Accounting for Managers Class Notes

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Content

Financial statement consists of
Balance Sheet
-

Asset
Liability
Equity

Income Statement
-

Income
Expenses

Cashflow Statement
-

Cash generated from operating activities – cash from core
business (both inflow and outflow)
Cash generated from investing activities (from investment from
other companies and other assets)
Cash generated from financing activities (from where the funds
are raised, such as issuance of additional shares or long term
loan, redemption of debentures (outflow), etc.)

Statement of changes in equity – shows the changes in the equity by
issuance of shares or converting from retained earnings to ordinary shares
issued to shareholders.
-

-

-

Ordinary Shares
o Opening Balance
o Changes during the year
o Closing balance
Retained earnings
o Opening Balance
o Changes during the year
o Closing balance

Definition of accounting
Classification and recording of monetary transactions
Presentation and interpretation of the results
Monetary projection of future activities

Accounting statements are used as a bridge between business and internal &
external stakeholders
Qualitative characteristics of financial information

-

-

-

-

Relevance – Only relevant information should be provided based on the
context
Comparability – standards should be followed when preparing the a/c
statements so that it is comparable (FRS compliant)
Understandability – it should follow standard so that it can be
understood by the users. Also users need to have some knowledge on
how the statements should be read.
Timelines – Accounting information should be prepared in timely basis
so that the same can be used. Otherwise it will become useless
Materiality – some of the information which is of material value
(significant), then it should be either disclosed in the a./c statement of
in the Notes to the a/c.
Completeness & Accuracy – The accounting should be complete and
should not omit anything. Otherwise it will not become complete and
will not balance and should be accurate
Verifiability – The a/c prepared should be verifiable.
Balance between cost & benefit – Not to disclose everything. But at the
same time, it is decided which is relevant and important to the user
and should be disclosed.

Look into the Balance Sheet to find out what is the current position of the
company.
Assets = Liability + Equity
If investing in company which is having high gearing, the returns should be high
enough to invest (because we are taking high risk as the probability to go bust
very high)

For the short term, cash is important to run business. Whereas in the long term,
it is more on profitability. When looking at the profitability, it should be based on
the trend.

When looking into the income statement, financial performance can be found

When there is a change required in cash movement, then it needs to be checked
in cash flow statement.

DEPS (Diluted Earnings Per Share) – If the people who owns options comes in
what is the earnings per share and will affect the investment decisions.

Definition of Finance

Account is historical. Finance is forward looking.

Funds
-

-

Internal Fund
o Retained Earnings – since this is the amount pertains to
shareholders, expected return should also be met in using the
funds.
External Fund
o Long Term
 Ordinary Shares – cost involved is to meet expected return
otherwise the shareholder will pull out the money and
invest somewhere.
 Preferential Shares
 Term Loan
 Leasing
 Sales & Buy back for assets
 Bonds
 Debentures
 Etc.
o Short Term
 Supplier Credit Terms
 Factoring invoices

Finance should always look into how to reduce the cost
Theoretically Debts financing is of lower cost than the equity
When it comes to investment, the company uses below tools
-

NPV
IRR
Payback

Objective of Accounting and Finance
Accounting – to provide useful information to those who make business and
economic decisions
Finance – to raise funds and making investment decisions

Assets = Liability + Equity
To know the value of the company, the following will be used
Net worth of the company = Assets – Liabilities

Disadvantages of the company is that the Information should be disclosed
Cost will be more

Agency Theory
Where the owner and the person who manages the company are different
Shareholder is the principal of the company
Boards of directors are engaged by shareholders to make decisions on their
behalf.
Agency problem will arise due to conflict of interest
The problem can be solved by means of auditors, shares issuance, performance
related bonus, etc. which incurs cost to the company.

Employees are interested in the company accounts for income, stability, carrier
advancements

Chapter 2
Value of money changes over time based on
Consumption preferences
Risk preferences
Investment preference

Future Value = P (1+r)n
Present Value = Future Value / (1+r) n

Annuity is used to know how much to be deposited each period so that the future
value is achieved after a particular period.

