ACF - Week 1 - With Q Solutions - 4aug2011

Master in Business Administration (M.B.A.
LECTURE 1 Financial Statements
Dr Andry Rakotovololona
LECTURING RESOURCES & INSTRUCTORS

MBA Accounting & Corporate Finance
Google Docs Access: Username: andrytony@gmail.com Password: 09alrandry12 Dr Andry Rakotovololona: Email Address: arakotovololona@lsbf.org.uk
Lecture Outcomes
Explain the nature and purpose of the three (3) major financial statements. Prepare and interpret a STATEMENT OF FINANCIAL POSITION or BALANCE SHEET the information that it contains: The accounting conventions and its limitations. Nature of a STATEMENT OF FINANCIAL PERFORMANCE or INCOME STATEMENT: Prepare and interpret it from relevant financial information.
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Explain the nature of the CASH FLOW STATEMENT: The crucial importance of cash to a business. Prepare and interpret a cash flow statement. Identify the major categories of FINANCIAL RATIOS: Calculate and explain their significance for assessing the financial performance and position of a business.
Explain the relationship between COSTS, VOLUME and PROFIT: Distinguish between fixed and variable costs. Deduce the break-even point and discuss its weaknesses in analysis.
PART 1: INTRODUCTION TO ACCOUNTING
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1. Accounting: Meaning & Functions

Accounting is concerned with collecting, analysing and comparing financial information. Functions: Information gathering: capturing data as business is transacted & book keeping. Classify and summarise: financial reports Communicating: distribution of information to decision makers and other interested parties.
2. Main Users of Financial Information

Owners
Customers
Competitors
Managers
Employees and their representatives
Business
Lenders Government
Suppliers
Investment analysts
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Community representatives
Examples of Uses of Accounting Information

MBA Accounting & Corporate Finance User groups Investors Employees Lenders Suppliers Customers Government General public Management Interested in Risk & return Job security & wages Interest & repayment Payment continuity Continuity Statistics, profitability & Tax Prosperity, employment & activities All aspects
Why Do Managers Need Accounting Information?

Develop new products and services: e.g. Computer manufacturer developing new range of computers. Increase or decrease the price/quantity of existing products or services: e.g. Telecom business changing its mobile phone call and text charges. Borrow money to help finance the business: e.g. Supermarket wishing to increase the number of stores.
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Increase or decrease the operating capacity of the business: e.g. Beef farming business reviewing the size of its herd. Change the methods of purchasing, production or distribution: e.g. Clothing retailer switching from UK to overseas suppliers.
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Question 1
Fox and Co is pursuing the generally accepted goal of increasing of owners wealth. In an attempt to achieve this, the management has decided to cut costs by reducing staff salaries. Would this action be expected to achieve its Purpose? Explain why or why not. What general conclusion can be reached about the businesss goal and the treatment of other stakeholders (groups involved with the business)?
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Solution Q1
Possibly lead to lower costs (and higher profits) in the short term. Almost certainly lead to dissatisfaction among workforce. Likely to lead to lack of staff motivation, leading in turn to less efficient working. Also likely to lead to staff leaving, higher recruitment costs and possibly staff shortages and/or lower quality staff. Net effect: lower future profitability and loss of shareholder wealth. General conclusion: failure to treat all stakeholders reasonably is likely to lead to loss of owners wealth.
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3. Four (4) Characteristics of Good Accounting Information

Relevance: Accounting information must have the ability to influence decisions, therefore must be timely. Reliability: Accounting should be free from significant errors or bias. Comparability: Accounting quality should enable managers to identify changes of business over time.
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Understandability: Accounting reports should be expressed as clearly as possible. But .... Is it Material? In addition to its usefulness, information must reach a threshold of significance. Cost-Benefit theory: a particular information should only be produced if the costs of providing it less than the benefits/value derived.
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4. Accounting as an Information System

Information identification
Information recording
Information analysis
Information reporting
Accounting: Should have features that are valid to all information system
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5. Branches of Accounting
Financial Accounting: Information to outsiders. Seeks to meet needs of various users such as lenders, investors, employees, suppliers etc. Management Accounting: Information to insiders. Seeks to meet the accounting needs of managers.
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Differences between Financial & Management Accounting

