Non Finance Mgrs Seminar

1

FLOUR MILLS OF NIGERIA PLC, APAPA, LAGOSFINANCE FOR NON FINANCE MANAGERS WORKSHOPFINANCIAL STATEMENTS ANALYSIS

PRESENTED BY HEZEKIAH A. OYEYEMI BSc, AAT, ACA

ON WEDNESDAY AUGUST 27, 2014

AT THE HR SEMINAR ROOM, FLOUR MILLS OF NIGERIA PLC, APAPA, LAGOS

Finance for Non Finance Managers - INTRODUCTION TO

FINANCIAL STATEMENTS ANALYSIS

To expose the basic principles on which accounting practice rest to the audience

To educate the participants on the relevance of financial statements reporting to the business entity.

For clear understanding of basic elements of financial statements and it importance to business decisions

To expose the attendee to basic financial indicators from the information provided by the financial statements reporting.


FINANCIAL STATEMENTS ANALYSIS 2

OBJECTIVES

Understanding basic accounting principles and concepts

Objectives of Financial Statements

Elements of Financial Statements

Interpretation of Financial Statements

Ratio Analysis and Key indicators



Scope

Finance for Non Finance Managers - INTRODUCTION TO FINANCIAL

STATEMENTS ANALYSIS 4

Introduction

A financial statement (or financial report) is a formal record of the financial activities of a business, person, or other entity.

Relevant financial information is presented in a structured manner and in a form easy to understand.

Financial statements include reports such as Income Statement, Statement of Financial Position (Balance Sheet), Statement of Changes in Equity, Statement of Cash Flow among others accompanied by a management discussion and analysis.



Financial Statements - Overview

Generally Accepted Accounting Principles (GAAP) - In the world of financial accounting, there are many different rules, concepts, and guidelines that govern how companies should account for financial transactions and present their financial statements. These rules and concepts are called generally accepted accounting principles (GAAP). Every private company that issues financial statements to the public must follow the rules of GAAP. This is useful because it maintains accounting consistency through years and across companies. This way an investor can compare a 2013 Statement of Financial Position (SFP) of one company to the 2013 SFP of another company.

The numbers and ratios will be meaningful because both companies used the same methods and techniques to prepare and present their balance sheets.

NGAAP is created by ICAN and known as Nigerian Accounting Standard Board –NASB before it was taken over by government. NASB is now known as FRCN – Financial Reporting council of Nigeria overseeing the setting of accounting standard and guidelines in Nigeria.



Financial Statements - Overview

GAAP was mainly concerned about the end users of financial statements to evaluate business decisions. End users include people like investors, banks, lenders etc. For instance, an investor will look at a company's financial statements in order to decide whether to invest.

It was meant to make consistent standards that help end users understand and use the company's financial data.

To make financial statements universally understandable, comparable and usable for all users.

For proper evaluation of financial statements by the users, GAAP came up with the accounting qualitative characteristics which are Relevance, Reliability, Comparability and Consistency.



Financial Statements – OverviewGAAP Objectives



Basic Accounting Principles &

Concepts

Accounting Concepts and Principles are a set of broad conventions that have been devised to provide a basic framework for financial reporting. As financial reporting involves significant professional judgments by accountants, these concepts and principles ensure that the users of financial information are not mislead by the adoption of accounting policies and practices that go against the spirit of the accountancy profession.

Accountants must therefore actively consider whether the accounting treatments adopted are consistent with the accounting concepts and principles.



Basic Accounting Principles, Conventions and Guidelines



Accounting Concepts and Conventions

ConceptsEconomic Entity

Monetary UnitTime Period (Periodicity)

Historical Cost

ConceptsGoing Concern

Matching/Accrual Revenue Recognition

ConventionsConsistencyPrudency/

Conservatism Materiality Objectivity



Accounting Concepts (Explained)

Economic Entity Assumption The accountant keeps all of the business transactions of a sole proprietorship separate from the business owner's personal transactions. For legal purposes, a sole proprietorship and its owner are considered to be one entity, but for accounting purposes they are considered to be two separate entities.

Monetary Unit Assumption Economic activity is measured in a nation’s currency, and only transactions that can be expressed in that currency are recorded. For instance, transactions in Nigeria are recorded in Naira. Because of this basic accounting principle, it is assumed that the naira's purchasing power has not changed over time. As a result accountants ignore the effect of inflation on recorded amounts. For example, naira from a 1960 transaction are combined (or shown) with naira from a 2013 transaction.

