Tag Archives | equity

Standard Chart of Accounts

See Also:
Chart of Accounts (COA)
Problems in Chart of Accounts Design
Complex Number for SGA Expenses

Standard Chart of Accounts

In accounting, a standard chart of accounts is a numbered list of the accounts that comprise a company’s general ledger. The company chart of accounts is basically a filing system for categorizing all of a company’s accounts and classifying all transactions according to the accounts they affect. The chart of accounts list of categories may include assets, liabilities, owners’ equity, revenues, cost of goods sold, operating expenses, and other relevant accounts. (See chart of accounts example below). The standard chart of accounts is sometimes also called the uniform chart of accounts. A chart of accounts template is used to prepare the basic chart of accounts for any subsidiary companies or related entities in order to make consolidation easier.

A standard chart of accounts is organized according to a numerical system. Each major category will begin with a certain number, and then the sub-categories within that major category will all begin with the same number. For example, if assets are classified by numbers starting with the digit 1, then cash accounts might be labeled 101, accounts receivable might be labeled 102, inventory might be labeled 103, and so on. And if liabilities accounts are classified by numbers starting with the digit 2, then accounts payable might be labeled 201, short-term debt might be labeled 202, and so on.

Depending on the size of the company, the chart of accounts may include a few dozen accounts or it may include a few thousand accounts. Depending on the sophistication of the company, the chart of accounts can be paper-based or computer-based. The chart of account is useful for analyzing past transactions and using historic data to forecast future trends.

Below is an example of chart of accounts that may be used to set up the general ledger of most companies. You may customize your COA to your industry by adding to the Inventory, Revenue and Cost of Goods Sold sections to the sample chart of accounts.

SAMPLE CHART OF ACCOUNTS

1000 ASSETS

1010 CASH Operating Account
1020 CASH Debitors
1030 CASH Petty Cash

1200 RECEIVABLES

1210 A/REC Trade
1220 A/REC Trade Notes Receivable
1230 A/REC Installment Receivables
1240 A/REC Retainage Withheld
1290 A/REC Allowance for Uncollectible Accounts

1300 INVENTORIES

1310 INV – Reserved
1320 INV – Work-in-Progress
1330 INV – Finished Goods
1340 INV – Reserved
1350 INV – Unbilled Cost & Fees
1390 INV – Reserve for Obsolescence

1400 PREPAID EXPENSES & OTHER CURRENT ASSETS

1410 PREPAID – Insurance
1420 PREPAID – Real Estate Taxes
1430 PREPAID – Repairs & Maintenance
1440 PREPAID – Rent
1450 PREPAID – Deposits

1500 PROPERTY PLANT & EQUIPMENT

1510 PPE – Buildings
1520 PPE – Machinery & Equipment
1530 PPE – Vehicles
1540 PPE – Computer Equipment
1550 PPE – Furniture & Fixtures
1560 PPE – Leasehold Improvements

1600 ACCUMULATED DEPRECIATION & AMORTIZATION

1610 ACCUM DEPR Buildings
1620 ACCUM DEPR Machinery & Equipment
1630 ACCUM DEPR Vehicles
1640 ACCUM DEPR Computer Equipment
1650 ACCUM DEPR Furniture & Fixtures
1660 ACCUM DEPR Leasehold Improvements

1700 NON – CURRENT RECEIVABLES

1710 NCA – Notes Receivable
1720 NCA – Installment Receivables
1730 NCA – Retainage Withheld

1800 INTERCOMPANY RECEIVABLES

 

1900 OTHER NON-CURRENT ASSETS

1910 Organization Costs
1920 Patents & Licenses
1930 Intangible Assets – Capitalized Software Costs

2000 LIABILITIES

 

2100 PAYABLES

2110 A/P Trade
2120 A/P Accrued Accounts Payable
2130 A/P Retainage Withheld
2150 Current Maturities of Long-Term Debt
2160 Bank Notes Payable
2170 Construction Loans Payable

2200 ACCRUED COMPENSATION & RELATED ITEMS

2210 Accrued – Payroll
2220 Accrued – Commissions
2230 Accrued – FICA
2240 Accrued – Unemployment Taxes
2250 Accrued – Workmen’s Comp
2260 Accrued – Medical Benefits
2270 Accrued – 401 K Company Match
2275 W/H – FICA
2280 W/H – Medical Benefits
2285 W/H – 401 K Employee Contribution

2300 OTHER ACCRUED EXPENSES

2310 Accrued – Rent
2320 Accrued – Interest
2330 Accrued – Property Taxes
2340 Accrued – Warranty Expense

2500 ACCRUED TAXES

2510 Accrued – Federal Income Taxes
2520 Accrued – State Income Taxes
2530 Accrued – Franchise Taxes
2540 Deferred – FIT Current
2550 Deferred – State Income Taxes