Major Differences
Financial Accounting
Nature of the reports produced
Management Accounting Providing more strategic and customerfocused approach by developing Key
Reporting
accounting information to external parties.
Level of detail
The existence of regulations
Performance Indicators.
Reporting interval
Time orientation
Range and quality of information
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Illustration of these Differences

MBA Accounting & Corporate Finance Financial Accounting Focus Accuracy Business Focus Regulation Timeline Reporting External-legal requirements Precise Business sectors Highly regulated Historic Annual accounts Management Accounting Internal-cost, benefits, evaluation Estimations, less precise Individual products, processes, markets No regulation Forward looking Annual monthly, weekly, daily etc
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6. Meaning of Finance
Concerns with the best ways funds for business are raised and how they are invested with the highest returns. Helps to identify forms of funding available, costs and benefits of each funding type, risks associated with each funding type and any investment option, role of financial markets in supplying funds.
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Why is the Risk & Return Relationship Important?

Return
Risk
Portfolio theory Investors are naturally "Risk Averse, therefore if given a choice between two assets with equal returns, they will select the asset with lower level of risk.
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Risk is an unavoidable factor in business decisions. Successful businesses try to minimise risks as far as possible. Banks and other lenders make a regular assessment how risky is each lending. The cost of borrowing is the interest rate that must be paid on a regular basis to the lender when financing the capital used in business.
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(11:00am)
PART 2: STATEMENT OF FINANCIAL POSITION
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Statement of Financial Position or Balance Sheet

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A snapshot in time of the firms financial position:

LIABILITIES ASSETS
EQUITIES
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Balance Sheet Equation

equals
plus
Assets
Equity
Liabilities
Assets What the company owns. Liabilities What the company owes. Shareholders Equity The difference between the value of the firms assets and liabilities.
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Question 2
Jake starts a business, selling denim clothes, trading as "Cowboys Clothing Co. On 1st January Jake opens a business bank account with 30,000 of his own money. Prepare the balance sheet.
Solution Q2
Cowboys Clothing Co Balance Sheet as at 1st January Assets Cash & Bank Total assets Equity Owners Capital
30,000 30,000
30,000 30,000
1. ASSETS
A resource held by a business. For accounting purposes, major characteristics of an asset: A probable future benefit exists. The business has an exclusive right to control the benefit. The benefit must arise from some past transaction or event. The asset must be capable of measurement in monetary terms. Does not have to be a physical items: tangible or intangible. 30
Classification of Assets
CURRENT ASSETS Assets held for the short term. Meet the following obligations: Held for sale or consumption. Expected to be sold within the next year. Held principally for trading. Cash or near equivalents to cash.
Cash. Marketable Securities: Short term and low-risk investment, easily sold or converted into cash (e.g. short term government debt called treasury bill). Accounts Receivables: Amounts owed to the firm by customers who purchased goods or services on very short term credit (Max. 90 days).
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Inventories: Raw materials + work-in-progress & finished goods. Other Current Assets (catch-all category) e.g. Prepaid expenses (in advance) like insurance premium or rent.
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Circulating Nature of Current Assets

Inventories (stock)
Cash
Trade receivables (debtors)
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Inventory Costing Methods

Common Assumptions
First in, First out (FIFO)
Last in, First out (LIFO)
Weighted Average Cost (AVCO).
Example:
FIFO, LIFO & AVCO treatment of the inventories
Business starting on 1st May, supplying oil to factories. During the first month, we have the following transactions:
Tonnes 2 May, Purchased 10 May, Purchased 18 May, sold 10,000 20,000 9,000 Cost / Tonnes 10 13
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FIRST IN, FIRST OUT

