Financial reporting apps – now and the future
The October 2011 issue of CIMA’s Financial Management had a good article summarising the development to date of iphone/ipad/android apps for financial reporting. Since the advent of the internet, most public companies (and many other organisations) now publish their financial statements on their websites. Some just provide a static PDF file, while others offer more dynamic PDF files, Excel downloads and even XBRL formats. I suppose it is only logical that some firms are now providing a corporate reporting app, which not only make financial information more readily available, but also available in an offline format. According to the article, only a few companies have taken the “ground-breaking” step to develop and provide an app solely for financial information. Nestle launched the first such app (30,000 downloads), which incorporates news, financial reports, presentations and share prices. The article also mentions (just) two other firms, Shell (3,000 downloads) and Cemex – i think Tesco also have an app. There are obvious benefits of an app – reducing distribution and print costs, faster information dissemination – but the objective according to the article is to make the user’s experience far more interactive than web pages currently do. At present, given the infancy of such apps, interaction is their biggest downfall too. According to the author, only increased interactivity and a more user-friendly approach will increase the use of financial reporting apps. But, no matter what way these apps develop over the coming years, one thing is for sure – mobile communication will increase. Perhaps these early adopters of financial reporting apps may become the leaders in the field soon – only time will tell.
Gross Profit Margin – 2 of 6 in series on financial ratios
Let’s now look at a second useful profitability ratio (see the previous post also). The Gross Profit Margin is a simple ratio which shows the percentage profit made on sales before deducting business expenses. It is calculated as follows:
Gross Profit x 100
Sales
The Gross Profit Margin will vary by business sector. For example, some businesses/sectors may make quite a large Gross Profit Margin on each, but have lots of overheads to pay e.g. the hospitality sector, like pubs and clubs. Other sectors may have a much lower figure. The Gross Profit Margin is usually closely watched by business owners in particular. If you remember that Gross Profit is Sales less Cost of Sales, and Cost of Sales in turn includes opening/closing inventories and purchases. With any abnormal changes in these figures the Gross Profit Margin will change.It might be something simple like an increased purchase price which has not yet been passed on to customers through a price increase, or it could be something more sinister like theft or stock or unrecorded sales.
As in the last post, let’s use the accounts of Diageo plc as an example. Based on their 2010 Income Statement (p.106 of the annual report), the Gross Profit Margin is;
5681 x 100 = 57.5%
9870
If you do the same figure for 2009 it’s 58.1%, which is in a similar range. Most business managers will know what their average Gross Profit Margin is. Although the Diageo figure seems high, there are lost of expenses to be paid out of the Gross Profit. You can also calculate a Net Profit Margin, which use the Net Profit before tax instead of Gross Profit in the above formula. This is not as useful as the business expenses tend to be more variable from year to year, although it is still widely used.
Using ratio analysis – an introduction
Over the coming weeks, I’ll be writing a number of posts on using ratios to analyse financial statements. First though, let me give an outline of what ratio analysis is about.
If you want to compare the financial statements on a business from one year to another, or, compare two businesses you cannot use direct comparisons of figures. Here’s a simple example:
Company A has a profit in 2010 of €1m according to its income statement. Company B has a profit of €5m. Which company is the most profitable?
You’re probably thinking Company B, as its profit is five times that of Company A. However, this comparison is mis-leading. Now let’s assume Company A has capital of €2m, but Company B has capital of €25m. Now we can do a quick calculation as follows::
Return on investment Company A €1m/€2m = 50%
Return in investment Company B €5m/€25m – 20%.
Looking at the figures this way, we can see that Company A actually manages to make 2.5 times the return of Company B. This simple shows one problem of compare raw numbers, that is scale. However if we use financial ratios, which express figures in relative terms, we are able to make more direct comparisons between businesses. Over the next few weeks, I ‘ll be writing a number of posts detailing some individual ratios, so keep an eye out. By the way, if you already know how to do ratios and/or want your accounts analysed, here’s a great website where you can plug in your data for a free analysis.
Single entry accounting
Elsewhere on my blog, I have written a post of the basics of the double entry accounting system. I had a comment on this post asking for some more information on single entry accounting – so here it is.
The basic idea of the double entry accounting system is that information is recorded twice. The system allows any business or organisation to get a picture of its incomes, expenditures, assets, liabilities and capital at any point in time. The double entry system is encoded into all accounting software and is the basis of all financial reports of businesses.
