TOPIC 1: Introduction and Revisioniiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiii
Financial Reporting vs Management Accounting
Financial Reporting Management Accounting
Follows the International Financial Reporting Does not follow any particular outlined standards
Standards (IFRS) / US GAPP or local GAPP set by
the International Accounting Standards Board
(IASB). This is to help provide a ‘true and fair view’
No room for creativity - the process is standardized More room for creativity - no external users
and heavily regulated - Reports can be published as often as
- Financial reports must be published at least required
annually - Reports can be in any format
- Estimates and assumptions can be made
External users (particularly investors) rely on Internal users (managers) rely on the information to
financial statements to provide information on the help them with decision-making
company’s
- Financial position
- Financial performance
- Generation of cash
- Changes in financial position
What is a Company?
● A separate legal entity
● Run by directors
● Owned by shareholders who elect the board of directors
● Shareholders invest in the company. They provide equity (shown in the statement of financial position)
Equity
● Resource provided to the company by investors
● The amount of money that would be returned to the company’s shareholders if all of the assets
were liquidated and all of the company’s debts pad off
Share capital = number of shares * nominal value of shares
Share premium = excess proceeds from share issue over nominal value of shares
Retained earnings - not distributed to investors but retained within the company and reinvested in assets
1
,Statement of Financial Position
● State of affairs at a particular date e.g. as at 31st December 2019
● Every transaction changes the statement of financial position
● Only transactions that are completed prior to the year end should be included
Statement of Cash Flows
● Cash is king
● Without cash a company cannot operate
● Investors need to understand where cash is generated from and what it is being used for
2
,TOPIC 2 & 3: Financial Statement Analysisiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiii
★ Always keep in mind the industry in question, as well as the company’s competitors, when deciding
whether these numbers are low or high
Performance Formula Explanation
of a
Company:
Profitability
Gross Profit (Gross Profit / Measures how much each dollar of sales contributes to profit. It
Margin Revenue) * indiciates how efficient a company uses its raw materials and labor
100 during the production process
The higher the profit margin, the more efficient the company is. A
high profit margin may mean:
- Low costs of production
- Increase in sales price
- Overvaluation of closing stock or undervaluation of opening
stock
Known as the conclusive ratio because if there are major issues with
other ratios or the company’s performance, it will have its impact on this
ratio
If a company has a 5% profit margin then 5 cents of every sales dollar
would go towards profit, and 95 cents towards expenses
Limitation: does not take into account any costs, and hence is not a
measure of total profitability
Operating Profit (Operating Measures how much each dollar of sales contributes to profit, taking
Margin Profit / into account costs including overhead, and administration costs
Revenue) * which are necessary to keep the business running If a company has a
100 40% profit margin it means that 40% of each dollar remains after the
company pays for its operating expenses
(Profit before
interest and Reflects the percentage of profit a company produces from its
tax / revenue) operations, before subtracting taxes and interest
* 100
Investors pay attention to this ratio because it shows the
proportion of revenues that are available to cover non-operating
costs such as paying interest and tax.
3
, The reason for underperformance could be the minimal control
Nestlé has over direct production costs leading to exceptionally
high operating expenses.
The higher the profit margin, the more efficient the company is. A
high profit margin may mean:
- Low costs of production
- Increase in sales price
Return on Operating Capital Employed is the total investment into a business. It is different
Capital Profit / (Total from Capital as Capital Employed includes funds coming from not
Employed Assets - only owners but lenders, i.e. equity and debt
(ROCE) Current
Liabilities) * Judges management performance, letting investors know whether
100 capital is being used efficiently
Profit before A higher ROCE signifies that a larger chunk of profits can be
interest and invested into the company for the benefit of shareholders
tax / capital - The reinvested capital is employed again at a higher rate of
employed return, which helps produce higher EPS growth
A company with a higher return on every dollar invested year after year
is bound to have a higher market valuation than a company that burns
up capital to generate profits
Limitations:
1. Does not consider the market values of assets, only the
book values
2. It may not provide an accurate reflection of performance for
companies that have large cash reserves. These reserves
could be funds raised from a recent equity issue. They would
be counted as part of the capital employed even though they
may have not yet actually been invested, reducing the ROCE
Return on (Profit After Measures profit as a percentage of the total equity put into the business
Equity (ROE) Tax Less
Preference Limitation: a very high ROE value may be misleading, making it look like
Dividend / a company is doing well when it is not. A high ROE may be the result of
Equity) * 100 falling equity due to falling profits for instance
Asset Turnover Revenue / Measures the value of a company’s revenue relative to its assets
Capital
Employed It helps investors understand how effective companies are using their
assets to generate sales
A fall in the ratio may indicate that a company is holding obsolete
4
Financial Reporting vs Management Accounting
Financial Reporting Management Accounting
Follows the International Financial Reporting Does not follow any particular outlined standards
Standards (IFRS) / US GAPP or local GAPP set by
the International Accounting Standards Board
(IASB). This is to help provide a ‘true and fair view’
No room for creativity - the process is standardized More room for creativity - no external users
and heavily regulated - Reports can be published as often as
- Financial reports must be published at least required
annually - Reports can be in any format
- Estimates and assumptions can be made
External users (particularly investors) rely on Internal users (managers) rely on the information to
financial statements to provide information on the help them with decision-making
company’s
- Financial position
- Financial performance
- Generation of cash
- Changes in financial position
What is a Company?