COST OF SALES
(9,000 @ 10 PER TONNE)
90,000
CLOSING INVENTORIES
(1,000 @ 10 PER TONNE) (20,000 @ 13 PER TONNE)
10,000 26,000 270,000
LAST IN, FIRST OUT COST OF SALES (9,000 @ 13 PER TONNE) 117,000
CLOSING INVENTORIES
143,000 100,000 243,000
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WEIGHTED AVERAGE COST AVERAGE COST = [(10,000*10) + (20,000*13)] / (10,000 + 20,000) = 12 / TONNE
COST OF SALES CLOSING INVENTORIES
108,000 252,000
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Balance Sheet
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LONG-TERM or NON-CURRENT ASSETS (fixed assets) Do not meet the definition of current assets. Held on long-term.
Net Property, Plant, & Equipment: Book Value = Acquisition cost. Minus Depreciation (i.e. accumulated depreciation, but not an actual cash-outflow): Depreciation = Over time assets are losing value as result of wear and tear, age and obsolescence. Depreciation methods: straight-line basis, declining-balance/reducing-balance. Goodwill: prudent or excess value of a company beyond its assets and liabilities book values.
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Intangible Assets: something of value that cannot be physically touched, e.g. brand , franchise , trademark , or patent. Can be subject to Amortization. Other Long-Term Assets: e.g. Investments in long-term securities.
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Balance Sheet
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2. CLAIMS
An obligation of the business to provide cash or a form of benefit to an outside party. Two types of claim: Equity: claim of the owners against the business or owners capital (Shares + Profits). Liabilities: claims of all individuals or organisations other than the owner(s) Arise from past transactions and settled through an outflow of assets (usually cash).
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3. CLASSIFICATION OF CLAIMS
CURRENT LIABILITIES Amounts due for settlement in the short term. Meet any of the following condition: Expected to be settled within normal operating cycle. Held principally for trading purposes. Due to be settled within a year after the relevant balance sheet. No right to defer the settlement beyond a year.
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Accounts Payable: amounts owed to the suppliers for products and services purchased with a very short term credit (Max. 90 days). Short-Term Debt / Notes Payable: all repayments of debt within the next year. Current Maturities of Long-Term Debt: all repayments concerning then current year. Other Current Liabilities (Accruals items) Taxes or wages that are owed but not yet paid (i.e. Payable)
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Balance Sheet
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NON-CURRENT LIABILITIES Amounts that do no fit the definition of current liabilities. Represent longer-term liabilities. Long-Term Debt: loan or debt obligation of more than a year. Capital Leases: long term lease contract that obligate the firm to make regular lease payments in exchange of the use of the assets. Deferred Taxes.
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The difference between current assets and current liabilities is the firms Net Working Capital (NWC), the capital available in the short term to run the business: NWC = Current Assets Current Liabilities
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Balance Sheet
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Equation for the Standard Layout

Noncurrent assets
Current assets
Equity
Noncurrent liabilities
Current liabilities
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Equation for the Non-Standard Layout

Noncurrent assets
Current assets
Current liabilities
Noncurrent liabilities
Equity
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4. Shareholders Equity
Share Capital: Ordinary share, basic unit of ownership of a business, also known as equities. Preference share, guarantee dividend payments which entitled the preference shareholders to receive the first dividends.
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Effect of Trading Operations

The balance sheet equation can be extended as follows:
equals
plus (minus)
plus
Assets
Equity
Profit (Loss)
Liabilities
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Reserves: Revenue Reserves are retained trading profits and gains part of shareholders equity. Capital Reserves: arise for two reasons Issuing shares at above their nominal value (e.g. Issuing 1 shares at 1.50). Revaluing (upwards) non-current assets. Bonus Shares: Open to company to turn any reserves of any kind into share capital. Then, distribution of new shares to existing shareholders.
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Book Value of Equity Book Value of Assets Book Value of Liabilities Could possibly be negative. Market Value of Equity or Market Capitalization Market Price / Share x Nb. Shares Outstanding Cannot be negative.
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Balance Sheet
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5. Accounting Conventions
Business entity : business and owner quite separate and distinct. Historic cost: value of an asset shown on balance sheet based on acquisition cost. Going concern: financial statements prepared as if business will continue operations for the foreseeable future. Dual aspect: each transaction has two aspects, an increase in an asset (e.g. car) and a decrease in another (e.g. cash). Prudence: caution should be exercised when making accounting judgements.
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Activity 1
(12:30pm)
Sarah started a new business on 1 June. During the first month of her business, the following transactions took place: (a) Sarah opened a bank account in the name of her business and transferred 50,000 of her own money to it. (b) She borrowed 35,000 from the Commercial Loan Company and paid the money into the business bank account. (c) She paid 40,000 for a small business unit (premises). (d) She paid 3,000 for a second-hand delivery van. (e) She bought goods for resale (inventories) for 10,000, paying immediately, and further goods for 20,000, on credit.
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Required: Open a balance sheet for Sarahs business and show each of these transactions on it as a series of pluses and minuses to reach the position of the business as at the end of June.
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PART 3: STATEMENT OF FINANCIAL PERFORMANCE
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Statement of Financial Performance or Income Statement

