Managing Financial Principles And Techniques Conducting Operational Audits - Free Essay Example

Sample details Pages: 11 Words: 3423 Downloads: 5 Date added: 2017/06/26 Category Finance Essay Type Analytical essay Did you like this example? The financial statements are prepared for the purpose of presenting a periodical review or report of the progress made by the concern. It shows the  µstatus of the investment in the business and result achieved during the accounting period. Financial Statements refer to at least two statements which the accountant prepares at the end of a given period. These statements are Profit and Loss Account (Income Statement) and Balance Sheet (Position Statements).The purpose of Profit and Loss Account is to ascertain the net result of the training activities (i.e. profit or loss).Balance Sheet is prepared to show the financial position of the business as on a particular date. Don’t waste time! Our writers will create an original "Managing Financial Principles And Techniques Conducting Operational Audits" essay for you Create order Definitions According to John N Mayer, The Financial Statements provide a summary of the accounts of a business enterprise, the Balance Sheet reflecting the assets and liabilities and the income statement showing the results of the operations during a certain period. According to Smith and Ashburne, Financial as the end product of financial accounting is a set of financial statements, that purport to reveal the financial position of the enterprise, the result of its recent activities, and an analysis of what has been done with earnings ´. As per the definition financial statements are the outcome of preparing financial accounts and these statements reveal financial position and profitability of the concern and the utilization of retained earnings. Thus, financial statements include: Profit and Loss Account Balance Sheet Statement of Retained Earnings Fund Flow Statements Cash Flow Statement Certain Schedules Nature of Financial Statements The financial statements are prepared on the basis of recorded facts. The facts are recorded in monitory terms. The statements are prepared for a particular period and the transactions are recorded in a chronological order. The American Institute of Certified Public Accountants states the nature of financial statements as,  ³Financial statements are prepared for the purpose of presenting a periodical review of report on progress by the management and deal with the status of investment in the business and the result achieved during the period under review. They reflect a combination of recorded facts, accounting principles and personal judgments. The following points explain clearly the nature of financial statements: Recorded Facts This refers to the data taken out from the accounting records. The original cost or historical cost is the basis of recording various transactions. The financial statements do not disclose such facts as are not recorded in the accounting books whether or not such facts are material. Accounting Conventions While preparing financial statements certain accounting conventions are followed. E.g. Stock is valued at cost price or market price is lower, valuing fixed asset at cost less depreciation, etc. Personal Judgment Although concepts and conventions provide a good guideline to the accountant for arriving at a decision as to how much should be charged to the Profit and Loss Account of the year and how much should be carried forward to the next year as unexpired costs, the applications of these concepts and conventions depend on the personal judgment of the accountant. Postulates The accountant makes certain assumptions while making accounting records. One of these assumptions is that enterprise is treated as a going concern; similarly, he has to use other postulates like business entity concept, money measurement concept etc. ANALYSIS OF FINANCIAL STATEMENT The financial statements provide rich information about the operational result of a business unit and much can be learnt from a careful examination of these statements. Financial statements are prepared primarily for decision making. The statements are not an end in them, but are useful in decision making. Financial analysis is the process of determining the significant operating and financial characteristics of a firm from accounting data. The profit and loss account and balance sheet are indicators of significant factors-Profitability and Financial soundness. DEFINITIONS Metcalf and Titard: Analysis of financial statements is a process of evaluating the relationship between component part of a financial statement to obtain a better understanding of a firms position and performance. Myers: Analysis of financial statements is largely a sound of relationships among the various financial factors in a business as disclosed by single set of statements, and a study off the trend of these factors as shown in a series of statements ´. OBJECTIVES OF FINANCIAL ANALYSIS The following are the main objectives of the financial analysis of financial statements: 1. 2. 3. 4. 5. 6. 7. 