ASS#2 Draft

Chapter 4: Analysing financial statements

Step 1

Key concepts that occur to me and Key concepts questions

v  How firms add value

How is free cash flow (FCF) and dividends relevant to a way to add value for companies?

When I read this part in chapter 4 study guide, I realised that I have still misunderstood about the concept of companies’ real value in business because whenever I think about companies’ value, the most important is the amount of dividends that is paid to equity investors. I did not carefully think about the importance of free cash flow. However, through reading this part, I learned that the importance of free cash flow and how to measure economic profit.

·         Free cash flow and dividends are both a transfer of value.

·         What is another good measure of companies’ performances? Can it complement free cash flow’s practical problem?

·         How can people prepare for the next free cash flow statement?

·         Free cash flow is calculated by determining the operating cash flow and then subtracting capital expenditures. Free cash flow = net operating profit after taxes – net investment in operating capital.

·         How can people calculate free cash flow to equity in excel?

·         What are limitations of free cash flow analysis?

·         Can operating free cash flow represent the total rate in the cash balance for the period?

 

v  Operating and financial activities

How can companies separate operating and financial activities? Why is it important for companies’ restated financial statements?

Before I read this part in study guide, I was quite nervous because lots of formulas and financial statements were included in it. The author explained the basic concepts of operating and financial activities with easy example (Kinder Surprise). I understood about the basic concepts easily and comfortably. Also, I learned that it is really important to separate operating and financial activities in order to restated financial statements. However, overall understanding of this part was a bit difficult because I had to think about a view of firm (operating and financial activities) in relation to free cash flow. I tried to read it more than two times for understanding of the figure.

·         Why cash flow from operating and financial activities is important?

·         Operating activities are business activities of companies and decide the companies’ income or loss.

·         Restatement of changes in equity is consist of opening balance, restated balance, dividends, income of loss for the period, other income or loss and closing balance.

·         Statement of changes in equity is helpful to identify the factors cause a change in the owner’s equity over the period.

 

v  Restate two key financial statements

How to restate balance sheet and income statement? Why do we need to restated financial statements?

As I read this part, I learned how to restate balance sheet and income statement practically. When I first tried to restate my company’s financial statement, I referred to the restated financial statement of the author’s company ‘Ryman Healthcare’ and then I was embarrassed a little bit because two financial statements were quite different.  I realised that restated financial statements are normally different depending on companies’ items. Restating income statement was so difficult to me because I had to consider lot of things such as adapting to tax rate and separation between operating and financial activities. However, the activity for restated financial statements was good opportunity for me to learn cooperation with my classmates because I and my classmates shared our own ideas or knowledge and helped out one another.

·         Why financial statements are restated?

·         Can restated financial statements fix some error? Or is it helpful to get correct conclusion in financial analysis?

·         Balance sheet can also be referred as statement of financial position.

 

v  What is Author trying to say?

I think that the author is trying to say is that restated financial statements such as balance sheet, statement of changes in equity and income statement is really important because companies can make sure about some errors and value added by companies. Also, with practical example, the author tried to explain how to restate financial statements and separated financial activities.

v  What I understand and believe

I learned how to restate financial statements through chapter 4 in study guide. Before I do this, I should identify how operating and financial activities are different and what it is and then reclassify items as operating and financial activities. I also understood about free cash flow and economic profit. Economic profit means net operating profit and RNOA must be greater than cost of capital. If so, it means adding value.

v  What I difficult to understand

The most difficult part of issue was to understand about restated income statement because of tax benefit. I had to include it into my company’s restated income statement. Also, It was difficult for me understand about the formula of economic profit. When I first read the part, the formula did not look complicated. However, after I read about the explanation of the calculation process, I was confused and then had to spend lots of time because I had to remind the relationship between profitability and efficiency and then remember the meanings of terminologies such as net operating assets and cost of capital. I think that I still need to review this part with my company’s restated financial statements.

v  Questions

·         4-1) why should we bother restating a firm’s financial statements?