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INCOME STATEMENT
TOTAL SALES/REVENUES minus Cost of Sales (COGS = Cost of Good Sold) equals GROSS PROFIT minus Operating Expenses Selling, General, and Administrative Expenses R&D Depreciation & Amortization equals OPERATING INCOME ( or OPERATING PROFIT)
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OPERATING INCOME ( or OPERATING PROFIT) plus/minus Other Income/Other Expenses equals EARNINGS BEFORE INTEREST & TAXES (or EBIT) plus/minus Interest Income/Interest Expense equals PRE-TAX INCOME minus Taxes equals NET INCOME (or Net PROFIT)
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Question 3
(1)Gross Profit is: (a) Sales less purchases (b) Cost of goods sold less closing stock (c) Excess of sales over cost of sales (d) Net profit less expenses for the period
Answer:
Question 4
(2) What is the Gross Profit Margin of a business that records the following for an accounting period: Sales 30,000; Purchases 18,000; Cost of Sales 20,000 (a) 10% (b) 33.3% (c) 40% (d) 10,000 Answer: b 30,000 20,000 = gross profit 10,000 10,000/30,000 x 100 = gross profit margin of 33.3%
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1. Recognition of Revenue
Basic criteria that MUST be met before REVENUE is recognised:

The amount of revenue can be MEASURED RELIABLY
It is probable that the ECONOMIC BENEFITS will be RECEIVED
Additional criterion, where the revenue COMES FROM the sale of goods:
OWNERSHIP and CONTROL of the item should pass to the buyer
2. Recognition of Expenses
Matching Convention: the expenses should match the revenue they helped to generate.
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3. Accounting conventions and the income statement

Materiality Convention: Where the amounts involved are material, then we should consider only what is reasonable (e.g. a stationary of 5). Accruals Convention Accruals Accounting (for Balance Sheet and Income Statement, not Cash Flow Statement): All income and charges relating to the financial period should be taken into account WITHOUT regard to the date of payment or receipt of cash. Accruals concept results in profit NOT being equal to net cash flow for the accounting period.
4. Calculation of Depreciation
To calculate a depreciation charge for a period, FOUR FACTORS have to be considered:
Cost (or Fair Value) of the Asset
Useful Life of the Asset
Residual Value (Disposal Value) of the Asset
Depreciation Method.
Straight-Line Method
Written-Down Value against Time
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Written-Down Value (000) Down
60
40
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Asset Life (Years)
Calculating the Annual Depreciation Charge

Cost (Fair Value)

Less
Residual Value
Equals
Depreciable Amount
Year 1
Depreciation
Year 2
Depreciation
Year 3
Depreciation
Year 4 and so on
Depreciation
Asset Life (Number of Years)
Example:
STRAIGHT-LINE METHOD Assumption: Cost of Machine Estimated Value @ End of Useful Life Estimated Useful Life (in Years) Total Amount to be Depreciated Annual Depreciation Charge
Carrying Amount 76,124 57,093 38,062 19,031 Dep. Charge 19,031 19,031 19,031 19,031
78,124 2,000 4 76,124 (i.e. 78,124 - 2,000) 19,031 (i.e. 76,124 / 4)
Year 1 Year 2 Year 3 Year 4
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Reducing Balance Method

Written-Down Value against Time
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Written-Down Value (000) Down
60
40
20
Asset Life (years)
Calculating the Depreciation Percentage

