Analysis & Interpretation Accounting - Unit 4

Why is it necessary to evaluate performance? Is the business doing well? Is the business achieving its goals/targets? Is there adequate cash flow? Is the business growing? What opportunities exist? How can the business improve? Should you stay in business?

The difference between analysis and interpretation... Analysis is the process of breaking down something complex into to simpler, smaller parts. Interpretation is then the process of explaining the meaning of the analysis

How will you be assessed? 20% of your internal assessment for unit 4 20% of your internal assessment for unit 4 Also tends to feature heavily in the Nov Exam Also tends to feature heavily in the Nov Exam Relevance of changes mentioned and explanation of possible reasons for the changes Relevance of changes mentioned and explanation of possible reasons for the changes Details of changes – You must state the direction, magnitude and effect of any change mentioned. Details of changes – You must state the direction, magnitude and effect of any change mentioned. Explanation of relationships between changes mentioned Explanation of relationships between changes mentioned And the relevance of the advice that you And the relevance of the advice that you give the business owner give the business owner

Profitability The ability of the business to make a profit. Factors that must be covered include any significant changes in Revenues, COS, Gross Profit, Functional Expense groups, Net Profit/Loss and the Profitability Ratios. The ability of the business to make a profit. Factors that must be covered include any significant changes in Revenues, COS, Gross Profit, Functional Expense groups, Net Profit/Loss and the Profitability Ratios.

Efficiency The ability of a business to use its resources to earn revenue with little waste. This includes the volume of assets compared to the revenue earning capacity of the business. It also covered all turnover ratios, such as, Debtors Turnover, Stock Turnover, etc. The ability of a business to use its resources to earn revenue with little waste. This includes the volume of assets compared to the revenue earning capacity of the business. It also covered all turnover ratios, such as, Debtors Turnover, Stock Turnover, etc.

Liquidity The ability of a business to meet its day to day debts as they fall due. Consideration of the Cash Flow Statement is essential. What cash came into the business during the two years and where did it go? Other factors that must be considered include the Debtors Turnover, Creditors Turnover, Stock Turnover and the Cash Cycle. Working Capital and Quick Assets must also be assessed.

Horizontal Analysis Compare the data from one year to the next. Eg. In 2003 they spent $4,000 on advertising and in 2004 they spent $6,000, an increase of 50% due to....

Vertical Analysis Compare the percentage of revenue/assets used. Eg. In cents in every dollar of revenue was spent on advertising and this increased to 12 cents in For vertical analysis of the Performance – Total Revenue is assumed to be 100% For vertical analysis of the Position – Total Assets/Equities is assumed to be 100% There is no vertical analysis of the Cash Flow Statement

An Example Credit Sales54.0%69.0% Cash Sales46.0%31.0% TOTAL SALES100.0% less Cost of Sales46.6%53.1% GROSS PROFIT53.4%46.9% Selling Expenses29.9%25.9% Occupancy Expenses6.4%6.2% Office Expenses4.0%7.8% Finance Expenses3.6%4.0% Net Profit8.8%2.1%

Visuals can be helpful

Profitability Ratios Return on Owners Investment Return on Owners Investment Return on Assets Return on Assets Asset Turnover Asset Turnover Net profit Ratio Net profit Ratio Gross Profit Ratio/ Adjusted Gross Profit Ratio Gross Profit Ratio/ Adjusted Gross Profit Ratio

Efficiency Ratios Debtors Turnover Debtors Turnover Creditors Turnover Creditors Turnover Stock Turnover Stock Turnover Cash Cycle Cash Cycle Interest Coverage Ratio Interest Coverage Ratio

Liquidity Ratios Working Capital Working Capital Quick Assets Ratio Quick Assets Ratio Cash Flow from Operations Cash Flow from Operations

Making Comparisons Industry Averages Industry Averages Industry Trends Industry Trends Similar Businesses Similar Businesses The Businesses Objectives The Businesses Objectives

Limitations of Ratio Analysis Ratios are based on historical data Ratios are based on historical data Historical Cost Accounting Historical Cost Accounting Changes in accounting methods Changes in accounting methods Inter-firm comparisons Inter-firm comparisons Frequency of reporting Frequency of reporting Limited Information Limited Information

Non Financial Indicators Customer Satisfaction Surveys Customer Satisfaction Surveys Quality Assurance Quality Assurance Quality of Management Quality of Management Profit compared to hours worked Profit compared to hours worked Economic Climate Economic Climate

The importance of Goals What are the goals of the business? Has the business achieved it’s goals? Are the goals appropriate? Would you have different goals? If so, Why?

Giving Advice Make sure you consider the business type Make sure you consider the business type Focus on the areas where problems have been highlighted Focus on the areas where problems have been highlighted Consider the goals of the business Consider the goals of the business Consider the additional information Consider the additional information

Advice Basics Profitability increase revenue, decrease expenses increase revenue, decrease expensesEfficiency improve cash cycle improve cash cycleLiquidity increase cash receipts, decrease cash payments increase cash receipts, decrease cash payments

Where to from here? Complete the following Horizontal Analysis Vertical Analysis Calculate your Ratios Consider the preamble & additional information Make a list of key points Make a list of potential advice for each area of analysis