8. To estimate the earning capacity of the firm. To gauge the financial position and financial performance of the firm. To determine the long term liquidity of the funds. To judge the solvency of the firm. To determine the debt capacity of the firm. To decide about the future prospects of the firm. To know the progress of the firm. To measure the efficiency of operations. TYPE OF FINANCIAL ANALYSIS Distinction between the different types of financial analysis can be made either on the basis of material used for the same or according to the modus operandi of the analysis or the object of the analysis. The following chart will give a snap-shot view of it. TYPE OF FINANCIAL ANALYSIS According to Material used According to modus operandi According to objectives of analysis External Analysis Internal Analysis Horizontal Analysis Vertical Analysis long term Analysis Short term Analysis 1. External Analysis External Analysis of financial statements is made by those who do not have access to the detailed accounting records of the company, i.e. banks, creditors and general public. 2. Internal Analysis Such analysis is made by the finance and accounting department to help the top management. These people have direct approach to the relevant financial records. 3. 3. Horizontal Analysis When the financial statements for a number of years are reviewed and analyzed, the analysis is called  ³horizontal analysis ´. 4. Vertical Analysis When ratios are calculated from the balance sheet of one year, it is called vertical analysis 5. Long term Analysis In long term analysis the fixed assets, long term debt structure and the ownership interest is analyzed. 6. Short term Analysis It is mainly concerned with the working capital analysis. The current assets and current liabilities are analyzed and cash position of the concern is determined. Performance Auditing What Does Performance Audit Mean? An audit performed on an asset manager by an outside accounting firm to verify that the performance figures shown to the public on marketing materials represent the true aggregate results of the firms clientele. Appraisal of how a particular activity is carrying out the companys policies and procedures. Such review may cover any activity within a department, division, or local area. A performance audit can be a review of a program to assure that it is satisfying its objectives. The program may apply to management and accounting procedures, guidelines, or policies. The performance audit may take into account the anticipated benefits of a program relative to the actual performance. Also relevant may be the costs and time associated with the activity. A report of managements abilities is typically prepared to meet particular goals. Included in the report are measures of the effectiveness of internal controls and efficiency of procedures and processes. The performance audit may be initiated by the organization or by external interested parties. However, the performance audit is not performed as a means to attest to the financial records and statements of the company. An example of a performance audit is how certain work routines are being conducted. Performance auditing: a powerful management practice to enhance performance in your organization Because we are in a dynamic environment, we have got new people, new technology, a new marketplace, new competitors and new regulations, we need to be very vigilant about the fundamentals of this business. And that is a role performance auditing plays; the ability to collect information and impart that knowledge on processes and to do it constantly through all of this change (Duane Ackerman, CEO, BellSouth Corporation; source IIA wesbite) What is performance auditing? Performance audits are short term assignments, usually two or three week long, sometimes more conducted internally within the organization in order to address key issues that may impact performance as well as recommend solutions. Experts usually describe performance auditing also called operational auditing as a management tool to provide managers with reasonable assurance that their organization will achieve its objectives. Although they represent a valuable service to managers in an increasingly complex environment, performance auditing is a delicate process which should be conducted carefully in cooperation with employees at various levels of the organization if it wants to really achieve a value adding contribution to the organization. Performance auditing also reflects the commitment of management to maintain a good internal governance system of the firm to the benefit of its stakeholders. It is extensively used by large companies as a common practice to tackle with the increasing complexity of their worldwide operations and necessary decentralized organizational models. If you are asked to conduct a performance audit within your organization you will need to: develop a proactive communication in order to install a good climate for cooperation, carefully define the scope and objectives of the assignment; develop a top-down approach for understanding risks and processes, find an appropriate level for gathering evidence and documenting your work in order to support your findings communicate findings in a proactive manner in order to enhance empowerment of employees For this you will need to rely on methodologies and tools; this workshop will provide you with the necessary skills and deliverable templates to carry out performance audits successfully; it will give you the opportunity to share experience with professionals who have led operational audits and experienced the many pitfalls you will need to avoid. Introducing performance auditing in organizations: