Accounting

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Accounting Financial Analysis 1 Lecture
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Interpret financial information
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What is financial information ?

• Financial information is anything that helps
  management to understand the direction a business
  is taking.
• It is the source of every transaction and also
  the conclusion of that same transaction

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Financial information can be presented as

• Historical
• which is a report of activities that have
  already happened.
• These reports are generally accurate and can be
  traced back to source documents.

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Financial information can be presented as (2)

• Future predictions
• which are reports that project the historical,
  plus future planned activities, to predicted
  outcomes.
• These reports will act as benchmarks to compare
  and monitor the actual activities and
• to take corrective action if drifting away from
  the plan.

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Historical reports can be

• Departmental (relating to individual
  departments)
• each department manager will identify certain
  indicators that can measure the activity of his
  department and produce reports to monitor the
  performance of these activities.
• It is up to the manager to identify which are the
  Key Performance Indicators that will best assist
  him in the management of his department.
• The organizations policy and procedures usually
  identifies certain activities that need to be
  monitored and regularly reported on.
• There are a range of financial reports that will
  help to effectively monitor business performance
  at a day-to-day operational management level.

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Managers reports

• Once the reports are prepared it is up to the
  manager to
• access and review the reports
• identify any variances from the established
  benchmark
• discuss with appropriate staff the recommended
  corrective action
• implement corrective action as soon as practical.

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Interpreting reports

• Financial information has to be presented and
  interpreted correctly.
• If the information is wrongly interpreted any
  corrective action will be
• Inappropriate - will not produce the required
  outcome.
• Costly - it may involve expenditure which was not
  really required (E.g. Purchase of new equipment).
• Delayed - corrective action will not happen as
  early as it could have if the information was
  correctly understood causing extended
  inefficiencies, low staff morale, and unsatisfied
  customers.

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Some relevant departmental reports (Based on Key
Performance indicators)

• Restaurant Number of meals per week (covers),
  sales revenue report, average revenue per meal,
  number of staff (weekly roster), wages report,
  wastage reports, breakages report, other expenses
  reports, etc.
• Each of these reports should be compared to the
  budget for the same period any variances
  investigated and corrective action taken where
  necessary.

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Rooms

• Number of rooms occupied, average rate charged
  per room report, revenue report from rooms,
  number of staff (weekly roster), wages report,
  other expenses reports, etc. Each of these
  reports should be compared to the budget for the
  same period any variances investigated and
  corrective action taken where necessary.

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Gym

• Number of users, revenue report, wages report,
  expenses report etc. Each of these reports should
  be compared to the budget for the same period any
  variances investigated and corrective action
  taken where necessary.

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Sales

• Number of functions booked, type of functions,
  revenue report from functions, staff required for
  functions (roster), estimate cost of food drink
  required, other expenses per function, estimate
  profit return on each function, etc.
• Each of these reports should be compared to the
  budget for the same period
• any variances investigated and
• corrective action taken where necessary.

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Holistic financial reports

• Holistic holistic reports (relating to the
  business/company performance)

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Holistic/Performance Reports

• Income statement shows Income, expenses and
  profit.
• Balance sheet shows Assets, Liabilities, and
  Owner Equity.
• Budget is the financial plan prepared prior to
  a defined period of time.

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Holistic/Performance Reports (2)

• Performance/Variance report the report that
  compares the actual performance to the budget
  plan showing areas that require corrective
  action.
• Cash flow statement this report shows the
  opening cash balance plus cash inflows less cash
  outflows and the closing cash balance at the end
  of the accounting period.
• The closing balance should reconcile to the bank
  account balance (current asset) in the balance
  sheet.

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Holistic/Performance Reports (3)

• Business Activity Statements (BAS)
• The business activity statement is sent to the
  Australian Tax Office at the end of each quarter
  by medium to small businesses and monthly by
  large businesses.
• This statement should be checked for accuracy and
  compared to the financial reports for the same
  accounting period

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BAS covers various tax requirements/obligations
such as

• GST collected on sales (owed to ATO)
• Input Tax Credits on purchases (owed to the
  business by the ATO)
• Net amount payable to ATO for GST (GST Input
  Tax Credit)
• Business instalment tax (due to ATO on estimated
  profits for the year)
• Employee tax deductions (amounts deducted from
  employee wages to be paid to ATO)
• Shows income earned (and amount of GST collected)
• Shows business expenses (and amount of GST paid
  Input Tax Credits)
• Required to remit tax due to ATO within
  designated timeline.

