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Ratios and Account Chapter 17 Understanding Balance Sheet and Income Statement. 2 pages in-text citation and citation pages. Calculate two important ratios 1) Debt to owner’s equity ration and 2) Return on sales of the Very Vegan Restaurant that would help you determine if you would invest in their business if they decided to become an S corporation. Based on the numbers of two ratios, describe the pro's and cons of investing in this company.

1 page : Two paragraph to analyze each of ratios.

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Methodology of Calculating Inventory Carrying Costs ASSOCIATES MANAGEMENT CONSULTANTS 20 NASSAU STREET, SUITE 244 PRINCETON, NEW JERSEY 08542 REM Associates 1 Contents ! The Truth About Carrying Inventory ! What Makes Up Inventory Carrying Costs? ! Inventory Carrying Cost Summary ! Inventory Carrying Costs Studies REM Associates 2 The Truth About Carrying Inventory Studies of industries about inventory carrying costs reveal the following . . . . ! Over 65% of most companies do not compute inventory carrying costs, they use rough estimates ! Leading logistics experts place the cost of carrying inventory between 18% per year and 75% per year depending on the type of products and business ! The standard “rule of thumb” for inventory carrying cost is 25% of inventory value on hand ! The cost of capital is the leading factor in determining the percentage of carrying cost REM Associates 3 What Makes Up Inventory Carrying Costs? Inventory carrying costs are made up of the following . . . . Inventory Carrying Costs Capital Costs Inventory Service Costs REM Associates 4 Storage Space Costs Inventory Risk Costs What Makes Up Inventory Carrying Costs? Capital costs include the investment in inventory . . . . Capital Costs Inventory Investment REM Associates 5 What Makes Up Inventory Carrying Costs? Inventory service costs include insurance, physical handling, and taxes . . . . Inventory Service Costs Insurance Physical Handling REM Associates 6 Taxes What Makes Up Inventory Carrying Costs? Storage space costs include public, plant, rented, and company owned warehouses . . . . Storage Space Costs Plant Warehouses Public Warehouses REM Associates 7 Rented Warehouses Company Owned Warehouses What Makes Up Inventory Carrying Costs? Inventory risk costs are made up of obsolescence, damage, shrinkage, and relocation costs. . . . Inventory Risk Costs Obsolescence Shrinkage Damage REM Associates 8 Relocation Costs Inventory Carrying Costs In Summary Total inventory carrying costs can be estimated at . . . . ! Cost of Money 6% - 12% ! Taxes 2% - 6% ! Insurance 1% - 3% ! Warehouse Expenses 2% - 5% ! Physical Handling 2% - 5% ! Clerical & Inventory Control 3% - 6% ! Obsolescence 6% - 12% ! Deterioration & Pilferage 3% - 6% Total 25% - 55% Richardson, Helen: Transportation & Distribution, “Control Your Costs then Cut Them” December, 1995 REM Associates 9 Inventory Carrying Costs In Summary Total inventory carrying costs can be broken down by . . . . Warehouse Expenses 2-5% Insurance 1-3% Taxes 2-6% Physical Handling 2-5% Clerical & Inventory Control 3-6% Obsolescence 6-12% Cost of Money 6-12% Deterioration & Pilferage 3-6% REM Associates 10 Inventory Carrying Costs Studies Inventory Management Perspective . . . . ! CLM Conference attendees identified the management of inventory as the top priority in the next several years. The conference referred to Logistics, as inventory in motion. ! Inventory is money and many companies assess an inventory carrying cost of 2% per month. Inventory Reduction Report, December 1994 REM Associates 11 Inventory Carrying Costs Studies Author Publication Textbook inventory carrying costs are suspect. Inventory carrying costs should not always be based on industry averages. Inventory carrying costs should be calculated by business. That being said the following estimates of inventory carrying costs from Strategic Logistics Management, L.P. Alford & John R. Bangs (eds.) George W. Aljian Dean S. Ammer Donald J. Bowersox, David J. Closs and Omar K. Helferich Joseph L. Cavinato J.J. Coyle and E. J. Bardi Gordon T. Crook Thomas W. Hall 2nd edition, 1987,James R. Stock and Douglas M. Lambert, Irwin, Homewood, Illinois, can be used as rules of thumb only: J. L. Heskett, N.A. Glaskowsky, Jr., and R. M. Ivie James C. Johnson and Donald F. Wood Production Handbook, (New York: Ronald Press, 1955) p. 397. Purchasing Handbook, (New, York: McGraw-Hill, 1958), pp. 9-29. Materials Management, (Homewood, Ill.: Richard D. Irwin, 1962), p. 137. Logistics Management, 3rd ed., (New York: Macmillan, 1986), pp. 189-97. Purchasing and Materials Management, (St. Paul, MN.: West Publishing, 1984), p. 284. The Management of Business Logistics, 3rd ed. (St. Paul, MN.: West Publishing, 1984), p. 144. “Inventory Management Takes Teamwork,” Purchasing, March 26 1962, p. 70. “Inventory Carrying Costs: A Case Study,” Management Accounting, January 1974, pp. 37-39 Business Logistics, 2nd ed. (New York: Ronald Press, 1973), p. 20. Contemporary Physical Distribution and Logistics, 3rd ed. (Tulsa, OK.: PenWell Publishing, 1986), p. 253. John F. Magee “The Logistics of Distribution,” Harvard Business Review, July-August 1960, p. 99. Benjamin Melnitsky Management of Industrial Inventory (ConoverMast Publication, 1951), p. 11. Thomson M. Whitlin The Theory of Inventory Management, (Princeton, NJ.: Princeton University Press, 1957), p. 220. * Not specified, although 20 percent was used in examples. REM Associates 12 Estimate of Carrying Costs as a % of Inventory Value 25% 12-34% 20-25% 20%* 25% 25-30% 25% 20.4% 28.7% 25% 20-35% 25% 25% ASSOCIATES MANAGEMENT CONSULTANTS 20 Nassau Street, Suite 244 PO Box 7345 Princeton, New Jersey 08543-7345 Phone: 609-275-4444 Fax: 609-275-5651 E-Mail: rem@remassoc.com www: http://www.remassoc.com REM Associates 13 CHAPTER 17 Understanding Accounting and Financial Information Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. LEARNING OBJECTIVES 1. Demonstrate the role that accounting and financial information play for a business and its stakeholders. 