2600 DEFERRED TAXES

2610 D/T – FIT – NON CURRENT
2620 D/T – SIT – NON CURRENT

2700 LONG-TERM DEBT

2710 LTD – Notes Payable
2720 LTD – Mortgages Payable
2730 LTD – Installment Notes Payable

2800 INTERCOMPANY PAYABLES

 

2900 OTHER NON CURRENT LIABILITIES

3000 OWNERS EQUITIES

3100 Common Stock
3200 Preferred Stock
3300 Paid in Capital
3400 Partners Capital
3500 Member Contributions
3900 Retained Earnings

4000 REVENUE

4010 REVENUE – PRODUCT 1
4020 REVENUE – PRODUCT 2
4030 REVENUE – PRODUCT 3
4040 REVENUE – PRODUCT 4
4600 Interest Income
4700 Other Income
4800 Finance Charge Income
4900 Sales Returns and Allowances
4950 Sales Discounts

5000 COST OF GOODS SOLD

5010 COGS – PRODUCT 1
5020 COGS – PRODUCT 2
5030 COGS – PRODUCT 3
5040 COGS – PRODUCT 4
5700 Freight
5800 Inventory Adjustments
5900 Purchase Returns and Allowances
5950 Reserved

6000 – 7000 OPERATING EXPENSES

6010 Advertising Expense
6050 Amortization Expense
6100 Auto Expense
6150 Bad Debt Expense
6200 Bank Charges
6250 Cash Over and Short
6300 Commission Expense
6350 Depreciation Expense
6400 Employee Benefit Program
6550 Freight Expense
6600 Gifts Expense
6650 Insurance – General
6700 Interest Expense
6750 Professional Fees
6800 License Expense
6850 Maintenance Expense
6900 Meals and Entertainment
6950 Office Expense
7000 Payroll Taxes
7050 Printing
7150 Postage
7200 Rent
7250 Repairs Expense
7300 Salaries Expense
7350 Supplies Expense
7400 Taxes – FIT Expense
7500 Utilities Expense
7900 Gain/Loss on Sale of Assets

35

Return on Common Equity (ROCE)

See Also:
Return On Equity Example
Return on Asset Analysis
Return on Equity Analysis
Define Leverage (Finance)
Gross Profit Margin Ratio Analysis
Fixed Asset Turnover Analysis

Return on Common Equity (ROCE)

The return on common equity, or ROCE, is defined as the amount of profit or net income a company earns per investment dollar. The investment dollars differ in that it only accounts for common shareholders. This is often beneficial because it allows companies and investors alike to see what sort of return the voting shareholders are getting if preferred and other types of shares are not counted.

Return on Common Equity Explanation (ROCE)

Return on common equity is a measure of how well a company uses its investment dollars to generate profits; often times, it is more important to a shareholder than return on investment (ROI). It tells common stock investors how effectively their capital is being reinvested. A company with high return on equity (ROE) is more successful in generating cash internally. Investors are always looking for companies with high and growing returns on common equity. However, not all high ROE companies make good investments. The better benchmark is to compare a company’s return on common equity with its industry average. The higher the ratio, the better the company.

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Return on Common Equity (ROCE) Formula

The return on common equity formula is as follows:

ROCE = Net Income (NI)/ Average Common Shareholder’s Equity

The average common equity is found by combining the beginning common stock for the year, on the balance sheet, and the ending common stock value. These values are then divided by two for the average amount in the year.

Return on Common Equity is one of the many variables that can impact the value of a company. If you’re looking to sell your company, download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your value.

ROCE

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ROCE

3

Required Rate of Return

See Also:
Valuation Methods
Arbitrage Pricing Theory
Capital Budgeting Methods
Discount Rates NPV
Internal Rate of Return Method

Required Rate of Return

The required rate of return, defined as the minimum return the investor will accept for a particular investment, is a pivotal concept to evaluating any investment. The required rate of return is supposed to compensate the investor for the riskiness of the investment. If the expected return of an investment does not meet or exceed the required rate of return, the investor will not invest. The required rate of return is also called the hurdle rate of return.

Required Rate of Return Explanation

Required rate of return, explained simply, is the key to understanding any investment. This essentially requires determining the investor’s cost of capital. The investment will be attractive as long as the expected returns on the project or investment exceed the cost of capital. The cost of capital can be the cost of debt, the cost of equity, or a combination of both.

If the investor is a company considering the required rate of return on a corporate project, then calculating the cost of debt is simple. It is the interest rates on the company’s debt obligations. If the company has numerous differing debt obligations, then the cost of debt is the weighted average of those interest rates.

Calculating the cost of equity can be done using the capital asset pricing model (CAPM). It can also be estimated by finding the cost of equity of projects or investments with similar risk. Like with the cost of debt, if the company has more than one source of equity – such as common stock and preferred stock – then the cost of equity will be a weighted average of the different return rates.