22-Oct-2011
Annuity – Consistently deposit a particular amount over a period of time
Compounding – Deposit one time and wait for the end of the period

29-oct-2011
Budget is a formal written statement of management’s plans for a specified
future period, express in financial term
Budgeting – forward looking, how to achieve the target,

If the variance is significant, it needs to be analysed and controlled
Brainstorming – budget is made by management whereas it may be that they
don’t have hands on. Hence ideas need to be received from ops. Also
brainstorming relates to ideas on cost cutting.
In Japanese company they have something called Kaisen to have inputs of ideas
on how to improve the efficiency
Resources – resources required to achieve the target. Also resources such as
human resources and data, system, sufficient time, money is required which is
also a resource required to prepare the budget.

Company Performance – to know the current performance and what is the target
for performance
Negotiation – negotiation with management on targets, negotiate with external
party such as suppliers, bankers, negotiate with staffs to set the targets,
negotiate with customers (expectation of the market), between departments –
how to interact with each other to achieve the common goal of the company.

Importance of Budgeting
-

-

-

-

To aid the planning of actual operations – what we are going to achieve
in the coming, how to achieve and resources required to achieve the
same
To co-ordinate the activities of the organization – (negotiation)
To communicate plans to various responsibility centre managers –
communicate the information to all the relevant persons to achieve the
common goal.
To motivate managers to strive to achieve the budget goals – to
motivate for rewards, appraisal, etc. target should be challenging but
achievable. If the target is not achievable it will de motivate the staff
rather than motivating.
To control activities – to see whether the staff is working towards the
target by comparing the actuals with the target
To evaluate the performance of managers

Budget System
Long term planning process
Short terms (annual budgeting process)
1.
2.
3.
4.
5.

Identify objectives
Identify potential courses of action (i.e. strategies)
Evaluate alternative strategic options
Select alternative courses of action
Refer textbook……

Methods of Preparing Budget
-

Bottom up budget – participation budget
o Advantages
 Achievable
 Commitment
 Accountable
 Improve communication between staff
 Motivation the staff (as prepared by staff and gives
motivation to achieve it)

Disadvantages
 Build in budget slack (which will be waste of resources as
each will commit to less than what is achievable)
 Too many opinions and will create confusion and will not be
able to achieve the goal
 Time consuming and requires more effort
Rolling Budget
o When one period expires (month, qtr, etc) one more period added
so that it is always for next 1 year
o Advantages
 Up to date forecasting
 Immediate response to incorporate controls in the budget
 Always have clear direction
 Will have updated and relevant information in future
o Disadvantages
 Time consuming
 Moving targets (changing targets) which may create
confusion on organisational goal
 Could be contradicting with the long term target
Top down budget
o Advantages
 Aligns with the strategic goals of the company
 Time saving (as it involves resources to participate in budget
preparation)
o Disadvantages
 Domino effect (gives the impression that the company is
dominated by managers)
 The target may be set targets which may be unachievable
which in turn demotivates the staff
 No commitment from staff
 Loss of human capital because of demotivation
 Survival of company falls in the small group of people
Zero based budget (priority budget)
o Prioritize resources according to the target and not based on the
past achievement
o Advantages
 More focussed on achieving the target
 Will help innovations (new ideas on achieve the goals more
efficiently and effectively)
 Gives more freedom to budget to achieve the goals
o Disadvantages
 Will lead to trial and error
 Time consuming to support the budget facts
 The accuracy of the budget is in question as the previous
data is not referred
 Gives way to manipulate the personal goals since past data is
not used
Incremental budget
o Refer to previous year and increase the target by referring to last
year
o

-

-

-

-

Advantages
 Accurate (based on past year)
 Realistic (based on past year)
 Time saving
 Easy to achieve as the budget is already implemented last
year and it is well known what should be done to achieve the
target
o Disadvantages
 May not increase the performance
 Not taken into the consideration of current market situations
 If budget slack was implemented earlier, this system will
increase the wastage
 Long term goals is not taken care in the budget and will not
meet them over the years.
Consultative budgeting
o Combination of both top down and bottom up budgeting system.
Staffs are given opportunity to provide the ideas and this may or
may not be taken into consideration when designing the budget by
top management.
o Advantages
 Has certain level of participation
 Time saving
o Disadvantages
 Demotivation – if none of the ideas implemented and staffs
will be reluctant to achieve the target
 No responsibility and accountability – since is more towards
top-down as the budget is prepared by top management.
o

-

Now a days company uses combination of multiple budgeting system
Order of budget preparation
-

-

Sales Budget
Cost of sales budget
o Material budget
o Manpower / labor budget
o Overhead budget
Selling and Administration budget (selling refers to marketing, human
resources, etc.)
Income statement budget
Cash budget
o Capital expenditure
Budgeted Balance Sheet

