Accountings for manager - Essay Example

ACCOUNTINGS FOR MANAGER Introduction: Financial ments are prepared with the intention of providing information that can be used by investors for taking decisions relating to investments. At the end of every financial year business concerns prepare Profit and Loss a/c and Balance Sheet. The P & L a/c reflects the result of the business operations for a period of time and balance sheet gives a summary of the assets and liabilities of a business undertaking on a particular date. However, these two statements fail to explain certain major transactions that take place during the year. Balance sheet is a statutory statement. It does not sharply focus on those major transactions that took place behind the balance sheet change. One can draw inferences from the balance sheet about major financial transactions, only after comparing the balance sheet of two accounting periods. Thus, it has to prepare a statement explaining the reason for change in financial position from one accounting period with another. Cash flow statement: A cash flow statement is a financial statement, which shows inflows and outflows of cash of a firm. It is a description of the sources and applications of funds in business activities during an accounting period. It gives explanations to changes in the balance sheet figures between two accounting periods. Thus, managers can easily understand the changes in cash position between two accounting periods. It is also known as statement of changes in financial position. Cash flow statements are analytical tools for determining the short-term viability of a firm especially in relation to repayment of bills and accounts. Preparation of cash flow statement is compulsory since 1987: International Accounting Standard 7 (IAS 7) is relating to the internationally accepted Cash flow Statement preparation standards. According to IAS 7.1, it is insisted that all enterprises that prepare financial statements in conformity with IFRS should present a statement of cash flows. "The statement of cash flows analyses changes in cash and cash equivalents during a period. Cash and cash equivalents comprise cash on hand and demand deposits, together with short-term, highly liquid investments that are readily convertible to a known amount of cash and that are subject to an insignificant risk of changes in value." (Summary of International Financial Reporting Standards 2008). A cash equivalent is that investment which has the maturity of three months or less from the date of acquisition. From the equity investments are normally excluded, unless they are in substance a cash equivalent (e.g. preferred shares acquired within three months of their specified redemption date). Bank overdrafts which are repayable on demand and which form an integral part of an enterprise's cash management are also included as a component of cash and cash equivalents. (Summary of International Financial Reporting Standards 2008). The main principles specified by IAS 7 for the preparation of cash flow statement are as follows: 1. Operating activities are the main revenue-producing activities of the enterprise. So operating cash flows include cash received from customers and cash paid to suppliers and employees [IAS 7.14]. 2. Investing activities are the acquisition and disposal of long-term assets and other investments that are not considered to be cash equivalents [IAS 7.6]. 3. Financing activities are activities that alter the equity capital and borrowing structure of the enterprise [IAS 7.6]. 4. Interest and dividends received and paid may be classified as operating, investing, or financing cash flows, provided that they are classified consistently from period to period [IAS 7.31]. 5. Cash flows arising from taxes on income are normally classified as operating, unless they can be specifically identified with financing or investing activities [IAS 7.35]. For operating cash flows, the direct method of presentation is encouraged, but the indirect method is acceptable [IAS 7.18]. (Summary of International Financial Reporting Standards 2008). For taking decision relating to investment in enterprise, investors require an evaluation of the firm's capacity to generate financial surpluses and associated net cash flows since this is an indicator of the firm's ability to pay dividend, which has influence on the market price of shares. It also indicates the capacity of a firm in repaying loans and ability to provide steady employment. It also helps to evaluate other aspects of the firm's future like the productive capacity alteration and its effects on future employment. Thus, the financial statement relating to the financial position and profitability of a firm is important for the investing community. The investors are looking for the profitability and safety of their funds in the firm. The shareholders are interested in knowing the growth rate of the firm because it is an indication of their growing dividend income. Contents of cash flow statement: A cash flow statement contains information relating to the cash transactions. Three different heads present the cash transactions. They are explained below. 