Lesson 1_Liquidity_Current Ratio, Quick Ratio, Cash Ratio PDF

2025. 01. 15. C&F C&F_Income statement What is accounting? a. Revenue (Top Line): Total income earned from...

2025. 01. 15. C&F C&F_Income statement What is accounting? a. Revenue (Top Line): Total income earned from selling goods or providing services. The starting point for analyzing profitability. If a restaurant sells food and earns €50,000, this is Accounting is an information system is a system that gathers, processes, and its revenue. communicates financial and operational information. b. Cost of Goods Sold (COGS): Direct costs associated with producing goods or delivering services. ○ Raw materials ○ Direct labor ○ Manufacturing overhead For the restaurant, these might include the cost of ingredients like meat, vegetables, etc. c. Gross Profit: Revenue - COGS Measures the profitability of core operations before considering indirect expenses. If the restaurant earns €50,000 and spends €20,000 on ingredients, the gross profit is €30,000. Why is it important? Some examples: d. Operating Expenses: Costs incurred to run the business, excluding direct production costs. Deciding on Production Expansion (helps determine if the company has sufficient ○ Selling Expenses: Marketing, advertising, and sales commissions. resources and if the expansion will be profitable). ○ General and Administrative Expenses (G&A): Office rent, utilities, administrative staff Assessing the Need for External Financing (decide if a loan is needed to cover salaries. operational expenses or new investments). ○ Research and Development (R&D): Costs related to innovation and product development. Setting the Sale Price (setting a competitive and profitable price). The restaurant might pay €5,000 for rent and €8,000 for staff salaries. 1 2 1  2025. 01. 15. C&F_Income statement C&F_Income statement e. Operating Income (EBIT): Earnings before interest and taxes (EBIT)= Gross Profit - Operating The Income Statement, also known as the Profit and Loss Statement (P&L) summarizes a Expenses company's revenues, expenses, and profits or losses over a specific period (e.g., monthly, quarterly, Indicates the profitability of the core business operations. If the restaurant has a gross profit of or annually). €30,000 and operating expenses of €15,000, the operating income is €15,000. Purpose: f. Non-Operating Income and Expenses: Revenue or costs not related to core business To show a company’s financial performance over a specific period. activities. It highlights whether the company is generating profits or incurring losses. ○ Interest income or expense Helps stakeholders evaluate the company's financial health. ○ Gains or losses from investments ○ Foreign exchange gains/losses Important: Provides a clearer picture of overall profitability. The restaurant might have a bank loan and pay €2,000 in interest. Snapshot in Time: Represents a specific period but doesn’t show trends. Subjectivity: Some items (e.g., depreciation, amortization) are based on g. Taxes: Taxes owed on income. estimates and assumptions. Subtracted from Pre-Tax Income to determine Net Income. If the restaurant has an operating income of €15,000 and pays €2,000 in interest, the net income before taxes is €13,000. Common variations: h. Net Income (Bottom Line): Revenue - (COGS + Operating Expenses + Non-Operating Expenses + - Single-Step Income Statement→Combines all revenues and expenses into two Taxes) categories (Total Revenues and Total Expenses). Final profit or loss after all expenses. - Multi-Step Income Statement→Breaks down revenues and expenses into Key indicator of overall profitability. If the restaurant has €13,000 and pays €2,600 in taxes, its net detailed categories, providing a clearer picture of operational and non-operational income is €10,400. performance. 3 4 2  2025. 01. 15. C&F_Balance Sheet C&F_Balance Sheet The Balance Sheet is based on the accounting equation: Assets=Liabilities+Equity b. Liabilities (represent what the company owes to others) are categorized as: a. Assets (represent what the company owns or controls) are categorized as: - Current Assets (Expected to be converted to cash or used up within one year). Examples: § Current Liabilities (Obligations due within one year). Cash and Cash Equivalents: Most liquid assets, including cash and short-term Accounts Payable: Money owed to suppliers for goods or services received. investments. Short-Term Debt: Loans or credit lines maturing within a year. Accounts Receivable: Money owed by customers for goods or services delivered. Accrued Expenses: Expenses incurred but not yet paid (e.g., wages, Inventory: Raw materials, work-in-progress, and finished goods. utilities). Prepaid Expenses: Payments made for expenses not yet incurred (e.g., insurance Example: The restaurant owes €8,000 to suppliers for ingredients and €2,000 in premiums). short-term loans. Example: The restaurant has €10,000 in cash and €5,000 in accounts receivable (money customers owe). - Non-Current Assets (or Long-Term Assets, Expected to provide benefits over a longer period § Non-Current Liabilities (or Long-Term Liabilities, Obligations not due within a (more than a year). Examples: year). Property, Plant, and Equipment (PP&E): Tangible assets like land, buildings, and Long-Term Debt: Bonds, loans, or mortgages payable beyond one year. machinery. Deferred Tax Liabilities: Taxes owed but deferred to future periods. Intangible Assets: Non-physical assets such as patents, trademarks, and goodwill. Pension Liabilities: Obligations to employees under retirement plans. Long-Term Investments: Investments not intended to be sold within a year. Example: The restaurant has a long-term loan of €50,000 from the bank. Example: The restaurant owns kitchen equipment worth €30,000 and a building valued at €100,000. 