Some advisable tips for Portfolio Managers

• You should have an academic background in computer science or engineering physics or biology
• If you are a degree student you have to consider masters degree in business, economics, accounting and math. An MBA degree is the most important and popular among portfolio managers.
• A professional designation is to choose the Financial Chartered Analyst charter. In order to consider this, candidates must demonstrate a proficiency in financial and accounting terms and techniques, economics and quantitative analysis as well as prove the required work experience.
• In a firm or company, analyst post is the background training for becoming a portfolio manager
• Incase if you enter in to a professional environment, you may want to begin by picking and choosing stocks in a mock portfolio club/online simulator

Types of Portfolio Manager Positions

There are various positions with in the realm of Portfolio mangers. The positions are following types -

Investing Style

This depends upon specialize the equity or fixed-income investing. The range of investment styles includes using hedging techniques, a growth or value style of management, small or large cap specialties, and domestic or international fund investing.  

Size of Fund

A Portfolio Manager should manage the assets for a relatively small independent fund or a large asset management institution. A portfolio manager may also manage the capital of a large business such as a bank or an organization that has a large endowment such as a college or university. In such cases, a manger who manages the large asset management institution is known as a Portfolio Manger and who manages the small asset management is known as a Fund Manager.

Type of Investment Vehicles

A manager performs the managing assets for their widely investment vehicles. he range of investment vehicles includes retail or mutual funds, institutional funds, hedge fund, products, trust and pension funds, and commodity and high net worth investment pools.

A Portfolio manager's day life is very difficult to notice, one constant is checking the status of the financial markets and staying on top of current events. A portfolio manager will meet regularly with his or her analysts in order to discuss market developments and the trends of relevant current events.

In addition to meeting with the analysts on staff and monitoring the markets and current events, a portfolio manager has many other responsibilities to attend to. Portfolio managers often meet with high-level investors, or potential investors, in person or over the phone.

Return-on-equity can be calculated on a per-share basis or on a whole figure basis.

On a per-share basis RoE is calculated by dividing Earnings Per Share, EPS, by Book Value. Earnings Per Share are calculated by dividing the Net Profit After Tax, NPAT, by the number of shares outstanding for the company. Book Value is the business Equity divided by the number of shares outstanding in it. It is also called Equity Per Share.

As an example, Qantas EPS are $0.398 while its Book Value is $3.12. RoE can be calculated as follows: 0.398/3.12*100 = 12.76%. Because RoE is a percentage figure if must by multiplied by 100.

On a whole figure basis, RoE is calculable by dividing NPAT by Equity.

To know how much Return-on-equity you should be demanding, RoE has been statistically found to be on average 12 per cent in the US. So, you could take that as a benchmark.

On the other hand, when appraising an investment decision, you should find out how much return alternative investments such as bank deposits or bonds are offering and compare it with your company's RoE.

There are other measures of profitability such as Return-on-capital, RoC. Since when you start a business you often use debt besides equity it makes sense to take that into account and find out how much the business is faring on that basis.

RoC is calculated by dividing NPAT by Equity plus Long-Term Debt multiplied by 100. RoC should be lower than RoE.

Still using Qantas as an example, NPAT is $719.4 million, Equity is $6189.1 million and Long-Term Debt is $4978.7 million. So, RoC is: 719.4/(6189.1+4978.7)*100 = 6.44%.

Another measure of profitability is Return-on-assets, RoA. This is especially important for businesses which have great asset requirements such as the automobile industry and manufacturing generally. RoA is calculated by dividing the NPAT by the Assets of the company and multiplying by 100.

The reader could find the information to seed these calculations from the websites of the companies in question. Just look for Corporate and download their latest Annual Report where you can find all the necessary financial information. Additionally, you could find the required financial data from online databases accessible through this and other websites.

 

Sell your product to different companies:

Many industrialists produce goods for only one Consumer Company. They also depend on single public sector companies and also mediators. Most of them install large machinery in their factories for producing goods for this single consumers or public sector companies. But they may not have solid contracts (long term) with this companies.

But these single consumers may later start to reduce the orders cancel the Contract it self. Or they may take a lot of time to give you the money. In most cases, they will do both .The small industries will face a difficult time due to this. The consumer companies do this because of reasons like economic recession or a low Budget. The depth of the problem depends on how much the small industry depends on its single consumer company.

Don't expand the fixed assets without sufficient working capital

Looking for more orders, many small industries will expand their assets without sufficient working capital. You can grow only if you have money in your hand reach.

Why do you need a working capital?

• You need to give money for raw materials in advance
• Stock raw materials if it is available in a low price in the market
• Keep a normal stock of raw material
• You wait for the money from your consumer till they sell the products

Don't take a loan with a huge interest

Many industries have to take loan for the following reasons. And they will face an invited money related stress due to improper money management. This happens in situations when they have to do more business than the working capital permits. Then they will face problems like unavailability of liquid cash, difficulty in giving salaries and paying taxes and settling all kinds of bills. To avoid this difficulty, most of the industrialists will take a loan. Paying the large interest will reduce the original profit from the business.