Time Period (Periodicity) Assumption This accounting principle assumes that it is possible to report the complex and ongoing activities of a business in relatively short, distinct time intervals such as the five months ended May 31, 2013, or the 5 weeks ended May 1, 2013. The periodicity principle is based on the assumption that the financial statements must be prepared to cover a particular time frame usually a year. Hence, it is imperative that the time interval (or period of time) be shown in the heading of each element of financial statement. For instance, Income statement for the year ended December 31, 2013.

Historical Cost Principle From an accountant's point of view, the term "cost" refers to the

amount spent (cash or the cash equivalent) when an item was originally obtained, whether that purchase happened last year or thirty years ago. For this reason, the amounts shown on financial statements are referred to as historical cost amounts. Because of this accounting principle asset amounts are not adjusted upward for inflation.



Accounting Concepts (Explained)

Going Concern Principle This accounting principle assumes that a company will continue to exist long enough to carry out its objectives and commitments and will not liquidate in the foreseeable future. If the company's financial situation is such that the accountant believes the company will not be able to continue on, the accountant is required to disclose this assessment. The going concern principle allows the company to defer some of its prepaid expenses until future accounting periods.

Matching/Accrual Principle This accounting principle requires companies to use the accrual basis of accounting. The matching principle requires that expenses be matched with revenues. For example, sales commission expense should be reported in the period when the sales were made (and not reported in the period when the commissions were paid). Wages to employees are reported as an expense in the week when the employees worked and not in the week when the employees are paid.

Revenue Recognition Principle Under the accrual basis of accounting (as opposed to the cash basis of accounting), revenues are recognized as soon as a product has been sold or a service has been performed, regardless of when the money is actually received. Under this basic accounting principle, a company could earn and report N20,000 of revenue in its first month of operation but receive N0 in actual cash in that month.



Accounting Conventions (Explained)

Consistency: It states that accounting method used in one accounting period should be the same as the method used for events or transactions which are materially similar in other period (i.e. accounting practices should remain unchanged from period to period ). This also involves treatment of transaction and valuation method. Consistency is also advisable so that the comparison of accounting figures over time is meaningful. Consistency also states that if a change becomes necessary, the change and its effect should be clearly stated

Prudency/Conservatism convention If a situation arises where there are two acceptable alternatives for reporting an item, conservatism directs the accountant to choose the alternative that will result in less net income and/or less asset amount. Conservatism helps the accountant to "break a tie.“ That is, the accountant is empowered to report envisaged loss in a transaction that the company might suffer rather than anticipating gains thereon. Accountants are expected to be unbiased and objective.

Materiality An item should be regarded as material if there is reason to believe that knowledge of it would influence decision of informed investors. An item is also considered material if its omission or misstatement could distort the financial statement such that it influences the economic decision of users taken on the basis of financial statement. Professional judgment is needed to decide whether an amount is insignificant or immaterial.

Objectivity. This convention states that the financial statement should be made on verifiable evidence. It gives proof of a transaction in an objective manner in contrast to subjectivity or dependence on the verifiable opinion of the accountant preparing the financial statement. It states that information relating to the economic affairs of the enterprise which are of material interest should be clearly disclosed to the readers.



Effect of Accounting Principles and Guidelines on FS

Balance Sheet For a sole proprietorship owned by Mary Smith named Mary Smith Associates, the

effect of principles and practice on its balance sheet showing the snapshot of the company's assets, liabilities, and owner's equity at a particular point in time for economic entity assumption will only capture the assets, liabilities, and owner's equity specifically identified with business. The personal assets of the owner, Mary Smith, are not included on the company's balance sheet.

The assets listed on the balance sheet have a cost that can be measured and each amount shown is the original cost of each asset (Historical Cost). For example, assuming that a plot of land was purchased in 1986 for N10,000, Mary Smith Associates still owns the land, and the land is now valued at N250,000. The historical cost principle requires that the land be shown in the asset account i.e. Land at its original cost of N10,000 rather than at the recently valued amount of N250,000. If Mary Smith Associates were to purchase a second piece of land, the monetary unit assumption dictates that the purchase price of the land bought today would simply be added to the purchase price of the land bought in 1986, and the sum of the two purchase prices would be reported as the total cost of land.