Deriving the fixed percentage
P
Where:
(1 - R/C) x 100%
P = Depreciation percentage. n = Useful life of the asset (in years). R = Residual value of the asset. C = Cost, or fair value, of the asset.
Example:
REDUCING BALANCE METHOD Assumption: Cost of Machine 78,124 Estimated Value @ End of Useful Life 2,000 Estimated Useful Life (in Years) 4 Depreciation Percentage 60%
78,124 46,874 31,250 18,750 12,500 7,500 5,000 3,000 2,000
i.e. DP = [1 - (2000 / 78,124)1/4 ] * 100%
Cost Machine Dep. Charge Year 1 (60% * Cost) Carrying Amount Dep. Charge Year 2 (60% * Carrying Amount) Carrying Amount Dep. Charge Year 3 (60% * Carrying Amount) Carrying Amount Dep. Charge Year 4 (60% * Carrying Amount) Residual Value
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Question 5
(03:00pm)
True - False Questions: Are the following statements true or false? (i) Profit reduces both capital and net assets. False. Trading at a Profit INCREASES net assets and capital. (ii) Inventory is a current liability. False. Inventory (stock) is a current asset. (iii) Drawings are a business overhead. False. Drawings are NOT a business expense so do NOT influence business profits. They are business assets taken for personal use of the owner. (iv) If a Sole Trader pays himself wages, this is treated as an overhead. False. The reward of the owner of the business is profit NOT wages. Whenever the owner withdraws money or other assets from the business it is treated as drawings.
PART 4: CASH FLOW STATEMENT
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Cash is King!!!
It is not a fall in profit that leads to failure, but a lack of cash. Poor cash management is one of the key reasons why 9 out of 10 companies fail.
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Relationship:
Balance Sheet, Income Statement & Cash Flow Statement

Balance Sheet End of Period 1 Balance Sheet End of Period 2
Balance Sheet Beginning Period 1
Income Statement 1
Income Statement 2
Cash Flow Statement 1
Cash Flow Statement 2
Period 1
Period 2
Time
Measuring flows of wealth (Income statement) or flows of cash (Cash-flow statement). Measuring the amount of wealth at a particular moment in time.
1. Definition of Cash and Cash Equivalents

Definitions:
Notes and coins in hand.
Cash
Deposits in banks and similar institutions accessible on demand.
Cash equivalents
Short-term, highly liquid investments readily convertible to cash.
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2. Standard Layout of the Cash Flow Statement

Cash Flow from Operating Activities Plus / Minus Cash Flow from Investing Activities Plus / Minus Cash Flow from Financing Activities Equals
Net Increase / Decrease in Cash & Cash Equivalents over the Period
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3. Two Methods to Prepare the Statement of Cash Flows

Direct Method: Analysis of the cash records of the business for the period. Pick up all payments and receipts relating to operating activities. Summarise the total figures for inclusion in the Statement of CF. Done simply on a computer, but NOT MANY businesses adopt this method
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Indirect method: More POPULAR method. Broadly, revenues give rise to cash inflows and expenses give rise to cash outflows. Since businesses have to produce an income statement, it can be used as a starting point to deduce cash flows from operating activities.
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Example: Cash and Profit

Consider the following examples and discuss how they effect profit and cash
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Cash and Profit
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Cash and Profit
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Cash and Profit

So, business transactions have different effects on profit and cash

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Approach 1
Operating Activity Adjusts Net Income by all non-cash items related to operating activities (depreciation & amortization) and changes in net working capital: Accounts Receivable (deduct the increases) Accounts Payable (add the increases) Inventories (deduct the increases)
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Statement of Cash Flow

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Investment Activity
Capital Expenditures Buying or Selling Marketable Securities Financing Activity Payment of Dividends Dividends = Net Income Retained Earnings Changes in Borrowings
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Approach 2
m CASH FLOWS FROM OPERATING ACTIVITIES Profit before taxation (after interest) Adjustments for: Depreciation Interest receivable Interest payable Increase in trade receivables Decrease in trade payables Decrease in inventories Cash generated from trading operations Interest paid Taxation paid Dividend paid Net cash from operating activities
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79 (17) 23 (18) (1) 3 262 (23) (39) (50) 150
Net Profit before Taxation Depreciation Expense Plus Plus Plus / Minus
Interest Expense Adjustments to Operating Activities Increase (minus) or Decrease (plus) in Inventories Increase (minus) or Decrease (plus) in Receivables Increase (plus) or decrease (minus) in Payables Interest Paid Taxation Paid Dividend Paid
Plus / Minus
Plus / Minus
Less Less Less Equals
Net Cash Flows from Operating Activities