How much honesty?

Corruption is a common thing. Even in the age of globalize Markets, industrialists need to go back door if they want to reduce the time due to red tape and other monetary difficulties and grow their company. Many industrialists evade taxes. But this is not good. Of course, an intelligent tax consultant can reduce your burden but still don't try to slash your original sales and profit for evading the Taxes. This may create you problems in your future.

Look for your safety when you are selling in debt.

In 1993, Steel Industry faced a great recession and took average 6 months to get back the money from the market. In such situations selling in debt is very unsafe especially if you took a loan with a large interest. Many good industrialists hence always try to reach a stage where they will receive the money before or at the time of selling.

Absorb good labor

Replacing a bunch of costly efficient laborers with a large number of less efficient and less costly labors is a habit of most Industrialists. This should be avoided for growth. The best thing is to wait before appointing a person. Take a person only if you have well defined tasks that should be implemented immediately or if you feel that the person is effective and you have the capability to give the demanded salary.Dont appoint in a hurry. Search and select the best only. Don't show misery when setting his salary. Try to give more than the demanded salary. Then increase the number of tasks. You can surely demand good performance and if he is up to mark congratulate him.

Face the competition

Competition is unavoidable in every Business. Competition is mainly from 4 sources

• From companies in the same industry
• Suppliers of the raw material straightly start production
• The consumers of that product also starting industries
• From industries with products used for the same application

There are two ways to face the competition. First, increase your market presence with more investments while safeguarding your market. Second, try to control the opponents and distance the likely to be opponents from the market.

Conclusion

This is some tips to progress your company from a small scale level. But experience teaches better than theory.

Working Capital is defined as Current Assets minus Current Liabilities.

Current Assets are mainly Inventory, Accounts Receivable (Debtors), Cash and Bank Balances, other debtors and prepayments.

Current Liabilities are mainly Accounts Payable (Creditors), Bank Borrowings, Other Liabilities such as Accrued Expenses. Bank Borrowings are short term borrowings or part of long term borrowing which are repayable within a year.

When Current Assets is greater than Current Liabilities it is known as Positive Working Capital. When a company has positive working capital it would generally mean that the company is handling its operations well enough to meet its short term obligations. It speaks about the efficiency with which it is managing its day to day operations.

When Current Liabilities is greater than Current Assets it is known as Negative Working Capital. One of the interpretations would be that the company does not have sufficient funds to run the day to day business and thus may have to rely on introduction of funds by owners or long term borrowings to meet its operational requirement.

Formula of Working Capital

Working Capital = Current Assets - Current Liabilities.

Example of Working Capital

• Abstract from the Balance Sheet as on 31-12-07
• Stock - $ 25,000
• Debtors - $ 35,000
• Cash In Hand - $ 2,000
• Other Debtors and Prepayments - $ 12,000
• Creditors - $ 28,000
• Bank Borrowings - $ 15,000
• Accrued Expenses & Other Liabilities - $ 6,000
• Working Capital = Current Assets - Current Liabilities
• Current Assets = Stock + Debtors + Cash In Hand + Other Debtors and Prepayments
• Current Assets = 25,000 + 35,000 + 2,000 + 12,000
• Current Assets = $ 74,000
• Current Liabilities = Creditors + Bank Borrowings + Accrued Expenses & Other Liabilities
• Current Liabilities = 28,000 + 15,000 + 6,000
• Current Liabilities = $ 49,000
• Working Capital = 74,000 - 49,000
• Working Capital = $ 25,000

The Working Capital amounts to $ 25,000. It means that the company is able to meet its daily operational requirement. The business appears to be self sufficient. The cash generated from operations over a period of a year or two can be utilized to purchase fixed assets and other expansion to grow the business.

Companies and investors would also compute the Current Ratio after calculating the Working Capital. Current Ratio is Current Assets divided by Current Liabilities. Thus in this case the Current Ratio is

• Current Ratio = Current Assets / Current Liabilities
• Current Ratio = 74,000 / 49,000
• Current Ratio = 1.5

The Current Ratio needs to be compared with the industry standards. For most industries the Current Ratio between 1.5 to 2 is considered good.

Working Capital Management

It is important for any organization to manage its Working Capital, a skill which a Finance Professional needs to possess.

The major elements in the working capital requirement which need to be managed are

• Inventory - Inventory needs to be kept at a reasonable level which is not too high to result in non moving stock nor too low such that the company suffers stock outs. The factors in determining the inventory to be stored are Reorder Level, Minimum Level, Maximum Level and Economic Order Quantity.
• Debtors - The credit period enjoyed by the Customers needs to be defined. Customers are required to pay within the credit period. The receivables need to be followed up on maturity for collection.
• Creditors - The payment terms need to be well negotiated with the creditors. This usually depends upon the product purchased.

