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Financial Statement Analysis at different Stages After studying this chapter, you should be able to: 1. List basic financial statement analytical procedures. 2. Apply financial statement analysis to assess the solvency of a business. 3. Apply financial statement analysis to stress the profitability of a business. 4. Describe the contents of corporate annual reports. WHY? WHEN? HOW? How much money does the company need? When is the money needed? When will the company make money? How much money will they make? When? Shareholders equity, how much needed? Credit, how much needed? How much money does the company need? When is the money needed? When will the company make money? How much money will they make? When? Shareholders equity, is the mix correct? Credit, are current arrangements correct? Are actuals inline with forecasts? How much money does the company need? When is the money needed? When will the company make money? How much money will they make? When? Shareholders equity, is the mix correct? Credit, are current arrangements correct? Are actuals inline with forecasts? How to fund growth? Internal Users ◦ Management ◦ Owner (s) External Users Investors Creditors Government Customers Labour Unions (employees) ◦ Public ◦ ◦ ◦ ◦ ◦ Horizontal Analysis The percentage analysis of increases and decreases in related items in comparative financial statements is called horizontal analysis. 10 Exhibit 1 Comparative Balance Sheets Lincoln Company Comparative Balance Sheet December 31, 2008 and 2007 2008 2007 Increase (Decrease) Amount Percent Assets Current assets $ 550,000 $ 533,000$ 17,000 Long-term investments 95,000 177,500 (82,500) Prop., plant, and equip. (net) 444,500 470,000 (25,500) Intangible assets 50,000 50,000 Total assets $1,139,500 $1,230,500$ (91,000) Liabilities Current liabilities $ 210,000 $ 243,000$ (33,000) Long-term liabilities 100,000 200,000 100,000) Total liabilities $ 310,000 $ 443,000$(133,000) Stockholders’ Equity Preferred 6% stock, $100 par$ 150,000$ 150,000 — Common stock, $10 par 500,000 500,000 — Retained earnings 179,500 137,500$ 42,000 Total stockholders’ equity $ 829,500 $ 787,500$ 42,000 Total liab. & stockholders’ eq.$1,139,500$1,230,500$ (91,000) 3.2% (46.5%) (5.4%) (7.4%) (13.6%) (50.0%) (30.0%) 30.5% 5.3% (7.4%) 11 Lincoln Company Comparative Balance Sheet December 31, 2008 and 2007 2008 2007 Increase (Decrease) Amount Percent Assets Current assets $ 550,000 $ 533,000$ 17,000 3.2% Long-term investments 95,000 177,500 (82,500) (46.5%) Prop., plant, and equip. (net) 444,500 470,000 (25,500) (5.4%) Horizontal Analysis: Intangible assets 50,000 50,000 Total assets $1,139,500 $1,230,500$ (91,000) (7.4%) Difference $17,000 Liabilities = 3.2% Current liabilities $ 210,000 $ (2007) 243,000$ (33,000) Base year $533,000(13.6%) Long-term liabilities 100,000 200,000 100,000) (50.0%) Total liabilities $ 310,000 $ 443,000$(133,000) (30.0%) Stockholders’ Equity Preferred 6% stock, $100 par$ 150,000$ 150,000 — Common stock, $10 par 500,000 500,000 — Retained earnings 179,500 137,500$ 42,000 30.5% Total stockholders’ equity $ 829,500 $ 787,500$ 42,000 5.3% Total liab. & stockholders’ eq.$1,139,500$1,230,500$ (91,000) (7.4%) 12 Lincoln Company Comparative Balance Sheet December 31, 2008 and 2007 2008 2007 Increase (Decrease) Amount Percent Assets Current assets $ 550,000 $ 533,000$ 17,000 Long-term investments 95,000 177,500 (82,500) Prop., plant, and equip. (net) 444,500 470,000 (25,500) Intangible assets 50,000 50,000 Horizontal Analysis: Total assets $1,139,500 $1,230,500$ (91,000) Liabilities Difference $(82,500) Current liabilities $ 210,000 $ 243,000$ (33,000) Long-term liabilities 100,000 200,000 100,000) Base year (2007) $177,500 Total liabilities $ 310,000 $ 443,000$(133,000) Stockholders’ Equity Preferred 6% stock, $100 par$ 150,000$ 150,000 — Common stock, $10 par 500,000 500,000 — Retained earnings 179,500 137,500$ 42,000 Total stockholders’ equity $ 829,500 $ 787,500$ 42,000 Total liab. & stockholders’ eq.