Step 1: KCQS Chapter 4 ‘Analysing Financial Statements’

My blog post can be seen here.

Introduction

The introduction to this chapter was attention-grabbing and intriguing. It was of good structure to reel the readers in and gave them a look at what they might be learning for the rest of the chapter. I clearly understand that being able to understand the past can help you to predict the future however it is important to note that this won’t help to foresee some instances. For example, analysing a firm’s financial statements can help understand a firm’s economic and business status now and for the future.

Key concept: To be able to foresee or predict the future you must be able to look at and understand the past.

4.1 How firms add value

In this section we learnt about free cash flow and economic profit. This section was very informative and had a lot of really good examples to help me try and comprehend some of the concepts mentioned.

At first it took me a while to get my head around the concept of FCF however Table 4-1 and 4-2 clearly defined the key concept that the more a firm invests into its operating assets the less their free cash flow will be.

Key concept: FCF is a transfer of value NOT a creation of value.

As we move on it can be seen that economic profit is a direct measure of adding value for a particular year. This can be measured by the return on net operating assets (RNOA) less the

Assignment Stage 2: Restated Financial

StatementsACCT11059: Using Accounting for Decision Making

Student Name: Codi HortonCourse Coordinator: Martin TurnerDue Date: Monday, 9th May 2016

opportunity cost of capitals multiplied by the amount of net operating assets (NOA). Which can be easily be expressed as: Economic profit = (RNOA – cost of capital) x NOA. The idea that capital can only be invested in one thing at a time was pretty clear and straightforward and I understood it instantly.

Key concepts: By earning a return on net operating assets (RNOA) higher than the cost of capital

the firm can create value. Capital can only be invested in one thing at a time.

4.2 Operating and financial activities

Upon reading this section I instantly could sense that it is vital to separate your operating and financial activities and to restate your financial statements to classify them like this. I enjoyed the Kinder Surprise example it made me eager to learn why we should separate a firm’s activities and help to clearly identify their relationship in a firm.

From this section I know now that operating activities are interactions with product and inputs markets, with its customers and suppliers. A few examples of what operating activities include can be seen below:

Decisions about what operating assets to acquire or to sell What agreements to enter into wit employees, suppliers and customers Importantly, various activities to add value to the inputs a firm gains from its

suppliers

I’ve also learn that financial activities of a firm are its interactions with the capital markets, with equity and debt investors. This can involve decisions about financial structure and matters such as dividend policy.

All of the above is explained in figure 4-1, it separates net operating assets (NOA) on the left side and net financial assets (NFA) as financial activities on the right side and clearly sums up the above information. It can be shown that operating and financial activities of a firm although separate interact with each other.

4.3 Restate two key financial statements

I was eager to read this section of the chapter as it delved into restating the balance sheet and income statement of a firm. Martin showed us step-by-step the process of how he did exactly that for his firm, Ryman Healthcare. As restating our own firm’s financial statements is step 2 of our assignment 2 I was more conscious of how much I really needed to pay attention and try to understand the information in this section to correctly complete step 2.

This section clearly addresses how to restate the balance sheet and income statement, the use of examples really helped to identify the process needed to do so. I am a bit more confident heading into step 2 after reading this section than I was heading into this assignment.

Key concept: To better understand whether an asset or liability is an operating or financial item it helps to look at the footnotes.

4.4 Profitability and efficiency

This section provided an insight into how we can use the information from restated financial statements to look at key aspects of a firm’s performance. Below are the main key concepts I believe were the most important to me.

Key concepts: RNOA = PM x ATO

Where, PM = OI/Sales and ATO = Sales/NOABy remember the relationship between profitability and efficiency above it allows us to make sense of how we analyse financial statements.

A ratio expresses the relationship between two or more numbers or things. By looking at the footnotes to see if there have been sudden movements in a firms

NOA in the year it can help us decide whether to use opening or closing NOA when calculating our firms RNOA.

Profit Margin (PM) can be defined as:PM = OI/Sales Were OI = comprehensive operating income after taxThe profit margin focused on the profitability of each dollar of sales.

Asset turnover (ATO) can be defined as:ATO = Sales/NOA Where NOA = net operating assetsAsset turnover is the amount of sales generated by each dollar of net operating assets in the business.

RNOA = PM x ATOReturn on net operating assets (RNOA) is driven by the interaction between profit margins and asset turnover:

Conclusion

In conclusion, unlike other chapters I have read, I found chapter four very confusing and a little harder to grasp the concepts. I think this could be narrowed down to the lack of prior knowledge I have on this subject in particular which means I couldn’t really personally relate to the information or build onto what I already know. Each and every concept was new to me and I spent a lot of time re-reading this chapter to actually try and understand some of the information. Ultimately, I am pleased to say a have furthered my understanding of what concepts are involved with restating financial statements and why it is a vital part of accounting.

Step 2: Restating your firm’s financial statements, issues or concerns when restating your firm’s financial statements and the results of your discussion with other students.

Still to complete.

Step 3: Identify 3 products or services of your firm and estimating their selling price and variable cost, comments on contribution margins calculated and identify and comment on constraints.

My blog post can be seen here.

AJ Lucas (my designated firm) is a specialist service provider to the energy, mining and infrastructure sectors. They provide professional drilling services to the coal and coal seam gas industries as well as engineer and construct complex civil infrastructure and commercial development projects including desalination plants, power stations, gas and water pipelines and buildings.