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(05:00pm)
m CASH FLOWS FROM INVESTING ACTIVITIES Payments to acquire tangible non-current assets Interest received Net cash used in investing activities CASH FLOWS FROM FINANCING ACTIVITIES Repayments of loan notes Issue of ordinary shares Net cash used in financing activities NET INCREASE IN CASH & CASH EQUIVALENTS Cash & cash equivalents @ 1 January 2010 CASH AND CASH EQUIVALENTS AT 31 DECEMBER 2010 (150) 90 (60) 12 (68) (56) (95) 17 (78)
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PART 5: Financial Ratios Analysis
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Financial ratio classifications

Categories
Profitability
Efficiency
Liquidity
Financial gearing
Investment
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Ratio Benchmarking
Ratios to be compared with:
Past Periods
Peers during the Same Period
Planned Performance.
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Profitability Ratios
Return on ordinary shareholders funds
Profit for the year (net profit) any preference dividend Ordinary share capital + Reserves
x 100
Return on capital employed

Operating profit Share capital + Reserves + Non-current liabilities
x 100
Operating profit margin

Operating profit Sales revenue
x 100
Gross profit margin

Gross profit Sales revenue
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x 100
Efficiency Ratios
Formulas
Average inventories turnover period
= = = = =
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Average inventories held Cost of sales Average trade receivables Credit sales revenue
x 365
Average settlement period for trade receivables
x 365
Average settlement period for trade payables
Average trade payables Credit purchases
x 365
Sales revenue to capital employed
Sales revenue Share capital + reserves + non-current liabilities
Sales revenue per employee
Sales revenue Number of employees
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Calculating the Operating Cash Cycle

Average inventories holding period Plus
Average settlement period for trade receivables Minus
Average payment period for trade payables Equals
Operating cash cycle
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Liquidity Ratios
Formula
Current assets Current ratio
Current liabilities
Acid test ratio
Current assets (excluding inventories)
=
Current liabilities
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Gearing Ratios
Formula
Gearing ratio
Long-term (non-current) liabilities Share capital + Reserves+ Long-term (non-current) liabilities
x 100
Interest cover ratio
Operating profit Interest payable
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Investment Ratios
Formula
Dividend payout ratio
= = = =
Dividends announced for the year Profit for the year
x 100
Dividend per share / (1 t) Dividend yield ratio Market value per share
x 100
Earnings per share
Profit for the year Number of ordinary shares in issue
Market value per share Price/earnings ratio (P/E)

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Earnings per share

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Investment Ratios
(Continued)
Formula
Earnings per share
Earnings available to ordinary shareholders Number of ordinary shares in issue
Cash generated from operations per share
Cash generated from operations less preference dividend (if any) Number of ordinary shares in issue
Price / earnings ratio (P/E)
Market value per share Earnings per share
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Average (Mean) Ratios of Failed and Non-failed Businesses

Non-failed Businesses (a) Failed Businesses
Cash flow Total debt

+0.45 +0.35 +0.25 +0.15 +0.05 0.05
(b)
Net income Total assets

+0.1
(c)
Total debt Total assets

0.79 0.72
0.0
0.65 0.58
0.1
0.51 0.44
0.15
0.2
0.37
1
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Average (Mean) Ratios of Failed and Non-failed Businesses (Continued)