1. Cash flows from operating activities: It includes cash flow items such as operating profit, depreciation, amortisation (loss of intangible asset value overtime), net impairment release, profit or Loss on disposal of property, plant and equipment, fair value losses on derivative instruments, charges in respect of employee share incentive schemes, increase in inventories, increase in receivables and increase in payables. The total sum is the cash generated from operations. From these, interest and tax payments are charged. 2. Cash flow from investing activities: It includes the following: Purchase of tangible and intangible fixed assets, proceeds from sale of property, plant and equipment, Payment of deferred consideration, and acquisition of subsidiary. 3. Cash flow from financing activities: The items included under this head are as below: Dividends paid in the year, issue of ordinary share capital, share buy back; sale and purchase of own shares by ESOPs, draw down on loan facility, net decrease in cash and cash equivalents and the effect of exchange rate changes on opening balances. (Burberry Established 1856, P. 100). The users of cash flow statement: Cash flow statement is useful for both the internal and external parties of an enterprise. Cash flows are essential to solvency. Cash flow is crucial for survival of firms.' Inadequate cash flow results in insolvent and bankruptcy. Financial analysts use the cash flow statement to measure the financial performance. Financial statements are used by companies for informing various groups of people about the financial position of them. Along with the shareholders of the company, the statements are useful for creditors, suppliers, bankers, tax authorities, and potential investors who are interested in the activities of the enterprise. (Crowther 2004, P. 62). 2. Profit and loss account: A profit and loss account is a statement which indicates the revenue earned by a firm through its business activities. It shows the revenue earned by the firm during an accounting period along with the expenditure made for earning the income. It is a statement, which shows the profit or loss incurred by a firm through its business during the accounting period. This statement is also known as income statements prepared for inform the managers and investors about the business profitability. it represents a period of time. "An income statement is a financial statement which presents the financial performance over a specific accounting period. Financial performance is assessed by taken into consideration revenues and expenses through both operating and non-operating activities. It shows the profit or loss incurred over a specific accounting period. It is a standard financial statement used by both investors and company managers in order to understand the company's financial condition." (Reh 2008). The preparation of Profit and loss Account is mandatory under the Company Laws of UK. Accounting concepts relating to income statement: "International Financial Reporting Standards (IFRS), IFRIC interpretations and parts of the Companies Act 1985 applicable to companies reporting under IFRS. The consolidated financial statements have been prepared under the historical cost convention, except as modified by the revaluation of financial assets and financial liabilities at fair value through profit or loss." (Press Release 2005). Contents of profit and loss account: The profit and loss account of a company includes information relating to the following; Revenue cost of sales, operating expenses. The gross and net profit earned from the business is separately shown in this statement. The tax and interest charges are also shown in this statement. By dividing the profit for the year with the number of equity shares, it can calculate earnings per share. (Burberry Established 1856, P. 97). Users of Profit and loss Account: This statement is highly used by the investors and creditors to determine the past performance of the enterprise, to predict the future performance, and to assess the financial strength ness of the firm for generating future cash flows. Comparison of information supplied by different financial statements of a firm: 1. From the cash flow statement we can gather information relating to cash flow from different activities separately. While the profit and loss account provide information relating to the profitability of a firm. 2. Cash flow Statement bridges a link between cash balances from one accounting period to another. While profit and loss account contains information relating to the business operations during a specific accounting year. 3. Cash flow statement provides information relating to the sources from which the firm raises its finance and the ways in which it is profitably invested whereas the income statement shows the result of application of fund in various business activities. 