Understanding financial statements - a business tool

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� Determine financial performance› Gross profit

› Net profit

� Determine financial position� Close off financial year

� Check monthly bookkeeping cycle

� Ensure accuracy of transactions (reconciliations)


� Trading account

� Profit and Loss

account

� Combined into a

statement known as

Income Statement

› reflects financial

performance

� Statement of

Financial Position

� Better known as

Balance Sheet

› Reflections financial

position


� By sufficiently preparing for your annual audit will not only reduce your audit fees but will also free up your finance/accounting personnel whilst your audit is in progress.

� The following is some examples of information that can be prepared in advance.


� Invoices for additions

& disposals of all

fixed assets

� Statements for

investments

reflecting their

balance at year

end.

� A reconciliation of

movement on

investment accounts

� A copy of the

inventory at year

end, reflecting any

necessary notes&

explanations thereto


� A copy of the debtor’s age analysis at year end as well as a summary of what sundry debtors consist of.

� Statements for bank accounts & Cash on Hand reflecting their balance at year end.

� A summary of change in Capital or Members interest.

� A copy of the creditors age analysis of year end as well as a summary of what sundry creditors consist of


� Amortisation (depreciation) schedules for all instalment agreements and a summary of movements on all the loans

� Copies of receipts for any taxes paid

� A separate file can be done with all creditors reconciliations at year end.


� All bank statements filed with bank reconciliations

� UIF and PAYE submissions

� Cash slips filed with cash reconciliations

� Archive and catalogue documents

� Digital backups filed

� Asset register

� Statutory returns


� Sort all documents into categories

� File in date order

� Capture on a spread sheet or piece of paper.

� Bank and cash reconciliations

� Debtors’ invoices

� Debtors’ Statements

� Creditors’ invoices

� Creditors’ Statements

� Inventory list at cost price

� Asset register


� Backup – at least two; stored in different places.

� Print out all relevant financial statements

� Check through all general ledger accounts for errors

� Check through all debtors’ accounts

� Check through all creditors’ accounts

� Run data integrity

� Run year end

� Back up – if you make use of passwords ensure they are recorded somewhere you can find them when needed


� Trial Balance

� Income Statement

� Balance Sheet

� Cash Flows

� General Ledger

� Debtor’s Ledger

� Creditors’ Ledger

� Age Analysis for

Debtors’ & Creditors’

� Budget

� Inventory

� Stock Take

� Ensure end of

financial year Bank &

Cash Reconciliations

printed.

� PAYE reconciliations

� UIF reconciliation


� Physical Stock Take

� Compare to records

� Make adjustments with full account of any discrepancies and why.

� Carrying too much/little stock.

� Obsolete stock

� Damaged stock

� Selling of obsolete/damaged stock

� Write off’s

� Trading inventory deficit’s/excess


� Accruals› Expenses and incomes relevant to the financial year / period

� Matching principle› Match expenses to income within the financial period in which the profit or loss was incurred

� Principle of Prudence› Where the real value of an asset or income is doubtful one should rather be conservative and UNDERESTIMATE the true value

› and

› Expenses or Liabilities should be overestimated when in doubt.


� Should be done at least monthly

› Bank reconciliation

› Debtors reconciliation

› Creditors reconciliation

› VAT (bi-monthly)

› PAYE (bi-annually)


� Profitability ratios

› Gross profit percentage

(Gross Profit ÷ Total Sales) x 100%The GP % indicates how much gross profit is earned for every R1 of sales.

› Net Profit percentage

(Net Profit ÷ Total Sales) x 100%The NP & indicates how much net profit is earned for every R1 of sales.


› Return on average Owner’s Equity

(Net Profit ÷ Average Owner’s Equity) x 100%Average Owner’s Equity (opening balance + closing balance ÷ 2)

Is it worth the owner’s investment.


� Liquidity ratios

› Current Ratio

Current Assets : Current LiabilitiesIndicates how liquid the business is i.e. if the business is able to cover its

short-term liabilities.

› Acid Test Ratio (Quick Ratio)

(Current Assets – Inventory) : Current LiabilitiesIndicates liquidity without having to sell stock


� Liquidity ratios continued

› Average Debtors Collection Period

(Average Trade Debtors ÷ Credit Sales) x 365 days

› Average Creditors Settlement Period:

(Average Trade Creditors ÷ Credit Purchases) x 365 days

› Average Inventory Turnover

Cost of Sales ÷ Average Inventory


� Degree of Solvency

› Total Assets : Total Liabilities

Indication that business is not bankrupt.

� Leverage

› Debt/Equity ratio

� Long-Term debt : Total EquityRatio between borrowed capital and own capital. Used to establish credit

worthiness of a business


� Depreciation

› Adjustment at the end of the financial year (or on sale of asset) where the value of the non-current asset is adjusted to a realistic value relative to the life span of the non-current asset. (net realisable value –realistic trade value)

› The original cost of the asset is adjusted with the calculated depreciation = carrying value / book value

› Depreciation is the expense

� Two methods of depreciation

› Straight line method

› Diminished balance method


� Shows all important details regarding a

particular non-current asset

� Supporting documentation to the general

ledger

� Information kept from date of purchase till date

of sale

� Pre-requisite of SARS


� Care must be taken when disposing of assets

to be realistic in regards to final calculation of

depreciation

� Net realisable value vs market value

� Profit or Loss on Sales of the non-current asset


� Why is financial year end so important?

� What can be learned from financial year end

� Cash Controls?

� Management decisions

� Financial decisions

� Stock controls

� Debtor control

� Creditor control

� Ensure your costing's are correct

� Successful, vibrant, encouraging entrepreneur.

� Analysis & interpretation



The End

Alison Engelbrecht

[email protected]

Understanding financial statements - a business tool

Business

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