The Stock/Inventory account shows the cost of supplies (if material in amount) that were obtained by Mary Smith Associates but have not yet been used. As the stocks are consumed, their cost will be moved to the Material Expense account on the income statement. This complies with the matching principle which requires expenses to be matched either with revenues or with the time period when they are used. The cost of the unused stocks remains on the SFP as asset.



Effect of Accounting Principles and Guidelines on FS

Income Statement Revenues are the fees that were earned during the period of time shown in

the heading. Recognizing revenues when they are earned instead of when the cash is actually received follows the revenue recognition principle and the matching principle. The matching principle is what steers accountants toward using the accrual basis of accounting rather than the cash basis.

Gains are a net amount related to transactions that are not considered part of the company's main operations. For example, Mary Smith Associates is in the business of designing, not in the land development business. If the company should sell some land for N30,000 (land that is shown in the company's accounting records at N25,000) Mary Smith Associates will report a Gain on Sale of Land of N5,000. The N30,000 selling price will not be reported as part of the company's revenues.

Expenses are costs used up by the company in performing its main operations. The matching principle requires that expenses be reported on the income statement when the related sales are made or when the costs are used up (rather than in the period when they are paid).

Financial statements are reports prepared and issued by company management to give investors and creditors additional information about a company's performance and financial standings. One of the fundamental purposes of financial accounting is to provide useful financial information to users outside of the company.

A set of general-purpose financial statements is designed to report the earnings and profitability, assets and debt levels, uses of cash, and total investments by company owners for a specific time period following the periodicity assumption.




Companies issue financial statements for a variety of reasons at a variety of times during the year. Public companies are required to issue audited financial statements to the public at least every quarter. These regulated financial statements must meet SEC and NSE guidelines.

Non-public or private companies generally issue financial statements to banks and other creditors for financing purposes. Many creditors will not agree to loan funds unless a company can prove that it is financially sound enough to make its future debt payments. Both public and private companies issue financial statements to attract new investors and raise funds for expansions.




Other Objectives of Financial Statements are; Assessment Of Past Performance Past performance is a good indicator of future performance.

Investors or creditors are interested in the trend of past sales, cost of goods sold, operating expenses, net income, cash flows and return on investment. These trends offer a means for judging management's past performance and are possible indicators of future performance.

Assessment of current position Financial statement analysis shows the current position of the firm in terms of the types of assets owned by a business firm and the different liabilities due against the enterprise.

Prediction of profitability and growth prospects Financial statement analysis helps in assessing and predicting the earning prospects and growth rates in earning which are used by investors while comparing investment alternatives and other users in judging earning potential of business enterprise.

Prediction of bankruptcy and failure Financial statement analysis is an important tool in assessing and predicting bankruptcy and probability of business failure.

Assessment of the operational efficiency Financial statements analysis helps to assess the operational efficiency of the management of a company. The actual performance of the firm which is revealed in the financial statements can be compared with some standards set earlier and the deviation of any between standards and actual performance can be used as the indicator of efficiency of the management.




• FS consists of the under listed elements

• Income Statement• Statement of Owner's Equity• Statement of Financial Position

(Balance Sheet)• Statement of Cash Flows• Notes to the FS • Value Added Statements and• 5- Year Financial Summary

FS are reports prepared and are issued to the

public as a set of reports/statements as required by law by a business entity. This

means they are not only published together, but they are also designed

and intended to be read and used together. Since

each statement only gives information about

specific aspects of a company's financial

position, it is important that these reports are

used together.




Income Statement The income statement

is the first financial statement typically prepared during the

accounting cycle because the net income or loss must be calculated and

carried over to the statement of

owner's equity before other financial

statements can be prepared. This report shows investors and creditors the overall profitability of the

company as well as how efficiently the

company is at generating profits

from total revenues.

Statement of Stockholders

Equity/Changes in equity. This

statement displays how equity changes from the beginning of an accounting period to the end.

The statement displays all equity

accounts that affect the ending equity balance including equity stock, net income, paid-in

capital, and dividends.

The balance sheet/SFP reports a company's

financial position based on its assets, liabilities, and equity at a single

moment in time. Unlike the income statement, the balance sheet does

not report activities over a vast time frame. The

balance sheet is essentially a picture of a

company's resources, debts, and ownership on

a given day. Investors and creditors generally look at the statement of financial position for insight as to

how efficiently a company can use its resources and

how effectively it can finance them.

