Chapter 4 - The balance sheet. In this chapter you will learn why owners, investors, lenders, and managers all must know how to read and understand a balance sheet. You will also learn how accountants prepare a balance sheet and, most important, how managerial accountants evaluate the information contained in a balance sheet using vertical and horizontal analysis techniques.
Chapter The Balance Sheet © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Chapter Outline The Purpose of the Balance Sheet Balance Sheet Formats Balance Sheet Content Components of the Balance Sheet Balance Sheet Analysis © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Learning Outcomes State the purpose of regularly preparing a balance sheet for a hospitality business Explain the way managers and accountants actually prepare a balance sheet Analyze a balance sheet to better understand the financial condition of your own business © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes The Purpose of the Balance Sheet The type of information contained on a business’s balance sheet is of critical importance to several different groups including: Owners Investors Lenders Creditors Managers © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Owners The balance sheet, prepared at the end of each defined accounting period, lets the owners of the business know about the amount of that business which they actually “own” A lien is the legal right to hold another’s property to satisfy a debt A bank’s lien is similar to a business’s liabilities These liabilities must be subtracted from the value of the business before its owners can determine the amount of their own equity (free and clear ownership) The balance sheet is designed to show the amount of a business owner’s free and clear ownership © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Investors Investors seek to maximize the return on investment (ROI) they receive When a business’s balance sheet from one accounting period is compared to its balance sheet covering another time period, investors can measure their return on investment Investors must have the information contained in a balance sheet if they are to accurately compute their annual returns on investment (ROI) © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Lenders Lenders are most concerned about a business’s ability to repay its debts Lenders read the balance sheet of a business in an effort to better understand the financial strength (and thus the repayment ability) of that business © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Creditors Business creditors, much like lenders, are concerned about repayment It would not be unreasonable for vendors to ask to see their customer’s respective balance sheets before a decision was made regarding the wisdom of extending credit to them The balance sheet is the financial document that most accurately indicates the long-term ability of a business to repay a vendor who has extended credit to that business © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Managers Managers most often are more interested in the information found on the income statement than that found on the balance sheet However, they too must be able to read and analyze their own balance sheets to determine items such as the current financial balances of cash, accounts receivable, inventories, and accounts payable, and other accounts that have a direct impact on operations © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Limitations of the Balance Sheet Knowledgeable readers of a balance sheet recognize that accountants utilize a variety of evaluation approaches, each of which may make the most sense for specific asset types based upon circumstances and available information It is also important to note that balance sheets have been criticized because of the company assets they not value Consider the fact that, of all the assets listed on the balance sheet, none take into account the relative value, or worth, of a restaurant or hotel’s staff, including its managers © 2009 John Wiley & Sons Hoboken, NJ 07030 10 Managerial Accounting for the Hospitality Industry Dopson & Hayes Owner’s Equity Common stock is valued at its historical cost regardless of its current selling price Initially, most companies designate a stated or par value for the stock they issue and as each share is sold, an amount equal to the par value is reported in the common stock section of the balance sheet Differences between the selling price and par value are reported in the paid in capital portion of the balance sheet Some companies also issue preferred stock that pays its stockholders (owners) a fixed dividend © 2009 John Wiley & Sons Hoboken, NJ 07030 31 Managerial Accounting for the Hospitality Industry Dopson & Hayes Owner’s Equity When more