$1,139,500$1,230,500$ (91,000) 3.2% (46.5%) (5.4%) (7.4%) (13.6%) = (46.5%) (50.0%) (30.0%) 30.5% 5.3% (7.4%) 7 13 Exhibit 2 Comparative Schedule of Current Assets Lincoln Company Comparative Schedule of Current Assets December 31, 2008 and 2007 Cash Marketable securities Accounts receivable (net) Inventories Prepaid expenses Total current assets 2008 $ 90,500 75,000 115,000 264,000 5,500 $550,000 Increase (Decrease) 2007 Amount Percent $ 64,700 $ 25,800 39.9% 60,000 15,000 25.0% 120,000 (5,000) (4.2%) 283,000 (19,000) (6.7%) 5,300 200 3.8% $533,000 $17,000 3.2% 14 Lincoln Company Comparative Schedule of Current Assets December 31, 2008 and 2007 Increase (Decrease) 2008 2007 Amount Percent Cash $ 90,500 $ 64,700 $ 25,800 39.9% Marketable securities 75,000 60,000 15,000 25.0% Accounts receivable (net)Horizontal 115,000 120,000 (5,000) (4.2%) Analysis: Inventories 264,000 283,000 (19,000) (6.7%) Difference Prepaid expenses 5,500 5,300 $25,800 200 3.8% Total current assets $550,000 $533,000 $64,700 $17,000 = 39.9% 3.2% Base year (2007) 9 9 15 Exhibit 3 Comparative Income Statement Lincoln Company Comparative Income Statement For the Year Ended December 31, 2008 and 2007 Increase (Decrease) 2008 2007 Amount Percent Sales Sales returns and allowances Net sales Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Income from operations Other income Other expense (interest) Income before income tax Income tax expense Net income $1,530,500 $1,234,000 32,500 34,000 $1,498,000 $1,200,000 1,043,000 820,000 $ 455,000 $ 380,000 $ 191,000 $ 147,000 104,000 97,400 $ 295,000 $ 244,400 $ 160,000 $ 135,600 8,500 11,000 $ 168,500 $ 146,600 6,000 12,000 $ 162,500 $ 134,600 71,500 58,100 $ 91,000 $ 76,500 $296,500 (1,500) $298,000 223,000 $ 75,000 $ 44,000 6,600 $ 50,600 $ 24,400 (2,500) $ 21,900 (6,000) $ 27,900 13,400 $ 14,500 24.0% (4.4%) 24.8% 27.2% 19.7% 29.9% 6.8% 20.7% 18.0% (22.7%) 14.9% (50.0%) 20.7% 23.1% 19.0% 16 Lincoln Company Comparative Income Statement For the Year Ended December 31, 2008 and 2007 Increase (Decrease) 2008 2007 Amount Percent Current assets $1,530,500 $1,234,000 $296,500 24.0% Sales returns and allowances 32,500 34,000 (1,500) (4.4%) Net sales $1,498,000 $1,200,000 $298,000 24.8% Cost of goods sold 1,043,000 820,000 223,000 27.2% Gross profit $ 455,000 $ 380,000 $ 75,000 19.7% Selling expenses $ 191,000 $ 147,000 $ 44,000 29.9% Horizontal104,000 Analysis: 97,400 Administrative expenses 6,600 6,.8% Total operating expenses $ 295,000 $ 244,400 $ 50,600 20.7% Increase$ amount $296,500 Income from operations 160,000 $ 135,600 $ 24,400 18.0% = 24.0% (22.7%) Other income 8,500 11,000 (2,500) Base year (2007) $1,234,000 $ 168,500 $ 146,600 $ 21,900 14.9% Other expense (interest) 6,000 12,000 (6,000) (50.0%) Income before income tax $ 162,500 $ 134,600 $ 27,900 20.7% Income tax expense 71,500 58,100 13,400 23.1% Net income $ 91,000 $ 76,500 $ 14,500 19.0% 17 Exhibit 4 Comparative RE Statement Lincoln Company Comparative Retained Earnings Statement December 31, 2008 and 2007 A percentage analysis that Increase (Decrease) shows the2008 relationship of Percent 2007 Amount Retained earnings, Jan. 1 $137,500 $100,000 $37,500 37.5% each component to the Net income for year 91,000 76,500 14,500 19.0% Total $228,500 a $176,500 total within single$52,000 29.5%) Dividends: statement called vertical— On preferred stock $ is 9,000 $ 9,000 On common stock 40,000 30,000 10,000 33.3% analysis. Total Total current assets $ 49,000 $ 39,000 $179,500 $137,500 $10,000 $42,000 25.6% 30.5% 18 Exhibit 4 Comparative RE Statement Lincoln Company Comparative Retained Earnings Statement December 31, 2008 and 2007 A percentage analysis that Increase (Decrease) shows the2008 relationship of Percent 2007 Amount Retained earnings, Jan. 1 $137,500 $100,000 $37,500 37.5% each component to the Net income for year 91,000 76,500 14,500 19.0% Total $228,500 a $176,500 total within single$52,000 29.5%) Dividends: statement called vertical— On preferred stock $ is 9,000 $ 9,000 Horizontal Analysis: On common stock 40,000 30,000 10,000 33.3% analysis. Total Total current assets $ 49,000 $10,000 25.6% Increase amount $ 39,000$37,500 = 37.5%30.5% $179,500 $42,000 Base year (2007) $137,500 $100,000 19 Vertical Analysis A percentage analysis used to show the relationship of each component to the total within a single statement is called vertical analysis. 