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SCHOOL OF BUSINESS AND LAW ckhl August 18, 2013 [FINANCIAL MANAGEMENT ANALYSIS] Contents STUDENT: HUYNH LINH CHAU KHAC ID no: B0225HNHN0213 2 August 18, 2013 [FINANCIAL MANAGEMENT ANALYSIS] Question 1: Discuss extent how legal and professional framework for accounting ensures that financial reports offer reliable, relevant, objective and comparable information to users 1.1. INTRODUCTION Accounting is an essential part of any companies. It is can be seen as the heart of the enterprises’ body. It holds the whole information of other parts to make a financial report for the company to provide for many users. It is fact that enterprises produce a lot of reports each year but the financial reports is the most important. It is because it provides the companies’ financial statement for different users to make decisions. In addition, because of different users, the financial report has to be in the same structure. It means that all financial report is organized in the framework to present and interpret for users. That is the reason why the legal and professional framework of accounting must be reliable, relevant, objective and comparable. In the content below, I will present the meaning of framework of accounting and further discuss some qualitative characteristics of it. 1.2. OVERVIEW OF LEGAL AND PROFESSIONAL OF FRAMEWORK FOR FINANCAIAL REPORTING. The purpose of financial reporting is providing the useful information for many users. These users are attached following: investors, lenders, suppliers and other trade creditors, customers, employees, government, and analyst advisors. Each has different requirement from the report’s information. It is clearly above: - Investors who are interested in the risk inherent in and return which is provided by their investments. The investors need information of the financial report to help them to decide whether they should buy or sell. They are also concerned with the information that helps them to access the power or ability of the company to pay dividends as well as to know deeply the management performance. - Employees who are concerned with the stability and profitability information of the employers. In addition, they also interested in the guerdon, retirement benefits and opportunity of employment in this company to help them have an overview of the company’s working conditions. - Lenders who are interested in the interest that they will be paid - Suppliers or other trade creditors: they are concerned with the efficiency of the company. It means the ability to pay for creditors. - Customers who are concerned with the ability of the company be continuance when they are dependent on the enterprise. - Government and their agencies are concerned with the allocation and resource information of the company. They need more information from the financial report to supervise the company’s activities and control them by tax policies and their donation to gross domestic product to the national income. STUDENT: HUYNH LINH CHAU KHAC ID no: B0225HNHN0213 3 August 18, 2013 [FINANCIAL MANAGEMENT ANALYSIS] - Public are interested in the enterprise’ contribution to the local economy which is shown through their employment rate. Moreover, in order to ensure the reliable and relevant of the financial report’s information, financial report needs to be organized in the worldwide framework. It is called the legal and professional framework for accounting. The legal framework is about the company Act. It is mainly interested in disclosure and protecting shareholders and creditors’ rights. Some main company Acts: 1862 is the first act. It was required an increase in exposure over former Acts in 1929. There was a significantly increase in the earlier disclosure requirements in 1948. 1981 witnessed the standardization of formats – EC 4 th Directive which includes the “True and Fair” principle. It requires the financial accounts to be accurate, not misleading and the financial reporting’s information is less flexibility. Until 1985, the major consolidating Act is produced. Further, EC 7 th and EC 8 th Directive were combined and laid down in 1989. Whilst these rules require all financial performance respect to presentation and format. However, it is no means comprehensive. However, International Accounting Standards (IASs) and International Financial Reports Standards (IFRSs) could not be a considerable feature of United Kingdom financial reporting while Statements of Standard Accounting Practice (SSAPs) and Financial Reporting Standards (FRSs) play a priority in the preparation of financial statement. Accounting Standard Board (ASB) did not ignore the work of International Accounting Standard Board (IASB) but Accounting Standard Board (ASB) had a legal and professional position in the UK while the International Accounting Standard Board (IASB) Consequently, both the Accounting Standard Board (ASB) and the International Accounting Standard Board (IASB) did not have. Until 2005, EU adopted the International Accounting Standard Board (IASB), because of EU’s members, UK have to accept it but it is also in different setting. That is the reason why Accounting Standard Board (ASB) and the International Accounting Standard Board (IASB) and similar standard setting bodies in many countries have working to find a conceptual framework for accounting information. Taking a prior, International Accounting Standard Board (IASB) published its ideas into a document which is called Framework for the preparation and Presentation of Financial Statements. In contrast, Accounting Standard Board (ASB) created its own framework which is called Statement of principles for financial reporting. Accounting Standard Board (ASB) has issued 8 Financial Reporting Standards and Statement of Principle in 1995. The statement of Principles – ASB consist of: - First chapter, the objective of financial statements. - Second chapter, the qualitative characteristics of financial information. - Third chapter, the elements of financial statements. STUDENT: HUYNH LINH CHAU KHAC ID no: B0225HNHN0213 4 August 18, 2013 [FINANCIAL MANAGEMENT ANALYSIS] - Fourth chapter, Recognition in financial statements. - Fifth chapter, Measurement in financial statements. - Sixth chapter, presentation of financial information. - Seventh chapter, the reporting entity. In the chapter 2, the Qualitative characteristics of financial information contain the feature reliable, relevant, objective and comparable information to users. 