than one type of stock is issued by a company, the value of each type should be listed separately on the balance sheet Retained earnings are the final entry on the owners’ equity portion of the balance sheet Retained earnings refer simply to the accumulated account of profits over the life of the business that have not been distributed as dividends If net losses have occurred, the entry amount in this section may be a negative number © 2009 John Wiley & Sons Hoboken, NJ 07030 32 Managerial Accounting for the Hospitality Industry Dopson & Hayes Balance Sheet Analysis After the balance sheet has been prepared, managerial accountants use a variety of methods to analyze the information it contains Three of the most common types of analysis are: Vertical (common-size) analysis Horizontal (comparative) analysis Ratio analysis © 2009 John Wiley & Sons Hoboken, NJ 07030 33 Managerial Accounting for the Hospitality Industry Dopson & Hayes Vertical Analysis of Balance Sheets Income statements can be analyzed using vertical and horizontal techniques In very similar ways, the balance sheet can be reviewed using these same techniques When using vertical analysis on a balance sheet, the business’s Total Assets take on a value of 100% Total Liabilities and Owners’ Equity also take a value of 100% © 2009 John Wiley & Sons Hoboken, NJ 07030 34 Managerial Accounting for the Hospitality Industry Dopson & Hayes Figure 4.8 Vertical (Common Size) Balance Sheet Analysis Blue Lagoon Water Park Resort Balance Sheet December 31, 2010 $ % Assets Current Assets Cash Marketable Securities Net Receivables Inventories Total Current Assets 2,314,750 3,309,600 1,053,950 1,497,200 8,175,500 5.0 7.1 2.3 3.2 17.6 5,023,500 10.8 7,712,550 22,290,500 7,289,000 4,668,900 32,623,150 669,800 46,491,950 16.6 47.9 15.7 10.0 70.2 1.4 100.0 1,438,100 1,319,900 1,264,600 4,022,600 3.1 2.8 2.7 8.6 Long-Term Liabilities Long-Term Debt Total Liabilities 14,577,400 18,600,000 31.4 40.0 Owners’ Equity Common Stock Paid in Capital Retained Earnings Total Owners’ Equity 3,000,000 18,775,100 6,116,850 27,891,950 6.4 40.4 13.2 60.0 Total Liabilities and Owners’ Equity 46,491,950 100.0 Investments Property and Equipment Land Building Furnishings and Equipment Less Accumulated Depreciation Net Property and Equipment Other Assets Total Assets Liabilities and Owners’ Equity Current Liabilities Accounts Payable Notes Payable Other Current Liabilities Total Current Liabilities © 2009 John Wiley & Sons Hoboken, NJ 07030 35 Managerial Accounting for the Hospitality Industry Dopson & Hayes Vertical Analysis of Balance Sheets When utilizing vertical analysis, individual asset categories are expressed as a percentage (fraction) of Total Assets Individual liability and owner’s equity classifications are expressed as a percentage of Total Liabilities and Owner’s Equity Each percentage computed is a percent of a “common” number, which is why this type analysis is sometimes referred to as common-size analysis Vertical analysis of the balance sheet may be used to compare a unit’s percentages with industry averages, other units in a corporation, or percentages from prior periods © 2009 John Wiley & Sons Hoboken, NJ 07030 36 Managerial Accounting for the Hospitality Industry Dopson & Hayes Horizontal Analysis of Balance Sheets A second popular method of evaluating balance sheet information is the horizontal analysis method As was true with the income statement, a horizontal analysis of a balance sheet requires at least two different sets of data Because of this “comparison” approach the horizontal analysis technique is also called a comparative analysis © 2009 John Wiley & Sons Hoboken, NJ 07030 37 Managerial Accounting for the Hospitality Industry Dopson & Hayes Horizontal Analysis of Balance Sheets Managers who use horizontal analysis to evaluate the balance sheet may be concerned with comparisons such as their: Current period results vs prior period results Current period results vs budgeted (planned) results Current period results vs the results of similar business units Current period results vs industry averages © 2009 John Wiley & Sons Hoboken, NJ 07030 38 Managerial Accounting for the Hospitality Industry Dopson & Hayes Figure 4.9 Horizontal (Comparative) Balance Sheet Analysis Blue Lagoon Water Park Resort Balance Sheets December 31, 2009 and 2010 2009 2010 $ Change % Change Assets Current Assets Cash Marketable Securities Net Receivables Inventories Total Current Assets 2,370,800 4,109,600 1,655,300 897,200 9,032,900 2,314,750 3,309,600 1,053,950 1,497,200 8,175,500 (56,050) (800,000) (601,350) 600,000 (857,400) (2.4) (19.5) (36.3) 66.9 (9.5) 4,223,500 5,023,500 800,000 18.9 7,712,550 22,290,500 5,063,655 3,408,900 31,657,805 588,800 45,503,005 7,712,550 22,290,500 7,289,000 4,668,900 32,623,150 669,800 