20 Vertical Analysis of Balance Sheet In a vertical analysis of the balance sheet, each asset item is stated as a percent of the total assets. Each liability and stockholders’ equity item is stated as a percent of the total liabilities and stockholders’ equity. 21 Lincoln Company Comparative Balance Sheet For the Years Ended December 31, 2008 and 2007 2008 2007 Amount Percent Amount Percent Assets Current assets Long-term investments Property, plant, & equip. (net) Intangible assets Total assets Total assets Liabilities Current liabilities Long-term liabilities Total liabilities Stockholders’ Equity Preferred 6% stock, $100 par 2.2% Common stock, $10 par Retained earnings Total stockholders’ equity Totalliab. liab.&&stockholders’ Stockholders’equity equity Total $ 550,000 48.3% $ 533,000 43.3% 95,000 8.3 177,500 14.4 444,500 39.0 470,000 38.2 50,000 4.4 50,000 4.1 $1,139,500 100.0% $1,230,500 100.0% $1,139,500 100.0%$1,230,500100.0% $ 210,000 100,000 $ 310,000 18.4% 8.8 27.2% $ 243,000 200,000 $ 443,000 19.7% 16.3 36.0% $ 150,000 13.2% $ 150,000 12.2% 500,000 43.9 500,000 40.6 179,500 15.7 137,500 11.2 $ 829,500 72.8% $ 787,500 64.0% $1,139,500 $1,230,500 100.0% $1,139,500 100.0% 100.0% $1,230,500100.0% 22 To demonstrate how vertical analysis percentages are calculated for the balance sheet, let’s see how the 48.3 percent was calculated for the 2008 current assets in the next slide. 23 Lincoln Company Comparative Balance Sheet For the Years Ended December 31, 2008 and 2007 2008 2007 Amount Percent Amount Percent Assets Current assets $ 550,000 48.3% $ 533,000 43.3% Long-term investments 95,000 8.3 177,500 14.4 Property, plant, & equip. (net) 444,500 39.0 470,000 38.2 Intangible assets 50,000 4.4 50,000 4.1 Total assets $1,139,500 100.0% $1,230,500 100.0% Total assets $1,139,500 100.0%$1,230,500100.0% Liabilities Current liabilities $ 210,000 18.4% $ 243,000 19.7% Long-term liabilities 100,000 8.8 200,000 16.3 Total liabilities $ 310,000 27.2% $ 443,000 36.0% Stockholders’ Equity Vertical Analysis: Preferred 6% stock, $100 par $ 150,000 13.2% $ 150,000 1 Current assets $550,000 2.2% Common stock, $10 par 500,000 43.9 500,000 40.6 48.3% 137,500 Retained earnings 179,500 = 15.7 11.2 Total assets $1,139,500 Total stockholders’ equity $ 829,500 72.8% $ 787,500 64.0% Totalliab. liab.&&stockholders’ Stockholders’equity equity $1,139,500 $1,230,500 100.0% Total $1,139,500 100.0% 100.0% $1,230,500100.0% 24 Vertical Analysis of Income Statement In a vertical analysis of the income statement, each item is stated as a percent of net sales. As an example, let’s see how the percent of 12.8% was calculated for 2008 selling expenses. 25 Lincoln Company Comparative Income Statement For the Years Ended December 31, 2008 and 2007 2008 Amount Percent Amount 2007 Percent Sales $1,530,500 102.2% $1,234,000 102.8% Sales returns and allow. 32,500 2.2 34,000 2.8 Net sales Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Income from operations Other income $1,498,000 1,043,000 $ 455,000 $ 191,000 104,000 $ 295,000 $ 160,000 8,500 $ 168,500 Other expense (interest) 6,000 Income before income tax $ 162,500 Income tax expense 71,500 Net income $ 91,000 100.0% 69.6 30.4% 12.8% 6.9 19.7% 10.7 0.6 11.3% 0.4 10.9% 4.8 6.1% $1,200,000 820,000 $ 380,000 $ 147,000 97,400 $ 244,400 $ 135,600 11,000 $ 146,600 12,000 $ 134,600 58,100 $ 76,500 100.0% 68.3 31.7% 12.3% 8.1 20.4% 11.3% 0.9 12.2% 1.0 11.2% 4.8 6.4% 26 Lincoln Company Comparative Income Statement For the Years Ended December 31, 2008 and 2007 2008 Amount Percent Amount 2007 Percent Sales $1,530,500 102.2% $1,234,000 102.8% Sales returns and allow. 