2. Identify the different disciplines within the accounting profession. 3. List the steps in the accounting cycle, distinguish between accounting and bookkeeping, and explain how computers are used in accounting. 4. Explain how the major financial statements differ. 5. Demonstrate the application of ratio analysis in reporting financial information. 17-2 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. WHAT’S ACCOUNTING? LO 17-1 • Accounting -- Recording, classifying, summarizing and interpreting of financial events and transactions in an organization to provide interested parties needed financial information. The Accounting System 17-3 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. MANAGERIAL ACCOUNTING LO 17-2 • Managerial Accounting -- Provides information and analysis to managers inside the organization to assist them in decision making. • Managerial accounting is involved with: - Costs of production - Costs of marketing - Preparation and control of budgets - Minimizing tax liabilities 17-4 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. FINANCIAL ACCOUNTING LO 17-2 • Financial Accounting -- Financial information and analyses are generated for people primarily outside the organization. Outside users are interested in these questions: - Is the organization profitable? - Is it able to pay its bills? - How much debt does it owe? • Annual Report -- A yearly statement of the financial condition, progress, and expectations of the firm. 17-5 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. PUBLIC vs. PRIVATE ACCOUNTANTS LO 17-2 • Private Accountants -- Work in a single firm, government agency, or nonprofit organization. • Public Accountants -- Provide accounting services to individuals or businesses. • Certified Public Accountants (CPAs) -Accountants who have passed a series of examinations established by the American Institute of Certified Public Accountants (AICPA) and met a state’s requirements for education and experience. 17-6 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. AUDITING CHECKS ACCURACY LO 17-2 • Auditing -- Reviewing and evaluating the information used to prepare a company’s financial statements. • Independent Audit -- An evaluation and unbiased opinion about the accuracy of a company’s financial statements. • Certified Internal Auditors (CIAs) -- Accountants who have a bachelor’s degree and two years of experience in internal auditing and pass an exam administered by the Institute of Internal Auditors. 17-7 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. SPECIALIZED ACCOUNTANTS LO 17-2 • Tax Accountants -- Accountants trained in tax law and are responsible for preparing tax returns or developing tax strategies. • Government and Not-forProfit Accounting -Support for organizations whose purpose is not generating a profit, but serving others according to a duly approved budget. 17-8 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. The ACCOUNTING CYCLE LO 17-3 • Accounting Cycle -- A six-step procedure that results in the preparation and analysis of the major financial statements. 17-9 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. BOOKKEEPER’S ROLE and TOOLS LO 17-3 • Bookkeeping -- The recording of business transactions. Bookkeepers divide a firm’s transactions into meaningful categories and post them into a record book or computer program called a journal. • Double-Entry Bookkeeping -- Bookkeepers record all transactions in two places so they can check one list of transactions against the other for accuracy. • Ledger -- A specialized accounting book or program where all information is in one place. • Trial Balance -- A summary of all the information in the account ledgers. 17-10 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. FINANCIAL STATEMENTS LO 17-3 • Financial Statement -- A summary of all the financial transactions that have occurred over a particular period. • Key financial statements of business are: - Balance Sheet -- The financial statement that reports a firm’s financial condition at a specific time. - Income statement - Statement of cash flows 17-11 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. The FUNDAMENTAL ACCOUNTING EQUATION LO 17-4 • Assets -- Economic resources owned by a firm. Items can be tangible or intangible. • Owners’ Equity -- The amount of the business that belongs to the owners minus any liabilities of the owners. • Fundamental Accounting Equation -- The basis for the balance sheet. • The equation must always be balanced and includes the formula: Assets = Liabilities + Owners Equity 17-12 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. CLASSIFYING ASSETS and LIABILITIES ASSETS • Current Assets -- Items that can or will be converted to cash within