46,491,950 0 2,225,345 1,260,000 965,345 81,000 988,945 0.0 0.0 43.9 37.0 3.0 13.8 2.2 2,038,100 2,104,255 1,814,600 5,956,955 1,438,100 (600,000) 1,319,900 (784,355) 1,264,600 (550,000) 4,022,600 (1,934,355) (29.4) (37.3) (30.3) (32.5) Long-Term Liabilities Long-Term Debt Total Liabilities 13,821,750 19,778,705 14,577,400 755,650 18,600,000 (1,178,705) 5.5 (6.0) Owners’ Equity Common Stock Paid in Capital Retained Earnings Total Owners’ Equity 2,925,000 17,850,100 4,949,200 25,724,300 3,000,000 18,775,100 6,116,850 27,891,950 75,000 925,000 1,167,650 2,167,650 2.6 5.2 23.6 8.4 Total Liabilities and Owners’ Equity 45,503,005 46,491,950 988,945 2.2 Investments Property and Equipment Land Building Furnishings and Equipment Less Accumulated Depreciation Net Property and Equipment Other Assets Total Assets Liabilities and Owners’ Equity Current Liabilities Accounts Payable Notes Payable Other Current Liabilities Total Current Liabilities © 2009 John Wiley & Sons Hoboken, NJ 07030 39 Managerial Accounting for the Hospitality Industry Dopson & Hayes Determining Variance The dollar change or variance shows changes from previously experienced levels, and will give you an indication of whether your numbers are improving, declining, or staying the same All dollar variances and percentage variances on the balance sheet can be calculated in the same way The dollar differences between identical categories listed on two different balance sheets is easy to compute and is always the numerator in any percentage change (variation) calculation © 2009 John Wiley & Sons Hoboken, NJ 07030 40 Managerial Accounting for the Hospitality Industry Dopson & Hayes g o fig u re! To calculate the variance in cash, you would use the following formula: Cash This Year – Cash Last Year = Variance or $2,314,750 - $2,370,800 = ($56,050) Effective managers are also interested in computing the percentage variance, or percentage change, from one time period to the next Thus, the cash percentage variance is determined as follows: (Cash This Year – Cash Last Year) Cash Last Year = Percentage Variance or ($2,314,750 - $2,370,800) $2,370,800 © 2009 John Wiley & Sons Hoboken, NJ 07030 = (2.4%) 41 Managerial Accounting for the Hospitality Industry Dopson & Hayes ( g o fig u re! continued) Of course, an alternative and shorter formula for computing the percentage variance is as follows: Variance Cash Last Year = Percentage Variance or ($56,050) $2,370,800 = (2.4%) Another way to compute the percentage variance is to use a math shortcut, as follows: Cash This Year Cash Last Year –1 = Percentage Variance or $2,314,750 $2,370,800 © 2009 John Wiley & Sons Hoboken, NJ 07030 – = (2.4%) 42 Managerial Accounting for the Hospitality Industry Dopson & Hayes Inflation Accounting The second reason for computing percentage change in the preparation of balance sheets (as well as other financial documents) is because the value of money changes over time As economists (as well as managerial accountants) know well, if you don't adjust for inflation (the tendency for prices and costs to increase) just about everything is more expensive today than it was 30 years ago © 2009 John Wiley & Sons Hoboken, NJ 07030 43 Managerial Accounting for the Hospitality Industry Dopson & Hayes Inflation Accounting Because of the potential effects of inflation and deflation (the tendency for prices and costs to decrease), managerial accountants must know how to properly consider them when comparing financial data from two different time periods The purchasing power (amount of goods and service that can be bought) of money is likely diminished over time due to the effects of inflation Accounting for inflation (sometimes called current dollar accounting) can be very complex © 2009 John Wiley & Sons Hoboken, NJ 07030 44 Managerial Accounting for the Hospitality Industry Dopson & Hayes Review of Learning Outcomes State the purpose of regularly preparing a balance sheet for a hospitality business Explain the way managers and accountants actually prepare a balance sheet Analyze a balance sheet to better understand the financial condition of your own business © 2009 John Wiley & Sons Hoboken, NJ 07030 45 Managerial Accounting for the Hospitality Industry Dopson & Hayes ... 27,891,950 46 ,49 1,950 Managerial Accounting for the Hospitality Industry Dopson & Hayes Balance Sheet Formats When using the report format those preparing the balance sheet list the assets... Hoboken, NJ 07030 46 ,49 1,950 14 Managerial Accounting for the Hospitality Industry Dopson & Hayes Balance Sheet Content The Accounting formula is stated as Assets = Liabilities + Owner’s Equity The content... Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Owners The balance sheet, prepared at the end of each defined accounting period, lets the owners of the business