Finance & Funding in Travel and Tourism - Financial accounts

The International Travel College of New Zealand 1

Finance & Funding in the Travel and Tourism Sector

Unit #2 – Learning Outcome 3

Interpret travel and tourism financial accounts


Financial Accounts• Financial accounts are concerned with classifying, measuring and

recording the transactions of a business.

• Recap on the key features of financial accounts and the differences between financial accounts and management accounts.

• Financial accountants draw up the financial accounts for the company as a whole in order for users to answer questions such as:

- "Should I invest my money in this company?"

- "Should I lend money to this business?"

- "What are the profits on which the company must pay tax?"


What is included within Financial Accounts?

Profit and Loss AccountAlso known as the income statement. Describes the trading performance of the business over the accounting periodBalance Sheet (also known as Statement of Financial Position)Statement of assets and liabilities at the end of the accounting period (a "snapshot") of the businessStatement of cashflowsDescribes the cash inflows and outflows during the accounting periodStatement of movements in equity Shows all changes in owner’s equity for a period of time. Capital transactions with ownersCapital represents the money that shareholders or owners have invested in the businessStatement of accounting policiesNormally comprised of: a definition of the reporting organization and , statement of general accounting policies Notes to the AccountsAdditional details that have to be disclosed to comply with Accounting Standards and the Companies ActDirectors ReportDescription by the Directors of the performance of the business during the accounting period + various additional disclosures, particularly in relation to directors' shareholdings, remuneration etc. Audit reportDated and signed by the auditor


Financial Management

• Financial Management can be defined as:• The management of the finances of a business /

organisation in order to achieve financial objectives.• Taking a commercial business as the most common

organisational structure, the key objectives of financial management would be to:

• Create wealth for the business• Generate cash, and• Provide an adequate return on investment bearing in

mind the risks that the business is taking and the resources invested


Three key elements to the process of financial management:

1. Financial Planning

Management need to ensure that enough funding is available at the right time to meet the needs of the business. In the short term, funding may be needed to invest in equipment and stocks, pay employees and fund sales made on credit.In the medium and long term, funding may be required for significant additions to the productive capacity of the business or to make acquisitions.

2. Financial Control

Financial control is a critically important activity to help the business ensure that the business is meeting its objectives. Financial control addresses questions such as:Are assets being used efficiently?Are the businesses assets secure?Do management act in the best interest of shareholders and in accordance with business rules?

3. Financial Decision-making

The key aspects of financial decision-making relate to investment, financing and dividends:Investments must be financed in some way – however there are always financing alternatives that can be considered. For example it is possible to raise finance from selling new shares, borrowing from banks or taking credit from suppliersA key financing decision is whether profits earned by the business should be retained rather than distributed to shareholders via dividends. If dividends are too high, the business may be starved of funding to reinvest in growing revenues and profits.


Cash Flow Statements

• Operating Activities –provides an overview of the cash flow generated by regular company operations

• Financing Activities – cash inflows or outflows received from investors, such as stock or share holders. A cash outflow is the money paid for the use of funds such as interest and dividends. A cash inflow represents the money raised from issuing or selling shares.

• Investing Activities – refers to the purchase of items which can be sold for a profit in the future, and that profit or loss is not related to operations. This may also include the sale or purchase of assets such as property or land.


Income Statement (Profit and Loss Account)


What is an Income Statement)• An income statementor profit and loss account – also known as

P & L, revenue statement, statement of financial performance, earnings statement, operating statement, statement of operations or statement of comprehensive income

• Shows the company's revenues and expenses (‘top line’) during a particular period.

• Indicates how the revenues are transformed into the net income (the result after all revenues and expenses have been accounted for, also known as ‘net profit’ or the ‘bottom line’).

• Displays the revenues recognized for a specific period, and the cost and expenses charged against these revenues, including write-offs (e.g., depreciation and amortization of various assets) and taxes.

• The purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported.

• It represents a period of time, like the cash flow statement.


Depreciation• Depreciation is the decline in price of an asset over time attributable

to deterioration, obsolescence, and impending retirement.

• Depreciation is used to ‘write off’ the cost of an asset over its useful lifetime.

• It does not reflect the passing of actual money but is a measure of the "cost to the company" of the use and ownership of the asset for the period under review.

• The ‘net book value’ (cost less depreciation) of the assets, as shown in the accounts, reflects the "value to the company" rather than the "market value".

• During each accounting year, a figure of depreciation will be calculated which represents an approximation of the cost to a business of owning the asset.


Amortization• A principle of accounting similar to depreciation where it gradually

reduces the value of an asset or liability over time via payments.

• For a tangible asset, this process spans the useful life of the item.