5 6 3  2025. 01. 15. C&F_Balance Sheet C&F_Balance Sheet c. Equity represents the residual interest in the company’s assets after liabilities are The Balance Sheet, also called the Statement of Financial Position, provides a snapshot of subtracted. It is often referred to as Net Worth or Shareholders' Equity. a company's financial position at a specific point in time. It summarizes what the company owns (assets), owes (liabilities), and the value remaining for its shareholders (equity). Common Components: ○ Common Stock: Par value of issued shares. Importance of the Balance Sheet ○ Retained Earnings: Accumulated profits reinvested in the business. Liquidity: ○ Additional Paid-In Capital: Excess amount paid by investors over the par ○ Assessed by comparing current assets to current liabilities (e.g., current ratio, value of shares. quick ratio). ○ Treasury Stock: Shares repurchased by the company, reducing equity. ○ Indicates the company’s ability to meet short-term obligations. Solvency: Example: ○ Evaluated by analyzing long-term liabilities and equity. - Contributed Capital: The owner invested €20,000 to start the restaurant. ○ Shows the company’s ability to sustain operations in the long term. Capital Structure: - Retained Earnings: Over time, the restaurant has kept €40,000 of its profits in ○ Proportions of debt and equity used to finance assets. the business for future growth. ○ Helps assess financial stability (e.g., debt-to-equity ratio). Equity=Assets−Liabilities 7 8 4  2025. 01. 15. C&F_Cash Flow Statement C&F_Cash Flow Statement Structure of the Cash Flow Statement is divided into three sections: Two methods to report Operating Activities: a. Operating Activities (Cash from daily business operations). 1. Direct Method: Lists specific cash inflows and outflows (e.g., cash from Examples of cash inflows: customers, payments to suppliers). ○ Cash received from customers. ○ Cash receipts from interest or dividends. Examples of cash outflows: 2. Indirect Method (most common): ○ Payments to suppliers and employees. ○ Starts with Net Income (from the Income Statement). ○ Interest paid on loans. ○ Adjusts for non-cash items (e.g., depreciation) and changes in ○ Income tax payments. working capital (e.g., accounts receivable, inventory). The restaurant collects €50,000 from customers and pays €20,000 to suppliers for ingredients. It also pays €5,000 in staff salaries and €2,000 for utilities. Net cash from operating activities: €23,000 (€50,000 - €27,000). 9 10 5  2025. 01. 15. C&F_Cash Flow Statement C&F_Cash Flow Statement b. Investing Activities (Cash from buying or selling long-term assets) c. Financing Activities (Cash from borrowing or returning money to investors): Cash flows related to the purchase or sale of long-term assets and investments. Cash flows related to transactions with creditors and shareholders. Examples of cash inflows: Examples of cash inflows: ○ Proceeds from the sale of property, plant, and equipment (PP&E). ○ Proceeds from issuing debt or equity. ○ Proceeds from the sale of investments. Examples of cash outflows: Examples of cash outflows: ○ Repayment of loans or other borrowings. ○ Purchase of PP&E or other long-term assets. ○ Payment of dividends to shareholders. ○ Purchase of investments. ○ Repurchase of company stock. The restaurant purchases new kitchen equipment for €10,000 and sells old furniture for €3,000. Net cash from investing activities: -€7,000 (€3,000 - €10,000). The restaurant takes out a bank loan of €15,000 and repays €5,000 of a previous loan. It also pays €1,000 in dividends to shareholders. Net cash from financing activities: €9,000 (€15,000 - €6,000). 11 12 6  2025. 01. 