AUTONOMOUS GROUP LEARNING (AGL)

AGL NO. 1 FINANCE FOR NON - FINANCIAL MANAGERS

DAILY WORK PACK - PART I
Copyright: RGAB/IR 2010/2

S2 ABBREVIATIONS
IND

- INDIVIDUAL SG - S MALL GROUP CSG COMBINED SMALL GROUP MG MAIN GROUP ASS - ACCOUNTING STEP BY STEP PL - PROGRAM LEARNING L - LECTURE D DISCUSSION LRT LEARNING RECALL TAPE CAI COMPUTER ASSISTED INSTRUCTION

S3 ASSIGNMENT 1.0 - INTRODUCTION (30 minutes)

1.1

SPECIFIC OBJECTIVES

The program provides members with the opportunity to understand financial terms, techniques and reports so that they can become better managers. Learning objectives:

a. Understand accounting language and concepts. b. Interpret balance sheets and income statements. c. Use basic financial ratios. d. Develop confidence in using accounting and financial data . e. Motivate further study in the future.

S4 1.1 SPECIFIC OBJECTIVES (continued)

The syllabus of the program includes: accounting terminology, concepts, and reports liquidity & profitability evaluating business potential of new ventures and projects activity analysis & operating statements reserves and equity financial forecasting & budgeting LAPP system of financial analysis.

S5 1.2 AUTOMATED GROUP LEARNING (AGL)

The AGL method is designed to achieve rapid individual learning using special materials and the stimulus of group activity without a formal instructor. The groups use the materials to find the answers to all problems and questions.

S6 1.3 GROUP ARRANGEMENTS

The work will be done: INDSG Individually, or Small Groups which will change daily, or

CSG - Combined Small Groups (two small groups together), MG Main Group (for short taped lectures on key learning points with visual aids).

S7 1.4 SG - SMALL GROUPS

Group names provided on the flip charts. Please note the name of your SG and names of the other members.

S8 1.5 LEARNING MATERIALS

(a) Retained by members Textbook (ASS) Notebook - for recording every key point Daily Course Diary Learning Recall Tape Articles (2) (b) Used by not retained by members: Daily work packs including: introduction, lectures, cases, exercises and key learning points

S9 1.5 LEARNING MATERIALS (continued)

Use your notebook. Do not mark the Daily Workpack which must be handed back at the end of each day. You receive all the materials in your SG. Don't look ahead in the workpack until you are specifically asked to do so!

S10

1.6 METHOD

Try to complete every task in the time allowed. A pattern of learning methods will be used including:

Programmed learning
Case analysis Lectures Quizzes Learning patterns Homework reading Learning Recall Tape (LRT) CAI

S11

1.7 LEARNING PATTERNS - REVIEW

1. Objectives
Language

Ratios Forecasting Income Statements

Concepts Balance Sheets Financial Health

CONFIDENCE

S12

1.7 LEARNING PATTERNS - REVIEW

2. Learning

continuous activity ....

IND

SG

CSG

MG

S13 1.7 LEARNING PATTERNS - REVIEW 3. Methods

Program Learning Lectures Small Groups Combined Small Group

Cases & Exercixes LRT CAI

Main Group

LEARNING FOR YOU

S14

1.8 INSTRUCTIONS (15 minutes)

Assemble in SG's to introduce yourself, indicate your past experience in finance and what you hope to contribute to and gain from the course. Complete the registration sheet in the Daily Course Diary. NOTE: Please check that you have a full set of learning materials now.

S15 ASSIGNMENT 2.0 - QUIZ (45 minutes)

2.1 INSTRUCTIONS SMALL GROUP WORK Assemble in SG Answer the quiz of 100 questions; mark your answers a, b, c, or d with a clear "x" on the special form provided in the course diary Work as quickly as possible but don't guess leave blanks. Hand in your answer sheet to the Organizer Reassemble in MG when the bell rings

S 16 ASSIGNMENT 3.0 - PROGRAMME LEARNING (60 minutes)

Assemble in SG Read ASS pages 9 and 10 programme" "How to use the

Read ASS Ch. 1. Do ASS Ch. 2 in writing and aloud Record significant points in your notebook Reassemble in MG when the bell rings A

S17 3. 1 INSTRUCTIONS - INDIVIDUAL WORK (continued)

Work very quickly. Write the answers in the ASS book; check out one question at a time. Don't hesitate to "cheat" when you don't know the answer In finance a little "cheating" can be very educational ...

S18 ASSIGNMENT 4.0 - LECTURE ON ACCOUNTING REPORTS

4.1 METHOD Read aloud, listen and respond verbally to any questions.

S19 4.2 ACCOUNTING REPORTS

(a) Income Statement (IS) Profit and Loss Account or Operating Statement Accounting period is one year Sales less cost of goods actually sold = gross profit Gross profit less expenses = net profit Ratios are thermometers Gross profit over sales = gross profit percentage Net profit over sales = net profit percentage

S20 4.2 ACCOUNTING REPORTS (continued)

(b) Balance Sheet (BS) Situation at the beginning of accounting period Situation at end of accounting period Assets of a business are financed by liabilities and owners' equity

S21 ASSETS AND LIABILITIES

4.3 ASSETS (A) Things owned by a business which have measurable cost: cash, accounts receivable (debtors), inventories (stock), prepayments, equipment, buildings, land, etc. 4.4 LIABILITIES (L) Amounts due to be paid (cash must be paid to "them"): accounts payable, trade creditors, other liabilities, taxation payable, long term liabilities

S22 4.5 OWNERS' EQUITY

Rights of the owners of a business Initial capital plus profits Assets less liabilities = owners' equity Assets less liabilities = owners' equity Profits increase owners' equity Losses reduce owners' equity

S23 4.6 EQUITY:DEBT (LIABILITIES) (E:D)

This means equity as distinct from liabilities

Ratio of assets financed from owners equity and liabilities This is the gearing of the company which is critical to financial health..