However it cannot be stated that if the working capital is high the business is managed efficiently. There needs to be balance between the Current Assets vis-à-vis the Current Liabilities. An increase in Current Assets could also mean that the business is not able to collect its debts on time or has Inventory piled up which they are not able to sell. Each element in the Working Capital calculation (stock, debtors, creditors) has its own relevance and needs to be managed.

Fixed Assets Turnover Ratio = Sales / Net Fixed Assets

Instead of Net Fixed Assets, one can even use the Average Net Fixed Assets. The Average Net Fixed Assets is calculated by adding the Opening and Closing Net Fixed Assets for the period and dividing the result by 2.

As per the Formula the Fixed Asset Turnover Ratio needs to be calculated on Net Fixed Assets. One can always debate whether to take Gross Fixed Assets or Net Fixed Assets for the purpose of calculating Fixed Asset Turnover Ratio. It is best to calculate it on both the ways since both will give different results and thus will have different interpretations.

The 3 examples given below explain why it is better to take Gross Fixed Assets instead of Net Fixed Assets.

Examples

Various examples of Fixed Asset Turnover Ratio (FATR) to reflect the result calculated on the basis of Gross Fixed Assets vis-à-vis Net Fixed Assets are

Scenario 1

Assuming that the Turnover over a period of 5 years has remained the same and Depreciation is charged on Straight Line Method Basis (Fixed Basis) @ 15%.

Let us Assume that Sales for each year is $ 100,000.

Fixed Assets Purchased amounts to $ 50,000

Net Fixed Assets (i.e. after Depreciation) for the 5 Years is

Year 1 - $ 42,500

Year 2 - $ 35,000

Year 3 - $ 27,500

Year 4 - $ 20,000

Year 5 - $ 12,500

Fixed Asset Turnover Ratio on Gross Fixed Assets will be

FATR = 100,000 / 50,000 = 2

Fixed Asset Turnover Ratio on Net Fixed Assets

Year 1

FATR = 100,000 / 42,500 = 2.4

Year 2

FATR = 100,000 / 35,000 = 2.9

Year 3

FATR = 100,000 / 27,500 = 3.6

Year 4

FATR = 100,000 / 20,000 = 5

Year 5

FATR = 100,000 / 12,500 = 8

Thus FATR remains the same at 2 on Gross Fixed Assets for a period of 5 years, whereas it keeps increasing year on year if calculated on Net Fixed Assets although the Sales has remained the same. It may give an indication that the company is performing well which may not necessarily be the case. In case the expenses remain the same there would also not be any difference in the profits of the company for the 5 year period.

Scenario 2

Assuming that the Turnover has increased over a period of 5 years and Depreciation is charged on Straight Line Method Basis (Fixed Basis) @ 15%. There is additional purchase of Fixed Assets during the 5 year period.

Thus the Sales for the period of 5 years is

Year 1 - $ 100,000

Year 2 - $ 110,000

Year 3 - $ 125,000

Year 4 - $ 150,000

Year 5 - $ 200,000

Fixed Assets Purchased each year includes

Year 1 - $ 50,000

Year 2 - $ 10,000

Year 3 - Nil

Year 4 - $ 20,000

Year 5 - $ 20,000

Gross Fixed Asset Value for the period of 5 years is

Year 1 - $ 50,000

Year 2 - $ 60,000

Year 3 - $ 60,000

Year 4 - $ 80,000

Year 5 - $ 100,000

Net Fixed Asset Value for the period of 5 years is

Year 1 - $50,000 - (15% of $50,000) = $ 42,500

Year 2 - ($ 42,500 - $ 7,500) + ($10,000 - $1,500) = $ 43,500

Year 3 - ($ 35,000 - $ 7,500) + ($ 8,500 - $ 1,500) = $ 34,500

Year 4 - ($ 27,500 - $ 7,500) + ($ 7,000 - $ 1,500) + ($ 20,000 - $ 3,000) = $ 42,500

Year 5 - ($ 20,000 - $ 7,500) + ($ 5,500 - $ 1,500) + ($ 17,000 - $ 3,000) + ($ 20,000 - $ 3,000) = $ 47,500

Thus Year Wise Fixed Asset Turnover Ratio on Gross Fixed Assets and Net Fixed Assets is