In the double entry system, any transaction is recorded from its source all the way through to the financial statements. For example, if a supplier is paid the following happens:
- the cheque is recorded in a “day book” – normally a cash/cheque payments book
- the suppliers balance is updated – in a personal ledger account
- the bank balance is updated
- by virtue of the previous two items, the assets (bank) and liabilities (trade payables) are updated
- the financial statements (income statement and balance sheet) are updated.
In a single entry system, some of the above is not done. The best way to explain this is by an example. When I worked in small accounting firm some years ago, most sole traders kept what were single entry records. At that time (the early 1990’s) most small sole traders kept records in a manual form – most had no computer anyway. The records would typically comprise a book where all purchases/expenses were recorded, a book where all payment in and out of the bank were recorded and a book where all sales were recorded. Records of things like assets – how much was owed by customers or records of vehicles for example – and liabilities – how much was owed to suppliers for example – were not kept. Using these books, it is only possible to prepare an income statement. Thus, as the double entry system is not applied in full, i.e. transactions are not recorded through ledgers in this example, then the single entry system applies.
It is not possible to say that the single entry system means that only certain specific records are kept. It’s probably better to think of the single entry system of accounting as one which does not fully use the principles of double entry, but does allow profit to be calculated. In the example above, what we did was to build up a list of the assets and liabilities, as well as the capital of the business, to allow us to prepare an income statement (profit and loss account) and statement of financial position (balance sheet).
What organisations need to prepare acccounts?
One of the first few things that I would typically teach students that are new to accounting is that all most organisations need to control what they do in some way. Control can be of a financial nature, i.e. preparing financial statements, and this is something we typically associate with “for-profit” organisations.
However, many not-for-profit organisations also need to keep accounting records and have intricate financial/accounting based control systems. For example, a charity might like to know its sources of funding and keep a detailed trace on all expenditures. Similarly, any sovereign state needs to keep track of its income (usually taxes) and its outgoings e.g. expenditure on schools, roads and social welfare. A few months ago, a number of articles on the annual financial report of the Vatican State caught my eye (see here and here). In brief, the Vatican State had a surplus of about €10 million for 2010. The Vatican is a peculiar organisation in that it is somewhere between a Church and a State. I can’t find the annual report on-line, but as far as know one main source of income for the Vatican is the traditional “Peter’s Pence” collection held annually at all catholic churches across the world. The press releases surrounding the 2010 Vatican financial report seems to suggest that deliberate efforts were made compared to previous years to control costs and keep within budget. So, even the Vatican has a use for accounting information – both financial statements of some kind, and management accounting. By the way, if you do find the annual reports of the Vatican on-line, do get in touch
Three acounting mistakes made by entrepreneurs
I read an article on entrepreneur.com a few months ago. It recounted the experiences of some entrepreneurs in terms of the common accounting mistakes made. The 3 top mistakes/misconceptions according to this article are:
1. Treating sales as revenue before the product is delivered or service provided. A common mistake actually. For example, if you have agreed to sell goods in March, you cannot record the sale until then. There are some exceptions, but let’s keep it simple.
2. Capital expenditure is not reflected in the accounts immediately. If you buy a new asset, you part with some cash. But in accounting, the cash amount spent is recorded against profits over several years. Sometimes the cash outflow may be too much, so you need to consider the cash situation of the business.
3. Proftit and cash flows are confused. The best way to explain this is to think of selling on credit. If you sell on credit, the sale is recorded, but you don’t get the cash for some time later. So, you could be profitable but have no cash – a bad scenario.
The article gives some real examples, so have a read.
New code for Irish charities
In March 2011, the Irish Times reported on a new voluntary code for charities in Ireland. Yes, it’s a while ago and has been on my “to do” list for quite a while. Following the enacting of the Charities Act 2009, all Irish charities must submit an annual activity report to the Charities Regulatory Authority. Larger charities also have to complete and file audited accounts. The new proposed code aims to make charities more transparent financially, going beyond the requirements of the Act. The five key elements of the code are:
- charities commit to good practice and ensure fundraising activities are open and legal
- a donor charter will be introduced
- a complaints and feedback procedure
- a monitoring group will monitor code compliance
- an annual report and a statement of annual accounts will be publicly available
What is the prudence concept?
