Lecture 13 & 14: Company Finance Flashcards
Why are financial statements important?
They reflect the financial health of a company.
What are two types of financial statements?
- Income Statement (Profit & loss account)
- Balance Sheet
Describe engineering accounting.
A vector shows direction (income statement) and position (balance sheet or financial position)
What does a balance sheet show?
- Statement of Financial Position at a point in time
- A point in time where the income statement shows the earnings (and expenses) or ‘enrichment’ over time.
What is the purpose of an income statement?
To show whether or not a company’s business is profitable.
What does an income statement show?
- the profit or loss over a period of time (financial year)
- usually there is a comparison between the figures of the most recent year and that of the year before
What are the steps in income statement?
- Establish the revenue
- deduct the cost of sales to get the Gross Profit.
- further deduct the operating expenses to get the operating cost
- further deduct any financial costs or income to get the Profit before Income Tax
- deduct Tax to get Net profit for the period
What are the three major items in a balance sheet?
- assets
- liabilities
- equity (Net Worth)
Total Assets is the sum of:
- Total Current Assets and
(cash, inventory, investments, account receivables, and estimated work done but not billed yet) - Fixed or non-current assets
(total value or property, plant, equipment
minus the accumulated depreciation to get ‘net’ fixed assets)
Total Assets = Equity + Total Liabilities
Liabilities is the sum of:
- Current Liabilities and
(accounts payable to subs/suppliers, accrued expenses, excess billings for work not done yet, bank overdraft and short term loan, suppliers and employers, rents, utilities) - Non-current or long term liabilities
(long term bank loans, mortgages of equipment, building, land, cars/trucks)
What are liabilities?
Obligations to third parties.
Current liabilities of a construction company are debts the company has to pay within a year.
Long term liabilities are obligations with a pay back period of more than one year.
Total equity is the sum of:
Capital, Stock, Retained Earnings
Can be calculated by summing the capital the owners have invested and the profits that have been accumulated (after deducting all the dividends paid) and retained up to the present moment since the business began.
What is equity?
Is the capital invested by the owner(s) of company.
Represents the net worth of the business
How to calculate Working Capital?
Working Capital = Current Assets - Current Liabilities
What is Working Capital?
A measure of the short term financial strength of a construction company.
How much current assets exceed current liabilities.
How can Working Capital be increased?
- Making profit, selling equipment or other assets, or have long term loans from a bank.
(A long term long increases current assets but also increases long term liabilities)
How can Working Capital be decreased
Losing money on a project, or purchasing equipment, or repaying long term loans.
How should construction companies stay healthy?
The volume of unfinished work:
- of all projects in hand should be at most 10x the working capital
- of the biggest project in hand should be at most 5x working capital
What does current ratio show?
A construction company’s liquidity (its ability to fulfill short term financial obligations)
(should be 1.3 or higher)
What is the current ratio?
Current Assets /
Current Liabilities
Where is under billing expressed?
In the balance sheet under Current Assets or “Costs and estimated earnings in excess of billings on work in progress”
Where is over billing expressed
In the balance sheet under current liabilities or “billings in excess of costs and estimated earnings on work in progress”
What does over billing mean?
That the construction company is borrowing money from the client by billing more than what the company has actually done.
What does under billing mean?
The construction company is allowing the client to borrow money from it, because it has incurred cost for doing work but without appropriately billed for the work.
What are the relevant financial ratios in financial analysis?
- profitability ratios
- liquidity ratios
- working capital ratios
- capital structure ratios
- activity ratios
What do profitability ratios measure?
A company’s ability to earn profit from its operation
- Gross Profit Margin Ratio
- Net Profit Margin Ratio
- Return on Equity Ratio
Gross Profit Margin Ratio =
Gross Profit / Revenue
Net Profit Margin Ratio =
Net profit before tax / Revenue
Return on Equity Ratio =
Net profit before tax / Owners’ equity
What do liquidity ratios measure?
The company’s ability to pay its obligations as they come due.
- Current Ratio
- Acid Test Ratio (or Quick Ratio)
- Current Assets to Total Assets Ratio
Current Ratio =
Current Assets / Current liabilities
Acid Test Ratio (or Quick Ratio) =
(Cash + Accounts receivables)/ Current liabilities
Current Assets to Total Assets Ratio =
Current Assets / Total Assets
What do working capital ratios measure?
How well the construction company is utilizing its working capital
- Working Capital Turnover
- Net Profit to Working Capital Ratio
Working Capital Turnover =
Revenue / Working Capital
Net Profit to Working Capital Ratio =
Net profit before tax / Working Capital
What do capital structure ratios show?
The ability of the construction company to manage liabilities. They show how the company prefers to finance its operation.
- Debt to Equity Ratio
- Leverage
Debt to Equity Ratio =
Total liabilities / Owners’ equity
Leverage =
Total assets / Owners equity
= (Total liabilites+owners’ equity)/ owners equity
= debt to equity ratio +1
What do activity ratios show?
Whether or not the construction company is using its assets effectively, and if yes, how effective they are
- Average age of material inventory
- Average age of under billings
- Average age of accounts receivable
- Cash conversion period
- Average age of accounts payable
- Average age of over billings
- Cash demand period
Average age of material inventory =
(material inventory / material cost) * 365 days
Average age of under billings =
under billings / revenue
Average age of accounts receivable =
(accounts receivable/ revenue) * 365 days
Cash conversion period =
average age of material inventory
+ average age of under billings
+ average age of accounts recievable
Average age of accounts payable =
(accounts payable / materials + subcontracts) * 365 days
Average age of over billings =
(over billings/ revenue) * 365 days
Cash demand period =
Cash conversion period
- average age of accounts payable
What is the break even point?
The pint at which the income from sales is equal to total expenses
Break Even Point (BEP) =
Fixed Costs / (Price - VC)unit
What is degree of operating leverage?
the percentage change in profit per percentage change in sold items.
higher leverage = more sensitive to price changes