Year 1

On Gross Fixed Assets

FATR = (100,000 / 50,000) = 2

On Net Fixed Assets

FATR = (100,000 / 42,500) = 2.4

Year 2

On Gross Fixed Assets

FATR = (110,000 / 60,000) = 1.8

On Net Fixed Assets

FATR = (110,000 / 43,500) = 2.5

Year 3

On Gross Fixed Assets

FATR = (125,000 / 60,000) = 2.1

On Net Fixed Assets

FATR = (125,000 / 34,500) = 3.6

Year 4

On Gross Fixed Assets

FATR = (150,000 / 80,000) = 1.9

On Net Fixed Assets

FATR = (150,000 / 42,500) = 3.5

Year 5

On Gross Fixed Assets

FATR = (200,000 / 100,000) = 2

On Net Fixed Assets

FATR = (200,000 / 47,500) = 4.2

From the example above it can be seen that FATR on Gross Fixed Assets has remained in the range of 1.8 to 2.1. Though the Turnover has doubled between Year 1 to Year 5, the company has consistently invested in Fixed Assets during these 5 years, the Gross Value of which has also doubled in these 5 years. Thus the FATR in Year 1 and Year 5 has remained the same i.e. Turnover is 2 times Gross Fixed Assets. Thus it appears that the company is capital intensive and may be heavily dependent on adding Fixed Assets to increase its turnover.

When the above ratio is calculated on the basis of Net Fixed Assets there is an improvement in FATR from 2.4 in Year 1 to 4.2 in Year 5. The FATR of 4.2 at the end of year 5 may prima facie appear to be encouraging, however this may not necessarily be the case if all facts are considered.

Calculated on Net Fixed Assets the FATR has reduced only once from Year 3 (FATR is 3.6) to Year 4 (FATR is 3.5) due to addition in Fixed Assets amounting to $ 20,000 in Year 4, whereas the Turnover has increased by only $ 25,000 between Year 3 and Year 4.

On the basis of Gross Fixed Assets, there is a good increase of FATR ratio by 0.3 between Year 2 (FATR is 1.8) to Year 3 (FATR is 2.1) since the Turnover has increased inspite of no addition in Fixed Assets.

It would be more satisfactory for an organisation to see its FATR improve due to increase in turnover rather than decrease in value of its Fixed Assets because of depreciation.

Scenario 3

Assuming that the Turnover has decreased marginally over a period of 5 years and Depreciation is charged on Straight Line Method Basis (Fixed Basis) @ 15%.

The Sales for the period of 5 years is

Year 1 - $ 100,000

Year 2 - $ 98,000

Year 3 - $ 95,000

Year 4 - $ 90,000

Year 5 - $ 80,000

Fixed Assets Purchased amounts to $ 50,000

Net Fixed Assets (i.e. after Depreciation) for the 5 Years is

Year 1 - $ 42,500

Year 2 - $ 35,000

Year 3 - $ 27,500

Year 4 - $ 20,000

Year 5 - $ 12,500

Thus Year Wise Fixed Asset Turnover Ratio on Gross Fixed Assets and Net Fixed Assets is

Year 1

On Gross Fixed Assets

FATR = (100,000 / 50,000) = 2

On Net Fixed Assets

FATR = (100,000 / 42,500) = 2.4

Year 2

On Gross Fixed Assets

FATR = (98,000 / 50,000) = 1.96

On Net Fixed Assets

FATR = (98,000 / 35,000) = 2.8

Year 3

On Gross Fixed Assets

FATR = (95,000 / 50,000) = 1.9

On Net Fixed Assets

FATR = (95,000 / 27,500) = 3.5

Year 4

On Gross Fixed Assets

FATR = (90,000 / 50,000) = 1.8

On Net Fixed Assets

FATR = (90,000 / 20,000) = 4.5

Year 5

On Gross Fixed Assets

FATR = (80,000 / 50,000) = 1.6

On Net Fixed Assets

FATR = (80,000 / 12,500) = 6.4

From the example of Fixed Asset Turnover Ratio above again it can be seen that though the Sales is dropping every year, the FATR calculated on Net Fixed Assets has kept increasing from 2.4 (Year 1) to 6.4 (Year 5). During the same period the FATR on Gross Fixed Assets has dropped from 2 to 1.6.

There is every possibility that there is a drop in the Net Profits due to the fixed costs involved in running the business. However the FATR calculated on Net Fixed Assets will continue to show a positive picture.

Interpretation and Conclusion

A higher ratio means that the company is efficiently utilizing its Fixed Assets to generate revenue. A low ratio would mean that the company has huge funds blocked in its Fixed Assets, which may require reduction of investment in Fixed Assets or improving the sales in line with the investment. However it is also advisable to compare the ratio with companies in the same industry / business. An internal comparison on a year to year basis will not be sufficient.