S24 4.7 TRANSACTIONS

Each transaction has a dual effect Assets increase and cash decreases, or Assets increase and liabilities increase, or Cash decreases and liabilities decrease

S25 4.8

LEARNING PATTERNS - REVIEW

CASH
INVENTORY ORDERS

1. Key Issues

S26 4.8

LEARNING PATTERNS - REVIEW

2. Income Statements
C+E + P=S C +E +P=S C +E +P=S

S27 4.8

LEARNING PATTERNS - REVIEW

3. Balance Sheets
A OE L = L + OE = A - L = A - OE

S28 4.8

LEARNING PATTERNS - REVIEW

4. Transactions
CASH 0 A + L+

CASH

A 0

L -

S29 4.9

INSTRUCTIONS (10 minutes)9

Reassemble in SG Study the lecture very carefully and record key points in your notebook Discuss any outstanding questions in SG When the bell rings carry on with the case study which follows

S30 ASSIGNMENT 6.0 LECTURE - JOHN MARAIS

6.1 STORY OF THE CASE John Marais has been in business for 6 months producing a toy. He reckons he made a profit of 10,000 and has drawn 50,000 from the business. He thinks he has done rather well, so let's now review the accounts.

S31 6.1 STORY OF THE CASE (continued)

First the Income Statement: Sales 40,000, cost 20,000 to manufacture, giving a gross profit of 20,000. From the gross profit the expenses of 10,000 are deducted to give a net profit of 10,000. In the Balance Sheet: assets of the business were cash, accounts receivable and inventory totalling 61,900. These were financed partly by liabilities 36,900 and partly by owners equity 25,000. Most of the money for the business was provided by S.O. Marais. Most of the money has been taken out by John Marais.

S32 6.2
Gross profit/sales 20,000/40,000 50%

RATIOS
x 100% x 100%

Net profit/sales 10,000/40,000 25% Net profit/owners equity 10,000/25,000 80% p.a. 40%)

x 100% x 100%

x 100% x 100%

= (twice

S33 6.2 RATIOS (continued)

Current Assets: Current Liabilities

61,900 : 16,900 = 4:1

(2:1)

Quick Assets: Quick Liabilities

1,900 : 16,900 = 1:9

(1 1/2:1)

Equity: Debt (Liabilities)

25,000 : 36,900 = 1:1-1/2

(2:1)

S34 6.3 FINANCIAL HEALTH

(a)

Liquidity - current assets to current liabilities are strong but quick assets to quick liabilities are weak, indicating a cash shortage = Critical Point. Equity : Debt - less than 1:1 means that there is not enough equity in the business = Critical Point. Drawings of 50,000 in this early stage of the business have led to a cash shortage = Critical Point.

S35 6.3 FINANCIAL HEALTH (continued)

(b) Activity - sales of 40,000 cost only 20,000 against a remaining inventory of 60,000. Thus for one toy sold we have three unsold in inventory. Production and marketing must be balanced = Critical Point.

S36 6.3 FINANCIAL HEALTH (continued)

(c) Profitability - good, but profit depends upon the value of the inventory which includes 50,000 of wages. If the inventory valued at market price is lower than cost (Christmas market has disappeared) then the inventory value must come down. Reduction in inventory value reduces the profit. Thus a reduction from 60,000 to 50,000 in inventory would mean no profit this year at all! = Critical Point. (d) Potential - Christmas is over; there is only one product; the garage is full of unsold toys; the cash is short; payments to creditors are overdue; management is doubtful = Critical Point.

S37 6.4 ACHIEVEMENTS AND PROBLEMS

John Marais has started the business and if the inventory can be sold at least for cost, he has made a small profit. He has drawn a large salary which is only earned if the inventory can be sold. The Christmas trade is over and he may make no sales for the next few months. He needs cash to pay his creditors. His inventory is too high and he may never sell it. He is not managing his finances well and may be bankrupt if the creditors press for payment.

S38 6.5 PLAN OF ACTION

Get cash to pay the creditors Stop production and sell off the inventory. Consider whether the business is viable or product range too narrow to be worthwhile Cut the salary to nothing. Look for partner with some money Go out and sell (or go to work for someone else).

S39 6.6 LEARNING POINTS (continued)

(a)

Cash is more important than profit in running

a business, because without cash the manager can do nothing.

(b)

Ratios are useful in assessing the health of a

business as follows: Liquidity & Gearing, Activity, Profitability and Potential.

(c)

It is not correct to charge all the wages to

S39 6.6 LEARNING POINTS (continued)

(d) The inventory is valued at the lower cost or market value (e) Inventory valuation is the key to profit (f) High drawings by the owner are bad for an expanding business. (g) Look for the story behind the figures. Learn the language of accounting quickly. (h) All financial statements are estimates based upon assumptions. They are not scientific facts.

S40 6.7 LEARNING PATTERNS - REVIEW 1. Key Issues

CASH

INVENTORY ORDERS

S41 6.7 LEARNING PATTERNS REVIEW 2. Income Statements

C E P=S C E P=S C E P=S

S42 6.7 LEARNING PATTERNS REVIEW 3. Balance Sheets

A OE L = L + OE = A - L = A - OE

S43 6.8 INSTRUCTIONS (10 minutes)

Re-assemble in CSG Study carefully the lecture on the case Record key learning points in your notebook Discuss outstanding questions When the bell rings it is time for lunch

S44 ASSIGNMENT 7.0 - PROGRAM LEARNING (75 minutes)

7.1 INSTRUCTIONS Reassemble in new SG. Do ASS Ch. 3 in writing Review the glossary for any difficulties with new words Record significant points in your notebook Reassemble in MG when the bell rings

S45
8.1

ASSIGNMENT 8.0 - LECTURE ON BALANCE SHEETS

ASSETS

Valuable things owned by a business. Fixed assets are for long term use in a business; valued at cost less depreciation, not market value. Current assets are cash or near cash within one year; valued at cost or lower realisable (market) value Other assets are special assets valued at cost or lower; examples: patents, trade investments, goodwill, etc.

S46

8.2 LIABILITIES

Amounts due to be paid by the business to someone else. Accounts payable (creditors) are liabilities. Current liabilities are due for payment within one year. Long term liabilities are due for payment in more than one year. Bank loans and overdrafts. Liabilities are normally unsecured but may have special security on particular assets.

