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Improving working capital

  
Working capital is defined as current assets less current liabilities. Current assets are inventory, receivables and cash, while current liabilities are amounts owed to suppliers, bank overdraft and other short term liabilities such as taxes due.

Managing working capital is very important. Tie up too much money in inventory and the business is in trouble. A recent report by PWC suggests companies are still not managing working capital as best they can. Read about it and some suggestions to improve working capital here.

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Why media reports on profits annoy me a little….

Ryanair made a profit of €865 million in 2014. The Irish Times reports this figure and also notes “operating profits rose 65 per cent to €1 billion from €658 million”. Great news for Ryanair. The main reasons for increased profit seem to be a combination of lower fuel costs and increased passenger numbers.  What sort of annoys me about such media reports – and all media seem to do this, not just the Irish Times – is that such reporting of numbers does not tell the full story.

Let’s take a brief look at more detail. In this example from Ryanair (or any company) on profits, we also need to consider the level of investment in assets. Forgetting about accounting for a moment, it is logical to think that if Ryanair for example acquired more aircraft, then it should be able to generate more profits due to increased passenger revenue. But, if we just make a statement like “profits rose by 65%”, this does not reveal the underlying assets.

The same Irish Times article reports that net assets (assets less liabilities) did in fact rise from €3.3 billion to €4 billion in the year. If we do a simple return on assets calculation (using operating profits), then for 2013 the return is 658/3300 = 19.9% and for 2014 it is 1000/4000, or 25%. This is a year on year increase in the return on assets of about 26%. This is a long way off the 65% reported increase in operating profit, and a lot more meaningful as it reflects the net assets (or capital) used. It is still a great improvement, but perhaps not so sensational a 65%!

The versatility of gross profit margin

gp

 

You may know the gross profit margin ratio, which is:

Gross Profit  x 100

Sales.

 

Gross profit is: Sales – Cost of Sales

and

Cost of Sales = Opening inventory + Purchases/cost of production – Closing Inventory.

In this short post I would just like to share some of my experiences on the versatility of this simple ratio. If we look at the elements of the ratio, it is easy to see that if each element remain stable, the answer should also be stable. So for example, if I buy something for €40, sell it for €100, then my GP margin is 60%. If my sales price or purchase price changes, then the GP margin changes. Then, if we think about inventory levels, if these fluctuate the GP margin changes too. Taking all this together, it’s easy enough to see how any business typically knows what its GP margin should be. Thus, if it varies considerably, there may be something wrong.

Here are two things I know the GP margin is used for. One, from my own experience, is in pubs/bars.  Most pubs/bars are susceptible to fraud and controls typically put in place by owners. One such control is monthly stock-takes and monthly accounts. A fall in the GP margin could indicate “lost” stock or unrecorded cash receipts – which further controls may reveal. Another use is to spot inflated revenues. Businesses may want to make their profits look better and thus do things like invoice for goods early, before the end of a financial year. These good may not even be bought/made yet. Thus, the GP margin may be lower. Again further investigation is needed to find the issue.

There may of course be more simple reasons for changes in the GP margin – costs and sales prices may simply change and affect the ratio. But once these have been ruled out, it is a useful indicator.

 

Some interesting small facts on the accounting profession

Here is a great little blog post I came across a few months ago. It’s a bit of fun, and worth a read.

Accounting for Bitcoin 

 

 We have probably all heard of the digital currency Bitcoin – there are some others but Bitcoin is the best known I think. I read a nice article on the Bitcoin magazine website recently which reminded me of the basic things us accountants need to consider if dealing in foreign currency or if a new currency comes along – it is not that long ago since the Euro came our way.

The article summarises well the three steps I experienced when operationalising the Euro more than a decade ago now. Like Bitcoin, the Euro was for me then a non-physical currency to begin with. The first “step” with the Euro and actually happening now with Bitcoin is use as a payment method. With the Euro, we had the ECU as a payment method first. In this case, the accounting entry is the same as any other payment method – such as a credit card or PayPal – all amounts are in local currency.  Step 2 would be to treat Bitcoin as a foreign currency. In my experience this typically happens when volumes of payments to/from customers/suppliers become larger. For example, many Irish SME treat GBP as a foreign currency in their accounting systems, but treat the USD more like a payment method. As the articles notes, if Bitcoin is treated as a foreign currency then exchange gains and losses need to be accounted for. Step 3 is adoption as a base currency. This may not happen of course, only time will tell. Let’s assume it does happen, then the accounting system works pretty much the same as in step 2. The would also be some work in translating assets and liabilities to the new currency. With the Euro this was relatively simple as fixed exchange rates were agreed and then it was matter of running a routine within the accounting software to do the calculations.

As the article suggests, more businesses are accepting Bitcoin (as its stabilises in value) and thus are at step 1.

Apple’s numbers

As you may know, profits at Apple for Q4, 2014 were some $18billion. This is reportedly the largest quarterly profit in history.