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Required Rate of Return Formula

The core required rate of return formula is:

Required rate of return = Risk-Free rate + Risk Coefficient(Expected Return – Risk-Free rate)

Required Rate of Return Calculation

Required rate of return calculations appear more complicated than they actually are. Using the formula above:

Required rate of Return = .07 + 1.2($100,000 – .07) = $119,999.99

If:

Risk-Free rate = 7%
Risk Coefficient = 1.2
Expected Return = $100,000

Weighted Average Cost of Capital (WACC)

Combining the cost of equity and the cost of debt in a weighted average will give you the company’s weighted average cost of capital, or WACC. This rate can be considered the required rate of return, or the hurdle rate of return, that the proposed project’s return must exceed in order for the company to consider it a viable investment.

Required Rate of Return for Investments

In terms of investments, like stocks, bonds, and other financial instruments, the required rate of return refers to the necessary expected return on the investment needed by the investor in order for him to consider investing. This rate can be based on investments with similar risk, or it can be the rate of the investor’s next best alternative investment opportunity.

For example, if an investor has his money in a savings account earning 5% annual interest, and he is considering investing in a risk-free treasury bond, then he might say the required rate of return on assets for such an investment is 5%. The treasury bond must yield more than 5% per year for the investor to consider taking his money out of the savings account and investing it in the bond. In this case, 5% would be the investor’s required rate of return.

Required Rate of Return Example

Joey works for himself as a professional stock investor. His work, highly analytical, is a perfect fit for him. Joey prides himself on his ability to evaluate where the market is and where it will be.

Joey knows his next investment option is high-stakes and risky. He wants to know his required rate of return on equity for a stock he is thinking about investing in. Joey performs the calculation below to find his answer:

Required Rate of Return = .07 + 1.2($100,000 – .07) = $119,999.99

If:
Risk-Free rate = 7%
Risk Coefficient = 1.2
Expected Return = $100,000

Joey decides that his investment is not a good decision because his required rate of return is quite high. He resolves to find less risky decisions in order to protect the success he has already created. Without calculating his required rate of return on stock Joey could have ruined everything that he has created so far. Joey uses this experience to humble himself as he moves forward.

Managing your investments can be overwhelming and difficult to do, but it’s an important part of being a successful CFO. To learn other ways to be a add value to your company, download the free 7 Habits of Highly Effective CFOs to find out how you can become a more valuable financial leader.

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required rate of return

5

EBITDA Valuation

See Also:
Valuation Methods
Success Is Your Business
Self-Liquidating Loans
What is dilution, how is it calculated, and how should you manage it?
Which Bank to Choose?
Calculate EBITDA
Adjusted EBITDA

EBITDA Valuation Method

There are multitudes of ways to value a company, as well as specific equity and debt claims on a company’s assets. One is the EBITDA valuation method, which relies on a multiple of EBITDA to arrive at a company’s enterprise value.

The definition of enterprise value is the total value of a firm’s equity and debt. It can be thought of as the total market value of a company’s expected cash flow stream. A company’s EBITDA is a measure of that stream. EBITDA is a company’s net income with tax, interest, depreciation, and amortization expenses added back. It is not an exact measure of a company’s cash flow, but it is one which has gained wide acceptance in the banking and investment communities.

The enterprise valuation formula is expressed as:

Enterprise Value = Multiple * EBITDA

where EBITDA is typically projected for the next twelve months. Sometimes, the amount used is the actual EBITDA of the company over the last twelve months and is labelled as “LTM EBITDA.”

EBITDA Valuation Multiple

The multiple is usually based on comparable actual sales transactions which have occurred recently in the company’s industry, though often the derived multiples of publicly traded companies in the industry are used in addition to or in lieu of actual transactions.

Also, while a single value for the EBITDA multiple may be used, often a range is given, based on the distribution of comparable multiples, with abnormally high or low multiples excluded so as to provide a useful range for the end user of the valuation.

Valuing Equity Using the EBITDA Valuation Method

The EBITDA valuation method can be used to value a company’s total equity. After arriving at the company’s enterprise value using the formula described above, the net debt of a company is subtracted to determine the value of the equity claim on the firm’s total cash flow (methods used to directly value equity adjust the firm’s cash flow to yield the cash flow available to shareholders, which is also known as “Free Cash Flow to Equity.”

The formula to value equity using the EBITDA valuation method is:

Equity Value = Enterprise Value – Total Debt – Cash and Cash Equivalents

 

Problems with the EBITDA Valuation Method to Value Equity

The primary problem is that this method relies on EBITDA as a measure of a firm’s cash flow, ignoring other significant factors which can impact a company’s cash flow, such as changes in working capital and capital expenditures.

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