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Working Capital

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Current Assets - Current Liabilities Measures the companies ability to pay current liabilities with current assets.

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Current Ratio

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Current Assets / Current Liabilities Test of short-term debt paying ability

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Quick Ratio ( AKA Acid Test Ratio )

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( Cash + Marketable Securities + Accounts Receivable + Short Term notes recievable) / Avareage accounts Receivable Balance Test of short term debt paying ability without relaying on inventory.

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Accounts Receivable Turnover

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( Sales on account / Average accounts receivable balance ) Measures how many times a company's accounts receivable has been turned into cash during the year.

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Average Collection Period

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(365 / Accounts Receivable Turnover) Measures the average number of days taken to collect an account recievable.

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Inventory Turnover

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(Cost of goods sold / Average inventory balance) Measures how many times a company's inventory has been sold during the year.

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Average Sales Period

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(365 / Inventory Turnover ) Measures the average number of days neccessary to sell a company's inventory once.

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Operating Cycle

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(Average sales period + Average collection period) Measures the ellapsed time from when inventory is recieved from suppliers to when cash is received from the customer.

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Total Asset Turnover

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(Sales / Average Total Assets) Measure how efficiently assets are being used to generat sales.

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Times Interest Earned

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(Earnings before interest expense and income taxes / Interest expense) Measures the company's ability to make interest payments.

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Debt to Equity Ratio

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(Total Liabilities / Stockholder's equity) Measures the amount of assets being provided by creditors for each dollar of assets provided by stockholders.

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Equity Multiplier

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(Average total assets / Average stockholder's equity) Measures the portion of a company's assets funded by equity.

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Gross Margin Percentage

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(Gross Margin / Sales) Measures profitability before selling and administrative expenses.

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Net Profit Margin Percentage

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(Net Income / Sales) A broad measure of profitability.

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Return on Total Assets

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(Net Income + (Interest Expense x ( 1- Tax Rate)) / Average Total Assets) Measures how well assets have been employed by management.

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Return on Equity

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(Net Income /Average Total Stockholders Equity) When compared to the return on total assets, measures the extent to which financial leverage is working for or against common stockholders.

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Earnings per Share

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(Net Income / Average number of common shares outstanding) Affects the market price per share ,as reflected in the price earnings ratio.

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Price-Earnings Ratio

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(Market price per share / Earnings per share) An index of whether a stock is relatively cheap or relatively expensive in relation to current earnings.

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Dividend Payout Ratio

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(Dividends per share / Earnings per share) An index showing whether a company pays out most of its earnings in dividends or reinvests the earnings internally.

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Dividend Yield Ratio

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(Dividends per share / Market price per share) Shows the return in terms of cahs dividends being provided by a stock.

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Book Value Per Share

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(Total stockholder's equity / Number of common shares outstanding) Measures the amount that would be distributed to common stockholders if all assets were sold at their balance carrying amounts and if all creditors were paid off.

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High Return on Assets ( ROA )

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Shows the company 's assets are well managed.

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High Return on Equity ( ROE )

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Borrowing debt to finance production. * If our ROE is higher than ROA we are taking advantage of other people's money.

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Burn up rate

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How much cash a company burns through while waiting to make a profit.

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Cost Object

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Anything in which cost data are desired. This includes products, customers, jobs, and organisational sub units.

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Direct Cost

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Costs that can be easily and conveniently traced to a specific. i.e A printing company making 10,00 brochures, the direct cost would be the paper required.

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Indirect Cost

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A cost that cannot be easily and conveniently traced to a specific cost object. i.e Manager's salary at a Campbells soup production factory

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Common Cost (Type of Indirect Cost)

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A cost incurred to support a number of cost objects but cannot be traced to them individually. i.e Manager's salary again from Campbells

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What are manufacturing costs seperated into ?

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Direct and Indirect Manufacturing costs

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Direct Materials

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Raw materials - the materials that go into the final product. . * The finished product of one company may be the raw material for another. * May include both direct and indirect costs.

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Direct Labor

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Labor costs that can be easily traced to individual units of product. * Sometimes called touch labor because direct labor workers typically touch the product while it is being made. i.e Assembly line workers at Toyota

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Indirect Labor

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Labor costs that cannot be physically traced to particular products, or that can be traced only at great cost and inconvenience.

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Indirect Manufacturing Overhead

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Includes all manufacturing overhead costs except direct materials and direct labor. Also know as : iNdirect manufacturing cost, factory overhead, and factory burden.

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Non-Manufacturing Costs 1

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Selling - Includes all costs that are incurred to secure customer orders and get the finished product to the customer. Includes advertising, shipping, sales travel, sales commissions, sales salaries, and cost of finished goods warehouses. * Can be direct or indirect - Marketing of an item is direct but a managers salary is indirect.

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Non-Manufacturing Costs 2

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Administrative - Includes all costs associated with the general management of an organization rather than with the manufacturing or selling. Includes executive compensation, general accounting, secretarial, public relations, and similar costs.

