Analysis & Analysis & InterpretatioInterpretatio

nnAccounting - Unit 4Accounting - Unit 4

Why is it necessary to Why is it necessary to evaluate performance?evaluate performance?

Is the business doing well?Is the business doing well? Is the business achieving its Is the business achieving its

goals/targets?goals/targets? Is there adequate cash flow?Is there adequate cash flow? Is the business growing?Is the business growing? What opportunities exist?What opportunities exist? How can the business improve?How can the business improve? Should you stay in business?Should you stay in business?

The difference between The difference between analysis and analysis and interpretation . . .interpretation . . . AnalysisAnalysis is the process of is the process of

breaking down something breaking down something complex into to simpler, complex into to simpler, smaller parts.smaller parts.

InterpretationInterpretation is then the is then the process of explaining the process of explaining the meaning of the analysismeaning of the analysis

How will you be How will you be assessed?assessed? 20% of your internal assessment for unit 420% of your internal assessment for unit 4 Also tends to feature heavily in the Nov ExamAlso tends to feature heavily in the Nov Exam Relevance of changes mentioned and Relevance of changes mentioned and

explanation of possible reasons for the changesexplanation of possible reasons for the changes Details of changes – You must state the Details of changes – You must state the

direction, magnitude and effect of any change direction, magnitude and effect of any change mentioned.mentioned.

Explanation of relationships between changes Explanation of relationships between changes mentionedmentioned

And the relevance of the advice that you And the relevance of the advice that you give the business ownergive the business owner

ProfitabilityProfitability

The ability of the business to The ability of the business to make a profit. Factors that must make a profit. Factors that must be covered include any be covered include any significant changes in Revenues, significant changes in Revenues, COS, Gross Profit, Functional COS, Gross Profit, Functional Expense groups, Net Profit/Loss Expense groups, Net Profit/Loss and the Profitability Ratios.and the Profitability Ratios.

EfficiencyEfficiency

The ability of a business to use its The ability of a business to use its resources to earn revenue with resources to earn revenue with little waste. This includes the little waste. This includes the volume of assets compared to the volume of assets compared to the revenue earning capacity of the revenue earning capacity of the business. It also covered all business. It also covered all turnover ratios, such as, Debtors turnover ratios, such as, Debtors Turnover, Stock Turnover, etc.Turnover, Stock Turnover, etc.

LiquidityLiquidity The ability of a business to meet its The ability of a business to meet its

day to day debts as they fall due. day to day debts as they fall due. Consideration of the Cash Flow Consideration of the Cash Flow Statement is essential.Statement is essential.

What cash came into the business What cash came into the business during the two years and where did it during the two years and where did it go? go?

Other factors that must be Other factors that must be considered include the Debtors considered include the Debtors Turnover, Creditors Turnover, Stock Turnover, Creditors Turnover, Stock Turnover and the Cash Cycle. Turnover and the Cash Cycle.

Working Capital and Quick Assets Working Capital and Quick Assets must also be assessed.must also be assessed.

Horizontal AnalysisHorizontal Analysis

Compare the data from one Compare the data from one year to the next. year to the next.

Eg. In 2003 they spent $4,000 Eg. In 2003 they spent $4,000 on advertising and in 2004 they on advertising and in 2004 they spent $6,000, an increase of spent $6,000, an increase of 50% due to . . . . 50% due to . . . .

Vertical AnalysisVertical Analysis Compare the percentage of Compare the percentage of

revenue/assets used. Eg. In 2003 10 cents revenue/assets used. Eg. In 2003 10 cents in every dollar of revenue was spent on in every dollar of revenue was spent on advertising and this increased to 12 cents advertising and this increased to 12 cents in 2004. in 2004.