benefits and challenges ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ How do organizations react to problems and find solutions ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Measuring performance and monitoring: fundamentals ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Latest trends and developments in the practice of operational auditing ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Performance auditing in the social market economy in China Conducting Operational Audits Step 1: Communication Developing a positive mindset around the audit ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Understanding expectations from the commissioner of the audit ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Defining your role and game rules Step 2: Planning Defining the scope and objectives ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Recruiting the team ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Carrying out the preparation works Step 3: Building the performance audit framework What the successful approach to auditing? ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Understanding the activities to be audited ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Identifying objectives, processes and controls ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Risk scoring ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Defining the key priority areas for the audit Step 4: Fieldwork Collecting information ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Conducting interviews ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Testing ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ How to deal with IT controls? Step 5: Communicating audit findings Writing audit reports ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Oral communication ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ The auditors behaviour Long-term perspective: continuous auditing and knowledge management in the modern firm Enhancing a risk culture within your organization ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Internal governance a competitive advantage ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Role of internal audit Financial Ratio Analysis: In order to make detailed financial analysis it is necessary to consider the trends in key figures over a number of years. Most important and interesting trends are: Sales, profit, Net assets and dividends. Most of the information on which the financial analysis is based is provided in the organisations Income statement and balance sheet. (Barry Elliott Jamie, august 2007). Methods of Ratio Analysis: Time Series analysis Cross-sectional analysis Time Series Analysis: Time-Series analysis evaluates performance over time. It allows to analyse trends over a number of years and to examine the way in which performance may have changed over time. For instance time series analysis can make by comparing any companys performance for two or more than two years i.e. 2007 and 2008. Cross-Sectional Analysis: Cross sectional analysis allows for comparison with the industry average or with competitors at a single point in time. This comparison allows a judgement to be made about the firms position within the industry. For instance to make a comparison of any companys performance against its rival (competitor) for the same year. E.g. Shall Companys ratios are compared with British Petroleum Company. (Both are in same industry and same business). Types of Financial Ratios: Following are the different types of financial ratios Liquidity Ratios Profitability Ratios Activity Ratios Solvency/Coverage Ratios Liquidity Ratios: Liquidity ratios assess companys ability to pay off its  short-terms debts obligations.   Generally, the higher the value of the ratio, the  larger the margin of safety  that  the company possesses to cover short-term debts. A  companys  ability to turn short-term assets into cash to cover debts is of the utmost importance when creditors are seeking payment. Bankruptcy analysts and mortgage originators frequently use the  liquidity ratios to determine  whether a company will be able to continue as a going concern. Ratio Name Formula Result Current Ratio Current Asset / Current Liabilities Higher Answer is Favourable Quick Ratio (Current Asset Inventories) / Current Liabilities Higher Answer is Favourable Absolute Quick Ratio (Current Asset- (Inventories + debtors) )/ Current liabilities Higher Answer is Favourable Working Capital Current Asset Current Liabilities Higher Answer is Favourable Profitability Ratios: Measures  that indicate how well a  firm  is performing in  terms  of its  ability  to generate  profit Formulae of some of the  common  ratios are as follows: Book Value Per share: Total common (ordinary)  equity   Number of common (ordinary)  shares  issued and outstanding. Dividends Per  Share: Dividends  paid   Number of common (ordinary) shares issued and outstanding. Earnings Per Share: (Net income  -  preferred stock  or preference share  interest) Number of common (ordinary) shares issued and outstanding. Gross profit  percentage: Total  cost of sales  in a  period  x 100 Total  sales revenue  for that period. Net income percentage: Net income for a period x 100 Total  sales  revenue  for that period. Operating profit percentage:  Earnings before interest and taxes (EBIT)  in a period x 100 Total sales revenue