Investment as Fixed Assets

Fixed investment assets cover any monies or shares held outside the company. These can shares in another organisation held for over 12 months

Questions to ask yourself about Fixed Assets

1 Are all fixed assets fairly stated in the cost and depreciation?

2 Do figures demonstrate adequate investment for the future?

3 Should any intangibles be ignored when analysing figures?

4 Have investments been valued and accounted for correctly?

5 Do intangibles make a realistic proportion of the balance sheet?

Working with Current Assets

Current assets are short-term assets that will be converted into cash (money) within the next 12 months of the financial year including cash (money) plus anything that will be converted into money. Current assets show how much the company has in cash or near cash and therefore they show viability of a business.

Three main categories of Current Assets

1 Stock: referring to raw materials, work in progress and finished goods.

2 Debtors: referring to people who have bought goods and owe the company some money.

3 Other current assets: which include money owed, petty cash, money held in the bank etc.

Defining and Valuing Stock

As already stated above there are three components of stock; raw materials, work in progress and finished goods. It is important to know how much is tied up in each component of stock, because raw materials take a long process to become cash. Finished goods are closer to becoming cash. Nevertheless, stock overall is the least liquid of all current assets.

Stock is usually valued at COST which is the price paid for the item when it was bought, or at net realizable, which is what it can be sold for, net of expenses. Cost should never be overstated.

Dos and Don’ts on stock

Do look for unexpected increases in stocks and debtors.	Don’t believe that more current assets are always good news.
Do not always believe the valuation applied to stock.	Don’t overlook other current assets and what they can tell you.

Tips about Current Assets

1 Look at current assets with care; because they represent the business’s lifeblood, they represent (cash or money) of the company.

2 Appreciate that stock on the balance sheet will impact profits on the profit and loss account.

3 Understand and realise that slow moving and obsolete stock is a common problem in business.

Understanding Assets within the Operating Cycle

The cycle starts with Stock which includes raw materials being made into finished goods, followed by Debtors, customers owing money for goods sold to them on credit, followed by Cash, paid by customers to clear their debts.

Identifying Stock

When stock prices rise, then raw materials bought earlier will cost less than those bought later. There are two ways of accounting for this type of materials

1 FIFO meaning (first in, first out) under which the profit and loss account profit and balance sheet closing figures will be higher.

2 LIFO meaning (last in, first out) under which both figures of profit and balance sheet will be lower.

Tips for Handling Stock Issues.

1 Always check that your stock is not over valued and reject any amounts that do not seem right.

2 If the debtor cannot pay, write off the sum as a cost on the profit and loss account statement.

3 Writing off (canceling) the debt is an (SG&A) cost on the profit and loss account statement.

4 Examine in detail the movement in cash for the (financial period) period in question.

5 Think of your current assets as cash temporarily looked after by someone else.

6 Cash includes everything that is liquid asset, money in the bank, cash in the till, petty cash etc.

Understanding Liabilities

Liabilities are debts payable in future because of transactions that have already happened. They can be current liabilities (due in the next 12 months) or long term (to be paid after 12 months).

1 Company liabilities should not be more than assets and all possible liabilities must be included.

2 In time all long term liabilities become short-term to be paid off within 12 months.

3 Increase in debt should be for increasing trade volumes or to acquire fixed assets.

Splitting Liabilities

Liabilities can be split into immediate and future obligations. Sums owed to leasing and hire purchase companies must be payable within 12 months. Installments due after 12 months are long term liabilities and that is why splitting liabilities into current and long term groups helps to find out how comfortable the business is able to pay immediate debts.

Understanding Shareholders Funds

The balance sheet must show funds invested into the organisation by shareholders and must be equal to the Total to Net Assets. It is in here that you can learn where the moneys invested in the balance sheet have come from.

The Share Capital is the money (Risk) that shareholders have invested into the business for no guaranteed return or payment. If a company raises $10 million of share capital, both share capital account and the bank account increase by $10 million.

Calculating Shareholders Funds

This part of the balance sheet looks at where the money came from and consists of share capital, retained profit and technical reserves.

Understanding Retained Profit

The second major source of shareholders’ funds is the Retained Profit. Calculated from the profit and loss account, it is actually the cumulative year-on-year retained profit from the time the company started; and is usually the most important source (in size) of continued funding of a business.

What this Retained Profit informs you, is how much funds (money) the shareholders have decided to leave behind in the business, which is the all at Risk should the company fail.

Understanding Technical Reserves

There are two types of technical reserves: the Share Premium and the Revaluation Reserves. The share premiums are proceeds from the company selling shares at a higher price than their normal value.

For example; a $1.00 share is sold for $4.00. This share premium is not retained profit because it has not been made during trading; therefore it has to be shown separately under Technical Reserves

However, a Revaluation Reserve occurs when a business revalues an asset (such as property) to show its current rise value rather than its original cost. Again, this is not strictly Retained Profit because it is merely a revaluation and no profit has yet been realised.

Revaluing Assets 448

Sometimes, an organisation decides to show an asset, such as a building, at a higher current value rather than at its original cost; the difference is shown as a Revaluation Reserve. This informs you that the profit exists but cannot be distributed because it has not yet been realised.