Example: Sales Budget
ABC S/B sales volume is expected to be 3,000 units I n Qtr. 1 with 500 units
increment in each succeeding quarter. Based on the selling price of Rm. 50 per
unit, prepare the sales budget for year 2012

Quarter
Sales Quantity
Selling Price per
unit (RM)
Sales (in Rs.) (RM)

ABC S/B
Sales Budget for Year 2012
Qtr1
Qtr2
Qtr3
Qtr4
3000
3500
4000
4500
50

50

50

50

150,000.
00

175,000.
00

200,000.
00

225,000.
00

Example: Material purchases Budget
ABC S/B believes that it can meet future sales requirement by maintaining an
inventory equal to 20% of next quarter’s budgeted sales volume in units. Prepare
the material purchases budget for year 2012. (Assume that each unit of material
cost RM 20 to purchase).
Material Purchases budget = Budgeted Sales Volume – Desired Closing inventory
– Opening inventory
ABC S/B
Material Purchase Budget for Year 2012
Quarter
Qtr1
Qtr2
Qtr3
Qtr4
Budgeted Sales Volume
3000
3500
4000
4500
Add: Desired Closing
Inventory
700
800
900
1000
Less: Opening
Inventory
600
700
800
900
Materials Required to
Purchase
3100
3600
4100
4600
Purchase Price per unit
(RM)
20.00
20.00
20.00
20.00
Total Material Purchase
(RM)

62,000.
00

72,000.
00

82,000.
00

92,000.
00

Example: Direct Labour Budget
It is estimated that each worker able to complete 100 units of product each
quarter and each worker will be paid RM 20 per unit of output completed.
Prepare the direct labour budget for year 2012.

ABC S/B
Direct Labour Budget for Year 2012
Quarter
Qtr1
Qtr2
Qtr3
Qtr4
Budgeted Sales Unit
3000
3500
4000
4500
Rate per unit (RM)

20.00

20.00

20.00

20.00

Budgeted Direct Labor
Cost (RM)

60,000.00

70,000.0
0

80,000.0
0

90,000.0
0

Quarter

ABC S/B
Cost of Sales Budget for Year 2012
Qtr1
Qtr2
Qtr3

Qtr4

Budgeted Material
Purchased (RM)

62,000.00

72,000.0
0

82,000.0
0

92,000.0
0

Budgeted Direct Labor
Cost (RM)

60,000.00

70,000.0
0

80,000.0
0

90,000.0
0

Budgeted Cost of Sales
(RM)

122,000.00

142,000.
00

162,000.
00

182,000.
00

Critically Evaluate – Yes & No and support for both
1.1 Budget process (how this helps to convert the objective to data). The process
involved in converting the objective to data.
Yes – It can be measured, gives directions to the employee (overall direction) put
the growth in numbers to be able to achieve and focus. Will help to communicate
the direction. Think and plan and convert the same to data. Improve
communication, teamwork, planning, resources allocation, motivational factors,
leadership of the management,
No – External factors – Economical & Political factors, Non participation of staff in
preparation of budget, management and control doesn’t give clear direction to
the employee then even though very good process in place, people doesn’t know
what to do. Not having sufficient time will not convert the objectives and goals
efficiently. attitude plays an important role
1.2 –
Yes - to move towards the direction,
No – External factors that makes the budget irrelevant such as inflation, rules
and regulations
1.3 –

Yes – identify the area of issue and to respond to the issue, to avoid same
mistake to be made in future,
No – cannot be prevented, the factors could be that the budget could be
outdated, effective control depends on who implements the control and has
human factor. It needs timely and effective response.

2.1
Imposed – Uses human resources that is management
Participatory – extensive human resources required
2.2
Yes – needs to be committed for employees to achieve the common goal of the
company, if the employee have the perception that the budget is used to control,
then it will have negative impact.
No – in case of top down, it is not necessary to have the correct perception and
only required to implement it.
2.3
Yes – It requires communication in both imposed and participatory
No – too much communication can create confusion

Introduction – Objective about preparing the assignment. Should not be more
than 350 words
Conclusion – summarize the main topic. Don’t put new points
Communication Flow – Provide table to show differences between imposed and
participatory budget.
References – Atleast 20 references

