Lesson 16



AOF Applied FinanceLesson 6Financial Record-Keeping and AnalysisStudent ResourcesResourceDescription Student Resource 6.1True or False: Business Record-Keeping and Financial AnalysisStudent Resource 6.2Assignment: Financial Tools MatrixStudent Resource 6.3Reading: Financial Analysis and Record-Keeping ToolsStudent Resource 6.4Assignment: Financial Tools Business LetterStudent Resource 6.5Frame: Letter to ECPak ManagementStudent Resource 6.1True or False: Business Record-Keeping and Financial AnalysisStudent Name:_______________________________________________________ Date:___________True/False QuestionsDirections: Circle the correct answer.TF1.A paper-based financial system can be backed up easily.TF2.Record-keeping is important to a business because of the number of transactions and the large amount of money involved.TF3. Sales made in foreign currencies must be converted into American dollars before an American company can record those sales in its financial system.TF4.A business is not required to have a financial system, but most do.TF5.Exchange rates are usually not important unless a business sells its product or service in another country or buys goods/raw materials in another country.TF6.The profit and loss statement, income statement, and cash flow statement model the financial operations of the business.TF7.A balance sheet presents the sources and uses of funds for a business during a period of time.TF8.EBIT is a financial analysis tool that stands for “earnings before income total.”TF9.Gross profit margin helps show a company’s efficiency.TF10.All other things being equal, the higher a company’s net income margin compared with those of other companies, the better.Student Resource 6.2Assignment: Financial Tools MatrixStudent Name:_______________________________________________________ Date:___________Directions: While in your expert group, research your assigned topic below. Ensure that your group can fill out the matrix below in detail for your topic. Make sure everyone in your group can sufficiently explain your topic to others for the mixed-group portion of the activity. For teams assigned to financial record-keeping tools, locate and print out a sample document. For teams assigned to financial analysis tools, find the tool formula and generate an example.Name of record-keeping toolWhat it showsHow it is usedSample documentProfit and loss statementBalance sheetCash flow statementName of analysis toolWhat it showsHow it is usedFormula and examplesEarnings before interest and taxes (EBIT)Gross profit marginNet income margin Student Resource 6.3Reading: Financial Analysis and Record-Keeping ToolsFinancial Analysis Tool: The Profit and Loss Statement (Record-Keeping Tool)Purpose of a Profit and Loss (P & L) StatementIt records both revenues and expenses during a stated period of time and shows the difference between them. This difference would be either a profit or a loss.It presents the financial results of a business in a formal, structured way.It models the financial operations of the business and can also be referred to as an income statement or a statement of operations.The profit and loss statement of a company that makes MP3 players will be different from that of a company that manufactures automobiles. Service-based businesses will have statements that look quite different from those of manufacturers.Structure of a Profit and Loss StatementEach line item is a “bin” or “container” for collecting all transactions of one kind.Those line-item bins or containers are similar to file folders in a real filing cabinet.Line items appear in different sections of the profit and loss statement depending on whether they are revenue or expense items.Line items on the P & L are usually compared to their budgeted amounts or to their prior year counterparts, or both.Time Frame of a Profit and Loss StatementA profit and loss statement reports history over a specific period, usually a month, a quarter, or a year. Once the reporting period ends, the information it reports should not change.Financial Analysis Tool: The Balance Sheet (Record-Keeping Tool)Purpose of a Balance SheetIt records both assets and liabilities at the end of a stated period of time and shows the balance between them. On a balance sheet, the assets must always equal the liabilities plus the owner’s equity.It presents the financial results of a business in a formal, structured way.It models the capital structure of the business.The balance sheet of a company that makes MP3 players will be different from that of a company that manufactures automobiles.Structure of a Balance SheetEach line item is a “bin” or “container” for collecting all transactions of one kind.Those line-item bins or containers are similar to file folders in a real filing cabinet.Line items appear in different sections of the balance sheet depending on whether they are asset or liability/equity items.Line items are often compared to their prior year-end balances.Time Frame of a Balance SheetA balance sheet is a snapshot of the firm’s financial position at a given moment in time. The balance sheet is usually prepared at the end of a month, a quarter or a fiscal year. The balance sheet may be requested at other times too, such as by a banker before making a final decision on a new loan to the firm. Like the profit and loss statement, the balance sheet for a given day should not change after it is issued. For example, a balance sheet dated June 30 should not change, say, on July 1 or any other date afterward.Financial Analysis Tool: The Cash Flow Statement (Record-Keeping Tool)Purpose of a Cash Flow StatementIt records both the sources and uses of money (cash) during a stated period of time and shows the balance between them.It presents the financial operations of a business in a formal, structured way.The cash flow statement of a company that provides a service (such as car repair) will be different from that of a company that manufactures automobiles or semiconductor chips.Some business managers and financial analysts consider the cash flow statement to be even more important than the profit and loss statement.Structure of a Cash Flow StatementItems appear on the statement in different sections depending on whether the item was a source of funds or something that used funds. The purpose of a cash flow statement is to show which business activities provide a source of cash (for example, selling assets can provide a source of cash) and which items are using funds (such as the payment of a short-term loan).A cash flow statement is broken up into three sections: The operations section deals with day-to-day matters, such as paying employees and collecting cash from customers. The investing section typically deals with cash used for buying or selling large items such as buildings and machinery—or even an entire division of a big firm. The financing section principally deals with cash to and from bankers and investors.Time Frame of a Cash Flow StatementA cash flow statement reports history over a given period of time (usually a month, a quarter, or a year). As with the profit and loss statement, the information it reports does not change once the reporting period ends.Financial