There are several common methods to protect your assets. Not placing all of your assets under your name is a method to protect your assets. You should seek the advice of your lawyer or accountant to properly do this. Make sure you have a licensed lawyer and certified accountant to assist you in handling the protection of your assets. It is important to have quality professional help. There are a lot of scam artists and untrustworthy people claiming to be certified. Always check their references before hiring people to aid in your finances. It is wise to protect your assets with insurance as well. Adequate insurance coverage is vital for protection of assets. You always have the potential risk of a sudden illness, accident, or case filed against you. The risk of being sued alone is enough to be insured. Double incorporating can be implemented for business owners to protect assets. Proper scheduling is a method that lets you manage your assets and keep privacy. Keeping a low profile of your assets can help to protect them in some cases too.

Assets are the tangible things your company owns. Your inventory for resale is an asset. So is any equipment you have, including computers, copiers, refrigerators and microwaves and office furniture. Even office supplies you have on hand are considered assets, though they are consumable. Any office supplies or other consumables you have on hand are valued at the amount at which they were purchased. So is inventory. Your checking account, petty cash and accounts receivables are also assets valued with no adjustment to your books. Any equipment your company owns is valued at a specific percentage of the purchase price based on age. The adjustment for the loss in value is called depreciation.

There is also a term for things that have no purchase value, but can still increase the value of your company. These things are called intangible assets. Contracts, customer lists, contacts, insider knowledge, and patents are intangible assets. Many of these things are based on the current condition of the market in your niche, and will vary depending on the timing of this calculation. Really anything you can stake a claim to is an asset. The value of these things is not based on anything other than purchase price and time since. If you owe money on something, that part of the calculation for the value of your company is recorded under liabilities.

Liabilities are accounts that show the amount of money your company owes people. Any loans, accounts payable and payroll liabilities are all accounts that indicate money owed and qualify as liabilities. The equity in your company is the difference between your assets and your liabilities. If your liabilities exceed your assets, then your equity will be negative. The report that shows all of this is called a balance sheet. It is a collective value for your company based on the assets, the liabilities and the equity. The assets will always equal the liabilities plus the equity. Subtracting the liabilities and the equity from the assets will always equal zero. That is the balance. The balance sheet is necessary in calculating taxes, but it has nothing at all to do with expenses.

Expenses are a record of how your company spends money. They help you budget, and they help you figure out your net profit and thereby your company taxes, but only figure into the value of your company in the net profit. Your expense accounts should be specific enough to help you keep your records organized, but they do not need to be individualized to each vendor. Common expense accounts are, among others, freight, office supplies, advertising, telephone, rent, utilities, insurance, licenses and fees, travel and entertainment, and taxes. Many companies also utilize a miscellaneous expense account for random expenses incurred which do not fall under any of the other categories, particularly if the purchase is a one-time thing. Donuts for a breakfast meeting might fall under this category.

Something that many people do not understand is that each and every time you spend money on something it falls under some expense account somewhere. Whether or not that expenditure is a valid expense is a totally different issue. If you spent the money out of your company and not personally, it falls under an expense account. If it is supposed to be personal, I recommend recording it under payroll as a bonus or something so that it is taxed appropriately and in the event of an audit you can avoid a penalty.

I highly recommend that everyone learn the basics of assets, liabilities and expenses. It will make everything you do in your business easier. It can help you calculate the value of your company in the event of a sale or merger, and it will also help you avoid problems with various revenue departments. It does not have to be complicated. It just has to be accurate and correct. Once you know the rules, you can follow them. If you already have someone following the rules in your company, now you can begin to understand them.

Accounting - an information system that measures business activities, processes information and communicates financial information.

Users of Financial Information

• External Users - make decisions about the entity

1. Creditors - before making a loan, creditors determine a businesses ability to meet scheduled payments. This determination is based upon the businesses financial information.
2. Individuals - use accounting information to manage bank affairs, evaluate job prospects and make investments.
3. Investors - evaluate the return on capital they can expect to receive from accounting information.

• Internal Users - make decisions for the entity

1. Business Managers - use accounting information to set goals for their orgs, to evaluate progress towards these goals and to take corrective action if necessary.

Fields of Accounting

• Financial Accounting - Focuses on information for people outside the firm, including creditors, government agencies and the general public.
• Management Accounting - Focuses on information for internal decision makers, including top executives, department heads or university deans.

Standards of Professional Conduct

Standards of Ethical Conduct of Individual Companies In light of the collapses of HIH and One Tel, companies are increasing seeing their responsibilities to stakeholders in a broader ethical context.

• KPMG: “ensuring good ethical conduct reduces corporate risk and enhances corporate reputation.”.
• Key to ethics is honest disclosure
• Ethical standards exist to ensure that accounting information is honest and accurate. Thus, users of accounting information are able to rely on this information for decision-making.

