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. 

 

 

 

 

Restatement of financial statements

Patties Foods Limited

 

 

 

ASS#1 Draft

Ë Step 4

Chapter 1 – Key Concepts and Questions (KCQs)

As I read chapter one in the study guide, I explored different key concepts and questions more deeply and broadened my knowledge of accounting and business.  I understood the world of accounting and my knowledge of the other accounting subjects effectively through chapter one reading.

v  Key Concepts and Questions (KCQs)

-       Accounting is definitely related to the realities of business because it shows how your business is doing.

-       There are different kinds of accounting computer software packages such as MYOB, Xero and QuickBooks for effective recording of firms’ accountants.

-       What is the best computer software package for business companies?

-       What is the standard that companies choose their bookkeeping systems? Security for their confidential accounts information? Or easy account management tools?

-       Do companies sometimes change their bookkeeping systems?

-       Changes in value (Revenue and Expenses) are explained as the extended accounting equation.

-       How has double entry bookkeeping discipline developed to digital accounting form?

-       Is it impossible to combine journal and ledgers and manage them together?

-       How did they extend the accounting equation concept?

-       Why did not they change the name from bookkeeping to digital keeping?

 

v  What do I find boring?

-       When the author mentioned lots of businesses come from everywhere, I found the business lists are quite boring because too many private stores were listed in the study guide. I really understood the author tried to explain different businesses exist everywhere but I could honestly not focus on the lists.

 

v  What do I find exciting or surprising?

-       I found accounting word origins are interesting (e.g. journal comes from the French word ‘jour’ and debit comes from the Latin word ‘debere’) because I simply recognised accounting words relating to modern idea.

-       I was so surprised that double-entry accounting system was invented in ancient times because I thought double-entry bookkeeping is invented with the development of computer technology.

 

v  What do I find difficult to understand or believe

-       I could not believe that the method of double-entry accounting was being used by merchants in Venice. The accounting system was described in a published book by Luca Pacioli. If so, how did Italian merchants adopt the accounting method to their business at the time?  

 

v  My understandings and reactions

-       I think that creating value is companies’ successful business achievements and accounting can be the way to measure the value effectively. Therefore, I tried to understand the key five elements of accounting such as Assets, Liabilities, Equity, Revenue and Expenses and extended accounting equation carefully.

 

v  Questions from the readings

-       Is it impossible to use common accounting software system regardless of businesses’ size?

-       Has the new accounting software system been developing for international business?

Questions

Question 1-1

: Most businesses use double-entry accounting system. The reason is that double-entry accounting allows for the recording of assets and liabilities. It takes benefit of the accounting equation (Assets = Liabilities + Owner's equity). With double-entry accounting, businesses including all stakeholders can receive accurate the financial statements such as balance sheet, income statement and cash flow statement. As a result, businesses can avoid some financial errors or mistakes and stakeholders can make decisions efficiently.

I do not think double-entry bookkeeping system means to repeat entry of all data and write things down twice because double-entry is recorded in at least two ledger accounts. Every transaction has a debit entry in one account and a credit entry in another account and debits and credits will affect different types of accounts. (E.g. Debits: ▲expense and asset, Credits: ▲liability and income). Therefore, the entry has to be recorded in two accounts and be balanced. I think accounting should be balanced.

Question 1-2

Assets

1. Inventories

: Inventory is classified as current assets. Current assets mean they can be converted into cash easily. Inventory represents raw materials and company’s finished goods for sale. It is related to calculating cost of goods sold and profit. According to my company’s (Patties Foods Limited) annual report, inventories increased to $44,976 in 2014 and from $30,947 in 2011.My company carried a large amount of raw materials every year since the year 2011 in order to produce goods.

2. Receivables

: Receivable is also included in current assets on balance sheet.  It means that a company has made a sale however has yet to collect the money form their customers. In my company’s annual report, accounting receivable for the year 2014 is recorded $46,818.  The $46,818 is listed as receivables until the customer has paid their invoice. There is no limitation.