The prudence concept is another fundamental accounting concept. It basically means we count count our chickens before they hatch. In other words, when presented with options, the prudence concept would dictate we err on the side of caution. In practice, this means we should not overstate income, understate expenses, over-value assets or understate liabilities. To give an example, inventory is valued at the lower of cost or net realisable value (which is more or less what something sells for). While there are detailed accounting rules on inventory valuation, this is an example of the prudence concept at work. So, if the net realisable value was less that cost, inventory would be stated on the books at below cost. Another example is providing for bad and doubtful debts. For example, a business might think 2% of its customer debt will not be paid. This might not actually happen, but it is prudent to assume it will.
What is the accruals concept?
Okay, in my last post I explained the entity concept. Today, it’s the turn of the accruals concept. The accruals (or matching) concept is probably the one that most accounting students come across so often. It also underpins quite a few of the complex accounting standards. So what does the accruals concept entail?
The matching concept is probably a better name for it, as the accruals concept is all about matching costs and revenues. When cash comes in from sales, or is paid out for costs does not matter. Let me give you an example. Assume a business has a delivery van which cost €20,000 and will be good for 5 years. This means it helps to generate revenue (by delivering goods) for 5 years. The accrual concept would dictate that the cost is matched against the revenue generating capability. So, even if the van were bought and paid for right now, the cost in the accounts would be €4,000 per year for each of the five years. In this way, the cost is matched against revenues over the same time frame. Here’s another real life example. How do you think an airline like Ryanair accounts for its’s revenues? You buy the ticket weeks or months in advance, so can they record the sale once you pay? The answer is no, as no cost has been incurred. Once you fly, the cost is now incurred and the revenue (sale) can be recorded in the accounts, even though the cash has been paid in advance.
Watch out for more on the basic accounting concepts soon!
What is the entity concept?
If you are learning accounting for the first time, one of the earlier things you should learn are basic accounting concepts. These are underlying rules which apply to accounting no matter how simple or complex the business or (to the best of my knowledge) the location.
One of these concepts is called the entity concept. In accounting, financial statements (e.g. income statement, statement of financial position (balance sheet)) need to be prepared for each business entity or group of entities under common control. When we think of large companies this is probably a simple enough concept to grasp. Companies are by nature separate legal entities too, and costs and revenues for each legal entity are normally easy enough to identify. In large groups, the entities are combined to prepare financial statements for the group as a whole. When we get down to the typical one-man-show type sole trader, things can get a bit blurred. But, the sole trader is probably the best example to explain the entity concept. For the sole trader, the entity concept would dictate that all business and personal expenses must be separated. Here’s an example. Let’s say a sole trader makes a business trip which means an overnight stay in a hotel. Let’s assume his/her partner comes along. Should any costs associated with the partner be treated as expenses in the sole trader’s accounts? Of course, the answer is no. (But hotel rooms often cost the same for 1 or 2 persons you’re thinking – so make sure your partner’s name does not appear on any bills for the room!). I remember another example from my time in practice. Following a tax audit, the tax inspectors correctly disallowed a repair to a washing machine as a business expense. This would only be an expense in a laundrette or similar business.
So the key thing to remember about the entity concept is to isolate the business entity and only include costs and revenues associated with that entity. Any personal costs/revenues should not be included. Costs/revenues of other entities should be excluded in general too (unless you are looking at a group).
XBRL on the up
According to CIMA Insight (December 2010), XBRL (the html-type languages used to electronically transmit financial reports) is becoming very common place. XBRL is an XML type language (used on web pages and e-business) used specifically for financial reporting. The increasing use of IFRS, and a XBRL file which encompasses IFRS is undoubtedly helping the rise of XBRL. It is also a free to use language, which helps too. So does XBRL do or offer?
The key advantage is that is provides a common and agreed method to file financial reports in all kinds of places. Using the main statements required under IFRS for example, anyone with a web-browser can make sense of the data in the financial statements and manipulate the data as required. The US stock exchange and the UK tax authorities are just two who already use XBRL. Indeed many authorities are likely to make it mandatory in the near future. By filing financial reports in XBRL format, many agencies could in theory use the one filing for multiple purposes – simply because the filing is electronic.
Although XBRL is being driven by regulators and external financial reporting, it could also streamline internal accounting processes. For example, a large organisation may have non-standardised financial reports, which could be standardised used XBRL – assuming of course a standard reporting mechanism/format could be agreed.