The Statement of Cash Flows summarizes how

changes in balance sheet accounts affect the cash account during the accounting

period. It also reconciles beginning and ending cash and

cash equivalents account balances. The cash flow

statement shows investors and creditors what transactions

affected the cash accounts and how effectively and efficiently a

company can use its cash to finance its operations and

expansions. This is particularly important because investors want to know the company is

financially sound while creditors want to know the company is

liquid enough to pay its bills as they become due

Notes to the FS

details out all other

information whose summary had been presented in the FS.

Value Added

Statement detailed out how

the money generated during the

period (value

added) are shared

among the stakeholde

rs – Employees, owners

of business, Governme

nt and future

expansion of

business.

5 Year Financi

al Summa

ry. Provides summari

es of past five

year financial summar

y for comparis

on purposes

.



Elements of Financial Statements (Explained)

Financial Statements interpretations is to provide enough information for the users of FS on which to base their investment decisions vis-à-vis the company’s operations efficiency and effectiveness.

Investors and creditors analyze Financial Statements on which their financial and investment decisions are based. They also look at extra financial reports like financial statement notes and the management discussion for better information about the business entity.

The income statement and balance sheet accounts are compared with each other to see how efficiently a company is using its assets to generate profits. Company debt and equity levels can also be examined to determine whether companies are properly funding operations and expansions.

The financial information so provided is by themselves rarely give outside users and decision makers enough information to judge whether or not a company is fiscally sound, however, investors and creditors generally compare different companies' ratios to develop an industry standard or benchmark to judge company performance.






Ratio Analysis & Key Indicators

Ratio analysis is the most popularly and widely used technique of financial statement analysis.

Accounting ratios are used as an important tool of analyzing the financial performance of the company over the years and its comparative position among other companies in the industry.

Ratio analysis is the process of determining and interpreting numerical relationship between figures of financial statements. It is also a process of determining and presenting the quantitative relationship between two accounting figures to evaluate the strengths and weakness of a business. It is important from the point of view of investors, creditors and management for analysis and interpretation of a firm's financial health.

Financial ratios are the most common and widespread tools used to analyze a business' financial standing. Ratios are easy to understand and simple to compute. They can also be used to compare different companies in different industries. Since a ratio is simply a mathematically comparison based on proportions, big and small companies can use ratios to compare their financial information. In a sense, financial ratios do not take into consideration the size of a company or the industry. Ratios are just a raw computation of financial position and performance.

Financial ratios are often divided up into the following main categories: liquidity, solvency, efficiency, profitability, investment leverage and coverage.



Ratio Analysis and Key Indicators

• Liquidity, • Solvency, • Efficiency, • Profitability, • Investment leverage and

Coverage.

Financial ratios are

often divided up

into the following

main categories:



Ratio Analysis and Key Indicators (Cont’d)

• Quick Ratio. measures the ability of a company to pay its current liabilities when they become due with only quick assets. Quick assets are current assets that can be converted to cash within a short-term. Cash, cash equivalents, short-term investments or marketable securities, and current accounts receivable are considered quick assets.

• Working Capital/Current Ratio. Measures a firm's ability to pay off its current liabilities with current assets. Current liabilities are best paid with current assets like cash, cash equivalents, and marketable securities because these assets can be converted into cash much quicker than fixed assets. The faster the assets can be converted into cash, the more likely the company will have the cash in time to pay its debts.

LiquidityLiquidity ratios analyze the ability of a company

to pay off both its current liabilities as they become due as well as

their long-term liabilities as they become current.

In other words, these ratios show the cash

levels of a company and the ability to turn other assets into cash to pay off liabilities and other

current obligations.




•Debt to Equity Ratio compares a company's total debt to total equity. It shows the percentage of company financing that comes from creditors and investors. A higher debt to equity ratio indicates that more creditor financing (bank loans) is used than investor financing (shareholders).

•Equity Ratio measures the amount of assets that are financed by owners' investments by comparing the total equity in the company to the total assets. The equity ratio highlights two important financial concepts of a solvent and sustainable business. The first component shows how much of the total company assets are owned outright by the investors and the other component shows how the company is leverage on debt.

•Debt Ratio measures a firm's total liabilities as a percentage of its total assets. In a sense, it shows a company's ability to pay off its liabilities with its assets. In other words, this shows how many assets the company must sell in order to pay off all of its liabilities.