15. C&F_Cash Flow Statement C&F_Cash Flow Statement Section Amount (in $) Operating Activities The Cash Flow Statement is a financial document that provides a detailed summary of a company's cash inflows and outflows over a specific period. Net Income $50,000 Limitations of the Cash Flow Statement: Depreciation $10,000 Purpose of the Cash Flow Statement Decrease in Accounts ($5,000) Does Not Reflect Profitability (A Payable company may have positive cash Tracks actual cash movements. Increase in Inventory ($7,000) flow but still be unprofitable). Helps stakeholders understand how cash is generated and used across three main Net Cash from $48,000 Ignores Non-Cash Transactions activities: Operations (E.g., depreciation and 1. Operating Activities: Day-to-day business operations. Investing Activities amortization are excluded, even 2. Investing Activities: Investments in assets or proceeds from their sale. Purchase of Equipment ($20,000) though they impact long-term 3. Financing Activities: Transactions with creditors and shareholders. Sale of Investments $10,000 financial health). Net Cash from Investing ($10,000) Snapshot in Time (It shows cash Importance of the Cash Flow Statement Financing Activities flows for a specific period but not Liquidity Assessment: Helps determine whether a company has enough cash to meet overall trends without comparison). Issuance of Stock $30,000 short-term obligations. Repayment of Debt ($15,000) Operational Efficiency: Identifies how effectively the company converts revenue into cash. Dividends Paid ($5,000) Investment Decisions: Reveals how the company allocates cash to growth and asset Net Cash from Financing $10,000 purchases. Net Change in Cash $48,000 Financing Strategy: Shows how the company raises funds and repays obligations. 13 14 7  2025. 01. 15. C&F_Accounting and lemonades C&F_Accounting and lemonades 2. Balance Sheet: This is like a snapshot of everything your business owns 1. Income Statement (or Profit and Loss Statement): This is like a report card (assets) and owes (liabilities) at a specific time. It shows how much your showing how much lemonade you sold and whether you made money or lost it. lemonade stand is worth. Revenue: This is how much money you earned from selling lemonade. What You Own (Assets): ○ Example: You sold 50 cups of lemonade at $1 each. Revenue = $50. ○ Cash you have in your jar. Expenses: This is how much money you spent to make the lemonade. ○ Leftover supplies (lemons, sugar, and cups). ○ Example: You spent $10 on lemons, $5 on sugar, and $5 on cups. What You Owe (Liabilities): Expenses = $20. ○ If you borrowed money from your parents to start the stand, you owe them Profit or Loss: This is the difference between how much you earned and how back. much you spent. Your Net Worth (Equity): ○ Formula: Profit=Revenue−Expenses ○ This is the difference between what you own and what you owe. ○ Example: $50 (Revenue) - $20 (Expenses) = $30 Profit! ○ Formula: Equity=Assets−Liabilities The income statement shows if you’re making money or losing it. Example: You have $30 in your cash jar and $10 worth of supplies (total assets = $40). You still owe your parents $10 (liabilities = $10). Your business is worth $30 (equity = $40 - $10). 15 16 8  2025. 01. 15. C&F_Accounting and lemonades C&F_Accounting and lemonades 3. Cash Flow Statement tells you where your money is going: how much money Why Are These Important? is coming in and how much is going out. Cash In: The $50 you earned from selling lemonade. These three documents help you understand: Cash Out: The $20 you spent on lemons, sugar, and cups. Income Statement: Are you making or losing money? It helps you see if you have enough cash to buy more supplies or pay off what you owe. Balance Sheet: How much is your lemonade business worth? Example: Cash Flow Statement: Do you have enough money to keep going? You start the day with $10. You earn $50 selling lemonade. You spend $20 on more supplies. At the end of the day, you have $40 in cash. The cash flow statement helps you manage your money and make sure you can keep running your stand. 17 18 9  2025. 01. 15. C&F_Accounting and lemonades Course Presentation- What we do The Income Statement, Balance Sheet, and Cash Flow Statement are all interconnected. Imagine you’re running a lemonade stand. 1. Income Statement ↔ Cash Flow Statement For example: Profit doesn’t always mean cash in your pocket: o Accounts Receivable: Revenue is recorded on the Income Statement when a customer makes a purchase on credit, but the cash only appears on the Cash Flow Statement once the payment is received. o Credit Purchases: Expenses are recorded on the Income Statement when supplies or At first, it might seem simple—you buy lemons, sugar, services are bought on credit, but the cash outflow is only reflected on the Cash Flow and cups, then sell lemonade. Statement when the payment is made. 2. Balance Sheet ↔ Cash Flow Statement ○ If your Cash increases (from selling lemonade), it shows up on the Balance Sheet under Assets and also as a positive cash inflow on the Cash Flow Statement. You need to check if you have enough cash for daily needs, if you’re using your ○ If you pay off a debt (Liabilities), your cash decreases on the Balance Sheet, and this is resources wisely, if you’re making a good profit, and if your business can handle recorded as a cash outflow on the Cash Flow Statement. unexpected challenges. 19 20 10  2025. 01. 15. Course Presentation- What we do Course Presentation- What we do You earn $50 selling lemonade, but you have $30 in short-term You use 10 lemons to make 10 cups of lemonade and sell bills: $10 for lemons, $10 for sugar, and $10 for cups. them for $1 each (total: $10). But if you find a way to make 15 cups with the same 10 lemons, you’ll earn $15 instead. If you only have $20 in cash, you don’t have enough liquidity to Or, if you take 2 hours to set up and make lemonade, you’re cover those costs. less efficient than if you only take 1 hour. you might need to borrow money! 