S47 8.3 OWNERS' EQUITY

Assets are financed by either liabilities or owners' equity. Owners' equity is the capital issued to shareholders (stockholders), in exchange for cash, plus reserves accumulated in the business. Reserves include capital reserves (share premium) or revenue reserves (retained earnings) or accumulated profits. Assets Assets Assets less liabilities = owners' equity = liabilities plus owners' equity less owners' equity = liabilities

S48 8.4 RATIOS

Ratios are like a thermometer which takes the actual temperature of a business in relation to some standard scale.
Good Average Poor

(a) Liquidity CA : CL QA : QL E:D 1:2 (b) Profitability GP/S NP/S NP/OE p.a

2:1 1.5:1

1:1 1:1 2:1

1:2 1:2 1:1

Up Same Down Up Same Down Up Same Down

S49 8.5 LEARNING PATTERNS - REVIEW 1. Asset Structure

FA CA OA FA CA OA FA CA OA

S50 8.5 LEARNING PATTERNS - REVIEW 2. Receivables & Payables

R receives the cash ,...

pays the cash ...

S51 8.5 LEARNING PATTERNS - REVIEW 3. Funding Structure

CL LTL TL OE CL LTL TL OE CL LTL TL OE

S52 8.6 INSTRUCTIONS (10 minutes)

Reassemble in SG Study the lecture carefully Discuss outstanding questions Record key points in your notebook When the bell rings, carry on with the case study which follows

S53 ASSIGNMENT 10.0 - LECTURE ON CAPE ELECTRONICS COMPANY

10.1 STORY OF THE CASE Two engineers had an idea for a new product and while fully employed elsewhere, they produced and sold a few units to their employers. They advertised and sold a few more units. They worked part-time in a garage and made a profit (if we ignore: labor, equipment, depreciation of patents, overhead, etc.). Should they now work in this new business full-time?

S54 10.2 RATIOS - COMPARED WITH A GOOD STANDARD

(a) Liquidity: QA : QL 10,380 : 9,870 CA : CL 45,880 : 9,870 E:D 64,800 : 59,870 (b) Activity: Sales/Assets p.a. 93,750 /124,670 (twice) Cost of G. S./Inventory 48,620/ 35,490 (twice) Actual Good Ratio Standard 1:1 1 1/2 : 1 5:1 2:1 1:1 2:1

1+ 2+

1+ 2+

S55 10.2 RATIOS - COMPARED WITH A GOOD STANDARD (continued)

(c) Profitability: Standard
Gross Profit/Sales X 100% 45,120/93,750 30% Net Profit/Sales X 100% 24,800/93,750 5% Net Profit /Owners Equity (p.a.)

Actual

48%

27%

S56 10.3 COMPUTATION OF NEW PROFIT FIGURE

The profit has been incorrectly calculated because there are no charges for: labor, equipment and patent depreciation and overhead. A better calculation is as follows: Profit per accounts for six months 24,800 Less: Labor 520 hours at 30 per hour Equipment depreciation (10 yr. life) Patent depreciation (4 yr. life) Overhead, estimate 24,280

15,600 1.430 6,250 1,000

S57 10.4

DEPRECIATION

Distinguish between the patent as an asset owned by Cape Electronics and the liability to pay for it (at some later date). Depreciate the asset in order to charge expense with the cost as the asset is used up, over the "working life". The "working life" of the patent does not depend upon the law or the time of payment. The "working life" depends upon the electronics industry. Such patent is probably not useful after 4 years. Use the term horizon.

S58 10.5 COMMENTS ON THE HEALTH OF THE COMPANY

Liquidity - the current ratio is reasonable, but the quick ratio indicates a shortage of cash to pay creditors Activity - fairly active, but the advertising of 14,630 has only produced 5 more sales. Profitability - the profit is nil after adjustment, except as a part-time hobby. Potential - product limited; market limited; physical facilities in a garage are not adequate for full scale production; management may not be adequate.

S59 10.6 ACHIEVEMENTS AND PROBLEMS

Operated for six months and made a small return for their time. Market for this product may be small and not last very long. Additional factory facilities and labor are required to produce in quantity. Assume the new overheads for full scale operations 120,000 per year, cost of direct labor/material 1,750 per unit (cheaper when we buy in quantity). Calculation shows they must produce and sell over 120 units to cover salaries of 128,000 each per annum plus the new overheads.

S60 10.6 ACHIEVEMENTS AND PROBLEMS (continued)

Selling price per unit Direct labor & material 1,750 per unit Contribution per unit 3,750

2,000

Fixed cost: 240,000 (salaries 128,000 + overheads 112,000) Fixed cost/contribution per unit = 240,000/2,000 = 120 units Is it possible to produce and sell so many units? Would the low equity base, support the working

S61 10.7 PLAN OF ACTION

Market research to determine the potential of the product. Cash to pay the creditors. More equity to finance a bigger operation if justified. Otherwise keep it as a hobby or sell out.

S62 10.8

LEARNING POINTS

a) Accounting depends upon assumptions; figures are only estimates. b) Income Statement is not valid unless all costs have been charged including: labor, depreciation, overhead, etc. c) Depreciation is based on the working life (horizon) of a fixed asset, not the time of payment. Depreciation of a patent is difficult because the working life is uncertain. Four years seems reasonable.

S63 10.8

LEARNING POINTS (continued)

d) Bigger production requires a proper factory and new overheads of about 112,000 per annum or more, and a larger "equity base". e) Cash is more important than profit. f) Sales orders are vital to the health of a business. They are not, however, recorded on the balance sheet. What a difference to financial health, if they had orders for 1000 units, g) Balance Sheet and Income Statement may be analysed under the LAPP system.

S64 10.8

LEARNING POINTS (continued)

h) Management competence may be judged from the financial story. i) Don't work in small figures (peanuts) not justified by the underlying assumptions. Financial statements should be in whole numbers using thousands, not dollars and cents since accounting is not that accurate e.g. 1,496,293 becomes 1,496,000 or better still 1,496 (thousands). j) For better communication in financial reports, keep the number of "digits" reported to a meaningful minimum.