It is essential for a company to restate their financial statements because after the release of the financial statements, some errors might be found by the company. Through restating the company’s financial statements, the errors can be fixed effectively. As a result, the company can get correct conclusions in their analysis.

·         4-2) Why is clearly separating a firm’s operating and financial activities a ‘powerful way of viewing a firm’?

It is obvious that separating a firm’s operating and financial activities is a powerful way of viewing a firm because it helps for a firm to identify cash flow and analyse some errors effectively. For this reason, restating financial statements is really essential to a firm for their successful business.

·         What is the difference between a firm’s operating and financial activities?

A company’s operating activities are related to the primary purpose of a business and it includes transactions which create expenses and revenues and its result is reported in the income statement. Also, balance sheet can reflect some result of operations. A company’s financial activities are transactions between a business and its investors. It includes owner’s equity, long-term liabilities and changes to short-term borrowings.

·         4-3) what aspects of a firm’s financial statements drive its return on net operating assets (RNOA)?

Through the calculation of return on net operating assets, it is able to generate a long-term perspective of the firm’s ability in order to add value.

Step 2

v  Brief commentary

Restating financial statements was quite hard process to me because I had to understand my company’s items and financial concepts completely. However, I have learned lots of things through this activity. Separating operating and financial activities was not easy but my classmate and tutor helped me out so I restated financial statements successfully. Especially, restating income statement was the most difficult part and complicated to me because I had to calculate tax benefit. Also, during the process, I found some errors relating to tax calculation so I had to calculate it again. I think I still need to learn more about restating process and practice it hard.

Step 3

1) Patties Sausage Rolls (12peices)	·         Patties sausage rolls is made of a mix of high quality mince and unique seasoning. ·         The size of the product is small so customers can take it comfortably. ·         Customers can buy it any supermarkets such as Coles, Woolworths and ALDI.    Estimated Selling Price               $8.50    Variable Costs                             $3.50    Contribution Margin                     $5.00
2) Creative Gourmet Blackberries (300G)	·         A creative gourmet blackberry consists of 100% blackberries. ·         Any artificial ingredients are not included in it. ·         Fresh and delicious blackberries are selected for the product.   Estimated Selling Price                $7.20   Variable Costs                              $4.10     Contribution Margin                      $3.10
30) Four’n Twenty Chicken and Vegetable pies (4pack)	·         Four’n twenty chicken and vegetable pies are made of fresh vegetables and 100% Australian chicken. ·         It contains gluten, milk and soy so customers who have allergens should be careful.   Estimated Selling Price                $9.00   Variable Costs                              $3.80     Contribution Margin                      $5.20

 

v  Identification and discussion with Contribution Margin

Contribution Margin is calculated as product’s selling price minus variable costs and it is the assets used to recover fixed costs (fixed cost does not control and change) and to subsequent profit. Total contribution margin for financial/year represents the total earnings available to recover the fixed costs and to contribute to profit of the products. In my company’s case, the contribution margins of three products differ because the three products have their unique selling price and their variable costs are different. For example, I have assumed the selling price for Patties sausage rolls is $8.50 and estimated the variable costs is $3.50. As a result, the contribution margin is $5.00. If my company can decrease variable costs, contribution margin will be increased and total profit will be increased.  

v  Identification and discussion with Constraints

Constraints are any factors which give some influences on product costs and it can be different depending on sales product or services. In case of my company’s products such as Patties sausage rolls, Creative gourmet blackberries and Four’n twenty pies, the cost of raw materials can be one of the strong constraints because if the cost of raw materials such as beef, chicken, wheat and milk increase, variable costs would be increased. As a result, my company has to raise the product’s selling price to maintain profit. Also, season can be another constraint for my company’s products. For example, if it is winter or fall, blackberries’ production would be decreased. If so, my company has to buy blackberries with higher price in order to make the frozen berry products. It can lead to change the product costs. In addition, equipment and labours can be constraints for the products.