Non-failed businesses Failed businesses
(d)
Working capital Total assets

0.42 0.36 0.30 0.24 0.18 0.12 0.06
(e)
Current ratio
3.5
3.0
2.5
2.0
1
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Question 6
(12:00pm)
BEAUTIFUL COMPANY Plc
Profit & Loss Account, Year ended 31 March 2011 (x 1,000)
REVENUE COST OF SALES GROSS PROFIT:
65000 -29000 36000
ADMINISTRATIVE & SELLING EXPENSES OPERATING PROFIT:
-22000 14000
DEBENTURE INTEREST PROFIT BEFORE TAXATION: TAXATION PROFIT FOR EQUITY HOLDER
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-840 13160 -4800 8360
BEAUTIFUL COMPANY Plc Balance Sheets, Year ended 31 March 2011 (x 1,000)
NET CURRENT (FIXED) ASSETS, NET OF DEPRECIATION INVENTORIES & WORK IN PROGRESS TRADE RECEIVABLES CASH CURRENT ASSETS TRADE PAYABLES OTHER CREDIT & ACCRUALS CURRENT LIABLILITIES CURRENT ASSETS less CURRENT LIABILITIES (WORKING CAPITAL) -3000 -9000 -12000 6000 15000 2000 23000
17000
11000
FIIXED ASSETS plus WORKING CAPITAL 6% DEBENTURES TOTAL NET ASSETS
28000 -14000 14000
ISSUED SHARE CAPITAL: 9,000,000 ORDINARY SHARES OF 50p NOMINAL VALUE RETAINED EARNINGS SHARE CAPITAL & RESERVES Note: Share Price of Beautiful Company Plc. = 1100 per share and dividdend per share recommended is 40 pence per share.
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4500 9500 14000
Requirements:
a) Calculate the ratios related to the following situation: Liquidity, Use of working capital, Management performance or profitability, Gearing. b) Assuming a market price of 1100 pennies per share, calculate the appropriate ratios for the investors interest.
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Solution Q6
CR =
CA 23000 = = 1.92 CL 12000
ACID TEST =
CA - INV 23000 - 6000 = = 1.42 CL 12000
AVG INV TURNOVER =
AVG INV 6000 x 365 Days = x 365 = 76 Days COST SALES 29000 AVG RECEIVABLES 15000 AVG DAYS RECEIVABLES = x 365 Days = x 365 = 84 Days SALES REVENUE 65000
AVG DAYS PAYABLES = AVG PAYABLES 3000 x 365 Days = x 365 = 38 Days COST OF SALES 29000
CASH CONV CYCLE = AIT + ADR + ADP = 76 + 84 - 38 = 122 Days
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ROSF = ROCE = OPM =
PROFIT AFTER TAX 8360 x 100 = x 100 = 59.7% SHARE CAPITAL + RESERVES 14000
PROFIT BEFORE INTEREST & TAX 14000 x 100 = x 100 = 45.2% SHARE CAPITAL + RESERVES + NON-CURRENT LIABILITIES 14000 + 17000 PROFIT BEFORE INTEREST & TAX 14000 x 100 = x 100 = 21.5% SALES REVENUE 65000
GPM =
GROSS PROFIT 36000 x 100 = x 100 = 55.4% SALES REVENUE 65000
D/E =
LONG TERM LIABILITIES 14000 x 100 = x 100 = 100.0% (SHARECAPITAL + RESERVES) 4500 + 9500
PROFIT BEFORE INTEREST & TAX 14000 = = 16.7 INTEREST 840
INT COVER =
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PROFIT AFTER TAX 8360 EPS = = = 0.93 NB ORDINARY SHARES 9000
SHARE PRICE 1100 PE Ratio = = = 11.83 EARNINGS PER SHARES 93

DIV COVER = EARNINGS PER SHARE 0.93 = = 2.3 DIVIDEND PER SHARE 0.40
DIVIDEND PER SHARE 36.7 DIV YIELD = = = 0.0364 = 3.64% SHARE PRICE 1100
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PART 6: Cost Volume Profit Analysis
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1. Behaviour of Costs
Costs may be broadly classified as follows:
Fixed
Those that stay fixed (the same) when changes occur to the volume of activity
Variable
Those that vary according to the volume of activity
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Graph of Fixed Costs against the Volume of Activity

Cost ()
Volume of activity (units of output)
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Graph of Rent Cost against the Volume of Activity

Rent cost ()
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Graph of Variable Costs against the Volume of Activity

Cost ()
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Graph of Total Cost against the Volume of Activity

Cost ()
Total Costs
Variable Costs
F
Fixed Costs
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2. Calculating the Breakeven Point

b=
Fixed costs Sales revenue per unit Variable costs per unit
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Break-even Chart
Cost ()
Total sales revenue Break-even Point Total Costs Variable costs
F
Fixed costs
0
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3. ProfitVolume Chart
Profit ()
Break-even Point
Profit
0
Volume of Activity (Units of Output)
Fixed Costs
Loss
Loss ()
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4. Weaknesses of Break-even Analysis

Three general problems
Non-linear Relationships
Stepped Fixed Costs
Multi-product Businesses
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5. Marginal Analysis
When deciding between 2 or more possible courses of action: Only costs that vary with decision should be included in decision analysis. Marginal analysis: We concern only with costs and revenues that vary with decision, i.e. fixed cost is ignored. Applied only to decisions involving minor alterations. Variable cost/unit = Marginal cost (i.e. Cost of producing one more unit)
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Uses of Marginal Analysis