S65 10.9

LEARNING PATTERNS - REVIEW 1. Estimates

Coconuts ... Big figures ...

S66 10.9 LEARNING PATTERNS - REVIEW 2. Horizon for Depreciation

Legal life Payment life Technical life Economic life

S67 10.9
Cash now ...

LEARNING PATTERNS - REVIEW 3. Cash is the Key

Profit later Profit later Profit later ... Profit later ...

S68 10.9

LEARNING PATTERNS - REVIEW 4. Inventory Valuation

Cost Realisable Market value Replacement Market value Sales orders?

S69 10.10 INSTRUCTIONS (10 minutes)

Re-assemble in CSG Study carefully the lecture on the case Record key learning points in your notebook Discuss outstanding questions Reassemble in MG when the bell rings

S70 ASSIGNMENT 11.0 - SUMMARY LECTURE FOR PART 1

11.1 OBJECTIVES
Understand accounting language and concepts Interpret balance sheets and profit and loss accounts Use basic financial ratios Develop confidence in using accounting and financial data Motivate further study in the future

S71 11.2

ACCOUNTING LANGUAGE

Glossary of ASS is a continuous reference Two hundred words (only) is the vocabulary USA/European accounting languages may be compared

S72 11.2

ACCOUNTING LANGUAGE (continued)

USA/European accounting languages may be compared:

receivables payables inventory capital stock capital surplus earned surplus ) retained savings ) earnings statement ) operating statement ) income statement ) debtors creditors stock share capital capital reserve accumulated profit revenue reserve profit and loss account

Records of transactions are converted into accounting reports by using practical accounting concepts:
cost (assets generally at cost) consistency/conservatism/comparability accounting period going concern (not break-up values) entity (the business not its workers) profit realisation accrual (cash and credit transactions included) true and fair (as possible) MATERIALITY (most important of all!)

S74 11.4

ACCOUNTING PERIOD

Try to associate all sales costs, expenses and profits with a specific accounting period. All accounting figures are estimates not scientific facts.

S75 11.5

PROFIT AND LOSS ACCOUNT

Sales less cost of goods sold equals gross profit. Gross profit less selling and administrative expenses equals net profit for the accounting period. Profit depends upon: charging all the proper costs and stock valuation.

S76 11.6

BALANCE SHEET

Assets of the business: how they are financed from liabilities and owners equity. Fixed assets valued at cost less depreciation (based on the horizon of the asset). Fixed assets such as land and building may have to be revalued periodically. Accounting periods create uncertainty and doubt. Current assets (one year only) valued at cost or lower realisable (market) value. Inventory valued at the lower cost or market value.

S77 11.7
LAPP System
Liquidity Activity activity

HEALTH OF THE BUSINESS

- cash and gearing are more important than profit. - turning over the assets and the stock ; more requires more assets!

Profitability owners equity. Potential management,

gross and net profit related to sales and

depends upon: market, product ,finance, sales orders, contingent liabilities etc.

S78 11.8

BASIC FINANCIAL RATIOS (continued)

Good Average Poor 1:1 1:1 1:1

a) Liquidity:

CA : CL 1:2 QA : QL 1:2 E : D 1:2

b) Activity:

2:1 1+: 1 2:1

Sales/ Assets Down CGS/Stock

Up Up

Same Same Down

S79 11.8

BASIC FINANCIAL RATIOS (continued)

Good Average

Poor
c) Profitability:

Gross Profit/Sales Down Net Profit/Sales Down Net Profit/Owners Equity Down

Up Same

Up

Same

Up

Same

S80 11.9

MATERIALITY

Look for the big figures which are significant. Compare them with the past, the future and the industry averages to determine the significance of changes. Look for "CHANGE" and ask the reasons why.

S81 11.10 LEARNING PATTERNS - REVIEW 1. BS & IS

Yr. 1 IS S C P BS BS Yr. 2 IS S C P BS Yr. 3 IS S C P BS Yr. 4 Yr. 5 IS IS S C P BS S C P BS

S82 11.10 LEARNING PATTERNS - REVIEW Accounting Concepts

Conservatism Comparability Profit realisation Consistency Cost Accounting period Materiality IAS Entity

S83 11.10
A-L A - OE OE + L S-C-E

LEARNING PATTERNS - REVIEW 3. Financial Formulae

= OE = L = A = P

S84 11.10 LEARNING PATTERNS - REVIEW 4. More Financial Formulae

CA:CL QA: QL E: D S/A CGS/I GP/S NP/S NP/OE

S85 11.10

LEARNING PATTERNS - REVIEW 4. Materiality

Peanuts ...................................................... and coconuts ...

S86 11.11 INSTRUCTIONS (20 minutes)

Reassemble in SG Review the Summary Lecture for Part I in the course diary and discuss questions arising To get the best out of Part II of the program, try to complete ALL of the following ... homework tonight ...

S87 11.11 INSTRUCTIONS (continued) ... very useful ... homework ... tonight ...
Read the articles on the accounting In the ASS text, review the chapter summaries and the glossary Do the optional exercises in the course diary and check the answers Review the summary lecture for Part I in the course diary Review your notes for Part I of the course and list outstanding questions to be resolved in Part II

S88 11.11 INSTRUCTIONS (continued) Final Note for Part I ...

Thank you for working so hard today .... Tomorrow .... its downhill all the way

S101 AUTOMATED GROUP LEARNING (AGL)

AGL NO. 1 FINANCE FOR NON-FINANCIAL MANAGERS

DAILY WORK PACK - PART II

Copyright: RGAB/IR 2010/2

S102
IND SG CSG MG ASS PL L D LRT CAI -

ABBREVIATIONS

INDIVIDUAL S MALL GROUP COMBINED SMALL GROUP MAIN GROUP ACCOUNTING STEP BY STEP PROGRAM LEARNING LECTURE DISCUSSION LEARNING RECALL TAPE COMPUTER ASSISTED INSTRUCTION

S103
1.1

ASSIGNMENT 1.0 REVIEW AND SHORT QUIZ (45 minutes)

INSTRUCTIONS

Assemble in new SG. Discuss outstanding questions from Part I Do the short quiz which follows. Work on each question individually and then compare answers in SG When all answers have been completed, check with the correct solution and discuss points arising Reassemble in MG when the bell rings

S104

ASSIGNMENT 2.0 PROGRAM LEARNING (75 minutes)

2.1

INSTRUCTIONS

Reassemble in SG. Review the summaries of ASS Ch. 1, 2, and 3 Do Ch. 4 in writing Record key points in your notebook Reassemble in MG when the bell rings

S105 ASSIGNMENT 3.0 - LECTURE INCOME STATEMENTS (30 minutes

3.1 ACCOUNTING PERIOD CONCEPT Income statement (profit and loss account, earnings statement for the accounting period. Balance sheet at the start and end of the accounting period. Normally one year. 3.2 ACCRUAL CONCEPT Sales, cost and expenses may be for cash or credit. Income statement includes both cash and credit transactions.