For vertical analysis of the Performance – For vertical analysis of the Performance – Total Revenue is assumed to be 100%Total Revenue is assumed to be 100%

For vertical analysis of the Position – Total For vertical analysis of the Position – Total Assets/Equities is assumed to be 100%Assets/Equities is assumed to be 100%

There is no vertical analysis of There is no vertical analysis of

the Cash Flow Statementthe Cash Flow Statement

An Example . . .An Example . . .2002 2003

Credit Sales 54.0% 69.0%

Cash Sales 46.0% 31.0%

TOTAL SALES 100.0% 100.0%

less Cost of Sales 46.6% 53.1%

GROSS PROFIT 53.4% 46.9%

Selling Expenses 29.9% 25.9%

Occupancy Expenses 6.4% 6.2%

Office Expenses 4.0% 7.8%

Finance Expenses 3.6% 4.0%

Net Profit 8.8% 2.1%

Visuals can be helpfulVisuals can be helpfulWhere did the revenue go? (2002)

less Cost of Sales

Selling Expenses

Occupancy Expenses

Office Expenses

Finance Expenses

Net Profit

Where did the revenue go? 2003

less Cost of Sales

Selling Expenses

Occupancy Expenses

Office Expenses

Finance Expenses

Net Profit

Profitability RatiosProfitability Ratios Return on Owners InvestmentReturn on Owners Investment Return on AssetsReturn on Assets Asset TurnoverAsset Turnover Net profit RatioNet profit Ratio Gross Profit Ratio/ Adjusted Gross Profit Ratio/ Adjusted

Gross Profit RatioGross Profit Ratio

Efficiency RatiosEfficiency Ratios

Debtors TurnoverDebtors TurnoverCreditors TurnoverCreditors TurnoverStock TurnoverStock TurnoverCash CycleCash Cycle Interest Coverage Interest Coverage

RatioRatio

Liquidity RatiosLiquidity Ratios

Working CapitalWorking Capital Quick Assets RatioQuick Assets Ratio Cash Flow from OperationsCash Flow from Operations

Making ComparisonsMaking Comparisons

Industry AveragesIndustry Averages Industry TrendsIndustry Trends Similar BusinessesSimilar Businesses The Businesses ObjectivesThe Businesses Objectives

Limitations of Ratio Limitations of Ratio AnalysisAnalysis

Ratios are based on historical Ratios are based on historical datadata

Historical Cost AccountingHistorical Cost Accounting Changes in accounting methodsChanges in accounting methods Inter-firm comparisonsInter-firm comparisons Frequency of reportingFrequency of reporting Limited InformationLimited Information

Non Financial IndicatorsNon Financial Indicators

Customer Satisfaction Customer Satisfaction SurveysSurveys

Quality AssuranceQuality Assurance Quality of ManagementQuality of Management Profit compared to hours Profit compared to hours

workedworked Economic ClimateEconomic Climate

The importance of The importance of GoalsGoals

What are the goals of the business?What are the goals of the business? Has the business achieved it’s Has the business achieved it’s

goals?goals? Are the goals appropriate?Are the goals appropriate? Would you have different goals?Would you have different goals?

If so, Why?If so, Why?

Giving AdviceGiving Advice

Make sure you consider the Make sure you consider the business typebusiness type

Focus on the areas where Focus on the areas where problems have been highlightedproblems have been highlighted

Consider the goals of the Consider the goals of the businessbusiness

Consider the additional Consider the additional informationinformation

Advice BasicsAdvice Basics

ProfitabilityProfitability increase revenue, decrease increase revenue, decrease

expenses expenses

EfficiencyEfficiency improve cash cycleimprove cash cycle

LiquidityLiquidity increase cash receipts, decrease increase cash receipts, decrease

cash paymentscash payments

Where to from here?Where to from here?

Complete the followingComplete the following Horizontal AnalysisHorizontal Analysis Vertical AnalysisVertical Analysis Calculate your RatiosCalculate your Ratios Consider the preamble & additional Consider the preamble & additional

informationinformation Make a list of key pointsMake a list of key points Make a list of potential advice for Make a list of potential advice for

each area of analysiseach area of analysis