Codes of Professional Conduct - have been established in many large accounting organizations”

• Lists obligations/duties of employees
• Requires employees to conduct themselves in certain ways
• Binding

ICAA and CPPA's Joint “Code of Professional Conduct” contains common prescriptions and places common obligations on the members of both professional bodies

• Purpose is maintaining and enhancing their credibility, professionalism and quality
• Lays down minimum standards of conduct

Types of Business Organizations

Proprietorships

• Single owner who is often the manager
• Each proprietorship is distinct from the proprietor

Advantages

• Total undivided attention
• Low levels of bureaucracy, allowing changes to be made quickly

Disadvantages

• Unlimited liability
• Capital is harder to find

Partnerships

• Joins two or more individuals together as co-owners
• Accounting records treat it as a separate entity, distinct from personal affairs of each partner

Advantages

• Skills and abilities of the partners will strengthen the companies foundation and knowledge
• Significantly broadens access to capital by increasing ability to borrow needed funds

Disadvantages

• Unlimited liability
• Possibility of personality or authority conflicts

Companies

• A business owned by shareholders, people whom own shares of ownership in the business
• A company is a legal, individual entity

Advantages

• Limited liability of shareholders
• Relative ease of ownership transference

Disadvantages

• Separation of ownership and control
• Extensive government regulations

Generally Accepted Accounting Principles

Primary Objective of Financial Reporting - To provide information useful for making investment and lending decisions.

The Entity Concept

• Defines the entity for which accounting data are collected
• An accounting entity is an organization or section of an organization that stands apart from other organizations and individuals as a separate economic unit for the purpose of some decision
• Sharp boundaries are drawn around each entity so as not to confuse its affairs with those of other entities and thus bring info that is not relevant to the decision being made
• Important also because allows a separation to be made between the owners of the business and the business itself

The Time Period Concept

• Defines the unit of time for which accounting data is collected and the financial reports prepared
• In Australia, many businesses prepare their statements for the financial year from July one to June 30 the following year
• As a result of this concept, there is a production of yearly financial reports and the calculation of periodic profit

The Cost Principle

• Assets and services acquired should be recorded at their actual cost

The Reliability (Objectivity) Principle

• Information must be reasonably accurate
• Information must be free from bias
• Information must report what actually happened
• Individuals would arrive at similar conclusions using the same data

The Matching Principle

• MP relates the inputs and outputs of a business to one another
• The cost of inputs used up to produce outputs are treated as expenses and subtracted from revenues associated with those outputs in calculating profit for their period

The Profit Recognition Principle

• Profit should be recognized when the revenues related to the relevant activity is “earned”
• Revenues are “earned” when goods and services are sold or otherwise disposed of and all the other expenses to be matched with them can be identified
• Therefore you do not wait for cash to be received or paid before recognizing profit

The Conservatism Principle

• Constrains management's natural optimism, as this could find its way into the reported assets and profits
• “Anticipate no profits, but anticipate all losses.”.
• Recognizing expected loss before expected revenues

The Going Concern Principle

• The entity will continue to operate in the future

Australian Accounting Standards

• Standards to govern measurement rules and level of discourse
• Australian Accounting Standards Board is responsible for technical accounting standards
• AU is moving towards the adoption of International Accounting Standards

The Accounting Equation

ASSETS = LIABILITIES + OWNERS EQUITY

Assets - the economic resources of a business that are expected to be of benefit in the future:

• Cash
• Accounts receivable
• Land/building
• Goodwill

Liabilities - are economic obligations/debts, payable to outsiders (creditors) - eg: accounts payables.

Owners Equity - owners claims to the businesses assets. It is what is left of the assets after liabilities have been deducted.

• Owners have a claim before they have invested in the business
• Also called net assets

Revenues - amounts received r to be received from customers for sales of products or services. Generated from:

Sales

• Performance of services
• Rent received
• Interest received

Expenses - amounts that have been paid or will be paid later for costs that have been incurred to earn revenues:

• Salaries and wages
• Services
• Supplies used
• advertising

Transactions that Affect Owners Equity

Increasing Owners Equity

• Revenue increases OE because they increase the businesses assets but not its liabilities. As a result, the owner's share of the businesses assets increases.
• Owner investments also increase OE

Decreasing Owners Equity

• Owner drawings are those amounts removed from the business by the owner
• Expenses are decreases in OE that occur as a result of using assets or increasing liabilities in the course of delivering goods and services to customers

Financial Statements

• The final product of the accounting process
• Tells how the business is performing and where it stands

Statement of Financial Performance (P&L)

• Summary of businesses revenues and expenses for a specific period
• Presents a moving financial picture of business operations during a period
• Shows net profit (revenues - expenses)

Statement of Owners Equity

• Presents a summary of the changes that occurred in the businesses owners' equity during a specific time - e.g. month or year.

Statement of Financial Position (Balance Sheet)

• Lists all the entity's assets, liabilities and OE as of a specific date
• A snap shot of the entity

Statement of Cash Flows

• Reports amount of cash entering and exiting an entity during a period
• Shows net increase or decrease during the period and cash balance at the end of the period

Accounting Terms

The Account - the basic summary device of accounting is the account - the detailed record of the changes that have occurred in a particular asset, liability or owners equity during a period of time. Are grouped in three broad categories, according to the accounting equation.