S106 3.3 INCOME STATEMENTS AND BALANCE SHEETS

Income statement shows how the profit was made. Balance sheet shows assets and how they are financed.

S107 3.4 SALES AND GROSS PROFIT

A measure of activity is: Sales/assets Cost of goods sold means cost of sales. "Trading Account" is part of income statement which indicates: sales less cost of sales = gross profit. Cost of sales for a trading company (buying and selling finished goods) is: opening inventory plus purchases of finished goods less closing inventory.

S108 3.4 SALES AND GROSS PROFIT (continued)

Cost of sales for a manufacturing company is different because it does not purchase finished goods. Finished goods are manufactured from factory labor, raw materials and manufacturing overhead. Manufacturing cost of finished goods must be adjusted for work in process changes.

S109 3.4 SALES AND GROSS PROFIT (continued)

For a manufacturer, therefore: factory labor + factory materials used + factory overhead ... plus or minus ... work in process changes = ... cost of finished goods manufactured for the period. This is the same as the "purchase of finished goods" by a trading company. Work in process is inventory unfinished. As the amount at the beginning and end of the accounting period changes, this difference must be added or deducted to manufacturing cost incurred, in order to compute cost of finished goods manufactured.

S110 3.5 NET PROFIT

Net income, net earnings, net profit. Expenses divided into: (a) normal operating expenses, and (b) special non-operating expenses Operating expenses (including selling, general and administrative) are normal costs not connected with manufacturing.

S111 3.5 NET PROFIT (continued)

Non-operating expenses are abnormal costs not connected with normal operations (e.g., loss of sales of assets, interest paid). There may be non-operating income too! (e.g., profit on sales of assets, dividends received, etc.) Gross profit less operating expneses = operating profit. Operating profit less non-operating expenses = profit before taxes. Profit before taxes less income tax = net profit.

S112 3.6 RATIOS

Profitability: Gross Profit/Sales Net Profit/Sales Net Profit/Owners Equity x 100% x 100% x 100% (p.a.)

S113 3.6 RATIOS (continued)

Activity: Sales /Assets = measure of "turnover" of assets (p.a.) Cost of Goods Sold/Inventory = measure of "turnover" of inventory (p.a.)

S114 3.7 ACCUMULATED PROFIT

Retained earnings, revenue reserves. Part of the Reserves in the Owners Equity part of the Balance Sheet. Appropriation Account or Statement of Retained Earnings. Balance brought forward + net profit less dividends = balance carried forward. Profit increases owners equity. Reserves increase the equity of the business but not necessarily the cash; cash may have been used to buy more assets or pay creditors.

S115 3.8
Buy now Pay later

LEARNING PATTERNS - REVIEW 1. Credit Transactions

A + L+ A- L-

S116 3.8 LEARNING PATTERNS - REVIEW 2. Cost of Goods Sold - Trading Inventory + Purchases - Closing Inventory = Cost of goods sold

S117 3.8 LEARNING PATTERNS - REVIEW 3. Cost of Goods Sold - Manufacturing RM + Labour + Manufacturing Overhead - Work in Process Changes = Cost of Finished Goods "purchased" from the factory

S118 3.8 LEARNING PATTERNS - REVIEW 4. Charges

Type - material, labour, overhead Function - production, sales, administration

S119 3.9 INSTRUCTIONS (10 minutes)

Reassemble in SG Study the lecture carefully and record key points in your note book Discuss outstanding questions When the bell rings continue with the case study which follows

S120 ASSIGNMENT 5.0 - LECTURE ON TOM LYSTER (30 minutes)

5.1 STORY OF THE CASE Tom Lyster compares this year's performance with that of last year, before preparing a budget for next year, using specific assumptions. All figures in 000 (thousands) - coconuts ....

S121 5.2 EVALUATION OF THIS YEAR COMPARED WITH LAST YEAR

Sales substantially down (5,000 - 3,240), but gross profit only slightly down (1,250 - 1,134) due to improved gross profit percentage (25% - 35%). Gross profit percentage improved due to lower direct labor cost and percentage. Operating profit unchanged (650 - 648) due to substantial cut in general and administrative expenses. Non-operating income down due to lower dividend received (450 - 200)

S122 5.2 EVALUATION OF THIS YEAR COMPARED WITH LAST YEAR (continued)
Net profit lower than prior year (450 - 324) due to: lower sales, lower dividend received, despite improved gross profit percentage, and cuts in general and administrative expenses. Causes of all these significant differences should be investigated. Company failed to make adequate sales but did well to improve efficiency; however, falling dividends received reduced the overall profitability.

S123 5.3 OPERATIONS - BUDGET AND ACTUAL

Budget % Net Sales 4,000 100 Less cost of goods sold: Direct labor Materials 15 Depreciation Manufacturing overhead 18 Actual 000 3,240 % 100 000

810 25 486 15 130 680 4 21 65

960 24 600 106 748 2,414 3

2,106

S124 5.3 OPERATIONS (continued)

Budget % Gross Profit 1,586 40 Operating expense: Selling 392 10 General & administrative 240 6 632 16 Operating Profit 24 Non-operating income & expense: Dividends received 400 10 Interest paid Actual 1,134 35 %

292 194 486 648 20 6 15

954

200 (200)

7 (7)

S125 5.4 COMMENTARY - BUDGET COMPARED TO ACTUAL

Sales increase (3,240 - 4,000) Gross profit percentage increase (35% - 40%) Operating profit increase Non-operating income increased substantially (200 400) yet interest paid reduced by half (200 - 100) Net profit increase by amount (324 - 629) and percentage (10% - 15%) due to sales, gross profit percentage, and dividends received.

