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ASS#2ACCT11059 - USING ACCOUNTING FOR DECISION MAKING Student Name: Katrin Cichon Student Number: 12016079 Lecturer: John McGrath Campus: CQU Bundaberg Step 1: My reflection and ideas about Chapter 4 ‘Analysing Financial Statements’ in the Study GuideKCQ’sAnalysing financial statements was so far the most challenging chapter for me. I was struggling to get my head around what restating actually is and why it is necessary to do it. All this information, acronyms like NOA, NFA, OI, FCF and so on as well as all the formulas created a knot in my head. Besides of having a lot of other commitments?I could not get motivated to start restating my financial statements. I just did not seem to fully understand the process.How firms add value – free cash flow and economic profitThis is a good question and I thought this should be easily answered. Already in other chapters we have discussed value to a firm is something money can be earned with. For example if a company buys a machine which speeds up production, this would add value. However, on page 2 of the study guide Martin is relating more about how firms add value to equity investors and talks about dividends. I know what dividends are but don’t know the exact definition. Therefore I was searching what dividend means. The explanation I found on google was following: “A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders. Dividends can be issued as cash payments, as shares of stock, or other property.” This is a good and simple explanation. But how are those get paid to shareholders and how are dividends connected to value of a firm? Reading further my understanding is that dividends are related to free cash flow (FCF) and that dividends as well as free cash flow are not measurements of creating value instead they are described as measurement of transfer of value. What? My knot in my brain starts already to tie together. I do understand that there is a difference between operating and financial activities in a firm and I also understand as more money a company makes the bigger the pay out of dividends to investors. It does all sounds logical but for some reason I have difficulties processing this all in my head. English is not my first language which makes everything even more challenging. Reading further along this section I have to read everything two to three times to understand all the acronyms and formulas; and for the information to make sense. To answer the question which firm would you prefer to own shares in I would say yet again, all those words and tables make kind of sense to me but I find it hard to get this in my ‘system’, so I am still unsure.Reaching the section of economic profit I think my brain shut down completely. Time for a break I guess! :-)Operating and financial activitiesThe understanding I got out of this section is that it is important to separate operating and financial activities to detect made errors in statements. Out of the four statements we only have to restate three: the balance sheet, the?income statement and the?statement of equity. As far as I understood the reason for not restating the statement of cash flow is that it easy to detect errors in this statement. Some items don’t show up on the income statement but they will appear on the cash flow statement and therefore make it easier for us to understand the cash situation of a firm. The statement of changes in equity connects the balance sheet and income statement through to the bottom line ('total equity' on balance sheet equals 'Balance at 30 June' on equity statement; 'total comprehensive income' on income statement equals 'total comprehensive income for the year on equity statement'). It seems accountants call it a ‘clean surplus’ if all earnings are incorporated in the income statement.The explanation Martin?gave about the Kinder Surprise, why it is important to separate those two activities, was a great way to describe it to someone like me. To my understanding it means by looking on a firm from the outside we only see the financial part, meaning that a company is earning money with an activity like a sale and we can derive from it how much a company is worth. However, we can’t see how the financial part is coming together (e. g. what costs does a company has to count against income). Walking into a company we can see all the operational activities (e. g. manufacturing or service), meaning what is actually happening inside?of a?company (e. g. production and the consequential occurring costs).Another description could be the following:?a firm is like a Mango (a whole fruit), but if you take the skin and the 'seed' away only the actual part of what is actually eatable is left. This eatable part is the reason why people buy a mango, meaning this is why and how a firm earns money with this fruit (= financial activity). Whereas the kernel or seed (I will describe it as seed in this case to make more sense of it) is the operational activity, as you can grow another mango tree from a seed. Therefore we get the separation from net operational assets and net financial assets.Figure 4.1 illustrate the differences between operational and financial activities. Besides the fact it looks to me like a description of a chemical reaction, it does make sense after analysing it for a while. At least I think so. On this image a firm is divided in net operating assets (NOA), which is on the right and net financial assets (NFA), which is on the of course on the opposite side. Customers increasing the cash flow of a firm by buying products (which are NOA to a company until they are sold). An example of my company Altium would be payments for property, plant and equipment. By contrast suppliers have an opposite impact, in other words they are expenses and therefore decreasing NOA (as Altium does not has NOA I cannot give an example from my company). However, NFA are assets which are not used in operations of a firm. NFA could be affected through equity investors and debt investors.Another advantage in?separating financial activities from its operational activities, is that it allows us to determine which part is most likely to add value to equity investors and therefore to the company.Overall I found this part with all the acronyms and formulas very confusing (it reminded me a bit of Maths) and I had to read this section a few times.?Restate balance sheet and income statementOnce I started analysing those two key financial statements of my company, Altium, I was not sure which item is an operational and which one is a financial activity. Therefore?I followed Martins advice and printed out the firms statements. It still has not made it any easier for me, as I did not understood the concept of the whole concept of restating. I found the statements of my company more complicated that the one from Ryan Healthcare, which was given as an example.Hence, it was a great advantage for me that this course is offered at my campus. This meant I had the opportunity to discuss those issues in a group and with the lecturer. It helped to improve my understanding of?the differences between operational and financial activities a bit better and to make sense out of their separation. However, in saying that, restating my balance sheet did my head in and for some reason?I had a complete?mental block when trying to understand it.Out of both those key financial statements I found the balance sheet less complicated than the income statement. However, with the balance sheet I did not understand how to treat current and non-current assets and liabilities. I also had difficulties with the numbers I had to fill in. I knew it was something with less than 1% of sales, but I wasn’t sure if I have to apply this