● A separate legal entity
● Run by directors
● Owned by shareholders who elect the board of directors
● Shareholders invest in the company. They provide equity (shown in the statement of financial position)
Equity
● Resource provided to the company by investors
● The amount of money that would be returned to the company’s shareholders if all of the assets
were liquidated and all of the company’s debts pad off
Share capital = number of shares * nominal value of shares
Share premium = excess proceeds from share issue over nominal value of shares
Retained earnings - not distributed to investors but retained within the company and reinvested in assets
1
,Statement of Financial Position
● State of affairs at a particular date e.g. as at 31st December 2019
● Every transaction changes the statement of financial position
● Only transactions that are completed prior to the year end should be included
Statement of Cash Flows
● Cash is king
● Without cash a company cannot operate
● Investors need to understand where cash is generated from and what it is being used for
2
,TOPIC 2 & 3: Financial Statement Analysisiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiii
★ Always keep in mind the industry in question, as well as the company’s competitors, when deciding
whether these numbers are low or high
Performance Formula Explanation
of a
Company:
Profitability
Gross Profit (Gross Profit / Measures how much each dollar of sales contributes to profit. It
Margin Revenue) * indiciates how efficient a company uses its raw materials and labor
100 during the production process
The higher the profit margin, the more efficient the company is. A
high profit margin may mean:
- Low costs of production
- Increase in sales price
- Overvaluation of closing stock or undervaluation of opening
stock
Known as the conclusive ratio because if there are major issues with
other ratios or the company’s performance, it will have its impact on this
ratio
If a company has a 5% profit margin then 5 cents of every sales dollar
would go towards profit, and 95 cents towards expenses
Limitation: does not take into account any costs, and hence is not a
measure of total profitability
Operating Profit (Operating Measures how much each dollar of sales contributes to profit, taking
Margin Profit / into account costs including overhead, and administration costs
Revenue) * which are necessary to keep the business running If a company has a
100 40% profit margin it means that 40% of each dollar remains after the
company pays for its operating expenses
(Profit before
interest and Reflects the percentage of profit a company produces from its
tax / revenue) operations, before subtracting taxes and interest
* 100
Investors pay attention to this ratio because it shows the
proportion of revenues that are available to cover non-operating
costs such as paying interest and tax.
3
, The reason for underperformance could be the minimal control
Nestlé has over direct production costs leading to exceptionally
high operating expenses.
The higher the profit margin, the more efficient the company is. A
high profit margin may mean:
- Low costs of production
- Increase in sales price
Return on Operating Capital Employed is the total investment into a business. It is different
Capital Profit / (Total from Capital as Capital Employed includes funds coming from not
Employed Assets - only owners but lenders, i.e. equity and debt
(ROCE) Current
Liabilities) * Judges management performance, letting investors know whether
100 capital is being used efficiently
Profit before A higher ROCE signifies that a larger chunk of profits can be
interest and invested into the company for the benefit of shareholders
tax / capital - The reinvested capital is employed again at a higher rate of
employed return, which helps produce higher EPS growth
A company with a higher return on every dollar invested year after year
is bound to have a higher market valuation than a company that burns
up capital to generate profits
Limitations:
1. Does not consider the market values of assets, only the
book values
2. It may not provide an accurate reflection of performance for
companies that have large cash reserves. These reserves
could be funds raised from a recent equity issue. They would
be counted as part of the capital employed even though they
may have not yet actually been invested, reducing the ROCE
Return on (Profit After Measures profit as a percentage of the total equity put into the business
Equity (ROE) Tax Less
Preference Limitation: a very high ROE value may be misleading, making it look like
Dividend / a company is doing well when it is not. A high ROE may be the result of
Equity) * 100 falling equity due to falling profits for instance
Asset Turnover Revenue / Measures the value of a company’s revenue relative to its assets
Capital
Employed It helps investors understand how effective companies are using their
assets to generate sales
A fall in the ratio may indicate that a company is holding obsolete
4