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Product Costs

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Include all costs involved in acquiring or making a product. * Direct material, direct labor, manufacturing overhead. * Also called inventoriable costs

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Period Costs

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All costs that are not product costs. * All selling and admin expenses are period costs. * Not included as part of the cost of either purchased or manufactured goods.

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Prime Cost

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The sum of direct materials cost and direct labor cost.

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Conversion Cost

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The sum of direct labor cost and manufacturing overhead cost.

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Cost Behavior

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Refers to how cost reacts to changes in the level of activity. * As activity levels rise and fall, a particular cost may rise in response and vice versa.

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Cost Structure

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The relative proportiong of each type of cost in an organisation.

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Variable Cost

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A cost that varies in proportion to changes in the level of activity. * For a cost to be variable it must be with respect to something.

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Activity Base

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A measure of whatever causes the incurrence of a variable cost.

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Fixed Cost

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A cost that remains constant, in total, regardless of changes in the level of activity. * Straight line depreciation, insurance, property taxes.

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Committed Fixed Costs

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Represent organizational investments with a multi year planning horizon that cannot be signifgicantly reduced even for short period of time without making fundamental changes,

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Discretionary Fixed Costs

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Usually arise from annual decisions by management to spend on certain fixed costs.

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Relevant Range

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The range of activity within which the assumption that cost behavior is strictly linear is reasonable.

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Does Per Unit Variable Cost remain the same ?

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Yes, unlike fixed cots per unit variable cost remains the same even as more is produced.

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How does variable cost change in proportion to changes in activity level ?

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Variable cost will increase or decrease in relation to the activity level of production.

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How does fixed cost change in proportion to changes in activity level ?

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Fixed cost does not change in relation to acitivity levels.

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Does per unit fixed cost remain the same ?

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No, the fixed cost per unit will change depending on the level of activity.

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Cost Analyzing Tools

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Scatter grpah, Least Squares method, High/Low method

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High Low Method Breakdown

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High Level of Activity - Low Level of Activity Cost at High Level - Cost at Low Level Difference in Cost / Difference in Activity = Variable cost per unit of activity.

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What is the equation used to express the relationship between a mixed cost and the level of activity ? AKA Least Squares Method

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Y = a + bx Where : Y = total mixed cost A = total fixed cost B = variable cost per unit of activity X = the level of activity

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Account Analysis

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An account is classified as either variable or fixed based on the analysist's prior knowledge of how cost in the account behaves.

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Engineering Approach

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Involved detailed analysis of what cost behavior should be, based on an industrial engineer's evaluation of the production methods to be used, the material specifications, labor requirements, equipement usage, production efficiency.

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High / Low and Least Squares Regression Analysis

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These methods estimate the fixed and variable elements of a mixed cost by analysing past records of cost and activity.

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The Traditional Format Income Statement

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Separates the statement into 2 categories : * Cost of Goods Sold Where COGS = Beg.Merch Inventory + Purchases - Ending Merch inventory * Selling and admin expenses

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The Contribution Format Income Statement

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Provides managers with an income statement that clearly distinguishes between fixed and variable costs.

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Contribution Margin

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The amount remaining from sales revenue after variable expenses have been deducted.

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Differential Cost

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A difference in costs between any two alternatives.

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Differential Revenue

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A difference in revenues ( usually just sales ), between any two alternatives.

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Incremental Cost

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An increase in cost from one alternative to another.

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Sunk Cost

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A cost that has been incurred and that cannot be changed by nay decision made now or in the future.

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Contribution Margin Ratio

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CM / Sales = CM Ratio

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Contribution Margin Per Unit

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CM Ratio / Units Sold

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Operating Income with respect to CM

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CM - Fixed Costs

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Break even point

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CM = Fixed Costs

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Unit of Sales to Break Even

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Fixed costs / CM per unit

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Sales dollars to break even

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Fixed Costs / CM %

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Target Profit Breakdown

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$ = ( Target Profit + Fixed Cost ) / CM % Units = ( Target Profit + Fixed Cost ) / CM Unit

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Margin of Safety Equation

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Sales - Break even sales = Margin of Safety

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Margin of Safety Purpose

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Ability to understand how much sales can rop before cost management decisions are required.

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Margin of Safety Percentage

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Margin of Safety / Sales

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Degree of Operating Leverage Purpose

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Allows one to predict percentage change in operating income.

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Degree of Leverage Equation`

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Contribution Margin / Net Operating Income

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Change in operating income

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( DOL x % change in sales ) x current operating income

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Cost Volume Profit Analysis

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Helps managers make many important decisions such as what products and services to offer, what prices to charge, what marketing strategy to use, and what cost structure to maintain.

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Profit in terms of CM

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Profit = CM Ratio x sales - expenses

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Change in profit in terms of CM

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Change in profit = CM ratio x Change in sales - Change in fixed expenses

Financial Accounting IMPORTANT TERMS / RATIOS – Flashcards

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