S126 5.4 COMMENTARY - BUDGET COMPARED TO ACTUAL

Ratios: BUDGET Gross Profit/Sales 1,586/4000 ACTUAL 1,134/3240 = 35% Net Profit/Sales 629/4000 324/3240 = 10% = 15% = 40%

S127 5.5 LEARNING POINTS

(a) Sales less cost of goods sold = gross profit less operating expense = operating profit. (b) Operating expense = selling, general and administrative (c) Operating profit less non-operating income and expense = profit before tax. (d) Non-operating income may be: dividends received or interest received or profit on sale of assets; non-operating expense is: interest paid, special losses, loss on sale of assets.

S128 5.5 LEARNING POINTS (continued)

(e) Profit before tax less income tax = net profit (net earnings or net income). (f) To evaluate the income statement (operating statement) compare significant items with previous year or budget r industry, by amount and percentage. (g) Concentrate on: sales, gross profit, operating expense, operating profit, non-operating income and expense, net profit.

S129 5.5 LEARNING POINTS (continued)

(h) Distinguish operating profit (OP) from net profit (NP). Net profit should be the total profit from all sources for the year after income tax.

(i) Non-operating income may materially affect the net profit of the period.

S130 5.5 LEARNING POINTS (continued)

(j) Forecast a future income statement when given: sales, ratios, estimates.

(k) Distinguish trading from a manufacturing company; "purchases of finished goods" are "manufactured" in the factory.

S131 5.6 LEARNING PATTERNS - REVIEW 1. Income Statements

S - CGS GP - S, G & A OP - NOP or +NOI PBT - IT = GP = OP = PBT = NP

S132 5.6 LEARNING PATTERNS - REVIEW 2. Comparison is the Key

Past Budget Industry

S133 5.6

LEARNING PATTERNS - REVIEW 3. Forecasting

Sales Ratios Income Statements Balance Sheets

S134 5.7 INSTRUCTIONS (10 minutes)

Reassemble in CSG Study the lecture on the case and resolve outstanding questions Record key points in your notebook Reassemble in MG when the bell rings

S135 ASSIGNMENT 6.0 - BILL BROWN (30 minutes)

6.1 INSTRUCTIONS

Reassemble in SG Study the case and individually answer all the questions (on the worksheet in the diary) Compare your answers in SG When the bell rings, stop for lunch! After lunch, check with the correct solutions and discuss outstanding questions

S136 ASSIGNMENT 7.0 PROGRAM LEARNING (30 minutes)

7.1 INSTRUCTIONS

Reassemble in new S. Do Assignment Ch. 5 in writing Review the summary and glossary Record outstanding questions in your notebook Reassemble in MG when the bell rings

S137 ASS. 8.0 - LECTURE - The Package of Accounting Reports

8.1 OBJECTIVES True and fair view (old idea) Fair in accordance with IAS (International Accounting Standards) - the new view! Materiality Judgement Estimates not scientific facts

S138 8.2 THE PACKAGE

Balance sheet at beginning Income statement for the period Statement of accumulated profit for the period Balance sheet at end Cash Flow and Funds Flow (covered in the next AGL)

S139 8.3 STATEMENT OF ACCUMULATED PROFIT

Retained earnings statement. Appropriation account

Connects one balance sheet with another Balance brought forward plus net profit less dividends equals balance carried forward Special charges to accumulated profit (i.e. not charged via the income statement) need special investigation!

S140 8.4

METHOD OF FINANCIAL ANALYSIS

the language

Understand

Determine the story behind the figures

Compare figures and ratios against standards

Concentrate of material (significant) items (coconuts!)

Ask questions

S141 8.5
(a) Liquidity Standard

LAPP SYSTEM OF FINANCIAL ANALYSIS

Rough

Current Assets: Current Liabilities 2:1 Quick Assets: Quick Liabilities Equity : Debt 1 1/2 : 1 2:1

S142 8.5 LAPP SYSTEM OF FINANCIAL ANALYSIS (continued)

(b) Activity: Standard Sales/Assets p.a. better Cost of Sales/Inventory p.a. Receivables/Sales x 360 days decreasing Payables/CGS x 360 days decreasing Rough

1 or

2 or better steady or

steady or

S143 8.5 LAPP SYSTEM OF FINANCIAL ANALYSIS (continued)

(c) Profitability: Gross Profit/Sales Net Profit/Sales Net Profit/Owners Equity Rough Standard steady or increasing steady or increasing steady or increasing

S144 8.5 LAPP SYSTEM OF FINANCIAL ANALYSIS (continued)

(d) Potential: Product Market Facilities (human and physical) Management Finance Sales Orders Contingent Liabilities Trade Name Patents

S145 8.6 COMPARISON - KEY TO FINANCIAL ANALYSIS

Compare the amounts and ratios against a standard: Ask: What is important? Did it change? Why did it change? Standard may be: past, budget, industry average

S146 8.7 POTENTIAL FOR THE FUTURE

Forecast forward to show what will happen under a range of specific assumptions.

Then do a PFD ... to avoid EI ... Coconuts ...

S147 8 .8

LEARNING PATTERNS - REVIEW 1. Reports

UK/USA/Germany/Russia .... IAS

S148 8.8
BS IS Cash flow Funds flow BS

LEARNING PATTERNS - REVIEW 2. The Package

S149 8.8

LEARNING PATTERNS - REVIEW 3. L.A.P.P.