2. Efficiency: Are you using your resources (like lemons, cups, and time) effectively 1. Liquidity: Do you have enough money to pay for your short-term needs (like to make as much lemonade and money as possible? buying lemons, sugar, or cups)? Efficiency shows if you’re making the most out of what you have. If you Liquidity checks if you have enough cash or other resources to keep the waste lemons or take too long to make lemonade, your business won’t business running day-to-day. Without it, you can’t pay for ingredients or perform well. other immediate expenses. The more efficiently you use your resources, the more If you don’t have enough cash on hand to cover short-term money you can make without spending extra. costs, your business could be in trouble, even if it’s profitable. 21 22 11  2025. 01. 15. Course Presentation- What we do Course Presentation- What we do You sell lemonade for $50, but you spend $40 on ingredients and ○ You borrow $50 from your parents to buy a fancy lemonade machine. cups. Your profit is $10. You need to make enough money to pay them back over time. If you can lower your costs (like finding cheaper lemons) or raise ○ If it rains for a week and you can’t sell lemonade, can your business your prices, you can make more profit! still survive? Do you have savings or other ways to make money? 3. Profitability: Are you earning enough money compared to what you spend? Profitability tells you if your business is making money. If you spend 4. Financial Stability: Can your lemonade stand survive long-term challenges (like bad weather or borrowing money)? more on lemons and sugar than you earn from selling lemonade, your business won’t survive. Stability shows if your business is secure enough to handle unexpected problems and stay open in the future. It looks at your debts and whether your business can survive tough times. Profitability is key to keeping your lemonade stand going and having extra money to grow your business or save. A stable business can handle surprises and keep going even if things get tough. 23 24 12  2025. 01. 15. LIQUIDITY INDICATORS C&F How do we know if a company is truly successful? Is it just about selling more products or earning higher revenue? Why These Matter for Your Lemonade Stand 1. Liquidity: Make sure you have enough money for daily costs like lemons and Liquidity indicators provide insights into a company’s ability to meet its short-term cups. obligations using its available assets. 2. Efficiency: Use your time and resources wisely to make more lemonade and money. Can the company pay its bills on time? Does it have enough liquid assets to cover unexpected expenses or 3. Profitability: Keep an eye on profits to ensure you’re earning more than you’re spending. obligations? 4. Financial Stability: Plan for the future so your lemonade stand can keep running, even if something unexpected happens. 25 26 13  2025. 01. 15. Current Ratio Current Ratio Current Assets: resources the company expects to convert into cash, sell, or use within one year or one operating cycle, whichever is longer. Examples: Example: Cash and cash equivalents: Money readily available for use. Current Assets: €50,000 Accounts receivable: Money owed by customers for sales made on credit. Current Liabilities: €25,000 Inventory: Goods ready for sale or raw materials to be processed. Marketable securities: Short-term investments that can be easily liquidated. Current Ratio=50,000/25,000=2.0 Prepaid expenses: Payments made in advance for future goods or services (e.g., rent, insurance). What does it mean? Current Liabilities: obligations the company is required to settle within one year or one operating For every €1 of liability, the company has €2 in current assets. This suggests strong liquidity. cycle. Examples: A ratio of: ○ >1: Generally good liquidity, as assets exceed liabilities. Accounts payable: Money owed to suppliers for goods or services purchased. ○ 2): Technology SaaS companies or tech 1.0 - 1.8 Typically asset-light with fewer liabilities, resulting in a balanced ○ In Real Estate, Big upfront costs and long projects need extra cash. startups ratio. ○ In Manufacturing, Lots of raw materials and finished products increase assets. Healthcare Hospitals and 1.2 - 2.0 Moderate ratio due to receivables from insurers and a need to ○ In Healthcare, Insurance payments take time, so receivables pile up. pharmaceutical companies maintain medical supply inventory. Manufacturing Producers of machinery or 1.2 - 2.0 Requires significant working capital to manage inventory and High ratios (>2) happen because some industries need more cash or inventory. consumer goods production, leading to slightly higher ratios. Energy Renewable energy firms or 1.2 - 1.8 Infrastructure maintenance and billing cycles lead to a slightly Low Current Ratio (