05-11-2011
Fixed & Flexibile Budget
Example: Below are the product cost for 10,000 units of product
Cee
Direct Materials
Direct Labour
Variable Overhead
Fixed Overhead (RM 150,000)
Selling Expenses
Administrative Expenses (RM 50,000)
Distribution Expense
Total

RM (Per Unit)
60
30
25
15
15
5
10
160

Required:
Prepare a fixed budget and flexible budget (6000,7000 & 8000 units) based on
the above information.
Fixed Budget @ 10,000
units

Units
Cost / Unit

Units

Total Cost

Direct Materials

60

10000 600,000.00

Direct Labour

30

10000 300,000.00

Variable Overhead

25

10000 250,000.00

150,000

1 150,000.00

15

10000 150,000.00

Fixed Overhead
Selling Expenses
Administrative Expenses

50,000

Distribution Expenses

10

1 50,000.00
10000 100,000.00

Total

1,600,000.00

Flexibile Budget

Units

Cee

Cost / Unit

6000
7000
8000
Total
Total
Cost
Total Cost
Cost

Direct Materials

360,000.0
60 0

Direct Labour

180,000.0
30 0

420,000.00

480,000.0
0

210,000.00

240,000.0
0

Variable Overhead

150,000.0
25 0

175,000.00

200,000.0
0

150,000.0
0

150,000.00

150,000.0
0

105,000.00

120,000.0
0

50,000.00

50,000.00

50,000.00

10 60,000.00

70,000.00

80,000.00

1,180,000.00

1,320,000
.00

Fixed Overhead
Selling Expenses

15 90,000.00

Administrative Expenses
Distribution Expenses

1,040,000
.00

Total

Cash Budget

Three important sections
Cash Receipts
Cash Payments
Ending Cash Balances

Net Inflow / Outflow = Opening Balance +Cash Receipts – Cash Payments
Depreciation and provision for doubtful debts should not be included in the cash
budget since these are not cash items and should only be shown as expenses in
the income statement.
Example: Cash Budget
For the month of December 2011, below is the cash transactions.
Cash Receipts
Cash Sales
Collection from customers
Sales / disposal of fixed assets
Total
Cash Payments
Cash Purchases
Payments to supplier
Payments of salaries, utility bills, etc.

Amount
Xxx
Xxx
XXX
XXXXXXXXX
Xxx
Xxx
Xxx

Tax payments
Dividend payment
Purchases of fixed assets
Total
Net cash inflow
Add: Opening Balance b/f
Closing Balance

Xxx
Xxx
Xxx
Xxxxxx
A-B
Xxx
C-D

Additional Question 1:
Cash Budget for 3 Months Ending June 30th
April
May
June
Cash Receipts
512,000.0
280,000.0
Collection from Sales from Cust
0 336,000.00
0
Sales
84,000.00
70,000.00 78,000.00
Sales of Fixed Asset
22,000.00
0.00
0.00
618,000. 406,000.0 358,000.
Total Receipts
00
0
00
Cash Payments
396,000.0
0
27,300.00
140,000.0
Salary & Wages
0
Overhead Expenses
62,000.00
Dividend Payment
0.00
Taxation
625,300.
Total Payments
00
Payment to Suppliers
Purchases

252,000.00
18,525.00
119,000.00
60,000.00
55,000.00
5,500.00
510,025.0
0

Opening Balance

110,000.0
0

Net Cash Inflow / Outflow

-7,300.00

102,700.00
104,025.00

Closing Balance

102,700.
00

-1,325.00

171,000.0
0
21,450.00
124,000.0
0
69,000.00
0.00
385,450.
00

-1,325.00
27,450.00
28,775.0
0

Question 2

Question 3
Flexi
bile
Budg

Units

9000

10000

11000

12000

et
Expe
nse
Type

Cost /
1000
0
Units

Vari
able
%

Variabl
e Cost
(per
Unit)

Total
Cost

Total
Cost

Group
1

45000

100% -

4.50

40,500
.00

45,000. 49,500
00
.00

54,000.
00

Group
2

30000

7,500.
75% 00

2.25

27,750
.00

30,000. 32,250
00
.00

34,500.
00

Group
3

27000

13,500
50% .00

1.35

25,650
.00

27,000. 28,350
00
.00

29,700.
00

Group
4

18000

13,500
25% .00

0.45

17,550
.00

18,000. 18,450
00
.00

18,900.
00

Group
5

18000
0

180,00
0% 0.00

-

180,00
0.00

180,00
0.00

180,00
0.00

180,00
0.00

291,4
50.00

300,0
00.00

308,5
50.00

317,1
00.00

Fixed
Cost

Total

Total
Cost

Total
Cost

Drawbacks of traditional budget
Traditional budget only emphasise on quantitative factors
Focuses on individual functional area
Emphasizes on a fixed time horizon
Based on incremental approach as previous year’s budget is used as a baseline