• For liabilities, (such as a loan) amortization covers a set period of time where the money is repaid.

• In this way a portion of known income is allocated to the life of the loan repayment.

• Depreciation and amortization are not the same!

• Depreciation is mainly used in regard to tangible assets, such as buildings, vehicles, machinery or property.

• Amortization is mainly used in regard to intangible assets, such as copyrights, patents or product development costs.


Statement in Movements in Equity

• Shows all changes in owner’s equity for a period of time. • Is is one the five components of complete financial

statements (balance sheet, income statement, statement of changes in equity, statement of cash flow and notes to financial statements.

• Provides readers with useful information on how the capital or business funds are used.

• Since it shows the movements of equity and accumulated earnings and losses, the readers can track where the company’s equity came from and where it’s gone.


Statement of Financial Position (Balance Sheet)


Content of Statement of Financial Position

• A summary of the financial balances of a business.• Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its

financial year. • A "snapshot of a company's financial condition"• The balance sheet is the only statement which applies to a single point in time of a business'

calendar year.• Three parts: assets, liabilities and ownership equity. • Assets are usually listed first, and typically in order of liquidity. • Assets are followed by the liabilities. • The difference between the assets and the liabilities is known as equity or the net assets or the

net worth or capital of the company• According to the accounting equation, net worth must equal assets minus liabilities.• Balance sheets are presented with assets in one section and liabilities and net worth in the other

section with the two sections "balancing".• A business operating entirely in cash can measure its profits by withdrawing the entire bank

balance at the end of the period, plus any cash in hand. • However, many businesses are not paid immediately; they build up inventories of goods and they

acquire buildings and equipment. • In other words: businesses have assets and so they cannot, even if they want to, immediately

turn these into cash at the end of each period. • Often, these businesses owe money to suppliers and to tax authorities, and the proprietors do not

withdraw all their original capital and profits at the end of each period. • These debt are the liabilities of the business.


Current Assets

• On a balance sheet, assets will typically be classified into current assets and long-term assets (known as non-current assets)

• A current asset is an asset which can either be converted to cash or used to pay current liabilities within 12 months.

• Typical current assets include cash, cash equivalents, short-term investments, accounts receivable, stock inventory and the portion of prepaid liabilities which will be paid within a year.


Non-current Assets• Fixed assets, also known as a non-current asset, such as property,

plant, and equipment (PP&E), is a term used in accounting for assets and property that cannot easily be converted into cash.

• This can be compared with current assets such as cash or bank accounts, which are described as liquid assets. These are assets whose future economic benefit is probable to flow into the entity, whose cost can be measured reliably.

• These are items of value that the organization has bought and will use for an extended period of time

• Fixed assets normally include items such as land and buildings, motor vehicles, furniture, office equipment, computers, fixtures and fittings, and plant and machinery.


Liabilities

Liabilities are monies owed by a business, and include:

Current Liabilities• Current liabilities are all liabilities of the business that are

to be settled in cash within the fiscal year or the operating cycle of a given business, whichever period is longer.

• For example, accounts payable for goods, services or supplies that were purchased for use in the operation of the business and payable within a normal period would be current liabilities.

• Amounts due to bank are current liabilities.


Non-current Liabilities

Non-current Liabilities• Non-current liabilities are those debts that are

long term, or not expected to be paid within one fiscal year.

• These debts are calculated as the present value of future cash payments.

• Some examples are mortgages, bonds, pensions, long term leases and business loans.

• Also called long term liability.


Financial Ratios


What are Financial Ratios?

• A ratio simply expresses the relationship between one figure appearing in the financial statements and some other figure in the financial statements:

• Financial ratios provide a quick and relatively simple means of examining the financial health of a business.

• A ratio can also be calculated by expressing the relationship between a financial figure in the financial statements with a figure from some resource of the business.

• Values used in calculating financial ratios are taken from the balance sheet, income statement, statement of cash flows or sometimes the statement of retained earnings.

• Ratios generally are not useful unless they are benchmarked against something else, like past performance or another company.

• Thus, the ratios of businessesin different industries, which face different risks, capital requirements, and competition are usually hard to compare.

• Financial ratios allow for comparisons within the business, between businesses.

• By calculating a relatively small number of ratios it is possible to build up a good picture of the position and performance of a business.

• Ratios are only the starting point for further analysis.

• They help to highlight the financial strengths and weaknesses of a business but cannot by themselves explain why certain strengths or weaknesses exist or why certain changes have occurred.


Financial Ratio Classification

• Ratios can be expressed in various forms – as a percentage, as a fraction, as a proportion.

• The way a particular ratio is presented depends on the needs of the user of the information.

• Many ratios exist, but these below are considered to be among the most useful for decision making purposes.