Ledger - for convenient access to the information, accounts are grouped in a record called the ledger, which usually takes the form of a computer listing.

Classification of Accounts

1. Cash at Bank account - shows the cash effects of a businesses transactions. Cash means money and any medium of exchange that a bank accepts at face value. Cash at bank includes bank account balances, currency, coins and cheques.
2. Bill Receivable - a written pledge that the customer will pay a fixed amount of money by a certain date. It offers more security for collection than a mere account receivable does.
3. Accounts Receivable - a business may sell its goods or services in exchange for an oral, implied or documented promise of future cash receipt. Such sales are made on credit (on account.)
4. Prepaid Expenses - a business often pays certain expenses in advance. It is seen as an asset because the business avoids having to pay cash in the future for the specified expense. The ledger usually holds a separate asset account for each prepaid expense. Prepaid rent and prepaid insurance are two examples.
5. Land - the land account is a record of the cost or value of land a business owns and uses in its operations. Land held for sale is account for separately in an investment account.
6. Buildings - the cost or value of a business's buildings - office, warehouse, garage, etc, appears in the Buildings account. Buildings held for sale are separate assets, accounted for as investments.
7. Equipment- a business has a separate asset account for each type of equipment - office equipment and store equipment, for example.

Classification of Accounts

1. Bills Payable - this account is the opposite of the Bills Receivable account and represents the amounts that the business must pay because it signed bills of exchange to borrow money or to purchase goods or services.
2. Accounts Payable - this account is the opposite of the Accounts Receivable account. The oral, implied or documented promise to pay off debt arising from credit purchases appears in the Accounts Payable account.
3. Accrued Liabilities - a liability for an expense that have been incurred by the business, but not paid for yet. Examples include Taxes Payable, Interest Payable.

Classification of Accounts - Owners Equity

1. Capital - this account shows the owner's claim to the assets of the business. After total liabilities are subtracted from total assets, the remainder is the owner's capital.
2. Drawings - the amounts taken out of the business by its owner appear in a separate account. If drawings were recorded directly in the Capital account, the amount of owner drawings would not be highlighted and decision-making would be difficult. This account shows a decrease in owner's equity.
3. Revenues - the increase in owner's equity created by delivering goods or services to customers are revenue. If a business lends money to an outsider, it will need an interest Revenue account for the interest earned on the loan.
4. Expenses - a business needs a separate account for each type of expense, such as Salary Expenses, Rent Expense and Advertising Expense.

Double - Entry Accounting

• Each transaction affects at least two accounts
• Each transaction is recorded with at least one debit and one credit
• Total debts must = total credits
• For example, by purchasing supplies by cash, this transaction decreases cash at the bank and increases supplies. A purchase on credit increases supplies and increases accounts payable.
• All transactions have at least two effects on the entity

The T - Account

The account format used most widely is called the T account because it takes the form of the capital letter “T”. The vertical line of the T divides the account into its left and right sides. The account title rests on the horizontal line.

Decreases and Increases in the Accounts

• Increases in assets are recorded on the left (debit) side of the account
• Decreases in assets are recorded on the right (credit) side
• Increases in liabilities and owners equity are recorded by credits
• Decreases in liabilities and owners equity are recorded by debits
• Assets are on the opposite side of the equation from liabilities and owner's equity
• Liabilities and owners equity are therefore, on the same side of the equal sign

• The process of creating a new T account in preparation for recording a transaction is called “opening the account.”

Recording Transactions in the Journal

Accountants record transactions in a journal - a list in chronological order of all the transactions for a business. The journalizing process follows four steps:

1. Identify the transaction from source documents, such as sales and sales receipts
2. Specify accounts affected by the transaction and classify it by type (asset, liability or owner's equity)
3. Determine whether each account is increased or decreased by the transaction. Using the rules of debit or credit the account to record its increase or decrease
4. Enter the transaction in the journal, including a brief explanation for the journal entry

The journal entry includes:

1. The date of the transaction
2. The title of the account debited
3. The title of the account credited
4. The dollar amounts of the debt, then credit
5. A short explanation of the transaction
6. Posting from the Journal to the Ledger

Ledger - A collection of all accounts utilized by an entity during an accounting period. Includes:

• Loose leaf pages
• Bounded books
• Computer printouts
• Cards

Posting - copying the amounts from the journal to the accounts in the ledger.

• Each journal entry posted to the ledger is keyed by date or by transaction number
• In this way, any transaction can be traced from the journal to the ledger and back to the journal. This linking allows you to locate any information you may need for decision-making.