Process for effective budgeting








Clearly defined areas of authority and responsibility
Realistic goals
Participation by managers in setting budgets
Acceptance by all levels of management
Comparison of actual to budget
Immediate action to be taken where comparisions indicate significant
deviations from budget
Broken down into periods corresponding to those in the financial
statements.

Budgetary slack

Capital Investment Decisions






Since capital investment is a long term, it is important to know how to take
decisions.
It is important because the expectation that expenditure today will
generate future cash gains
It should be in real terms
And that greatly exceed the funds spent today
Five Main Investment Appraisal Criteria Methods
o Account rate of return
o Pay back (doesn’t take into consideration of time value of money)
o Discounted pay back (time value of money)
o Net present value
o Internal rate of return

Accounting Rate of Return (ARR)



Advantages
o This will be in line with the share holders expectations
Disadvantages
o Doesn’t take time value of money
o Profit can be manipulated which is involved in calculation and hence
may not be accurate

Payback
The number of years it takes the cash inflows from a capital investment project
to equal the cash outflows
Advantages





Improve cashflow of the company
Will reduce the risk because of able to identify the paypback period
Cannot be manipulated
Easy to calculate

Disadvantages



Doesn’t take into consideration of returns after payback period
Don’t take into consideration of time value of money

Key prnciples underlying investment selection criteria
-

Real funds flows can be seen in cash but not in accounting profit
Interest charges become payable as soon as money is made available,
for example from a lender to a borrower not when an agreement is
made or contract is signed.

ARR = average accounting profit over the project / initial investment x 100%

Activity 4.4
ARR = 25%

Example:
Company has 2 investment opportunities which the information is as follows
Initial Outlay
Profit for year
Profit for year
Profit for year
Profit for year

1
2
3
4

A
100,000
15,000
10,000
10,000
15,000

B
150,000
20,000
20,000
25,000
25,000

Profit is after charging depreciation. Company accounting policy is to charge
depreciation on 4 years based on the straight line basis on all the initial outlay.
Required:
(i)
(ii)

Calculate the ARR for investment A & B
Compute the payback from investment A & B

ARR =

[email protected]

How to find the discount rate for the company – it is based on the cost of capital
Cost of capital -> internal & external
Internal -> Retained Earnings
External  Equity & Borrowing
Equity -> Ordinary Shares, Preference Shares
Borrowing -> Short Term & Long Term
The cost for Short Term & Long Term is the interest that needs to be paid
The cost for shares is the expected return from the share holder
The cost for retained earnings is also the expected return from shareholders
because the amount pertains to the shareholders.

Discounted cashflow uses time value of many. It is using Net Present Value (NPV)
or (IRR) and also it uses projected net cash flow using appropriate discount rate
or cost of capital.

Net Present Value – today’s value of the difference between cash inflows and
outflows projected at future dates, attributable to capital investments or longterm projects.
the IRR calculates the exact rate of return that a project is expected to
achieve, which is the discount rate used that results in a zero net present value
of the difference between cash inflows and outflows.
Calculation of IRR
IRR = a% + [(A / (A-B)) x (b%-a%)]
Where
a% = discounting rate that give Positive NPV
b% = discounting rate that give Negative NPV
A = NPV discounted at a%
B = NPV discounted at b%

Discounting Factor = 1/(1+r)^n where r is the discounting rate

Investment Appraisal Methods (Examples – Adhoc)
Question 1
a)
Future Value @ end of No.
of years
Discounting Rate
No. of Years
Discount Factor
Net Present Value

10000
18%
5
0.437109216
4371.092162

b)
Future Value @ end of No.
of years
Discounting Rate
No. of Years
Discount Factor
Net Present Value

5000
15%
8
0.326901774
1634.508869

c)
Future Value @ end of No.
of years
Discounting Rate
No. of Years
Discount Factor
Net Present Value