32,500 2.2 34,000 2.8 Net sales Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Income from operations Other income $1,498,000 1,043,000 $ 455,000 $ 191,000 104,000 $ 295,000 $ 160,000 8,500 Vertical Analysis: $ 168,500 Other expense (interest) 6,000 Selling expenses $191,000 Income before income tax $ 162,500 71,500 NetIncome sales tax expense $1,498,000 Net income $ 91,000 100.0% $1,200,000 69.6 820,000 30.4% $ 380,000 12.8% $ 147,000 6.9 97,400 19.7% $ 244,400 10.7 $ 135,600 0.6 11,000 11.3% $ 146,600 0.4 12,000 10.9% $ 134,600 =4.8 12.8% 58,100 6.1% $ 76,500 100.0% 68.3 31.7% 12.3% 8.1 20.4% 11.3% 0.9 12.2% 1.0 11.2% 4.8 6.4% 27 Solvency Analysis The ability of a business to meet its financial obligations (debts) is called solvency. The ability of a business to earn income is called profitability. 28 Current Position Analysis Using measures to assess a business’s ability to pay its current liabilities is called current position analysis. Such analysis is of special interest to short-term creditors. 29 Working Capital The excess of current assets of a business over its current liabilities is called working capital. The working capital is often used in evaluating a company’s ability to meet currently maturing debts. 30 Lincoln Company Current asset: Cash Marketable securities Accounts receivable (net) Inventories Prepaid expenses a. Total current assets b. Current liabilities Working capital (a – b) $ 90,500 75,000 115,000 264,000 5,500 $550,000 210,000 $340,000 31 Current Ratio The current ratio, sometimes called the working capital ratio or bankers’ ratio, is computed by dividing the total current assets by the total current liabilities. 32 Lincoln Company 2008 a. Current assets b. Current liabilities Working capital (a – b) Current ratio (a/b) 2007 $550,000 210,000 $340,000 2.6 $533,000 243,000 $290,000 2.2 33 Quick Ratio A ratio that measures the “instant’ debt-paying ability of a company is called the quick ratio or acid-test ratio. 34 Quick assets are cash and other current assets that can be quickly converted to cash. Lincoln Company 2008 Quick assets: Cash Marketable securities Accounts receivable (net) a. Total quick assets b. Current liabilities Quick ratio (a/b) $ 90,500 75,000 115,000 $280,500 $210,000 1.3 2007 $ 64,700 60,000 120,000 $244,700 $243,000 1.0 35 Accounts Receivable Turnover The relationship between sales and accounts receivable may be stated as the accounts receivable turnover. The ratio is to assess the efficiency of the firm in collecting receivables and in the managing of credit. 37 Number of Days’ Sales in Receivables The number of days’ sales in receivables is an estimate of the length of time (in days) the accounts receivable have been outstanding. Comparing this measure with the credit terms provides information on the efficiency in collecting receivables. 38 Lincoln Company a. b. Average (Total/2) Net sales Average daily sales on account (Sales/365) Number of days’ sales in receivables (a/b) 28.6 2008 2007 $ 117,500 $1,498,000 $ 130,000 $1,200,000 $ $ 4,104 3,288 39.5 39 Financial Statement Analysis at different Stages 2 Inventory Turnover The relationship between the volume of goods (merchandise) sold and inventory may be stated as the inventory turnover. The purpose of this ratio is to assess the efficiency of the firm in managing its inventory. 41 Lincoln Company 2008 a. Cost of goods sold Inventories: Beginning of year End of year Total b. Average (Total/2) Inventory turnover (a/b) 3.8 2007 $1,043,000 $ 820,000 $ 283,000 264,000 $ 547,000 $ 273,500 $ 311,000 283,000 $ 594,000 $ 297,000 2.8 42 Number of Days’ Sales in Inventory Lincoln Company a. Average (Total/2) Cost of goods sold b. Average daily cost of goods sold (COGS/365 days) Number of days’ sales in inventory (a/b) 95.7 2008 2007 $ 273,500 $1,043,000 $ 297,000 $ 820,000 $2,858 $2,247 132.2 43 Ratio of Fixed Assets to Long-Term Liabilities The ratio of fixed assets to longterm liabilities is a solvency measure that indicates the margin of safety of the noteholders or bondholders. It also indicates the ability of the business to borrow additional funds on a long-term basis. 