Josh Campbell

INDIE 250, 1328432

Chapter 2
Accounting and Financial Decision Making
2.1- Accounting: the Basis of Decision Making
Net Worth is when you add assets (cash, investments, and pension plans) and subtract
your liabilities (debts)
Accounting is the information system that measures business activities, processes the
resulting info into reports and communicates the health to decision makers.

2.2 Financial Status for Businessmen

All business prepare an annual report for stockholders which is crazy important.
Describes future prospects as well as current health of company.
Engineers primary responsibility is to plan for acquisition of equipment that will allow
firm to produce goods economically. This will affect the bottom line (profitability) which
will affect the firms stock price.

2.2.1 The Balance Sheet

o A Balance Sheet Statement or Statement of financial position reports on 3
categories, liabilities, assets and stockholders equity. Assets are arranged
according to liquidity most liquid at top, least on bottom. Cash is listed first.
Liabilities arranged in order of payment, most pressing at top.
o Liabilities + owners equity = Assets
o Current Assets can be converted to cash in one year. Included in this category
is cash in bank, Accounts receivable which is money owed to the company but
not yet collected. Last in current assets is inventories which is money invested
in raw materials, works in progress or finished goods available for sale

Josh Campbell
INDIE 250, 1328432
o Fixed Assets are relatively permanent and take time to convert to cash, which
include, land, factory machinery, office equipment and buildings. Most have
limited long term use. The value of many fixed assets may depreciate.
o Other Assets include investment in companies and intangible assets such as
goodwill, copyrights and franchises. Only appears when business is purchased
entirely.
o Current Liabilities is debts which must be paid in near future. Also included
are accrued expenses (wages, salaries interest) but are not yet due. Also
advance payments.
o Other Liabilities include long term stuff, bonds, and mortgages, longer than
one year.
o Stockholders equity is amount available to owner after debts have been paid.
Preferred stockholders earn a fixed payment. Assets liabilities preferred
stock = common stock.
o Common Stock is regular issued stock. Usually kept in lower numbers
o Paid- in Capital is the amount of money received from overpriced stock,
outstanding stock is stock held by public, if company buys back own stock it is
called treasury stock.
o Retained Earnings is net income of the frim since its inception; it is the assets
purchased form reinvested money. Belong to stockholders.
2.2.2 The Income Statement
o Income statement is whether a business is making or losing money in a period
of time. Revenue Expenses = Net Income.
o Revenue is income from goods or services
o Cost of revenue is the cost from producing a good, labor cost.
o Gross Margin is the Net revenue Cost of Revenue
o Operating Margin is the Operating Income Operating expenses
o Net Income is income taxable income, also called Net Margin
o Earnings per share is
Available Earnings

common stockholders
Number of Common stock outstanding
2.2.3 The Cash Flow Statement
o Cash flow statement describes how the company acquired and spent cash
o Investors determine value of asset by the cash flow it generates.
o Operating Activities is the net change in operating cash flows related to sale
and production of a good.
o Investing Activities is the cash flow transactions related to investment.
o Financing Activities is the cash transactions related to financing capital used
in business, paying off debt (Outflow) or selling stock( Inflow)

2.3 Using Ratios to Make Business Decisions

Josh Campbell
INDIE 250, 1328432
2.3.1 Debt Management Analysis
o Capital comes in two forms, equity and debt, equity is obtained from
owners and debt from financial institutions.
o Companies can issue bonds to raise capital which is long term. The
investor agrees to be paid a certain interest rate for his investment.
o Different types of equity capital include common stock and preferred
stock, preferred stock pays a dividend, however it is not a legal liability till
the company declares it.
Total Debt
o Debt Ratio Total Assets
o Times-interest-earned ratio

earnings before interest income taxes

Interset Expense

2.3.2 Liquidity Analysis

o Excess of current assets over current liabilities is called working capital.
Companies with high working capital are very liquid. Better liquidity
means a company can better pay its debt
current assets
o Current Ratio current liabilities
o Quick ratio

Current assetsInventories
current liabilities

says whether a company

could pay all of its current liabilities if they came immediately

2.3.3 Asset Management Analysis
o Inventory Turnover how many times a company sold and replaced its
inventory.

Sales
Average inventory balance

o Days Sales Outstanding (accounts receivable Turnover) is how many

times a firms account receivable has been turned in cash in a year.
Recivables
Average sales per day
o Total Assets Turnover

Sales
T otal Assets

how effective a firm is in

generating its revenues from total assets

2.3.4 - Probability Analysis
Net income avaliable
o Profit Margin on Sales common stockhol ders
Sales

Josh Campbell
INDIE 250, 1328432
o Return on Total Assets

Net income+ interest expense(1tax rate)

Average totalassets

o Return on Common Equity is how much income is generated for every

one dollar invested by common stockholders.
Net income availabe

common stockholders
Average common Equity

OR

Net Income
Stockholders Equity

2.3.5- Market Value analysis

o Price to Earning Ratio
o Book Value per Share

Price Per share

Earnings per share
total stockaholder equityprefered stock
Average shares outstainding