1.3. CHARACTERISTICS OF FINANCIAL INFORMATION IN FRAMEWORK Firstly, Relevance, the information is performed in the financial report should meet the users’ needs and it have to be timely. It means that all information have been updated day by day because the information is out up date, it leads to be irrelevant for determine to make an economic decisions by different users. In addition, relevant information also contains predictive value, confirmatory value or both. Predictive value helps users predicting future outcomes. Moreover, confirmatory value is included in the report if it can provide the feedback about the previous predictions. Materiality is a private aspect of relevance. Information is material if ignoring it or not considering it, it could impact the decision process. Immaterial information does not influence decisions. Thus, immaterial information is not relevant. It also leads to we have to state materiality information privately when extending standards. The second qualitative characteristic is the reliability. To be useful to users, information in the financial statement is not only relevant but also reliable. Reliable information is totally free from errors. It must be neutral and complete. To be reliable, information needs to represent the results and financial status of the entity faithfully. It also respects substance over form. It means that all events and transactions have to be accounted and presented in substance and economic rather than legal form. Prudence is also considered when appreciate assets. It is because we cannot overstate highly assets and turnover while understate liabilities and cost. In addition, neutrality of information in the financial statement is regarded to make the information objective. The third characteristic should be considered is objective. Information should be objective because subjective information cannot meet the needs of the users. The goals of financial report is to offer information to different users so if it relies heavily on someone, it easily leads to unreliability. In general, all information must be objective and reflect the market trends truly. Last but not least, the comparability of information to users. Those who use financial report must be able to compare the company’s information statement in the period of time in order to determine the financial trends and operating results as well as the others in order to appreciate financial statement, operating and changing the financial trends of each. STUDENT: HUYNH LINH CHAU KHAC ID no: B0225HNHN0213 5 August 18, 2013 [FINANCIAL MANAGEMENT ANALYSIS] 1.4. CONCLUSION On balance, financial report is very useful for many different users. It reflects the benefits of information in the financial statement for the users via the primary characteristics of principles: reliable, relevant, objective and comparable information. Moreover, the usefulness of financial report is affected by the method of determination, identification, measurement, recognition and presentation of financial statement’s elements. Pressure on the balance of benefits – cost, financial system adapt to change of the market trends slowly, risk of errors, knowledge of stakeholders and other impacts from external environment can decline the usefulness of financial performance. Hence, in order to improve the usefulness of financial statements by preventing the decline of usefulness and improve users’ knowledge on the existing accounting foundation. STUDENT: HUYNH LINH CHAU KHAC ID no: B0225HNHN0213 6 PRIMARY RATIO ROCE = PROFITABILITY RATIOS Net Profit % = SECONDARY RATIOS EFFICIENCY RATIOS Utilisation of Capital Employed (Asset turnover) = August 18, 2013 [FINANCIAL MANAGEMENT ANALYSIS] Question 2: Discuss the usefulness of pyramid of ratios in interpreting financial performance. Using some relevant examples explains the limitation of them. 2.1. INTRODUCTION. If I were a manager, I could want to reward my employees based on their performance. How can I know how hardworking they have done? How can I define what departments or agencies have performed better? If I were an investor, how do I anticipate how well the safety of the enterprise will represent related to that of the others? If I were a lender, how could I know how many interests can I get from the company’s activities. I only answer these questions through financial analysis. Financial analysis is the presentation and interpretation of financial data, along with offering the information for many different users so it needs data from many sources. For example, turn over, cost of sales, operating profit which are used in annual financial report that the company want to disclosure to the users. Especially, the other main purpose of financial report is enabling judgments on the current and future financial status and operating performance of the enterprise. In this essay, I want to introduce the benefits as well as the drawbacks of ratio analysis by illustration by pyramid of ratios. THE RATIO PYRAMID 2.2. THE BENEFITS OF PYRAMID OF RATIOS Normally, there are some main ratios like this: 2.2.1. Profitability ratios. It consists of Return on capital employed (ROCE), Net Profit (%), Gross Profits (%) and Expenses/Sales. STUDENT: HUYNH LINH CHAU KHAC ID no: B0225HNHN0213 7 August 18, 2013 [FINANCIAL MANAGEMENT ANALYSIS] 2.2.2. Efficiency Ratios or Asset Utilisation. It comprises Asset Turnover, FA Turnover ratio and Stock Turnover ratio, Debtor collection period, Creditor payment period and Stock holding period. 