1: Selected Segment Information for Goodyear Tire & Rubber Company
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Exhibit 2: Listing from Mergent’s Handbook of Dividend Achievers
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Exhibit 2: Listing from Mergent’s Handbook of Dividend Achievers
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Exhibit 2: Listing from Mergent’s Handbook of Dividend Achievers
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Foundations of Financial Performance Measurement
• Financial performance measurement comprises all the techniques that users of financial statements employ to show relationships in an organization’s financial statements and to relate those relationships to the organization's financial objectives.
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Foundations of Financial Performance Measurement
• Users of financial statements are classified as either internal or external.– Internal users include top managers who set and
strive to achieve financial performance objectives, middle-level managers of business processes, and employee stockholders.
– External users include creditors and investors wanting to assess how well managers accomplished their financial objectives and customers forming cooperative agreements with the company.
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Foundations of Financial Performance Measurement
• Management is responsible for devising, executing, monitoring, and reporting on a complete financial plan for a business that focuses on the following:– Liquidity—ability to pay bills when due and to
meet unexpected needs for cash– Profitability—ability to earn a satisfactory net
income– Long-term solvency—ability to survive for
many years
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Foundations of Financial Performance Measurement
• Management is responsible for devising, executing, monitoring, and reporting on a complete financial plan for a business that focuses on the following: (cont.)– Cash flow adequacy—ability to generate
sufficient cash through operating, investing, and financing activities
– Market strength—ability to increase the wealth of owners
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Foundations of Financial Performance Measurement
• Creditors and investors use financial statement analysis in two ways.– To judge past performance and current position– To judge future potential and the risk
associated with it
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Foundations of Financial Performance Measurement
• Decision makers judge performance in (at least) three ways.– Rule-of-thumb measures– Analysis of past performance– Comparison with industry norms (discuss
limitations)
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Foundations of Financial Performance Measurement
• Source of Information– A company’s annual report provides a
significant amount of information.– Interim financial statements may indicate
recent changes in earnings.
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Foundations of Financial Performance Measurement
• Incentive bonuses and stock options for top executives are typically based on the company's achievement of certain financial goals. For public companies, a compensation committee of independent directors must establish remuneration policy for top-level executives, and the components and criteria used must be reported to the SEC.
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©2011 Cengage Learning All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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Tools and Techniques of Financial Analysis
OBJECTIVE 2: Apply horizontal analysis, trend analysis, vertical analysis, and ratio analysis to financial statements.
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Exhibit 3: Comparative Balance Sheets with Horizontal Analysis
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Exhibit 3: Comparative Balance Sheets with Horizontal Analysis
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Exhibit 3: Comparative Balance Sheets with Horizontal Analysis
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Exhibit 4: Comparative Income Statements with Horizontal Analysis
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Exhibit 4: Comparative Income Statements with Horizontal Analysis
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Exhibit 4: Comparative Income Statements with Horizontal Analysis
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Exhibit 5: Trend Analysis
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Figure 1: Graph of Trend Analysis Shown in Exhibit 5
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Figure 2: Common-Size Balance Sheets Presented Graphically
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Exhibit 6: Common-Size Balance Sheets
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Figure 3: Common-Size Income Statements Presented Graphically
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Exhibit 7: Common-Size Income Statements
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Tools and Techniques of Financial Analysis
• Horizontal analysis shows absolute and percentage changes from one year to the next.– The first of the two years being considered is
called the base year. – The percentage change is computed by
dividing the amount of the change by the base year amount.
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Tools and Techniques of Financial Analysis
• Trend analysis is an application of horizontal analysis over several consecutive years.– This approach uses an index number, with the
base year set at 100 percent, against which changes in related items are measured.
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Tools and Techniques of Financial Analysis
• Vertical analysis calculates percentage relationships within a single statement.– The result is a common-size statement.
• On a common-size balance sheet, total assets and total liabilities and equity in their respective areas of the balance sheet are labeled 100 percent.
• On a common-size income statement, net sales or net revenues are labeled 100 percent.
• Common-size statements can be presented in comparative form.
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Tools and Techniques of Financial Analysis
• Ratio analysis shows meaningful relationships between financial statement components.– Ratios are useful in evaluating a company’s
financial position and operations and in comparing financial data for several years or for several companies.
– The primary purpose of ratios is to identify areas needing further investigation.
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©2011 Cengage Learning All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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Comprehensive Illustration of Ratio Analysis
OBJECTIVE 3: Apply ratio analysis to financial statements in a comprehensive evaluation of a company’s financial performance.
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Figure 4: Starbucks’ Operating Cycle
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Exhibit 8: Liquidity Ratios of Starbucks Corporation
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Exhibit 8: Liquidity Ratios of Starbucks Corporation
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Exhibit 9: Profitability Ratios of Starbucks Corporation
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Exhibit 10: Long-Term Solvency Ratios of Starbucks Corporation
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Exhibit 11: Cash Flow Adequacy Ratios of Starbucks Corporation
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Exhibit 12: Market Strength Ratios of Starbucks Corporation
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Comprehensive Illustration of Ratio Analysis
• Ratio analysis provides information about a company’s liquidity, profitability, long-term solvency, cash flow adequacy, and market strength.
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Comprehensive Illustration of Ratio Analysis
• There are five major types of ratios.– Liquidity ratios
• Current ratio
• Quick ratio
• Receivable turnover
• Days’ sales uncollected
• Inventory turnover
• Average days’ inventory on hand
• Payables turnover
• Average days’ payable
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Comprehensive Illustration of Ratio Analysis
• There are five major types of ratios. (cont.)– Profitability ratios
• Profit margin
• Asset turnover
• Return on assets
• Return on equity
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Comprehensive Illustration of Ratio Analysis
• There are five major types of ratios. (cont.)– Long-term solvency ratios
• Debt to equity ratio
• Interest coverage ratio
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Comprehensive Illustration of Ratio Analysis
• There are five major types of ratios. (cont.)– Cash flow adequacy ratios
• Cash flow yield
• Cash flows to sales
• Cash flows to assets
• Free cash flow
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Comprehensive Illustration of Ratio Analysis
• There are five major types of ratios. (cont.)– Market strength ratios
• Price/earnings ratio
• Dividends yield
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©2011 Cengage Learning All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.