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Holistic reports (relating to the
business/company performance) ctd.

• Inventory stock-take A stock-take should be
  done at the end of each accounting period.
• The stock count sheets will show the quantity and
  value of each item of stock on hand at the end of
  the accounting period.
• The total value of inventory should reconcile to
  inventory value (current asset) in the balance
  sheet.

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Holistic reports (relating to the
business/company performance) ctd.

• Debtors schedule (accounts receivable)
• this report shows a listing of all debtors and
  the amount owing by each debtor.
• The ageing of each account.
• The total of the debtors schedule should
  reconcile to the Accounts receivable value
  (current asset) in the balance sheet.

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Debtors (2)

• Debtor statements produced at the end of the
  accounting period are to be checked for accuracy
  against the debtors account in the subsidiary
  ledger.
• Any discrepancies should be adjusted in
  accordance with the organizations policy and
  procedures and the adjustment should be made
  before the statement is posted to the customer
  and within the designated timelines.
• If a discrepancy is found after the statement has
  been posted a manger or supervisor should contact
  the customer explaining/confirming the adjustment
  to be made

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Creditors schedule (accounts payable)

• this report shows a listing of all creditors and
  the amount owing to each creditor.
• the ageing of each account.
• The total of the creditors schedule should
  reconcile to the Accounts payable value (current
  liability) in the balance sheet.

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Creditors schedule (accounts payable) (2)

• The statements received from the suppliers
  (creditors), which list outstanding amounts owed
  to them, should be checked and compared to the
  suppliers account in the creditors subsidiary
  ledger.
• Any discrepancies should be referred to the
  appropriate staff member as per the
  organizations policy and procedures.
• If the error is found to be internal an
  adjustment should be made following receipt of
  appropriate authorisation.
• If the error originates from the supplier, they
  should be contacted, notified of the discrepancy
  and asked to adjust their account.
• A follow-up letter should be sent confirming the
  required adjustment.
• After reconciling the account, payment should be
  made as per the credit terms agreed.
• Early payment should not be made unless early
  discount terms are offered

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Access and review financial information

• Financial information is developed from source
  documents that are processed to the JOURNALS and
  summarised in the GENERAL LEDGER under
  appropriate account headings.
• It is the allocation of expenses to account
  headings that makes it possible to monitor
  business activity and to compare the actuals to
  the budget forecast.
• When comparing certain activity reports we may
  need to re-visit the source documents in order to
  confirm the data in the financial reports.

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Therefore financial information is

• Collected from source documents.
• Analysed according to their nature.
• Processed to the journals.
• Organised under appropriate account headings.
• Develop report for management review.
• Maintain timelines in accordance with
  organizational policy and financial reporting
  periods.

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Source Documents

• Source documents are the evidence that a business
  transaction has taken place. Any document that is
  back-up to an entry in the accounts is a source
  document.
• Source means The place from which things
  originate (start)
• The source documents help to record the
  transactions that take place within an
  organization (business) and it is from the source
  documents that the Financial Records are
  developed.
• Source documents are therefore important to the
  business and should be checked carefully to
  confirm their accuracy and that they meet company
  and legislative requirements. All source
  documents relating to an individual transaction
  should be attached together and filed in proper
  order.

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Examples of source documents

• Stores requisition order
• Business Purchase Order (issued to supplier)
• Suppliers Delivery note (to be signed as
  evidence of receipt)
• Suppliers Tax Invoice.
• Suppliers Statement of Account.
• Cheque Butts to confirm payment of invoices or
  expenses.
• Customer Purchase Order.
• Business Tax Invoice (issued to customer).
• Statement of Account issued to customer.
• Cheque Deposit Listing (list of cheques being
  deposited into bank account)
• Bank Statement (to pick-up direct entries by bank
  eg. Bank charges, bank interest paid/earned,
  direct debits etc.)