One of the things accountants often do is use ratios to compare businesses from one year to another and with other businesses. With such a large profit at Apple, I’d begin to think that any comparisons might not be of great value. So is there any way we could our such a number is perspective. Certainly Apple could probably clear all Irish sovereign debt with there cash pile, but here is an interesting presentation from the BBC

The Pope’s view on accountants

Image from wikipedia

Image from wikipedia

A recent quote from Pope Francis to the World Congress of Accountants captures the broader role of accounting quite well:

” everyone, especially those who practise a profession which deals with the proper functioning of a country’s economic life, is asked to play a positive, constructive role in performing their daily work, knowing that behind every file, there is a story, there are faces.”

This quote reminds us that behind the numbers are real jobs, real people and real effects. It may be easy to forget this as you trawl over a ledger audit trail or provide information to managers, but reminding ourselves of the broad reach of our accounting numbers can only be a good thing.

The full text the address by Pope Francis can be found here.

What does off-balance sheet mean – Vatican off-balance sheet cash

Image from wikipedia

Image from wikipedia

In December 2014, the media (see here for example) noted how millions for euro were “off-balance” sheet. According to reports from the Vatican “some hundreds of millions of Euros were tucked away in particular sectional accounts and did not appear on the balance sheet”. So how can this happen, and what does off-balance sheet actually mean?

Let’s go back to basics first. A balance sheet shows assets, liabilities and equity. Assets are essentially something an organisation own’s or has use of like a owner; a liability is a claim against the business. Both must be measurable in monetary terms. So for example, many large firm’s brands have values in $billions put on them, but these are off-balance sheet assets which are off-balance sheet because the value cannot be measured accurately in money terms.

In other cases, such a the Vatican example, assets can be seemingly omitted from the balance sheet. This is of course not a recommended practice. How is this done? Well, it is a little bit more complex than this, but essentially something is omitted from the books of the organization. Remember, now matter how complex an organization is, underneath its accounting system is the good old double entry system of accounting. If a transaction (e.g. bank account) is omitted from the double entry accounts, that’s it, it does not appear on the balance sheet.

Tesco and its hello money.

Image from Tesco.ie

A few weeks ago, a news story broke about an accounting scandal at Tesco – see here for example.

So how can this happen? It’s very simple actually. Now, we don’t know if it’s an error or something deliberate, but from an accounting view the entries in the books are the same.

When I was in college 20 years ago, one of our accounting lecturers asked is how would we account for this “hello money” as he called it. Within a decade I was calculating and accounting for what were termed “long term agreements” in my role.

For the likes of Tesco, the amount involved are large and I would guess they account for hello money as a separate income stream – although it’s not shown in the published accounts. Another way would be to reduce purchase cost, but this would probably be for smaller amounts. But how can Tesco make such an error you ask? Simple, just ” over accrue”. This means recording future hello monies now. Of course, I have no idea this is what actually happened, but it does show how easy errors or manipulation can happen by using the good old accruals concept.

Comparing profits and other figures from accounts

One thing really annoys me about how the media reports company performance – they only ever give % increases or decreases in sales or profit typically.

If you have ever studied accounting you probably learned about ratios analysis, and how just looking at absolute numbers ( like sales or profit ) can give a false picture. Here’s a recent example from the Irish Times to illustrate what I mean.

According to the Irish Times (see here :

“Irish-owned book and stationery retailer Eason & Son has recorded a net profit after tax of €2.3 million in its financial year to January 2014, compared with €2.6 million the previous year. Eason Group revenues, however, were down 7.1 per cent to €227.4 million, in what the company called a “challenging year”.”

All the above is true, but if we do a quick calculation, profit as a % of sales ( profit margin ) is pretty much the same from one year to another. So despite a 7% drop in sales, costs must also have been well managed to maintain a stable profit margin. I appreciate the media try to keep these reports simple for the general public, but a little more depth would be very useful.

Incomplete records

Sometimes a business does not keep (or have) proper records. Most countries require a business to keep accounting records by law, so in my experience the only time a business does not have records is when there is something like a fire, or records are lost or destroyed. When this happens, there are several techniques which can be used to help “build” a set of accounts. Here is a nice article from CPA Ireland which details some of these.

More accounting tricks – Hollywood accounting

My last post noted some “tricks” used to make a budget balance. Here’s another story on how accounting tricks can be used to make something with huge revenues into a loss maker – it’s Hollywood accounting.

20140531-233957-85197016.jpg

An interesting view on assets and income…

 

 

Here is a good post from worthytoshare.com which looks at a lady seeking a partner from an interesting view. It is worth a read, trust me

Accounting and public services

Accounting and accounting information is used for many purposes. Even the public sector immune to accounting information, and accounting-based controls. Recently (March 4th, 2014), BBC Radio 4 broadcast a very interesting programme (The Accountant Kings) on accounting in the provision of public services in the United Kingdom. Here is a link to the series website http://www.bbc.co.uk/podcasts/series/fileon4, and the podcast itself can be found at http://downloads.bbc.co.uk/podcasts/radio4/fileon4/fileon4_20140304-2050c.mp3.

A lively accountant’s website…

Have a look at this post from Accountancy Age. There is a link within to the website of a firm called Wood & Disney. It’s a well designed website, but with a touch of humour.

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