44 Lincoln Company 2008 a. Fixed assets (net) b. Long-term liabilities Ratio of fixed assets to long-term liabilities (a/b) $444,500 $100,000 4.4 2007 $470,000 $200,000 2.4 45 Ratio of Liabilities to Stockholders’ Equity The relationship between the total claims of the creditors and owners—the ratio of liabilities to stockholders’ equity—is a solvency measure that indicates the margin of safety for creditors. 46 Lincoln Company 2008 a. Total liabilities b. Total stockholders’ equity Ratio of liabilities to stockholders’ equity (a/b) $310,000 $829,500 0.4 2007 $443,000 $787,500 0.6 47 Profitability Analysis Profitability is the ability of an entity to earn profits. This ability to earn profits depends on the effectiveness and efficiency of operations as well as resources available as reported in the balance sheet. Profitability analysis focuses primarily on the relationship between operating results reported in the income statement and resources reported in the balance sheet. 48 Ratio of Net Sales to Assets The ratio of net sales to assets is a profitability measure that shows how effectively a firm utilizes its assets. 49 Lincoln Company a. b. Net sales Total assets: Beginning of year End of year Total Average (Total/2) 2008 2007 $1,498,000 $1,200,000 $1,053,000 1,044,500 $2,097,500 $1,048,750 $1,010,000 1,053,000 $2,063,000 $1,031,500 Excludes long-term investments 50 Lincoln Company a. b. Net sales Total assets: Beginning of year End of year Total Average (Total/2) Ratio of net sales to assets (a/b) 1.4 2008 2007 $1,498,000 $1,200,000 $1,053,000 1,044,500 $2,097,500 $1,048,750 $1,010,000 1,053,000 $2,063,000 $1,031,500 1.2 51 Leverage Leverage is a business term that refers to borrowing. If a business is "leveraged," it means that the business has borrowed money to finance the purchase of assets. The other way to purchase assets is through use of owner funds, or equity. One way to determine leverage is to calculate the Debt-toEquity ratio, showing how much of the assets of the business are financed by debt and how much by equity(ownership). Leverage is not necessarily a bad thing. Leverage is useful to fund company growth and development through the purchase of assets. But if the company has too much borrowing, it may not be able to pay back all of its debts. 52 Earnings per Share on Common Stock One of the profitability measures often quoted by the financial press is earning per share (EPS) on common stock. It is also normally reported in the income statement in corporate annual reports. 53 Lincoln Company a. b. Net income Preferred dividends Remainder—identified with common stock Shares of common stock Earnings per share on common stock (a/b) $1.64 2008 2007 $ 91,000 9,000 $ 76,500 9,000 $ 82,000 50,000 $ 67,500 50,000 $1.35 54 Price-Earnings Ratio Another profitability measure quoted by the financial press is the priceearnings (P/E) ratio on common stock. The priceearnings ratio is an indicator of a firm’s future earnings prospects. 55 Lincoln Company 2008 Market price per share of common stock Earnings per share on common stock Price-earnings ratio on common stock 25 2007 $41.00 $27.00 ÷ 1.64 ÷ 1.35 20 56 Dividend Yield The dividend yield on common stock is a profitability measure that shows the rate of return to common stockholders in terms of cash dividends. 57 Lincoln Company Dividends per share of common stock Market price per share of common stock Dividend yield on common stock 2.0% 2008 2007 $ 0.80 $ 0.60 ÷41.00 ÷27.00 2.2% 58 Corporate Annual Reports In addition to the financial statements and the accompanying notes, corporate annual reports usually include the following sections: Management Discussion and Analysis Report on adequacy of internal control Report on fairness of financial statements 59 Accounting is the process of measuring, interpreting, and communicating financial information to support internal and external business decision making. Financing activities provide necessary funds Investing activities provide valuable assets Operating activities focus on