4. Cash flow statement assures the ability of the firm to return value to shareholders. It is an indicator of company's financial strength. However, income statement shows only the profitability of a firm during an accounting year. 5. Cash flow statement excludes the amount relating future incoming and outgoing cash that has been recorded on credit. Only cash transactions are taken in to account in cash flow statement. While in income statement both cash and credit transactions are taken for calculating the profit or loss. Uses of cash flow statement: It is an essential tool of financial analysis for short- term planning. Since a cash flow statement is based on the cash basis of accounting, it is very useful in the evaluation of cash position of a firm. A projected cash flow statement can be prepared to in order to know the future cash position of a firm to enable it to plan and coordinate its financial operations properly. By preparing this statement a firm can come to know as to how much cash will be generated into the firm and how much cash will be needed to make various payments and thus the firm can well plan its future requirements of cash. A comparison of the historical and projected cash flow statements can be made to find the variations and deficiency for taking immediate and effective action. A series of intra- firm and inter-firm cash flow statements reveals whether the firm's liquidity or short-term solvency is improving or deteriorating over a period of time and in comparison to other firms over a given period of time. It helps in planning repayment of loans, replacement of fixed assets and such like long term planning of cash. It is also significant for capital budgeting decisions. It better explains the causes for poor cash position in spite of substantial profits by explaining the various applications made by a firm. It is relevant for short-term financial analysis for knowing the ability of the firm to meet its short-term financial obligations. (Gupta & Sharma 2006, P. 7.9). Income statement is prepared to determine the operational position of a firm. It is a statement of revenues earned and the expenses incurred for earning that revenue. In case of excess of revenue over expenditures, it will show a profit and in case expenditure is more than revenue, there is a loss. It is prepared according to the nature of the business. Trading concerns prepare trading / P&L a/c where as manufacturing concerns prepare manufacturing accounting in addition to the income statement. Types of information and its value to users supplied by P& L A/C and cash flow statement: From the profit and loss a/c of Burberry Group Plc., we can calculate ratios relating to its efficiency of stock management. 1. Inventory or stock turn over ratio = sales / inventory Sales = 995.4, inventory = 268. 6. (Burberry Established 1856, P. 97). = 995.4/ 268.6 = 3.7 The stock turn over ratio as per the industry average is 9 but in Burberry Plc. It is only 3.7. From these they can conclude that the current stock management system is not accurate. Therefore, the management can take appropriate steps to maintain the stock at optimal level. 2. Debtors turn over ratio = total sales / debtors. Sales = 995.4, Debtors= 169.2. (Burberry Established 1856, P. 97 & 99). = 995.4 / 169.2 = 5.88 The debtors turn over ratio of Burberry plc. Is 5.88. It indicates the number of times the debtors are turned over during a year. When the value is higher, it indicates that the management is more efficient in the management of debtors/ sales and vice versa. Incase of a very high debt turn over ratio it has to take precaution because it is an indication of firm's inability to due lack of resources to sell on credit thereby losing sales and profits. 2. Creditors turn over ratio = annual net purchase / average trade creditors Annual net purchase = 416, Average trade creditors= 172.5. (Burberry Established 1856, P. 97 & 99). = 416 / 172.5 = 2.41 Creditors turn over ratio indicates how much time the firm is likely to take in repaying its trade creditors. Generally, a lower ratio is better to the creditors. However, a higher payment period implies greater credit period enjoyed by the firm and consequently larger the benefit reaped from credit suppliers. Thus, the current ratio of Burberry Plc. is comparatively lower and thus the creditors are in less risk. Working capital turn over ratio = Cost of sales / net working capital. Cost of sales = 377.7, Net working capital =152.2. (Burberry Established 1856, P. 97 & 99). = 377.7 / 152.2 = 2.48 Working capital of a concern is directly related to sales. It indicates the velocity of the utilization of net working capital. It is measure of the efficiency with which the working capital is being utilized by a firm. A higher ratio indicates efficient utilization