Forecasting Cash Flow 454

Forward looking cash flow forecast is often forgotten because it is not required by law or regulations, yet it is an invaluable document to help you predict at what point the demands on the organisation’s resources will become so great that the cash will be exhausted.

Tips for Forecasting Cash Flow

1 Remember to control capital spending properly; revenue and capital spending are related.

2 Beware that cash flow usually turns out to be worse than you plan for.

3 Involve colleagues regularly in forecasting cash floor to prevent future cash flow problems.

4 Prepare a cash flow forecast from the profit and loss account and the balance sheet.

Dos and Don’ts of Forecasting Cash Flow

Be sensible about the timing of cash flows, they are often made more difficult by optimistic budgets	Don’t assume that cash flow will not be a problem for you because it has not been a problem in the past.
Ask many of “What if” questions about cash flows e.g. should the timing of certain events change?	Don’t presume that everyone will always keep their terms about payments into or out of your organisation.

Measuring Company Performance using Ratios. 456

Ratios such as ½, ¾, 1/5, or 1/10, are essential tools for interpreting the messages behind lines and figures in translating information about the performance of any business. They provide indicators and highlight trends and direction of the future of a company. They help to make year-on-year comparisons performance of companies.

However, because there are no two similar companies in the world, you should avoid relying on ratios that have been produced by another company because they could have been calculated differently from your way of calculating. (Creative Accounting).

When interpreting accounts most people are interested in four key areas of: Profitability; Efficiency; Financing and Liquidity.

Profitability measures how much income is made from sales; it is assessed by analysing the profit and loss account of the company.

Efficiency measures the use to which assets are put by the company.

Financing shows the degree and affordability of funding by the company.

Liquidity measures whether there is sufficient cash for the company to continue in business.

Measuring (ROCE) Return on Capital Employed.

The most important ratio overall and key ratio is the ROCE which reveals how much profit is being made on the money that has been invested in the company; it is also key to showing how well management is doing its job.

ROCE is calculated by dividing the operating profit by the capital employed (shareholders’ funds plus long term liabilities on the balance sheet). The ROCE should be higher than what shareholders could make by investing funds in another company. ROCE also needs be higher than the cost of borrowing, otherwise the business will pay more in interest than it makes on money it has borrowed. (Disaster).

Use the following sequence to assess your company performance:

a) Calculate your organisation’s ROCE;

b) Then assess whether your ROCE ratio is adequate for shareholders;

c) Then check whether the profits of the ROCE have improved on last year;

d) Then check your ROCE against your competitors ROCE and decide whether to boost your ROCE.

Dos and Don’ts in analysing your ROCE

Do use ratios that are appropriate to the nature, type and size of the organisation in scrutiny	Do not be fixed and inflexible in your choice of ratios for assessing your performance
Do take a balanced and holistic view of ration analysis.	Do not be too accurate about the results you calculate from accounting figures

Obtain sets of comparative ratios for your business and show ratio results graphically to help you spot trade trends. 457.

Understanding Investors’ Ratios OR Determining a Company’s Worth. 462.

The world of stock and exchange and external investors use their own ratios to determine the viability of a business. A stock exchange index is a list of the largest quoted companies on the stock market as measured by their overall worth or market capitalisation. As with all financial analyses, always look at more than one ratio or measure of performance of a company.

Whether you work for a quoted company, or you want to know how your competitors, customers, or suppliers are performing, market capitalisation gives you a crude estimate of a company’s worth in the market place.

Calculating Market Capitalisation

Market capitalisation is calculated by multiplying the number (a definite figure) of shares that the company has by the market price (a fluctuating figure). The way the market perceives (feels) the worth of a company will affect the company’s ability to borrow or raise more funds from the investment community.

Leading Companies in the Market

Companies in the stock markets are ranked according to their total worth, with the highest valued businesses forming that country’s stock market index (such as the Dow, FTSE, DAX, and the CAC). Pay particular attention to what the price earnings ratio tells you.

The price earnings (PE) ration provides a good indication as to how the market views a business’s prospects. A high PE ratio is a sign of confidence in a company and a low ration indicates low confidence in a company.

The Yield Ratio 462

The yield ratio reveals how much the shareholders of an organisation are making by way of return on every pound, Euro, Dollar or Ruble invested in shares.

Gathering More Information 464

In addition to the financial statements, many organisations disclose a wealth of information voluntarily or because they are forced by law to disclose the information.

Know where to look for these details, what you can glean from them and get to know what is contained in published reports and accounts.

Interpreting Auditors’ Code 464

The role of auditors is to report on whether financial statements have been properly prepared in accordance with company law and GAAP (Generally Accepted Accounting Principles) 424

In their reports auditors do not state that accounts are correct but they choose phrases such as, the accounts “give a true and fair” or the accounts “fairly represent”.

Reports with these phrases are said to be “unqualified” or clean.

If the reports are “qualified” opinions, they point to where there is uncertainty or more worrying disagreement with the internal auditors.