Can be used for the following short-term decisions:

Accepting/Rejecting Special Contracts
The Most Efficient Use of Scarce Resources
Make-or-buy Decisions
Closing or Continuation Decisions

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6. Break-Even Point (BEP)

Definition: At BEP, Total Sales = Total Cost Total Sales Revenue = Fixed Cost + Total Variable Cost If b units of output at BEP: b * Sales Revenue per Unit = FC + (b * VC per Unit)
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7. Margin of Safety
Definition: Extent to which planned volume of output or sales lies above the BEP. MS = Expected Volume of Sales - BEP.
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8. Target Profit
Definition: Total Sales Revenue = FC + Total VC + Target Profit If t the required number of units to output to achieve the target profit: t * Sales revenue per Unit = FC + (t * VC) + TF
t= FC + TF Sales Revenue per Unit - VC per Unit
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Question 7
(04:00pm)
A business makes three () different products, as mentioned below. Fixed cost is not affected by the choice of product as all 3 products use the same machine. Machine time is limited to 148 hours. Required: Which combination of products should be manufactured if the business is to produce the highest profit?
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PRODUCT CODE NAME SELLING PRICE PER UNIT () VARIABLE COST PER UNIT () WEEKLY DEMAND (UNITS) MACHINE TIME PER UNIT (HOURS)
B14 25 10 25 4
B17 20 8 20 3
B22 23 12 30 4
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Solution Q7
PRODUCT CODE NAME SELLING PRICE PER UNIT () VARIABLE COST PER UNIT () CONTRIBUTION PER UNIT () MACHINE TIME PER UNIT (HOURS) CONTRIBUTION PER MACHINE HOUR () ORDER OF PRIORITY B14 25 -10 15 4 3.75 2nd B17 20 -8 12 3 4 1st B22 23 -12 11 4 2.75 3rd
Therefore produce
20 Units of Product B17 using 22 Units of Product B14 using TOTAL:
(20 x 3 Hours) (22 x 4 Hours)
60 Hours 88 Hours 148 Hours
This leaves unsatisfied the market demand for: 1) A further 3 Units of B14, 2) 30 Units of B22.
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6. Questions & Answers

Q&A
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DOMINUS ILLUMINATIO MEA

Thank You !
August 4, 2011 4 August 2011
132

ACF - Week 1 - With Q Solutions - 4aug2011

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Master in Business Administration (M.B.A.

LECTURE 1 Financial Statements

LECTURING RESOURCES & INSTRUCTORS

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance

PART 1: INTRODUCTION TO ACCOUNTING

1. Accounting: Meaning & Functions

2. Main Users of Financial Information

Employees and their representatives

Examples of Uses of Accounting Information

Why Do Managers Need Accounting Information?

MBA Accounting & Corporate Finance

3. Four (4) Characteristics of Good Accounting Information

MBA Accounting & Corporate Finance

4. Accounting as an Information System

Differences between Financial & Management Accounting

The existence of regulations

Range and quality of information

Illustration of these Differences

Why is the Risk & Return Relationship Important?

MBA Accounting & Corporate Finance

PART 2: STATEMENT OF FINANCIAL POSITION

Statement of Financial Position or Balance Sheet

A snapshot in time of the firms financial position:

Balance Sheet Equation

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance

Circulating Nature of Current Assets

Trade receivables (debtors)

Inventory Costing Methods

Last in, First out (LIFO)

Weighted Average Cost (AVCO).

FIFO, LIFO & AVCO treatment of the inventories

FIRST IN, FIRST OUT

(9,000 @ 10 PER TONNE)

(1,000 @ 10 PER TONNE) (20,000 @ 13 PER TONNE)

10,000 26,000 270,000

(11,000 @ 13 PER TONNE) (10,000 @ 10 PER TONNE)

143,000 100,000 243,000

MBA Accounting & Corporate Finance

COST OF SALES CLOSING INVENTORIES

(9,000 @ 12 PER TONNE) (21,000 @ 12 PER TONNE)

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance

Equation for the Standard Layout

Equation for the Non-Standard Layout

Effect of Trading Operations

The balance sheet equation can be extended as follows:

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance

MBA Accounting & Corporate Finance