Liquidity and Gearing Activity Profitability Potential

S150 8.8
Sales

LEARNING PATTERNS - REVIEW 4. Effect of Expansion

Inventory & Receivables

S151 8.9 INSTRUCTIONS (10 minutes)

Reassemble in SG Study the lecture carefully and record key points in your notebook Discuss outstanding questions When the bell rings, carry on with the case study which follows

S152 ASSIGNMENT 10.0 - LECTURE SPECIAL SUPPLY COMPANY (30 minutes)

10.1 STORY OF THE CASE A businessman expands his business and seeks a loan from the bank. He forecasts a need of 30,000 but the bank lends him 75,000. Why? His results show increased sales over forecast and slightly increased profits. However, dividends use up necessary cash; inventory is high; creditors (payables) are stretched. The equity:debt relationship is weaker. Was the expansion really worthwhile?

S153 10.2 RATIOS

Past Comments (a) Liquidity CA : CL Good QA : QL Critical E:D Average Actual Current Forecast Current Actual

4.9 : 1 1.7 : 1 4.5 : 1

3.1 : 1 1.1 : 1 2.8 : 1

1.7 : 1 .5 : 1 1.0 : 1

S154 10.2 RATIOS (continued)

Past Actual (b) Activity S/A p.a. CGS /Inv. p.a. Receivables (drs.) Days of Sales Payables (crs.) Days of CGS 3.4 3.8 24 14 Current Forecast 3.3 4.0 30 9 Current Actual 3.0 3.3 29 Good Fair Good

48 Poor (losing cash discounts?)

S155 10.2 RATIOS (continued)

Past Current

Current

Actual Forecast Actual (c) Profitability GP/S Poor NP/S Poor NP/OE p.a. Good 35.0 4.3 18 37.0 5.6 25 33.5 4.4 26

S156 10.3 HEALTH OF THE COMPANY

Liquidity - not too good because dividends and inventory have used up existing cash; cannot conveniently pay back the 25,000 due in two weeks to the bank. Activity - very active; sales increase has led to increased inventory.

S157 10.3 HEALTH OF THE COMPANY (continued)

Profitability - slightly above forecast in amount; margin percentage has fallen with the increase in sales; however, return on equity good because leverage (GEARING - E : D) high. Potential - sales potential good; could lead to increased working capital requirements; cash problems and a weaker equity : debt ratio.

S158 10.4 STANDARDS OF PERFORMANCE

Compare actual last year, with forecast last year to measure management effectiveness. Compare actual last year, with actual of the previous year to measure the trend of operations.

S159 10.5 EQUITY : DEBT POSITION

Change from 4.5 : 1 to l : 1 indicates a debt capacity used up. If sales increase even further, the need for cash will rise and this ratio will become unhealthy, i.e., 1 : 2. Cash and E : D ratio are serious problems although the profit is better than the previous year.

S160 10.5 EQUITY : DEBT POSITION (continued)

Increase in sales requires more assets -

ALWAYS!!

If sales increase even further, even more assets will be required; Can only be financed from liabilities since profit is not retained sufficiently to increase the equity.

S161 10.6 PLAN OF ACTION

(a) Company (always seven alternatives!) Postpone repayment of 25,000 or stretch payables Hold back sales or get more equity capital Hold back dividends during rapid expansion , when cash flow from profits is needed to increase the equity base

S162 10.6 PLAN OF ACTION (continued)

(b) Bank Decide if company is a worthwhile client or not Decide if long term bank loan could be safe Decide if another bank would give the loan Then (a) above

S163 10.6 PLAN OF ACTION (continued)

KEY NOTES: The causes of financial difficulty were: sales expansion too quickly, dividends which used up the cash flow and too low equity base for the sales level. There was a clear failure of PFD and EI ... There are always seven alternatives to EVERY financial problem ... seek them out BEFORE deciding what to do ...

S164 10.7 LEARNING POINTS

(a) Increased sales lead to increased inventories and receivables. (b) Increased sales at falling margins may not necessarily improve profit but do increase the need for financial resources. (c) Dividends may not be healthy in times of expansion when cash is extremely short. (d) Compare financial statements against budget or against forecast to measure management performance.

S165 10.7 LEARNING POINTS (continued)

(e) Compare financial statement against the previous year to measure the trend of the company's activities. (f) Expanding sales at low profit levels emphasise the need for a bigger equity base (more capital). (g) Number of days sales in receivables and the number of days of cost of goods sold in payables are useful measures of activity and control.

S166 10.7 LEARNING POINTS (continued)

(h) Need to forecast future income statement and balance sheet to measure the forward effects of higher sales activities. (i) Seek seven alternatives to every finance problem .... (j) Always do a PFD ... and try to avoid EI ... especially for the coconuts ...

S167 !0,8 LEARNING PATTERNS - REVIEW 1. Effect of Expansion

Sales

Inventory & Receivables

S168 10.8 LEARNING PATTERNS 2. Sales, Assets and Gearing

A L

OE

OE

S169 10.8 LEARNING PATTERNS 3. Dividend Effects

A L A

L
OE

OE

S170 10.8 LEARNING PATTERNS 4. Control of Receivables & Payables

Sales Days of Receivables

Purchases Days of Payables

S171 10.9 INSTRUCTIONS (10 minutes)

Reassemble in SG Study the lecture on the case and resolve outstanding questions Record key points in your notebook Reassemble in MG when the bell rings

S172

11.0 - QUIZ (45 minutes)

11.1 INSTRUCTIONS Reassemble in SG. Do the quiz of 100 questions on the answer sheet in the diary Check your answer with the organiser and resolve outstanding questions Complete the first feedback form in the course diary and give it to the organizer. Reassemble in MG when the bell rings

S173 12.0 ASSIGNMENT - SUMMARY LECTURE FOR PART II (30 minutes)

12.1 WORK COMPLETED ASS Package of accounting reports Basic financial analysis

S174 12.2 POINTS ON THE CASES Tom Lyster

Analysis of profit and loss accounts Ratios: GP/S and NP/S Comparison with past years, budget and industry averages Forecasting a future profit and loss account based on assumptions of: sales, ratios, estimates

S175 12.2 POINTS ON THE CASES Bill Brown

Interpretation of financial statements Par and book value of owners equity E.P.S.