For more detailed information, check out http://xbrl.org/
Management control in NGO’s
Non-governmental organisations (NGO) are increasingly being held to account for their performance and uses of funding. Indeed, the funding they obtain is more likely to be based on having sufficient competencies to use the funds in the best possible way. Sounds like a business doesn’t it? But NGO’s are not businesses you might say, and they usually have a non-profit (and often very worthy) objective.
However, NGO’s are increasingly becoming like businesses. For example, the Charities Act (2009) in Ireland requires all charities to be formally registered and (in most cases) submit annual audited financial reports to a Registrar. From a management accounting view, NGO’s can of course adopt budgetary control and other performance measures as normally used in a business. A recent report from CIMA suggests “evidence shows that developing formal management controls can help NGOs to develop networks with government departments, funding agencies, other service providers and clients”. It goes on to say that management accounting can contribute in several ways to the success of an NGO:
- Planning and control when formulating proposals for funding, often involving networks of partner agencies.
- Clarifying within the NGO the importance of including economic efficiency as an organisational value alongside traditional welfare values.
- Linking non-financial operational performance to financial concerns.
Brand valuation standard sets challenge to finance
CIMA’s Insight e-zine from November 2010 (here) reports on a recent ISO standard which give guidelines on attributing a monetary value to brands. Under international accounting standards (IFRS3 in particular) brands are normally only valued when acquired as part of a new business (i.e. only when bought). According the CIMA piece, the new ISO standard suggests three well-known methods for valuing brands:
- Income approach: the objective of the income approach is to calculate the after-tax, present value of future cash flows attributable to the brand. These cash flows are the difference between the cash flows generated by the business with and without the brand. The standard outlines six key ways of doing this: the price premium, volume premium, income split, multi period excess earnings, incremental cash flow and royalty relief methods.
- Market approach: this methodology compares the brand with comparable transactions, looking at acquisition ratios that can be adjusted to consider the similarity of brand strength, goods and services or economic and legal situation.
- Cost approach: the cost approach calculates the amount invested in creating the brand and the cost of recreating it.
An example of a prior year adjustment – IAS10
International Accounting Standard 10 (IAS10) requires companies to make what is termed a prior year adjustment to its financial statements on a number of grounds. One reason is the discovery of an error of a material nature. Here’s a recent example from TUI Travel, one of Europe’s biggest travel operators. The (London) Independent reported on Oct 22, 2010 how TUI has to write off £117m (above 20% of its current year profits) as a result of errors in pricing systems.
TUI’s website reports the following adjustments:
- A reduction of underlying operating profit for the year ended 30 September 2009 of £42m from £443m to £401m, all of which relates to TUI UK.
- A reduction in opening reserves at 1 October 2008 of £70m, from £2,286m to £2,216m.
- As a result of the two adjustments above the separately disclosed items of £29m announced in the Q3 results will no longer be required.
- A reduction in the underlying earnings per share for the year ended 30 September 2009 of 2.8p from 23.8p to 21.0p.
This is a good example of IAS10 at work.
Why do we need a code of ethics?
CIMA’s Insight e-zine (October) reported on a new version of CIMA’s code of ethics. According to CIMA, upholding an ethical code can most simply be understood as “doing the right thing when no one is looking.” As an accountants, are you sure you know your right from wrong in the workplace? (corporate fraud profiling shows culprits are most likely to be senior male executives in the finance function).
CIMA’s ethical code (and other professional body codes) is a tool to help guide ethical practice and is revised periodically to reflect changes in the external environment and reinforce the ideal of professional duty. Most codes are principals-based, meaning there are no absolute rules. They are rather a roadmap of a journey. So how is it applied in practice? Management (and other) accountants have a position in society as trusted experts. They have a duty to maintain the highest standards of professionalism in their work, while acting in the public interest, by upholding the code and fundamental principles: in CIMA’s case these are: integrity; objectivity; professional competence and due care; confidentiality and professional behaviour. By not doing so, members can lose their professional standing.
With recent turbulence in the economy and financial markets, the failures of many companies can be traced to ethical breaches. It is no surprise that business ethics are very high in the minds of the public, regulators and governments, and that trust in professionals is at a low point.
As long as people work, ethical dilemmas in the workplace will always be present. Ethical grey areas and demands from misguided, or outright corrupt, peers and bosses remain a challenge to deal with.
Martin's accounting blog 