6000
10%
4
0.683013455
4098.080732

d)
Future Value @ end of No.
of years
Discounting Rate
No. of Years
Discount Factor
Net Present Value

3500
13%
18
0.110812312
387.843093

e)
Future Value @ end of No.
of years
Discounting Rate
No. of Years
Discount Factor
Net Present Value

8500
8%
13
0.367697925
3125.43236

Question 2
Discount
Rate

10%
Cashflo
w

Year

Discounting Factor

Present Value

1

2000 0.9091

1,818.18

2

5000 0.8264

4,132.23

3

7000 0.7513

5,259.20

4

10000 0.6830

6,830.13

5

8000 0.6209

4,967.37

6

6000 0.5645

3,386.84

Present Value

26,393.97

Discounting Factor

Present Value

Question 3
Initial
Overlay
Discount
Rate

19000
12%
Cashflo
w

Year
1

2000 0.8929

1,785.71

2

5000 0.7972

3,985.97

3

7000 0.7118

4,982.46

4

10000 0.6355

6,355.18

5

8000 0.5674

4,539.41

6

6000 0.5066

3,039.79

Present Value

5,688.53

Question 4
Project 1
Initial
Overlay
Discount
Rate

15000
10%

Payback Period
(years)

3 years

Cashfl
ow

Year

Discounting
Factor

Present
Value

Cumulative
Cashflow

1

4000 0.9091

3,636.36

11000

2

5000 0.8264

4,132.23

6000

3

6000 0.7513

4,507.89

0

4

7000 0.6830

0

15000 1.0000

4,781.09
15,000.0
0
12,942.4
2

Present
Value
Project 2
Initial
Overlay
Discount
Rate

16000

Payback Period

10%
Cashfl
Discounting
ow
Factor

Year

Present
Value

Cumulative
Cashflow

1

2000 0.9091

1,818.18

14000

2

2000 0.8264

1,652.89

12000

3

7000 0.7513

5,259.20

5000

4

7000 0.6830

-2000

0

16000 1.0000

4,781.09
16,000.0
0

Present
Value
Project 3
Initial
Overlay
Discount
Rate

18,488.6
3

17000
10%
Cashfl
Discounting
ow
Factor

Year

3 years
8.5714 mont
29 hs

Payback Period
Present
Value

Cumulative
Cashflow

1

3000 0.9091

2,727.27

14000

2

3500 0.8264

2,892.56

10500

3

5000 0.7513

3,756.57

5500

4

8500 0.6830

5,805.61

-3000

3 years
7.0588 mont
24 hs

0

17000 1.0000

Present
Value

Question 5
Project X
Initial
Overlay
Discount
Rate
Year

18,817.9
8

Payback Period
(years)

50000
9%
Cashflo Discounting
w
Factor

Present
Value

3 years
mont
6 hs

Cumulative
Cashflow

1

10000 0.9174

9,174.31

40000

2

25000 0.8417

21,042.00

15000

3

25000 0.7722

19,304.59

-10000

4

20000 0.7084

0

50000 1.0000

14,168.50
50,000.00

Present Value
Project Y
Initial
Overlay
Discount
Rate

13,689.40

50000

Payback Period

9%
Cashflo Discounting
w
Factor

Year

Present
Value

2 years
mont
0 hs

Cumulative
Cashflow

1

25000 0.9174

22,935.78

25000

2

25000 0.8417

21,042.00

0

3

15000 0.7722

11,582.75

-15000

4

500 0.7084

-15500

0

50000 1.0000

354.21
50,000.00

Present Value
Project Z

17,000.0
0

5,914.74

Initial
Overlay
Discount
Rate

50000

Payback Period

9%
Cashflo Discounting
w
Factor

Year

Present
Value

2 years
mont
9 hs

Cumulative
Cashflow

1

15000 0.9174

13,761.47

35000

2

20000 0.8417

16,833.60

15000

3

20000 0.7722

15,443.67

-5000

4

20000 0.7084

14,168.50

-25000

5

5000 0.6499

-30000

0

50000 1.0000

3,249.66
50,000.00

Present Value

13,456.90

Questio
n6
Project
X
Initial
Overlay
Discoun
t Rate
Year

1600000
13%
Profit

1

Payback
Period
(years)

