Question

1.Examine debt and its sources of current debt (or short-term liabilities).

2.Analyze the preparing of the statement of cash flows.

3.Assess debt ratio.

4.Describe the three different profit margins.

5.Examine the distinction between gross fixed assets and net fixed assets and how depreciation expense in the income statement relates to accumulated depreciation in the balance sheet. Assume a truck is bought at $40,000 and is evenly depreciated over a 4-year life.

6.Summarize a transactions balance.

7.Analyze the MACRS recovery period.

8.Explain the “value” of assets on a balance sheet.

9.Assess how the gross profit and expenses are calculated for the income statement.

Answer 1

1.What is 'Debt'

Debt is an amount of money borrowed by one party from another. Debt is used by many corporations and individuals as a method of making large purchases that they could not afford under normal circumstances. A debt arrangement gives the borrowing party permission to borrow money under the condition that it is to be paid back at a later date, usually with interest

Short term sources of funds

·         Accounts payable delays. You can delay paying suppliers, but they may eventually retaliate with higher prices or a lower order priority. This is essentially an interest-free loan, but can only be used with care.

·         Accounts receivable collections. You can add staff and use a variety of procedures to accelerate the payment of accounts receivable by customers.

·         Commercial paper. Quite inexpensive, but only available to large firms with a high rating from a credit rating agency.

·         Credit cards. Very expensive interest rates, and funds are generally only available in modest amounts.

·         Customer advances. It may be possible to successfully alter customer payment terms to require customers to pay all or a portion of their ordered amounts in advance. However, this approach can also send customers toward competitors who offer looser credit terms.

·         Early payment discounts. You can offer an early payment discount to customers, though the interest rate tends to be quite high.

·         Factoring. Funding based on accounts receivable. Decidedly expensive, but it can dramatically accelerate cash flows.

·         Field warehouse financing. Funding based on inventory levels. Requires detailed inventory tracking, and is more expensive than the prime borrowing rate.

·         Floor planning. Funding based on inventory held by a retailer. Requires detailed inventory tracking, and is more expensive than the prime borrowing rate.

·         Inventory reduction. One of the best forms of short term financing is to tie up fewer funds in inventory, which requires considerable attention to the management of inventory.

·         Lease. Specific funding that is tied to an asset, which is the collateral for the lease. Term can cover multiple years, and the interest rate can vary from near the prime rate to excessively high.

·         Line of credit. Short term general funding that may require assets for collateral. Cost can be near the prime rate, but is closely monitored by the lender.

·         Receivables securitization. Inexpensive, but only available to large firms with a broad base of quality receivables.

·         Sale and leaseback. Can result in immediate large cash receipt in exchange for a long-term lease commitment.

·        

3. 'Debt Ratio'

The debt ratio is a financial ratio that measures the extent of a company’s leverage. The debt ratio is defined as the ratio of total debt to total assets, expressed as a decimal or percentage. It can be interpreted as the proportion of a company’s assets that are financed by debt.

The debt ratio is also referred to as the debt-to-assets ratio.

4.The Three Main Types of Profitability Margins

Gross Profit Margin

Gross Profit Margin (GPM) = (Revenue – Cost of Goods Sold) / Revenue

Gross profit is derived after subtracting a company’s cost of goods sold (COGS). COGS is an aggregate expenses from direct labor, raw materials and other overheads costs such as utilities (e.g. power bill of a manufacturing plant)involved in the manufacturing of products. The gross profit margin is able to tell us whether companies have control over supply costs and/or whether they have a strong product differentiation which allows strong pricing power. For example, Super Group Ltd (SGX: S10) has S$557 million of revenue and S$209 million of gross profits earned in 2013. Gross profit margin is thus 37.5%.

Operating Profit Margin

Operating Profit Margin (OPM) = (Gross profit – selling & distribution costs – general administrative costs) / Revenue

Also known as EBIT (earnings before interest and taxes), operating profits show the residual earnings after subtracting out most of the fixed costs (i.e. staff costs, rental expenses, advertising & marketing costs, research & development costs). As a company with a large economics of scale grows its sales revenue, fixed costs should become a smaller percentage of total costs and operating profit margin should increase. A high operating profit margin might also suggest a firm has a low-cost operating model. For example, Texhong Textile Ltd (HKSE: 2678.HK) has RMB1.36 billion of operating profits earned. However, we have to exclude its other income gains of RMBRMB316 million as it is not part of its core business earnings. As such, based on its revenue of RMB8.23 billion in 2013, the Group’s operating profit margins stood at 12.6%.

Net Profit Margin

Net Profit Margin (NPM) = (Operating profit – interest expenses – tax expenses) / Revenue

The bottom-line. Net profit measures the profitability of a business after accounting for all its costs. Its net profit margin would indicate how much after-tax profit would a business make for every dollar of revenue generated.

5 Net fixed assets refers to the aggregation of all assets, contra assets, and liabilities related to a company's fixed assets. The concept is used to determine the residual fixed asset or liability amount for a business. The calculation of net fixed assets is:

+ Fixed asset purchase price (asset)
+ Subsequent additions to existing assets (asset)
- Accumulated depreciation (contra asset)
- Accumulated asset impairment (contra asset)
- Liabilities associated with the fixed assets (liability)
= Net fixed assets

Gross fixed assetsThe aggregate amount of physical goods owned by a business. The value of a company's gross fixed assets is typically assessed by accounting for each item at the price that the individual asset was originally obtained for, and so this measure does not take into account the depreciation or consumption over time of the fixed assets.

9. How Can I Calculate Gross Profit?

The formula for calculating gross profit is incredibly simple. You simply have to subtract cost of the goods sold from revenue. That is:

Gross Profit = Total Revenue - Cost of Goods Sold (COGS)

7. MACRS

Most business and investment property placed in service after 1986 is depreciated using MACRS.

This section explains how to determine which MACRS depreciation system applies to your property. It also discusses other information you need to know before you can figure depreciation under MACRS. This information includes the property's:

• Recovery class,
• Applicable recovery period,
• Convention,
• Placed-in-service date,
• Basis for depreciation, and
• Depreciation method.

Recovery Periods Under MACRS

• The recovery period of property is the number of years over which you recover its cost or other basis. The recovery periods are generally longer under ADS than GDS.
• The recovery period of property depends on its property class. Under GDS, the recovery period of an asset is generally the same as its property class.
• Class lives and recovery periods for most assets are listed in Appendix B of Pub. 946. See Table 2-1 for recovery periods of property commonly used in residential rental activities.