•Times Interest Earned (Interest Cover) Ratio measures the proportionate amount of income that can be used to cover interest expenses in the future. In some respects the times interest ratio is considered a solvency ratio because it measures a firm's ability to make interest and debt service payments

Solvency/LeverageMeasure a

company's ability to sustain operations

indefinitely by comparing debt

levels with equity, assets, and earnings.

In other words, solvency ratios identify going

concern issues and a firm's ability to pay its bills in the long

term.




• Accounts Receivable Turnover Ratio measures how many times a business can turn its accounts receivable into cash during a period. In other words, it measures how many times a business can collect its average accounts receivable during the year. This ratio shows how efficient a company is at collecting its credit sales from customers.

• Asset Turnover Ratio measures a company's ability to generate sales from its assets by comparing net sales with average total assets. In other words, this ratio shows how efficiently a company can use its assets to generate sales. The ratio calculates net sales as a percentage of assets to show how many sales are generated from each naira of company assets.

• Inventory Turnover Ratio shows how effectively inventory is managed by comparing cost of goods sold with average inventory for a period. This measures how many times average inventory is "turned" or sold during a period. Sales have to match inventory purchases otherwise the inventory will not turn effectively.

Efficiency Ratio Efficiency ratios also called activity ratios measure how well

companies utilize their assets to generate

income. Efficiency ratios often look at the time it

takes companies to collect cash from

customer or the time it takes companies to

convert inventory into cash—in other words,

make sales.




• Gross Margin Ratio measures how profitable a company sells its inventory or merchandise. In other words, it is essentially the percentage markup on merchandise from its cost. This is the pure profit from the sale of inventory/products that can go to paying operating expenses.

• Net Profit Margin Ratio measures the amount of net income earned with each naira of sales generated by comparing the net income and net sales of a company. It shows what percentage of sales which are left over after all expenses are paid by the business. Creditors and investors use this ratio to measure how effectively a company can convert sales into net income, pay dividend and loans.

• Return on Assets Ratio (ROA) measures the net income produced by total assets during a period by comparing net income to the average total assets. In other words, ROA measures how efficiently a company can manage its assets to produce profits during a period.

• Return on Capital Employed measures how efficiently a company can generate profits from its capital employed by comparing net operating profit to capital employed. ROCE is a long-term profitability ratio because it shows how effectively assets are performing while taking into consideration long-term financing.

Profitability Ratio Profitability ratios compare income statement accounts

and categories to show a company's ability to generate profits from its operations. It focus on a company's return on investment in inventory

and other assets. These ratios basically show how well companies can achieve

profits from their operations.Investors and creditors can

use profitability ratios to judge a company's return on

investment based on its relative level of resources and

assets.




• Dividend Payout Ratio shows the portion of net profits the company decides to keep for the funding of its operations and the portion of net profits that is given to its shareholders. Investors are particularly interested in the dividend payout ratio because they want to know if companies are paying out a reasonable portion of net income to investors.

• Dividend Yield Ratio measures the amount of cash dividends distributed to equity shareholders relative to the market value per share. It is used by investors to show how their investment in stock is generating either cash flows in the form of dividends or increases in asset value by stock appreciation.

• Earnings Per Share measures the amount of net income earned per share of stock outstanding. In other words, this is the amount of money each share of stock would receive if all of the profits were distributed to the ordinary shareholders at the end of the year.

• Price Earnings (P/E) Ratio calculates the market value of a stock relative to its earnings by comparing the market price per share by the earnings per share. The ratio shows what the market is willing to pay for a stock based on its current earnings. Investors often use this ratio to evaluate what a stock's fair market value should be by predicting future earnings per share.

Investment leverage and Coverage.

Investment leverage and coverage ratio

compares the portion of the company’s net

profit that is pay out as dividend to

shareholders and interest payment to

provider of debt capital during the financial

year.




It has become imperative for a potential investor to ensure that proper financial due diligence is conducted on any business of interest before venturing into such decision through adequate financial statements analysis and interpretation. Also, managers of business entity must ensure periodic appraisal of financial information at their disposal to aid them in their business decisions making. Regular financial data analysis and interpretation is a panacea to business success and longevity.



Conclusion



THANK YOU!!!

Non Finance Mgrs Seminar

Documents

Transcript of Non Finance Mgrs Seminar