selling goods to start a business and expand it after it begins operating. required to run a business. and services, but they also consider expenses as important elements of sound financial management. • Generally accepted accounting principles (GAAP) encompass the conventions, rules, and procedures for determining acceptable accounting practices at a particular time. • Financial Accounting Standards Board (FASB) is primarily responsible for evaluating, setting, or modifying GAAP in the U.S. • Sarbanes-Oxley Act responded to cases of accounting fraud. – Created the Public Accounting Oversight Board, which sets audit standards and investigates and sanctions accounting firms that certify the books of publicly traded firms. – Senior executives must personally certify that the financial information reported by the company is correct. – Resulted in increase in demand for accountants. Accounting process - set of activities involved in converting information about transactions into financial statements. • Assets - anything of value owned or leased by a business. • Liability - claim against a firm’s assets by a creditor. • Owner’s equity - all claims of the proprietor, partners, or stockholders against the assets of a firm, equal to the excess of assets over liabilities. • Basic accounting equation - relationship that states that assets equal liabilities plus owners’ equity. • Double-entry bookkeeping - process by which accounting transactions are entered; each individual transaction always has an offsetting transaction. Balance sheet - statement of a firm’s financial position—what it owns and the claims against its assets—at a particular point in time. Photograph of firm’s assets together with its liabilities and owner’s equity Follows the accounting equation Income Statement - financial record of a company’s revenues and expenses, and profits over a period of time. Firm’s financial performance in terms of revenues, expenses, and profits over a given time period. Reports profit or loss. Focus on revenues and costs associated with revenues. Statement of Owner’s Equity - is designed to show the components of the change in equity from the end of one fiscal year to the end of the next. Begins with the amount of equity shown on the balance sheet. Net income is added, and cash dividends paid to owners are subtracted. Statement of cash flows - a firm’s cash receipts and cash payments that presents information on its sources and uses of cash. Accrual accounting - method that records revenue and expenses when they occur, not necessarily when cash actually changes hands. Ratio analysis - tool for measuring a firm’s liquidity, profitability, and reliance on debt financing, as well as the effectiveness of management’s resource utilization. Total current assets Current ratio compares current assets to current liabilities. Total current liabilities Acid-test (or quick) ratio measures the ability of a firm to meet its debt payments on short notice. Cash and equivalents + short-term investments + accounts receivable Total current liabilities Net sales Inventory turnover ratio indicates the number of times merchandise moves through a business. Average of inventory Net sales Total asset turnover ratio indicates how much in sales each dollar invested in assets generates. Average of total assets Profitability ratios measure the organization’s overall financial performance by evaluating its ability to generate revenues in excess of operating costs and other expenses. • Leverage ratios measure the extent to which a firm relies on debt financing. • Total liabilities to total assets ratio > 50 percent indicates that a firm is relying more on borrowed money than owners’ equity. • Budget - planning and control tool that reflects a firm’s expected sales revenues, operating expenses, and cash receipts and outlays. • Management estimates of expected sales, cash inflows and outflows, and costs. • Budgets are a financial blueprint that serves as a financial plan. • Cash budget - tracks the firm’s cash inflows and outflows.