S176 12.2 POINTS ON THE CASES (continued) Special Supply Company

Comparison of financial statements against past and forecast figures Ratio analysis Effect of increased sales on assets required Deterioration of E : D ratio Bank problems Dividend reduction to save cash Need for equity base for expansion

S177 12.3 MATERIALITY

Compare data by amounts and ratios Concentrate on the big figures (coconuts!) Compare them against a standard (past, forecast, or industry average) Find out why they changed

S178 12.4 TRENDS TO BE EXPECTED IN A HEALTHY COMPANY

Sales and profits increase. increase Profitability ratios

Inventory and receivables in relation to sales Equity : Debt (2 : 1 strong) but not usually less than 1 : 1 Note: "In the EEC of the 1990's, the "health" of a business may well depend upon keeping up with both national and international industry averages ... "

S179 12.5 BALANCE SHEET

Fixed assets and current assets financed by liabilities and owners equity. Investigate how and why the assets are valued! Should they be "revalued" to more realistic current values? Notes on income tax : In some countries, there may be a long delay in actually paying corporation tax on profits; this may lead to two figures for income tax liability in the balance sheet: current and deferred. Where the reported NP is (by custom) the same as the NP for tax purposes, then ALWAYS ask for a reconciliation with NP according to IAS!

S180 12.6 PROFIT AND LOSS ACCOUNT

Sales less cost and expense gives profit for the accounting period. Distinguish operating (normal) profit from non-operating profits and losses. Investigate profit and losses NOT charged to the income statement but charged to: a. Accumulated profit b. Capital reserve

S181 12.6 PROFIT AND LOSS ACCOUNT (continued)

In some countries published financial statements often do not reveal gross profit or identify operating expenses, and sometimes simply follow the tax laws rather than good accounting .... So from 2000 onwards, they should ALWAYS show a reconciliation of the profit figure, with "International Accounting Standards" ... local national standards are NOT good enough ....

S182 12.7 RATIOS - SUBJECT TO INDUSTRY AVERAGES

Rough Standard Poor (a) Liquidity & Gearing CA : CL 1:2 QA : QL 1:2 E:D 1:2 Good Average

2:1 1+: 1 2:1

1:1 1:1 1:1

S183 12.7 RATIOS - SUBJECT TO INDUSTRY AVERAGES (continued)

Good Rough Standard Average

Poor (b) Activity S/A p.a. CGS/I p.a. Receivables Days of Sales 120 Payables Days of CGS 120

2 3 30

1 2 60

1/2 1

30

60

S184 12.7 RATIOS - SUBJECT TO INDUSTRY AVERAGES

Rough Standard Good Average

Poor (c) Profitability:

GP/S 5% NP/S 1% NP/OE 5%

40% 10% 25%

20% 5% 15%

Note: The above are only rough standards;

S185 12.7 RATIOS - SUBJECT TO INDUSTRY AVERAGES

(d) Potential Product, Market, Facilities, Management and Finance etc.
NOTE: Three items not recorded in the financial statements are critical to financial health: 1. Sales orders on hand (which confirm that the business is indeed a going concern) 2. Contingent liabilities (which may wipe out the OE) !!! 3. Forex & risk management (AGL 6)

S186 12.9 CONCLUSIONS

This program was designed to help you to develop financial language, concepts and confidence and to motivate you toward further study and practice in the future. Financial analysis helps to tease out the questions to ask; the layout of the financial statements is not important, provided you have the confidence to find your way around the data. Cash (liquidity and gearing) is more important than profit. Sales orders outstanding and inventory valuation are the keys to profit! (Orders outstanding effect the inventory valuation which can have an important effect on

S187 12.9 CONCLUSIONS (continued)

Profit must be judged in relation to target or budget or industry ratios, not merely last years performance. Financial statements are based on accounting concepts (which are as flexible as proverbs - one for every occasion!). However, always ask for a reconciliation of the net profit, with "International Accounting Standards" and investigate any differences arising. Figures are only estimates; compare them against a useful standard to determine their significance. Don't pretend to be too accurate! Look after the coconuts not the peanuts: ...

S188 12.9 CONCLUSIONS (continued)

Try to find out management's objectives in preparing the specific financial statements that you study (taxes? shareholders? bank? mergers? efficiency? etc.). Study the "notes to the financial statements" very carefully! Question the valuation of the assets. Always consider the effect of inflation on asset values and profits during the accounting period. Look out for possible manipulation, which is often politely referred to as "aggressive" or "creative"

S189 12.9 CONCLUSIONS (continued) Audit - check that financial reports have been audited by a firm that is professionally recognised, independent and adequately paid, to do a full timely ... audit, and to report freely to International Auditing and Accounting Standards ...

S190 12.9 CONCLUSIONS (continued)

Look for timely financial reports, completed and audited within two months after the end the accounting period. Long delays in producing and publishing financial statements (months or even years) are always justification for "concern" ... regardless of the reasons suggested ... Seven alternatives to every financial problem, PFD, EI, coconuts and peanuts .... and other conclusions ... from you and your SG?

S191 FINAL NOTES

This ends our AGL program; the first of a six part series.: AGL AGL AGL AGL AGL AGL 1 2 3 4 5 6 Finance for Non-financial Managers Cost Control Planning and Budgetary Control Capital Investment Analysis Management of Working Capital Forex & Risk Management

Some of the programs are now available in several EEC languages. Similar AGL programs in Business Policy and in Inter-cultural Communication are being used by major international companies.

S192 FINAL NOTES (continued)

We hope the AGL experience has inspired you to develop your skills by practical application. Thank you for your interest and hard work. Keep ASS glossary handy as a reference for accounting language. and read the WSJ (Wall Street Journal) every day ... its the best MBA program we know ... after HBS ... We hope that you have enjoyed the AGL experience and that it motivates you to read widely in finance and accounting and to continue your studies in the future.

S193 FINAL NOTES (continued)

Now reinforce your learning from the program by following the LRT (Learning Recall Tape) routine, as explained by the organizer, during the days following completion of the AGL program. Then please send the Final Feedback Summary on day 28, by email to robertboland@wanadoo.fr or to: Dr. Bob Boland: 33 450 40 8982 who responds to all AGL questions and supplies latest versions of all learning materials in various languages.

S194 FINAL NOTES (continued)

We trust that you have found AGL to be both "efficient" (doing things right) and "effective" (doing the right things). Thank you for being a member of our program.