2.2.3. Liquidity ratios. It includes Current ratio, Quick ratio, 2.2.4. Investor ratios. It consists of Gearing ratio, Earning per share (EPS), Price Earnings Ratio (P/E ratio) and Dividend ratios. I will discuss these ratios in detail. 2.2.1. Profitability Ratios a. Return on capital employed (ROCE) is the no.1 ratio or the primary ratio. It is also named ‘Return on net assets’ or ‘Return on Investment (ROI)’. ROCE = PBIT∗100 Capital Employed This ratio is important because it indicates the total turnover of the investment which is useful for investors when they need to compare the ROCE to the previous forms of investment). It is also the standard for the company when it needs additional borrowing because if new cost of borrowing is higher than ROCE leads to impacting the profitability adversely. In addition, it is the reference rate of return in evaluating new projects. b. The second ratios. ROCE = PBIT∗100 Capital Employed = PBIT Sales x Sales Capital Employed = Net Profit (%) x Utilisation of Capital Employed This ratio shows the operating expenses of the company so the users recognize the overall picture about the company’s expenses. In general, Profitability ratios measure performance, How much profit could the company gain in relationship with size of business and amount of capital invested. 2.2.2. Efficiency ratios. They measure the ability of the company to manage working capital resources over activities. Creditors could find out how quick the company can pay for creditors and they also help company when showing the financial report to catch the investors as it can manage the debtors well. Moreover, investors also know the company is able to solve the inventory in its activities. Stock holding period= Averagestock∗365 Costof sales Debtor collection peri od= Debtors∗365 Credit sales STUDENT: HUYNH LINH CHAU KHAC ID no: B0225HNHN0213 8 August 18, 2013 [FINANCIAL MANAGEMENT ANALYSIS] Creditor payment period= Credit∗365 Credit purchase 2.2.3. Liquidity ratios. They help measure the ability of the company to pay for short term debt. These ratios help users measuring the efficiency with quick assets and current assets have been used. It is clearly that Current ratio= Current assets Current liabilities (norm 2:1) Acid test (quick ratio )= Quick assets Current liabilities (norm 1: 1) If two ratios in the limitation of norm, the company is able to pay for any current liability. It means that the company always expects the current ratio is from 1.5 to 2.0. If this norm is too low, it is risky as well as if this norm is too high, it means the company is poor management of resources as too much money is tied up in inventory. Additionally, the quick asset ratio also expected at 1:1 or lower and not too much higher than 1:1 is accepted because it reflects the ability of company in paying for liability quickly. 2.2.4. Investor ratios Gearingratio= ¿interst capital∗100 TotalCapital(Equity) Earning per share= Earning(¿ pence) Noof ordinary shares Price earning ratio= Market price per share EPS If the P/E ratio is higher, investors’ confidence is greater. 2.3. THE DISADVANTAGES OF PYRAMID OF RATIOS - The first drawback is that ratio only give the results and does not shoe the causes. - The second thing is that it depends too much on the information which is shown on the financial performance so it is hard for the accuracy of this analysis. STUDENT: HUYNH LINH CHAU KHAC ID no: B0225HNHN0213 9 August 18, 2013 [FINANCIAL MANAGEMENT ANALYSIS] - Next, it is also impacted by the accounting policies of company. Following the Conceptual Framework of International Accounting Standard Board (IASB), any company has to apply coherent accounting policies every year. On contrast, it is shown that there is a choice under IFRS between benchmark and allowed alternative accounting treatment. For example, whether to appreciate PPE at depreciated historic cost or at Fair Value. - Furthermore, using ratio analysis is difficult for comparing two businesses if they are not organized in the same size, similar activity or stage of development. - Following these pros of this analysis is that published accounts are limited because the summary of formats, minimum disclosure as well as the value of market is not considered and out up dated information. 2.4. CONCLUSION It is said that ratios are the tool for many companies analysis the financial performance. From the figures which are shown on the report, it is easy for users having an overall picture about the company’s status. However, using these ratios is not totally free from limitation. Any company is in the similar size when comparing. Consequently, it is not fair in evaluating new projects of different business. Question 3: Discuss how to minimize the weighted average cost of capital (WACC) of the company by combining the capital structure. STUDENT: HUYNH LINH CHAU KHAC ID no: B0225HNHN0213 10 . AND LAW ckhl August 18, 2013 [FINANCIAL MANAGEMENT ANALYSIS] Contents STUDENT: HUYNH LINH CHAU KHAC ID no: B0225HNHN0213 2 August 18, 2013 [FINANCIAL. certain point, when cost of debt starts rising and it is still lower than the cost STUDENT: HUYNH LINH CHAU KHAC ID no: B0225HNHN0213 13 August 18, 2013