Efficiency RatiosEfficiency ratios examine the ways in which various resources of the business are managed. The ratios below consider some of the more important aspects of resource management in travel and tourism organizations:

Return on total assets (ROA)Regarded as a key ratio by many businesses this ratio measures efficiency of the business in using its assets to generate net income.

Asset turnover ratioThis ratio examines how effectively the assets of the business are being employed in generating sales revenue. A higher asset turnover ratio is preferred to a lower ratio as higher ratio suggests that assets are being used more productively in the generation of revenue.

Creditor DaysThis is the average time that a company takes to pay its creditors.

Debtor DaysThis is a measure of the average time payment takes to be made to the company.

Capital Employed per EmployeeThis ratio indicates the level of investment provided for each employee.


Profitability RatiosProfitability ratios measure the firm's use of its assets and control of its expenses to generate an acceptable rate of return. Profitability ratios offer several different measures of the success of the business at generating profits.

Net profit margin Relates the net profit for the period to the sales during the period. It is often regarded as the most appropriate measure of operational performance for comparison purposes as differences arising from the way in which a business is financed will not influence this measure.

Gross profit marginA measure of the gross profit earned on sales. It relates the gross profit of the business to the sales generated for the same period. The ratio is therefore a measure of profitability in buying or producing goods/services before any other expenses are taken into account.

Return on assets (ROA) – (also an Efficiency Ratio)A measure of how effectively the company’s assets are being used to generate profits. This is a fundamental measure of business performance. It uses net profit BEFORE tax

Return on equity (ROE) This is the bottom line measure for the shareholders, measuring the profits earned for each dollar invested and involves calculating net profit AFTER tax.

Return on Capital Employed (ROCE)This is a fundamental ratio used to monitor business performance, measuring the amount of profit earned as a percentage of capital employed. The higher the ratio, the better the company performance.


Liquidity RatiosLiquidity ratios provide information about a company’s ability to meet its short-term financial obligations. They are of particular interest to those extending short-term credit to the business. The three common ratio calculates for liquidity are:

The Current Ratio is commonly used for this calculation and is the ratio of current assets to current liabilities. Also known as the ‘working capital ratio’.

Quick Ratio (Acid Test Ratio) - The quick ratio is an alternative measure of liquidity that does not include inventory in the current assets. This is a more stringent test of liquidity.

The Cash Ratio is the most conservative liquidity ratio. It excludes all current assets except the most liquid: cash and cash equivalents. The cash ratio is defined as follows:


Gearing Ratios (leverage) • Gearing occurs when a business is financed, at least in

part, by contributions from outside parties.

• The level of gearing (the extent to which a business is financed by outside parties) associated with a business is often an important factor for assessing risk.

• In a capital intensive industry a Gearing Ratio of 50% or less can be considered reasonable. A Gearing Ratio above 50% is considered to be risky, since borrowing funds has a cost attached to it by way of interest.

The Gearing Ratio measures the contribution of long-term lenders to the long-term capital structure of a business:


Investment Ratios

These are ratios designed to help investors assess the returns on their investment.

Dividend Payout Ratio

This ratio measures the proportion of earnings that a company pays out to shareholders in the form of dividends.


Activity Ratios

Inventory Turnover Ratio• Shows how many times a company's inventory is sold and replaced over a period. • Companies that learn to turn inventory into revenue at a faster pace typically have

better cash flows because they are not sitting on inventory that is unsold.• Investors prefer higher inventory turnover ratios to lower ones.

Accounts Receivable Turnover Ratio• Is used to quantify a company’s effectiveness in extending credit as well as collecting

debts. • Tells how efficient a company is at collecting the money its customers owe. • Higher ratios usually mean that the company is efficiently collecting the money owed by

its customers.• A low ratio implies the company should re-assess its credit policies in order to ensure

the timely collection of imparted credit that is not earning interest for the firm.

Activity ratios measure how quickly a firm converts non-cash assets to cash assets:


Debt Ratios

The debt ratio compares a company's total debt to its total assets, which is used to gain a general idea as to the amount of leverage being used by a company. The more debt compared to assets a company has, (signaled by a high debt ratio), the more leveraged it is and the riskier it is considered to be.

• Debt ratios calculate what proportion of debt a company has relative to its assets. The measure gives an idea to the leverage of the company along with the potential risks the company faces in terms of its debt-load.

• A debt ratio of greater than 1 indicates that a company has more debt than assets.

• A debt ratio of less than 1 indicates that a company has more assets than debt.

• Used in conjunction with other measures of financial health, the debt ratio can help investors determine a company's level of risk.

Finance & Funding in Travel and Tourism - Financial accounts

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Transcript of Finance & Funding in Travel and Tourism - Financial accounts