3. Property, plant and equipment

: Property, plant and equipment is classified as non-current assets. Theses business assets are that a company owns that are usually used in order to run the business.  According to my company’s annual report, the assets increased to $74,415 in 2014 and from $67,707 in 2011. However, assets are not fully expensed in the year they are purchased.

Liabilities

1. Payables

: Payables are involved in current liability on the balance sheet. It is a company’s legal responsibility and debts to pay off within 12 months from the reporting date. It includes invoices a company has received for the purchase of materials to make their products.

2. Borrowings

: My company (Patties Foods Limited) borrowed money and some of value from banks, other entities or a previous transaction. The payments on a company's bank loans that are due in the next twelve months. My company maintained similar level of borrowings from the year 2011 to the year 2014 except for 2013.

3. Differed tax liabilities

: Differed tax liabilities are classified as non-current liabilities and a provision for future taxation. It is related to a difference between a company’s taxable income and income before tax and taken for long period compared to current liabilities.  

Equity

1. Contributed equity

: Contributed equity involves equity on the balance sheet. It is an element of the total amount of equity recorded by a company. I can show the total value of stock that shareholders have purchased directly from my company. In my company’s report, the level has maintained similarly from 2011 to the end of June, 2014.
2. Reserves

: Reserves are involved liabilities on the balance sheet. It means the amount of money companies set aside for future claims. In the annual report, my company increased around $9,600 reserve.  

3. Retained earnings

: Retained earnings are recorded as equity on the balance sheet. This equity is profits that a company has earned and used to grow equity. According to my company’s annual report, it increased to $137,144 in the year 2014 to $128,512 in the year 2011.

Chapter 3- Introducing financial statements

Through chapter three in the study guide, I explored fundamental components of financial statements. I learned about the two main financial statements such as the balance sheet and the income statement for successful business. I also understood the importance of value and the trustee relationship between companies in order to achieve their business goals.

v  Key Concepts and Questions(KCQs)

-       Setting out financial statements can be different depends on business industry.

-       Can they set out common financial statements for the financial analysis easily?

-       If they use the same names for the same or similar items, is it possible to communicate together easily and effectively?

-       The balance sheet is very essential because it shows company’s accurate financial position on particular period and help the company analyses their financial results.

-       How has the concept of consolidated financial statements been developing?

-       It is interesting that we can expect the future value in business by putting ‘present value’ on cash flow statements.

-       Even if some financial data is recorded to the balance sheet wrongly, is it still an evidence of trustee relationship in business?  

 

v  What do I find exciting or surprising?

-       It was interesting that ratios for financial statement analysis have developed since 300BC. Besides, I was interested in the word ‘ratio’ origins because the word comes from Greek word.

 

v  What do I find boring?

-       It was difficult for me to find boring things in the chapter 3 study guide because the author described the concepts of financial statements with easy examples such as party situation, making friends.

 

v  What do I find difficult to understand or believe

-       It was difficult to understand about the relationship between dividends and cash flow. I had to consider the concept of net dividends. I thought if examples of financial spread sheet are included in the study guide, it was easier than reading financial formulas.

 

v  My understandings and reactions

-       After I read chapter 3 in the study guide, I understood how to approach company’s financial position by the balance sheet, income statement and cash flow statement.

Also, I realised understanding of the financial terms’ origins is really important.

 

v  Questions from the readings

-       Do we have the other way to express trustee relationship between companies without the balance sheet?

Questions

 

Question 3-1

 

I think that we cannot do works simply relating to analysing financial statements because different kinds of companies use different names of items on their financial statements. Also, we need experienced practitioners for effective financial statements analysis because they have extensive business knowledge and compliance. As a result, they can help us to analyse our financial statements efficiently.

 

Question 3-2

Having a structure in a company’s financial statements is beneficial to use financial ratio analysis because it helps different companies compare their actual financial position one another in the same industry. Also, I think it is better than experienced practitioners just do it simply because the experienced practitioners might not extend the range of their knowledge and perception. If companies have a common structure in their financial statements, they can be analysed clearly and effectively.