-60000

Depreciati
on

Cashfl
ow

Discounting
Factor

4 years
11.2 months
Cumulativ
Present
e
Value
Cashflow

200000

14000
0 0.8850

123,893.
81

1460000

219,281.
07

1180000

2

80000

200000

28000
0 0.7831

3

160000

200000

36000
0 0.6931

249,498.
06

820000

4

200000

200000

40000
0 0.6133

245,327.
49

420000

5
6

250000
250000

200000
200000

45000
0 0.5428
45000

244,241.
97

-30000
-480000

0 0.4803

216,143.
34

7

250000

200000

45000
0 0.4251

191,277.
29

8

250000

200000

45000
0 0.3762

169,271.
94
1,600,00
0.00

Initial
0 Overlay

16000
00 1.0000
Net
Present
Value

ARR
IRR
a%
b%
A
B
IRR

10.78
13%
15%
58934.96
215
66579.08
557
14%

Discounted Payback
Compute using Present Value instead of Cash Flow

58,934.9
6

-930000
-1380000

Financial Statement Analysis
1.
2.
3.
4.

Balance Sheet (Statement of Finance position)
Income Statement
Cashflow statement
Statement of changes in equity
a. Face / Par value goes as equity
b. The premium goes as capitalisation of share premium as reserve
(premium is the difference between the listed price less the par
value)

Different ratio classification
Profitability
Efficiency
Liquidity
Financial gearing  what are the debts level. How much is the proption of debts
over equity. What is the capital structure of the company.
Investment  Mostly calculated by investor to check whether the company is
worth investing.

Ratio Benchmarks – Ratios may be compared with past periods, similar
businesses during the same period, Planned performance
Ratio can only be commented if it is compared with something else, either
previous years, or some other benchmarking
Comparision should happen within same industry, same size, etc.
Ratios may be compared with Past periods (trend), similar business during the
same period (competitiveness), planned performance (target achievement)

Profitability ratios
Return on ordinary shareholder’s funds (ordinary shares + reserves) = Net Assets
(Net profit after taxation and preference dividend (if any) / (Ordinary share
capital + Reserves)) * 100

Return on capital employed (capital employed = funds raised and used by the
company) -> used to identify company’s efficiency to use the funds raised and
get the returns as performance

(Net profit before interest and taxation / (share capital + reserves + long-term
loans)) * 100

Net profit margin
(Net profit before interest and taxation / Sales Revenue) x 100

Gross profit margin
(Gross profit / Sales revenue) x 100

Return on Asset -> how efficiently assets were used to generate income
(Net income / Average total assets) x 100

Efficiency ratios
Average inventories turnover period -> how fast the company can sell stock to
customers
(Average inventories held / cost of sales) x 365
Where average inventories held = (opening inventory + closing inventory) / 2

Average settlement period for receivables -> how fast the company is able to
collect from the customers
(Trade receivables / credit sales) x 365

Average settlement period for payables-> how fast the company is able to pay to
its suppliers
(Trade payables / credit purchases) x 365

Sales revenue to capital employed
(Sales revenue / (share capital + reserves + Non-current liabilities))

Sales revenue per employee

(Sales revenue / Number of employees)

Operating cycle = Average inventories turnover period + Average settlement
period for receivables
Cash conversion cycle = Operating cycle – Average settlement period for
payables

Main elements comprising the ROCE ratio
(Net profit interest and taxation / sales) x (sales revenue / long-term capital
employed) = ROCE

Liquidity Ratios
Whether the company has sufficient liquidity to satisfy short term liabilities
Current Ratio = Current Assets / Current Liabilities
Acid test ratio (Quick Ratio) = (Current assets (excluding inventories)) / Current
Liabilities

Gearing Ratios
can be used to find the capital structure
Gearing Ratio = (Long-term (non-current) liabilities) / (Share capital + Reserves
+ Long-term (non-current) liabilities)
Interest cover ratio = Profit before interest and taxation / interest payable

Investment Ratios
Dividend payout ratio = (Dividends announced for the year / earnings for the
year available for dividends) x 100
Dividend Yield ratio = ((Dividend per share / (1-tax%))/Market value per share) x
100
Earnings per share (EPS) = Earnings available to ordinary shares / No. of ordinary
shares in issue
Price/Earnings ration (P/E) = Market value per share / Earnings per share

Limitations of ratio analysis





the quality of underlying financial statements (it is based on historical data
and may not be relevant)
Restricted vision of ratios
The basis for comparison
Balance sheet ratios

measure both quanititave and qualitative such as customer satisfaction, growth,
etc.

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