to every number. With the income statement I had the most difficulties with the bottom part from ‘Profit before income tax benefit/(expense) to ‘total comprehensive income for the year attributable to the owners of Altium Limited’; I also?did not know how?to fit in the tax expenses (incl. calculating them). Even after comparing mine with the given restated example of Ryan Healtcare I could not figure it out as the wording of my statements differ from the statements of Ryan Healthcare.Profitability and efficiencyEven though I do know the meaning of words like profitability and efficiency I often look for a detailed definition of words (especially if it comes to comparison and/or distinction) purely because English is not my mother language. According to the business dictionary profitability is the state or condition of yielding a financial profit or gain. It is often measured by price to earnings ratio. While efficiency is the comparison of what is actually produced or performed with what can be achieved with the same consumption of resources (money, time, labour, etc.).?It is an important factor in determination of productivity. Despite the well written and mostly easy to understand chapters in the Study Guide this definition gives me an additional understanding of things. In addition Martins simple but valuable examples to explain things throughout all chapters help me also. Even though I had some accounting experience in the past, it was a long time ago and has faded only fade and near non-existing anymore. Therefore those explanations make it easier for me to relate to some of it which again gives me a better understanding. Taking the comparison between a supermarket and a car dealer in regards who makes more profit brings me back to my time as food stall holder. At that time I was also selling softdrinks. I was usually at least $ 0.50 cent cheaper per can than my competition. As people these days like to save wherever they can I sold more cans than other stallholders (this realisation is based on observation). Consequently I made more profit on softdrinks than my competition as I sold more for less. A supermarket has lots of customers while a car dealer sales a car only now and then. Therefore I believe a supermarket makes more profit than a upper class car dealer even though its profit margin is $ 0.12 higher per dollar of sales. To support this I actually went one step further and wanted to see the differences in revenue of a supermarket and a fancy car dealer. Unfortunate I could not find a specific annual report of Mercedes or Porsche Australia to compare, but my findings showed that Coles made a revenue of $ 38 billion in the last financial years. That is a lot.I think breaking things into bits is a great idea to get a better understanding of financial statements and therefore a firm. My understanding of economic profit is the difference between an income received from a sale of a product and the opportunity costs which includes things to produce a product. I have also learned in this section that the relationship between profitability and efficiency is very important in understanding and analysing financial statements and how to calculate return of operating assets (RNOA). The formula for profitability margin is: Gross profit = sales revenue - costs of goods soldHowever, it seems RNOA depends on which figures a company is using and that this has an influence on the result. As Altium does not has any ‘costs of goods sold’ I cannot give an example.ConclusionOf all the chapters, chapter four was a lot to take in and probably the most challenging for me. I had to read some of the sections a few times and referred to the restated statements of Rymans Healthcare several times to get my head around it. I took away that the purpose of restating a financial statement is to correct errors. On the end I finally understood that the most numbers from the original statement could be copied into the restated statement. Only the?'cash and cash equivalents' number on the balance sheet needed to be replaced?with the operational revenue (=1% out of the whole?revenue).??Same items in current and non-current Assets/Liabilities?can be combined and are separated into operating and financial; the equity part on the bottom of the?balance sheet stays the same (equity?is not?restated).?I have learned of a few new concepts about accounting?in this chapter?but I haven’t understood everything a 100%?yet.Analysing financial statements was so far the most challenging chapter for me. I was struggling to get my head around what restating actually is and why it is necessary to do it. All this information, acronyms like NOA, NFA, OI, FCF and so on as well as all the formulas created a knot in my head. Besides having a lot of other commitments I could not get motivated to start restating my financial statements. I just don’t seem to fully understand the process.Step 2: Restating my firms’ financial statements including a brief commentary on any issues or concerns I had during doing it and discussions with other students.See posts on my Ass#2 blog: katrinssite.Discussions with other students:1308101949450010223528448000right9652000Step 3: Identify three products or services of your firm and estimate/guess their selling price and variable costs and comment on the calculated contributions margin.Contribution Margin (CM) tells us that amount of each $ of sales contributes to covering a firms fixed costs and contributing to profits. Or in other words CM is the key factor to find out a company's break-even point, meaning how much a firm has to sell to cover their costs and more importantly how much they have to sell to start making profit.The formula is: CM = Sales – Variable CostsWhile fixed costs stay the same no matter how much or less a firm is selling, variable costs are changing through to changes in purchase prices (e. g. material costs; those costs can increase or reduce in time). As soon the fixed costs are covered through sales of a product the margin is what contributes to profit.Altium offers a few different Products and Servies. I have chosen following items:Circuitmaker (a free community-driven PCB design-tool)Altium Vault (Centralized platform for ECAD design data, library, workflow and team management)Altium Designer (Software)Circuitmaker: Sales-Price: $ 12,000Variable Costs:- $ 7,500CM = $ 4,500Altium Vault:Sales-Price: $ 27,800Variable Costs:- $ 14,300CM = $ 13,500Altium Designer: Sales-Price $ 95,900Variable Costs:- $ 52,000CM = $ 43,900The contribution margin figure can be used by a firm to find out if variable costs for a product need to be reduced, or if the price of the end product needs to be increased. If a product is not be profitable, the manager of a firm may decide to take that certain product out of his range to produce an alternate product which produces a higher contribution margin.All three items I have chosen are quite similar good in their contribution margin with percentages between 37.5% and 48.56%. It seems Altium is a respected company in regards to software solutions for different companies and universities. I believe all three items are popular items, especially software is always needed to be updated to current technology standards and changes. Therefore those products are purchased periodically. I would say the reason why my company has a broad range of products with different contribution margins is that they can offer some products on lower prices to make it more attractive to buyers pricewise. They most likely will still make profit in general through other products with a higher CM.Step 4: Providing and receiving feedbackSee posts on my Ass#2 blog: katrinssite. ................
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