ARA from exam sample

• What is Net Realisable Value (NRV)?

  The selling price of something less the anticipated cost of realisation.
• The lower of cost and net realisable value basis of valuing inventories is an example of:

  Conservatism
• Advantages of company form of organisation:

  • Limited liability of shareholders
  • Seperate legal existence
  • Continuous life
• Carrying amount - the amount at which an asset or liability is recognised in the statement of financial position. Usually the original amount minus the accumulated depreciation.
• To calculate the impairment of an asset, take the carrying value of the asset (its historical cost minus accumulated depreciation) and subtract its recoverable amount. It's recoverable amount will be the higher of its selling value or its value in use.
• Industry averages - Analysis that provide information about an entity's relative position within an industry.
• What is leverage?

  It is when one uses borrowed funds (debt) for funding the acquisition of assets in the hopes that the income of the new asset or capital gain would surpass the cost of borrowing is known as financial leverage.
• When analysing financial statements, considerations should be given to: The accounting policies applies, note disclosures, the industry which the entity operates and the economical and political environment.
• Return on Equity:

  • This is the underlying measure of performance, it is the return to ordinary shareholders.
  • ROE captures the profitability, efficiency and capital structure.
  • The higher the better for investors
  • (Profit available to ordinary shareholders/Average ordinary shareholder's equity) x 100 = n %
• A solvency ratio measures a firms ability to repay its long-term debts and is often used by business lenders.
• Return on Assets (ROA):

  • The ability of the entity to utilise its resources to generate returns
  • It captures profitability and efficiency
  • The HIGHER THE BETTER as an indicator of good management/use of resources.

  CALCULATED BY:

  (Earnings before interest & tax/Average total assets) x 100 = n %
• Profit Margins (Gross profit margin & EBIT profit margin)

  The rate at which sales revenue generates profit, the amount of profit generated by each sales dollar.

  • Captures profitability and efficiency

  
  

  GROSS PROFIT MARGIN - an indicator of mark-up

  • CALCULATED BY: (Gross profit/Sales revenue) x 100 = n%

  
  

  EBIT PROFIT MARGIN - the rate at which sales revenue generates EBIT

  • CALCULATED BY: (EBIT/Sales revenue) x 100 = n %
• EXPENSE RATIOS - the rate at which sales revenue is absorbed by a particular expense or cost centre.

  • CALCULATED BY: (Selling & marketing expenses/Sales revenue) x 100 = n %
  • DECREASE in expense ratio indicates improved cost efficiencies.
• Cash Flow to Sales Ratio

  • The rate at which sales revenue generates operating cashflow.
  • CALCULATED BY: (Net operating cash flows/Sales revenue) x 100 = n %

  WHAT COULD CAUSE THIS TO RISE?

  • increase in operating inflows (through more efficient procedures of collecting cash from customers) or decrease in operating outflows (due to better cost control).
• EBITDA


  Earnings Before Interest, Tax, Depreciation and Amortisation.
• Asset Turnover (ATO)

  Indicates the effectiveness of the entity's assets to generate sales revenue and how well the entity is managing its investment in current and non-current assets.

  • CALCULATED BY: (Sales Revenue/Average Total Assets) = n times p.a.

  What could cause a rise in ATO?:

  • Rise in sales revenue
  • Fall in average assets (disposals, depreciation, impairment).
• INVENTORY TURNOVER/DAYS INVENTORY

  The average number of days inventory is held, it is a measure of asset efficiency.

  • CALCULATED BY: (Average Inventory x 365)/Cost of Sales) = n days.
  • Improvements in Inventory turnover could be caused by selling more, selling quicker or holding less.
• DAYS SALES OUTSTANDING

  The average number of days sales are outstanding (days between sale and cash receipt)

  • CALCULATED BY: (Average trade receivables x 365)/(Sales revenue) = n days
  • Cause of improvements can include reduction in credit terms, introduction of discounts for prompt payments and improved screening/collection procedures.
• DAYS PURCHASES OUTSTANDING

  The average number of days payments for inventory are outstanding.

  • CALCULATED BY: (Average trade payables x 365)/(Cost of sales + net increase in inventory) = n days

  Causes in change of the days purchased outstanding include change in the suppliers credit terms, or changes in cashflows (ability for entity to repay).
• Liquidity ratios

  • Ability for an entity to clear short-term debt
  • This includes: Current ratio (aka Working capital ratio), Quick ratio (aka Acid-test ratio), Cash flow ratio.

  Solvency ratios

  • Ability for an entity to clear long-term debt.
• CURRENT RATIO (aka working capital ratio)

  The amount of current assets available to service current liabilities.

  • CALCULATED BY: (Current Assets)/(Current Liabilities) = n%
  • Rule of thumb: b/w 1.5 and 2

  Too low: indicates problems meeting ST commitments

  Too high: indicates inefficient use of assets
• QUICK RATIO

  Amount of quick assets available to service current liabilities.

  • CALCULATED BY: (Cash + Receivables)/(Current liabilties - Overdrafts) = n %
  • Rule of thumb 0.5 to 0.8

  Causes of increase in quick ratio same as those for current ratio (except those re inventory).
• CASH FLOW RATIO

  The amount of operating cash flow avaliable to service current liabilities

  • CALCULATED BY: (Net operating cash flow (or CGO))/(Current liabilities) = n times
  • THE HIGHER THE BETTER
• Capital structure ratios consider:

  • the extent to which assets are financed by debt relative to equity
  • reflects managements financing strategy.
• DEBT RATIO

  The extent to which the entity has used debt to finance its investment in assets

  • CALCULATED BY: (Total liabilities)/(Total assets) = n %
  • Benchmark: historically 60% has been considered high

  RECALL:

  • Debt is a cheaper source of finance than equity
  • Leverage can increase returns (ROE) but carries higher risk.
• EQUITY RATIO:

  • CALCULATED BY: 100% - Debt Ratio
• Interest Coverage Ratio

  The ability of an entity to generate earnings to cover financing costs.

  • CALCULATED BY: (EBIT)/(Finance costs) = n times
• DECLARATION OF DIVIDENDS


  stating how much will be paid out and over what timeframe.
• Margin of Safety

  • Margin of safety is the amount by which expected sales could fall (or vary unfavourably) and still cover costs (i.e. breakeven).
  • CALCULATED BY: (Expected sales volume - Breakeven volume)/(Expected sales volume).
• Breakeven point 


  CALCULATED BY: (Fixed costs)/(Contributed margin per unit)
• CONTRIBUTED MARGIN

  • CALCULATED BY: Sales revenue - Variable costs
• An avoidable cost is.....

  An avoidable cost is a cost that is not incurred if the activity is not performed
• Purchasing budget

  determines the volume of units required to be purchased to meet expected sales
• A business transaction is....

  A business transaction is a financial event that involves an exchange of value (such as goods, services, or money) between a business and an individual or another business.
• Liabilities Definition:


  'Decreases in economic benefits in the form of outflows or depletions of assets or incurrences of liabilities that result in a decrease in equity, other than those relating to distributions to equity participants'
• AASB accounting standards are legally enforceable in Australia under the:

  Corporations Act 2001
• The four types of business structures of 'for-profit' entities are:

  Trust, company, sole trader, partnership. 
• Moving amounts from retained earnings to general reserves leaves Shareholder equity unchanged.
• The share market being a market where transactions between two investors and brokers happen, the company is not involved in buying of shares from the stock exchange and hence the value of shares in the books will not be impacted by it.
• Financial statements prepared for a parent entity and all its subsidiaries are referred to as:

  consolidated financial statements.