Today I have chosen to identify three different services within Lucas’ Engineering and Construction sector. The projects can be seen below:

Contribution Margin Calculations

1. Service - Hyundai Headquarters

Project Type: Commercial BuildingSelling Price: $54 MillionVariable Cost: $40 MillionContribution Margin: $14 Million

2. Service – Dungog Clear Water Tank

Project Type: Civil ConstructionSelling Price: $11 MillionVariable Cost: $8 MillionContribution Margin: $3 Million

3. Service - West Corridor Recycled Water Pipeline

Project Type: Underground Water PipelineSelling Price: $550 MillionVariable Cost: $460 MillionContribution Margin: $90 Million

Service Provided Selling Price Variable cost Contribution Margin

Commercial Building - $54 Million $40 Million $14 Million

Hyundai Headquarters

Civil Construction – Dungog Clear Water Tank

$11 Million $8 Million $3 Million

Underground Water Pipelines - West Corridor Recycled Water Pipeline

$550 Million $460 Million $90 Million

Commentary on contribution margin

As seen in the table above three different projects (services) have been identified that have been completed by AJ Lucas. Each product has a selling price which is the price that the service is sold for which is affected by the variable cost which is an expense that varies with production volume. The difference between the selling price and variable cost forms the contribution margin. The contribution margin is the amount leftover to cover fixed costs and contribute to profit.

As can be noted above the three services have completely differing contribution margins. This is simply due to the fact that they are all in themselves entirely different projects and more importantly the factors that contribute to the variable cost. Each project would require specific time frames, materials, contractors, time of the year the engineering and construction is completed, the geographical location of the project and so forth. Each of these factors would all implicate how the variable cost is determined and ultimately the selling price which as mentioned above leaves you with the contribution margin. The firm produces a range of services with different contribution margins to maintain a competitive advantage and strong market presence in the industry.

Constraints

Two constraints my firm may face could be:

1. Lack of sub-contracting companies available.

The firm may face a lack of contracting companies to employee to complete a project. This could limit the amount of projects the firm agrees to take on at a time.

2. Lack and/or cost of resources available for construction.

The firm may face a limitation or lack of material and resources that are required to complete a project. Perhaps the firm may find themselves in a project where the materials are too costly to purchase. This would also limit the amount of projects the firm agrees to take on per year.

Step 4: Providing and receiving peer feedback

Feedback I provided:

Feedback From: Codi HortonFeedback To: Leah Fuller

Comments

Step 1KCQs

First of all, I’m glad to know that I’m not the only one that gets very lost after the examples stop!I enjoyed reading your KCQs. You are very honest with your questions regarding the information in the chapter and you have shown you have some key concepts down pat. My only suggestion to make your KCQs stronger is to separate them into the heading the come under. For example, your questions regarding how new companies predict the future as they don’t have much of a past to reflect on could come under a heading for ‘Introduction’ so that it makes it clearer and easier for people reading it to know what part of the chapter you are referencing to.

Step 2 Restated Statement of Changes in EquityBalance SheetIncome StatementCommentary and discussion with others

Your restated financial statements look in good shape and the layout is simple and easy to read. Your commentary on your issues and concerns when restating your financial statements could not be any truer to what I am going through as I am in the same boat (minus parenthood)! It makes me feel a little bit better to know that in the end you made it and it all worked out fine with some help of a peer.

Step 3Identify three products/servicesEstimate selling price, variable cost & CMsCommentary – CMsConstraints – identify and commentary

Let me know once you’ve completed this step and I’d be happy to provide some feedback.

Overall ASS#2 Overall, you have a strong assignment and have addressed all of the key points required.

Feedback From: Codi HortonFeedback To: Anne-Maree Friederichs

Comments

Step 1KCQs

Your KCQ was very well-written and structured well. You used some good personal examples of how you understand the material, however, it would’ve been nice to see you express the key concepts explained in each section in your own words separately under each paragraph.

Step 2 Restated Statement of Changes in EquityBalance SheetIncome StatementCommentary and discussion with others

Your spreadsheet looks in good shape. You commented clearly your issues and concerns when completing step 2 as required.

Step 3Identify three products/servicesEstimate selling price, variable cost & CMsCommentary – CMsConstraints – identify and commentary

You have identified three different products/services for your company and shown very logical explanations for your assumptions on the contribution margin calculations. You have shown constraints your company may face and have backed up your theories with good explanations.

Overall ASS#2 Overall, you have a very well-written and interesting assignment and have addressed all of the key points required.

Feedback From: Codi HortonFeedback To: Valda Goulevitch

Comments

Step 1KCQs

I really enjoyed your KCQs. It was extremely well-written and you have clearly shown your KCQs in your own words.

Step 2 Restated Statement of Changes in EquityBalance SheetIncome StatementCommentary and discussion with others

Your restated financial statements have a very simple layout which makes it extremely easy to read and understand.

You have provided discussions and issues arising when restating your financial statements.

Step 3Identify three products/servicesEstimate selling price, variable cost & CMsCommentary – CMsConstraints – identify and commentary

You have completed a very in-depth and research based step 3. Very good!

Overall ASS#2 Overall, you have done an excellent job on your assignment. It is set out very well, all key points have been addressed and it was an interesting read!

Feedback I received:

Still to complete.