of working capital and a low ratio indicates otherwise. Thus, the low working capital turn over ratio of Burberry Plc. is not good and the firm has to take care with their management of working capital. Total assets turn over ratio = sales / total assets. Sales = 995.4, Total assets= 364.8, (Burberry Established 1856, P. 97 & 99). = 995.4 / 364.8 = 2.73 The total assets turn over ratio of Burberry is 2.73, which are also not good as compared top the industry average. Profitability ratio: Basic earning power ratio = EBIT/ total assets. EBIT= 201.7, total assets= 953.2. (Burberry Established 1856, P. 97 & 99). = 201.7 / 953.2 = 21% The basic earning power ratio shows the raw earning power of the firm's assets before the charging of taxes and leverage. The high turn over ratio of Burberry Plc. shows that it is getting a high return on it assets. In place the industry average BE ratio of 17.2%. The ratio of Burberry is 21%. It is a good indication of Market value ratio: Price /earnings ratio = price per share / earnings per share. Price per share = 470.50, earnings per share= 31.3 (Burberry Established 1856 2008). = 470.50 / 31.3 = 15 The PE ratio of Burberry is 15 and the industry average ratio is 12.5. Here it is clear that the price-earning ratio of the firm is above the industry average and thus the shareholders of the company are in a better condition. From the cash flow statement, we can calculate the ratios relating to the financial position of a firm. 1. Debt management ratio: Total debts/Total tangible assets = 7.4/802 = .92% Industry average 40% from this it could be judged that most of the business Generated by Burberry plc are cash business and do not carry much debt risks. 2. Liquidity ratios: Current ratio = current assets / current liability = 588.4 / 436.2 = 1.35 times (Burberry Established 1856, P. 99). The current ratio of Burberry Group Plc. is 1.35 times only, where as the industry average is 4.2 times. A relatively low current ratio is an indication that the firm is not liquid and the ability to pay its current obligations in time is also not satisfactory. Hence, the low current ratio of Burberry is a bad indicator of its current assets management. 2. Quick ratio = quick assets / quick liabilities = 319.8 / 244.4 = 1.31 times (Burberry Established 1856, P. 99). The quick ratio of Burberry Plc. is 1.31 times where as the industry average is 2.1 from this it can conclude that the short term liquidity position of the company is not in a better level. They may face problems relating to repayment of short-term debt in time. DESCRIPTION RATIO AS PER BURBERRY A/c INDUSTRY AVERAGE COMMENTS Turn over ratios: Inventory or stock turn over ratio 3.7 9 Poor Creditors turn over ratio 2.41 - Working capital turn over ratio 2.48 - - Total assets turn over ratio 2.73 - 1.8 High Profitability ratios: Basic earning power ratio 21 % 17.2 % High Price per earnings ratio 15 12. 5 High Liquidity ratios: Debt management ratio 0.92 % 40 % Poor Current ratio 1.35 4.2 Poor Quick ratio 1.31 2.1 Poor Statement showing required financial ratio analysis of Burberry Plc: Conclusion: From the auditors repot we can assume that the group financial statements of Burberry Plc. gives a fair and true view on the state of affairs and its profit and cash flows in accordance with the IFRSs as adopted by EU. The group financial statements are prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation. Bibliography Burberry Established 1856: Annual Report 2007-2008: Group income statement. P. 97. [Online]. Last accessed 24 June 2008 at: http://smartpdf.blacksunplc.com/burberry2007-08ara/Burberry_2007-08_AnnualReport.pdf Burberry Established 1856. (2008). [Online]. Burberry plc. Last accessed 24 June 2008 at: http://www.burberryplc.com CROWTHER, David (2004). Managing Finance: A Socially Responsible Approach. P. 62. [Online]. Butterworth-Heinemann. Last accessed 24 June 2008 at: http://books.google.co.in/booksid=naaXGg-o0I0C&pg=PA62&lpg=PA62&dq=%E2%80%9CManaging+Finance:+a+socially+responsible+approach+by+David+Crowther-+2004,+page+no.+23-+Reporting+financial+performance)&source=web&ots=D8Gt6WBbwW&sig=6488snqqp25hEX0ND_hinv47xto&hl=en&sa=X&oi=book_result&resnum=3&ct=result Gupta, Shashi K., & Sharma, R K (2006). Financial Management Theory and practice: Uses and Significance of Cash Flow Statement. P. 7.9. New Delhi: Kalyani Publishers. Press Release: IASB Issues Standard to Improve Disclosures about Financial Instruments and Capital. (2005). [Online]. International Accounting Standards Board. Last accessed 24 June 2008 at: http://www.iasplus.com/pressrel/0508ifrs7.pdf REH, F John (2008). How to Read an Income Statement. [Online]. About.com: Management. Last accessed 24 June 2008 at: http://management.about.com/cs/adminaccounting/ht/readincomestmt.htm Summary of International Financial Reporting Standards. (2008). [Online]. IAS Plus. Last accessed 24 June 2008 at: http://www.iasplus.com/standard/ias07.htm Read More