Analysis Tool: Earnings Before Interest and Taxes (Analysis Tool)When a business uses a financial system to control its activities, that system ultimately contains quite a bit of information. When that information is analyzed, it reveals a lot about how well the business is operating. Businesses have been operating in our society for hundreds of years. Over that time, business owners have come up with some common-sense ways to assess business performance. Other business owners started using those tools, and now every business does. The financial analysis tools reviewed in this lesson are very basic measures of profitability that are easy to calculate and understand.Earnings Before Interest and Taxes (EBIT)Earnings before interest and taxes (EBIT) is a way to measure a business’s profitability while ignoring interest expense and taxes—factors that vary from two otherwise almost identical businesses. EBIT is a dollar figure and is never expressed as a percentage. Although the number doesn’t mean much by itself, it is a useful benchmark when tracked over time. Because companies can mask their overall operating efficiency through complex tax and financing structures, EBIT is a useful tool for comparing different companies without those things getting in the way.EBIT = Operating revenue ? Operating expenses + Non-operating incomeEBIT = Operating revenue ? (Cost of goods sold + Selling and administrative expenses) + Non-operating incomeFinancial Analysis Tool: Gross Profit Margin (Analysis Tool)The financial analysis tools reviewed in this lesson are very basic measures of profitability that are easy to calculate and understand. These measures are often most valuable when comparing, for example, the current year to a prior year. This kind of comparison allows managers to see if there is improvement (or not) and make additional adjustments to the firm’s method of operations.Gross Profit MarginGross profit margin is a ratio that measures gross profit as a percentage of sales. It is usually seen as a key indicator of a company’s efficiency—its ability to convert sales into profits.Gross profit margin = Gross profit / SalesAnother way to present this ratio is:Gross profit margin = (Sales ? Cost of sales) / SalesFinancial Analysis Tool: Net Income Margin (Analysis Tool)Net income margin is yet another very basic measure of profitability and should be rather easy to calculate and Income Margin (or Net Profit Margin)Net income margin is a percentage that tells how much net income is created from every dollar of sales revenue. Profit margins vary by industry, but all other things being equal, the higher the margin compared with other companies (and especially that of a firm’s competitors), the income margin = Net income after taxes / SalesStudent Resource 6.4Assignment: Financial Tools Business LetterThe Situation:ECPak is in trouble. The company has sustained huge losses, and the chief financial officer has resigned and left the company. The new management team needs your help! Specifically, Eduardo Cisneros wants you to analyze each issue and construct an explanation to the management team:The management team suspects that the company’s income is uneven throughout the year; some months show strong gains, and others are very slow. Suggest tools to track this information.Creditors are calling and wanting payments, but the accounting department says that the company currently doesn’t have enough funds to pay its bills. The accountants claim that this situation may improve soon, but they can’t say for sure. Suggest how they can track this information.Investors are clamoring for information about how the company is doing compared with other companies in the industry. Suggest some tools that ECPak could report to provide this information to investors.Directions: Eduardo Cisneros needs your help! It is your job to write a letter to his new management team, which offers suggestions based on your knowledge of business record-keeping and financial analysis. Please review each issue presented above independently, and then discuss each issue with a partner. When you feel comfortable enough to present your suggestions, you may begin your letter to Eduardo’s management team. Make sure your assignment meets or exceeds the following assessment criteria:It demonstrates an accurate understanding of the company’s financial dilemmas, which you state in the introductory paragraph.It contains a recommendation of appropriate financial record-keeping and analysis tools based on your understanding of the situation.It provides an explanation supporting your choice of appropriate financial record-keeping and analysis tools.The letter is written in the correct format (Student Resource 6.5).The letter is neat and legible, and uses proper spelling, grammar, and punctuation.Student Resource 6.5Frame: Letter to ECPak ManagementStudent Name:_______________________________________________________ Date:___________Directions: Use the following guide to help you organize your information for your letter. Once you have completed this guide, copy the information onto a blank piece of paper.Eduardo Cisneros123 Filbert St.Los Angeles, CA 54321Dear ECPak Management Team,I am writing to you because (write your understanding of ECPak’s situation here):______________________________________________________________________________________________________________________________________________________________________________________________________________________________________.I am currently enrolled in an applied finance course and we have been studying various financial record-keeping and analysis tools. Based upon the information that I have received about your situation, I would like to recommend three different ways for you to track and analyze your financial records.To begin, I understand that the ECPak Company has some months that show strong gains, while other months are very slow. One way to track this information is (write your recommendation for addressing this problem here):_____________________________________________________________________________________________________________________________________________________________________________________________________________.Your situation also indicates that creditors want payments and the accounting department claims that there’s no money on hand. For this situation I would advise that (write your recommendation for addressing this problem here):_____________________________________________________________________________________________________________________________________________________________________________________________________________.Lastly, if investors want information about how the company is doing I would recommend (write your recommendation for addressing this problem here): _________________________________________________________________________________________________________________________________________________________________________________________.I realize that your team has a tough job ahead of you; however, I hope that my suggestions can guide you in the right direction.Sincerely,(Your Name) ................
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