Interpret financial information Accounting & Financial Analysis 1 Lecture 6 Interpret financial information

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

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.

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.

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 organization’s 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.

Manager’s 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.

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.

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.

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.

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.

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.

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

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.

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.

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

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.

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.

Holistic reports (relating to the business/company performance) ctd. Debtor’s 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 debtor’s schedule should reconcile to the Accounts receivable value (current asset) in the balance sheet.

Debtors (2) Debtor statements produced at the end of the accounting period are to be checked for accuracy against the debtor’s account in the subsidiary ledger. Any discrepancies should be adjusted in accordance with the organization’s 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

Creditor’s 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 creditor’s schedule should reconcile to the Accounts payable value (current liability) in the balance sheet.

Creditor’s 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 supplier’s account in the creditor’s subsidiary ledger. Any discrepancies should be referred to the appropriate staff member as per the organization’s 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

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.

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.

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.

Examples of source documents Stores requisition order Business Purchase Order (issued to supplier) Supplier’s Delivery note (to be signed as evidence of receipt) Supplier’s Tax Invoice. Supplier’s 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.)

Horizontal and Vertical analysis In order to confirm their performance company’s 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.

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.

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

E.g: Horizontal Analysis (2) YEAR 2001 2002 2003 2004 2005 Sales $620,000 $670,000 $713,000 $775,000 $837,000 100% 108% 115% 125% 135%

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.

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

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.

Vertical Analysis (3) solution Year Sales revenue Gross Profit GP as % of Sales Revenue Net Profit NP as % of Sales Revenue 2001 $620,000 $279,000 45% $93,000 15% 2002 $670,000 $308,200 46% $107,200 16% 2003 $713,000 $342,240 48% $128,340 18% 2004 $775,000 $395,250 51% $170,500 22% 2005 $837,000 $426,870 $175,770 21%   $3,615,000 $1,751,560 $674,810 19%

Analysing company performance A company’s performance depends on the management structure and techniques applied to develop the business and to monitor it. There are various ways to monitor the company’s performance:

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

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

The principle sections of the report are: 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.)

Balance sheet (Statement of financial position) This shows the financial health of the company = “What it is worth” The company’s worth is the value of the owner’s equity. Total assets – total liabilities. In other words the accounting equation: (Assets – liabilities = Owner’s equity ) Ratios are applied to the balance sheet in order to establish the company’s ability to meet it’s debts and other commitments.

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.

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:

Cash flow statement (3) Processes Regular inspection of debtor’s subsidiary ledger and follow up on overdue accounts. Careful assessment of amount of stock (inventory) required. Supplier’s accounts to be paid on time to avoid interest charges and to maintain credit standard. Take advantage of special discounts when cash is available

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