The Trial Balance

• A list of all the accounts with their balances - assets first, followed by liabilities and then owner's equity - taken from the ledger
• Before computers, it provided a check on accuracy by showing whether total debits equal total credits

Locating and Correcting Trial Balance Errors

In a trial balance, the total debts and total credits should be equal. If they are not, then accounting errors exist.

1. Search the trial balance for a missing account. Trace each account from the ledger to the trial balance and you will locate the missing account.
2. Divide the difference between total debts and total credits by 2
3. Check journal postings
4. Review accounts for reasonableness

Your business as an entity is an “individual” like you. The life blood of your business is capital. Too much of it will hemorrhage your business to death through pilferage or cash losses, wastage or stock losses, mark down of prices because of inability to sell on time cum market price fall, and obsolescence. Inadequate capital can create coma in your business as well-a situation of having little and paying more. This way you are not able to take advantage of discounts on bulk buying, overdue debts not being paid on time, fines and penalties incurred for not making mandatory payments, etc. If you are like me, you need to understand or read the pulse of your business financials inside out (you must not necessarily be an accountant/expert or be very good with figures to do this) to be able to plug holes in whatever area(s) you deem important. This way your business will never go into coma or suffer high blood pressure as the case may be under your nose. If you can buy and sell you can x-ray your business too.

Now let's get down to brass tacks. Your business came about with a seed in the form of an idea. Usually this idea is seen as an intangible asset. It cannot be quantified immediately you commence business operations. Over time we can call this idea “goodwill” because it has gone from idea to a business with your reputation attached. Here people can believe and see what your business is and worth. The business can now be valued on the basis of Best Of Judgment (BOJ). It may be subjective but quite understandable.

The money you personally introduce into the business via savings to run it daily (i.e. working capital) or buy assets is treated as equity in the business. You may “borrow” from friends, relations, banking institutions, and so on to augment your equity contribution. This we will call “debt capital.” You will pay this debt at an agreed future date but not without a price to pay (i.e. cost of capital or interest). The lender's willingness and risk of lending you that money is the interest you have to bear. This is the opportunity cost of the lender not using that money elsewhere. That interest is simply an expense in your operations.

We will then translate the foregoing into a simple arithmetic:

(1.) EQUITY= ASSETS No Liability to Creditors or Lenders

(2.) EQUITY + DEBT= ASSETS Have Liability to Creditors or Lenders

From (1) above if your business fails (God forbid!) you are On Your Own (OYO). But with a good business plan from the outset and religious adherence to it you are sure to succeed. From (2) above you are not only responsible to yourself but to your lenders and creditors. You MUST not fail because the headache of having to explain to outsiders what went wrong will add insult to injury!

I am going to explain another important part of this article-Profitability and Cash flow. Profit is Revenues/Sales/Turnover(less returns) minus Cost of Sales. The profit here is because Sales is greater than Cost of Sales. Loss is possible and do arise. That is Sales is less than Cost of Sales using the above formula. Please you can always substitute either “Revenues” or “Turnover” where I have “Sales.”

PROFIT = SALES - COST OF SALES, sales > cost of sales

LOSS = SALES - COST OF SALES, sales

The above explanation is GROSS PROFIT/LOSS only. A step further will give you NET PROFIT. This is Gross Profit minus Expenses reasonably incurred in bringing in sales.

NET PROFIT = GROSS PROFIT - EXPENSES.

NET LOSS = GROSS LOSS + EXPENSES.

Mind you, “overhead expenses” will be added to “gross loss” to arrive at “Net Loss”. Your expenses simply increased your loss during a specified period. In computing Gross Profit/Loss many expense items are taken into consideration-those involving “cash” and “non-cash” items.

Cash Flow, on the other hand, determines how cash buoyant you are at any giventime-itis your liquidity level status. Cash flow is the movement of cash “in” and “out” of your business. It shows at any point in time how liquid your enterprise is. The importance of cash to the healthy growth or survival of your business should be taken seriously. This single factor can either make or mar your business. There are cases of business failures resulting from cash flow problems. This is also what is known as liquidity problem- i.e. no enough cash to do business when the need arises. Again the simple arithmetic for this is:

Beginning Cash Balance + Cash Inflow (Receipts) - Cash Outflows (Payments) = Ending Cash Balance

Therefore, there is no way the “Profit/Loss” of a business operation for a particular time period will always be the same as the “Cash Flow” of that same period. It is imperative to note that profit is actually a function of the judicious management of your business cash flow. The flow of cash- inflow and outflow- should be properly managed. The rule is: Cash Inflows should be accelerated while Cash Outflows should be decelerated when necessary.

In summary, if you understand why doctors examine and check their patients thoroughly, then you too need to examine your business operations in order to save its life! Always remember that your entrepreneurial, leadership and excellent skills will determine the level of your success and wealth in your business.

You Will Excel!