TUI UNIVERSITY Lewis Taylor Module 1 Case Assignment ACC501: Accounting for Decision Making Dr.

Mary Dereshiwsky April 19, 2010

ABSTRACT To understand how well a company is doing, you really need to understand the financial health of the company. This includes what kind of sales a company had in the current or previous year. What are the sales projections for the next year? What kind of debt does the company have and how soon does it all come due? What is the cash situation for the business? Do they have enough on hand to meet their immediate obligations? The answer to all these questions can be found in the financial statements. There are 3 main parts to a financial statement that will give you this kind of information. They are the Balance sheet, the Income Statement and the Statement of Cash Flows. Together with the financial notes at the end of the financial statements, an investor can gain a lot of insight into how well a company is performing as well as what could possibly lie in its future. In this paper, I will discuss what the various sections of a financial statement say and how they can help in understanding a companys bottom-line. In addition to this, I will use the financial statements from a couple of different companies to do a basic analysis of their bottom-line. Financial Statements There are some important accounting principles that need to be understood in order to make sense of a financial statement. These principles are the foundation for an accounting system that allows for companies to be compared on equal footing. A lack of standardization really could and has lead to companies and organizations reporting the health of their company in a way that enables them to present the most favorable view possible whether it is totally accurate or not. This would result, and has resulted, in an

inability of investors to be able to make sound judgments as to the true health of any given company. Additionally, it would prevent investors from making comparisons between two like companies. If two different hamburger joints, for example, reported their sales and earning in completely different ways, it could lead to an inability to compare the overall health of the restaurants on equal terms. It would be like comparing apples to oranges. So, the first concept used to standardize accounting is the Generally Accepted Accounting Principles (GAAP). GAAP, in a nutshell, is a set of rules that are used by corporations worldwide to record and summarize transactions and in preparing financial statements for any given corporation. The Financial Accounting Standards Board, or FASB creates the GAAP standards. FASB is a non-governmental organization whose mission is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information.1 FASB is also recognized by the SEC as the authoritative body for accounting standards as well as by the American Institute of Certified Public Accountants. GAAP allows companies to be analyzed on an equal footing; apples to apples and oranges to oranges. The next concept is Double Entry Accounting. To understand this, we must understand that just like in physics, every financial transaction has an equal and opposite transaction. By that, I mean that for every asset gained, something had to go out to acquire that asset. Double Entry Accounting accounts for those reactions. It explains how transactions occurred and where things came from, or in other words, it explains
1

"FASB: Financial Accounting Standards Board." FASB: Financial Accounting Standards Board. N.p., n.d. Web. 21 Apr. 2010. <http://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176154526495>.

what I have and how I got it. Next, Historical Cost is the cost of an item at the time it was originally purchased or acquired. It does not, however, represent the present value of that item. Accrual Basis Accounting and Cash Basis Accounting are accounting methods that essentially show what has actually happened versus what will happen at a future date. Accrual Basis Accounting records all transactions at the time the transaction was entered into regardless of whether items had yet changed hands. Cash Basis Accounting only records the transaction once the exchange of goods or services has happened. Accrual accounting uses notations such as accounts receivable and accounts payable, were cash basis does not. Lastly, Current Assets and Liabilities vs. Non-Current items details those assets or liabilities that will become liquid or be paid out in that current reporting period vs. those assets or liabilities that will not. All of these accounting tools help investors, creditors or auditors get credible, transparent, and comparable financial information for the companies they are analyzing. Analysis of Financial Statements In my comparison of these three multi-national companies, I needed to calculate a few ratios and calculations to help determine performance. I calculated the debt to equity ration, the operating margin, the working capital and the inventory turn-over for each of the companies. I was not able to calculate a comparable inventory turnover ratio for RTL, however, given that it is an entertainment company and does not have inventory in the same sense as that of Samsung or Lockheed. All calculations were done for reporting period 2008.

Results Looking at the Debt-to-Equity ratio, which shows every dollar of debt to every dollar of shareholder investment, I find that RTL has the lowest at .42. This means that they essentially have the lowest debt compared to shareholder investment. This makes sense to me since, of the three, they have the least amount of need for inventory storage and manufacture, as compared to Samsung and Lockheed. Samsung had a debt-to-equity ratio of .73 and Lockheed was 10.67. Lockheed should be larger given the cost of the items that they manufacture. The more expensive the raw materials are, the more money they may need to borrow to purchase those materials. And depending on what it is they are making, it may take longer to recoup those costs and repay that debt due to the time it takes to manufacture that item and deliver it to the customer. Samsung has a rapid inventory turnover indicating that they are able to build and move their goods more quickly then Lockheed. Lockheed, which mostly builds and sells large items such as aircraft, spacecraft and ocean vessels, requires many months to years to manufacture 1 item. Their turnover was 20.02 were Samsung turned over inventory at a ratio of .95. Two metrics where Lockheed seems to be sitting pretty is in working capital and in operating margin. For 2008, Lockheed had a working capital of 21.2 Billion dollars and an operating margin of 14.74%. Lockheed appears to operate at a fairly high margin compared to Samsung and RTL (4.9% and 8.1% respectively), where as Samsung turns over its inventory far more frequently. All three of these companies look to be healthy and in a position to be profitable in the future, barring uncontrollable events like economic downturns and such. Lockheed has the largest margins, but that does not always equate to greatest profitability,

especially since they turnover inventory so much slower then Samsung. Conclusion There are a lot of good tools available for investors, creditors and auditors alike to use as they analyze publicly traded companies. The various standards that are established through FASB via GAAP enable the public to make intelligent decisions when it comes to deciding on whether or not to invest in, lend money to or become involved with any given company(s). It truly pays to learn these tools and practice them. The exercise for this module wont make anyone an expert by any means, but did give a basic understanding of what info is available for use.