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Horizontal and Vertical analysis

• In order to confirm their performance companys
  compare certain key performance indicators over a
  number of years.
• They can compare a one line item such as sales
  (units or value), wages, gross profit, net
  profit, accounts receivable etc.
• Or they can compare a relationship between
  certain figures, such as cost of goods sold is
  40 of sales, and check whether this percentage
  will change over the years.

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Horizontal analysis

• Comparing a trend over different periods.
• E.g. monthly, quarterly, half yearly, or yearly.
• There must be a starting point which would be
  determined as 100
• All other points will relate to the starting
  point and give the percentage variation from that
  point.
• So we can say that sales are 110 compared to
  last year. Or sales have increased 180 compared
  to 2002.

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Example Horizontal Analysis

• Prepare a horizontal analysis for sales revenue
  using 2001 as the base year.
• 2001 620,000
• 2002 670,000
• 2003 713,000
• 2004 775,000
• 2005 837,000

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E.g Horizontal Analysis (2)
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Horizontal analysis (2)

• Horizontal analyses are also applicable to
  compare the actual results to the budget results
• Use the budget as the base 100 for comparison
  purposes.
• Sales for the month could be 105 on budget.

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Vertical Analysis

• When analysing financial statements management
  will be interested in comparing the relationship
  between two figures over a number of years.
• E.g in an Income Statement how does the
  Contribution margin, Gross profit and Net profit
  vary in relation to sales revenue each year

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Vertical Analysis (2)

• Year Sales revenue Gross Profit Net Profit
• 2001 620,000 279,000 93,000
• 2002 670,000 308,200 107,200
• 2003 713,000 342,240 128,340
• 2004 775,000 395,250 170,500
• 2005 837,000 426,870 175,770

Calculate the percentages for each year and
compare results.
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Vertical Analysis (3) solution
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Analysing company performance

• A companys performance depends on
• the management structure and techniques applied
  to develop the business and to monitor it.
• There are various ways to monitor the companys
  performance

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Analysing company performance (2)

• Check actual activity to budget plan.
• Check actual activity to previous years.
  (Horizontal analysis)
• Check percentage returns and compare to other
  periods. (Vertical analysis)
• Check actual activity to industry benchmarks
• Compare ratios to industry benchmarks
• Compare financial reports on historic basis

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Essential financial reports

• The three main financial reports that a company
  prepares are
• Income statement aka Profit Loss (Statement of
  financial performance)
• Balance sheet (Statement of financial position)
• Cash flow statement

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Income statement aka Profit Loss (Statement of
financial performance)

• This report shows the trading profit made by the
  company over the reporting period.
• The principle sections of the report are
• Contribution margin
• Gross profit
• Net profit before tax
• Net profit after tax (transferred to retained
  profit account in the balance sheet.)

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Balance sheet (Statement of financial position)

• This shows the financial health of the company
  What it is worth
• The companys worth is the value of the owners
  equity.
• Total assets total liabilities.
• In other words the accounting equation (Assets
  liabilities Owners equity )
• Ratios are applied to the balance sheet in order
  to establish the companys ability to meet its
  debts and other commitments.

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Cash flow statement

• Used to explain the application of funds. i.e.How
  did the company invest the inflow of money it
  received during the year?
• This statement shows the
• Opening cash balance
• All cash received either through trade sales,
  sale of fixed assets or loans.
• All cash paid out trade expenses, purchase of
  fixed assets, income tax paid, loans made to
  other companies or individuals.
• Closing balance which must reconcile to the Bank
  amount in the balance sheet.

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Cash flow statement (2)

• Needs to be effectively monitored in order to
  maintain financial stability.
• The following processes should be applied as part
  of the company policy procedures

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Cash flow statement (3)Processes

• Regular inspection of debtors subsidiary ledger
  and follow up on overdue accounts.
• Careful assessment of amount of stock (inventory)
  required.
• Suppliers accounts to be paid on time to avoid
  interest charges and to maintain credit standard.
• Take advantage of special discounts when cash is
  available

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Have a go!
Do Class Exercise 6 in your Handouts Finish Class
Exercise 5 in your handout Continue Class
Activity Lecture 5 in handout