one year. • Fixed Assets -- Long-term assets that are relatively permanent such as land, buildings, or equipment. • Intangible Assets -- Longterm assets that have no physical form but do have value such as patents, trademarks, and goodwill. LO 17-4 LIABILITIES • Liabilities -- What the business owes to others (debts). • Accounts Payable -- Current liabilities a firm owes for merchandise or services purchased on credit. • Notes Payable -- Short or longterm liabilities a business promises to pay by a certain date. • Bonds Payable -- Long-term liabilities that the firm must pay back 17-13 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. The INCOME STATEMENT • Income Statement -The financial statement that shows a firm’s bottom line - that is, its profit after costs, expenses, and taxes. LO 17-4 Formula for income statement Revenue -Cost of Goods Sold = Gross Profit -Operating Expenses = Net Income before Taxes • Net Income/Net Loss - The revenue left over after costs and expenses. -Taxes = Net Income or Net Loss 17-14 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. ACCOUNTS of the INCOME STATEMENT LO 17-4 • Revenue is the monetary value a firm received for goods sold, services rendered or other payments. • Cost of Goods Sold (or Manufactured) -Measures the cost of merchandise the firm sells or the cost of raw materials and supplies it used in producing items for resale. • Gross Profit (or Gross Margin) -- How much a firm earned by buying (or making) and selling merchandise. 17-15 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. ACCOUNTS of the INCOME STATEMENT LO 17-4 • Operating Expenses – Cost involved in operating a business, such as rent, salaries and supplies. • Depreciation -- The systematic write-off of the cost of a tangible asset over its estimated useful life. 17-16 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. The STATEMENT of CASH FLOWS LO 17-4 • Statement of Cash Flows -- Reports cash receipts and cash disbursements related to the three major activities of a firm: 1. Operations 2. Investments 3. Financing • Cash Flow -- The difference between cash coming in and cash going out of a business. • Managing cash flow is a key consideration of a business and can be particularly challenging for small and seasonal businesses. 17-17 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. USING FINANCIAL RATIOS LO 17-5 • Ratio Analysis -- The assessment of a firm’s financial condition using calculations and financial ratios developed from the firm’s financial statements. • Key ratios include: - Liquidity ratios - Leverage ratios - Performance ratios - Activity ratios 17-18 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. COMMONLY USED LIQUIDITY RATIOS LO 17-5 • Liquidity ratios measure a firm’s ability to turn assets into cash to pay its short-term debts. • Two key ratios are: - Current ratio - Acid-test ratio • This information is found on the firm’s balance sheet. 17-19 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. LEVERAGE RATIOS LO 17-5 • Leverage ratios measure the degree to which a firm relies on borrowed funds in its operations. • Key ratios include: - Debt to Owner’s Equity Ratio • This information is found on the firm’s balance sheet. 17-20 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. PROFITABILITY RATIOS LO 17-5 • Profitability ratios measure how effectively a firm’s managers are using the firm’s various resources to achieve profits. • Key ratios include: - Basic earnings per share - Return on sales - Return on equity • This information is found on the firm’s balance sheet and income statement. 17-21 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. ACTIVITY RATIOS LO 17-5 • Activity ratios measure how effectively management is turning over inventory. • Key ratios include: - Inventory turnover ratio • This information is found on the firm’s balance sheet and income statement. 17-22 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Ratios: What Do They Mean Butler Lumber Acid Ratio Test Measures the ability of a firm to pay its short term debt. The calculation does not include inventory. Current Ratio The ability of a firm to pay its short term debt. It includes its inventory in the formula. Return on Sales/Operating Income How efficiently a company runs its business to generate profits. What % of company revenues are converted into company profits. (Before Taxes and Interest) Inventory Turnover Rate The number of times a company’s inventory is sold and replaced over time. The number of days it takes to sell its existing inventory NET Profit Margin How much of a company’s revenue are kept as profit. Return on Equity How much profit a company is generating on with the money shareholders has invested . Debt to Owners Equity How much debt there is for every dollar of equity there in the company.
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Ratios
Debt to equity ratio= total liabilities/ total owners’ equity
=$613000/$213000
=2.88
Debt to equity ratio measures the amount of debt that the restaurant is carrying in relation
to the amount that has been invested by owners in the business. It indicates the firms financing
percentage that is obtained from creditors and the owners. A high debt to equity ratio indicates
that the firm is being financed more by debt. The optimal debt to equity ratio is 2. The firms
seem to have an optimal...


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