in the same period. Return On Common equity: (Net income for a period Dividends) (Common equity   Preferred stock). Return On Investment: Net income   Total assets. Activity Ratio: An indicator of how rapidly a firm converts various accounts into cash or sales. In general, the sooner management can convert assets into sales or cash, the more effectively the firm is being run. Solvency Ratio: One of many ratios used to  measure a companys ability to meet long-term obligations. The solvency ratio measures  the size of  a companys after-tax  income, excluding non-cash depreciation expenses, as compared to the firms total debt obligations. It provides a measurement of how likely a company will be to continue meeting its debt obligations. The measure is usually calculated as follows: Companies Introduction an institution created to conduct business; he only invests in large well-established companies; he started the company in his garage small military unit; usually two or three platoons the state of being with someone; he missed their company; he enjoyed the society of his friends organization of performers and associated personnel (especially theatrical); the travelling company all stayed at the same hotel caller: a social or business visitor; the room was a mess because he hadnt expected company Types of Companies There are following two types of companies Private Limited Companies Public Limited Companies Private Limited Companies Type of  incorporated  firm which offers  limited liability  to its  shareholders  but which  places  certain  restrictions  on its  ownership These restrictions are spelled out in the  firms  articles of association  or  by laws  and are meant to prevent any  hostile takeover  attempt. The major restriction are: (1)  stakeholders  (shareholders) cannot  sell  or transfer  their  shares  without  offering  them first to the other stockholders for  purchase, (2) stockholders cannot offer their shares or  debentures  to the general public over a  stock-exchange, (3) number of stockholders cannot exceed a fixed figure (commonly 50). Public Limited Companies Incorporated,  limited liability  firm  whose  securities  are traded on a  stock exchange  and can be bought  and  sold  by anyone.  Public companies  are strictly regulated, and are  required  by  law  to publish  their complete and true  financial position  so that  investors  can determine the true worth  of its  stock  (shares). Also called  publicly held company. Accounting Ratios for Nokia Corporation Ltd For the year 2008 Liquidity Ratios Current Ratio Current Assets / Current Liabilities X 100 24470 / 20355 X 100 120% Absolute Liquid Ratio Cash + cash Equivalents / Current Liabilities X 100 6820 / 20355 X 100 33.5% Quick (Acid Test) Ratio Current Assets inventories / Current Liabilities X 100 21937 / 20335 X 100 107.8% Profitability Ratios GP Margin Ratio Sales CGS / Sales X 100 17373 / 50710 X 100 34.26% Net Profit to net sales ratio Net Profit / Net Sales X 100 4970 / 50710 X100 9.8% Earning Per Share Ratio Net Profit Payable / Number of shares 3988 / 1000 3.988 Per share Solvency (Coverage) Ratios Debt to Total Asset Ratio Total Debts / Total Assets X 100 20355 / 39582 X 100 51.42% Activity Ratios Primary Activity Ratios Debtor turnover ratio Net credit sales / Avg. Debtors 50710 / 10322 4.91 Note: All the sales are assumed as credit sales Inventory turnover Ratio CGS / Avg. Inventory 33337 / 2704.5 12.32 Asset turnover Ratio Sales / avg. total assets 50710 / 241670.5 0.21 Supplementary Activity Ratios Avg. Collection Period 365 / Debtors turnover ratio 365 / 4.91 74.33 days Inventory Conversion Period 365 / Inventory turnover ratio 365 / 12.32 29.62 ~ 30 days Accounting Ratios for Nokia Corporation Ltd For the year 2007 Liquidity Ratios Current Ratio Current Assets / Current Liabilities X 100 29294 / 18976 X 100 154.37% Absolute Liquid Ratio Cash + Cash Equivalents / Current Liabilities X 100 6850 / 18976 X 100 36.1% Quick (Acid Test) Ratio Current Assets inventories / Current Liabilities X 100 26418 / 18976 X 100 139.23% Profitability Ratios GP Margin Ratio Sales CGS / Sales X 100 17304 / 51058 X 100 33.9% Net Profit to net sales ratio Net Profit / Net Sales X 100 8268 / 51058 X100 16.2% Earning Per Share Ratio Net Profit Payable / Number of shares 8268 / 1000 8.268 Per share Solvency (Coverage) Ratios Debt to Total Asset Ratio Total Debts / Total Assets X 100 18976 / 37599 X 100 50.47% Activity Ratios Primary Activity Ratios Debtor turnover ratio Net credit sales / Avg. Debtors 51058 / 8544 5.97 Note: All the sales are assumed as credit sales Inventory turnover Ratio CGS / Avg. Inventory 33754 / 2210 15.27 Asset turnover Ratio Sales / avg. total assets 51058 / 30108 1.7 Supplementary Activity Ratios Avg. Collection Period 365 / Debtors turnover ratio 365 / 5.97 61.13 days Inventory Conversion Period 365 / Inventory turnover ratio 365 / 15.27 23.9 ~ 24 days Ratio Analysis SN Ratios 2008 2007 01 Current ratio 120% 154.37% 02 Absolute Liquid Ratio 33.50% 36.10% 03 Quick ratio 107.80% 139.23% 04 GP Margin Ratio 34.26% 33.90% 05 Net Profit to net sales ratio 9.80% 16.20% 06 Earning Per Share Ratio 3.988 per share 8.268 per share 07 Debt to Total Asset Ratio 51.42% 50.47% 08 Debtor turnover ratio 4.91 5.97 09 Avg. Collection Period 74.33 days 61.13 days 10 Inventory Conversion Period 29.62 days 23.9 days 11 Inventory turnover Ratio 12.32 15.27 12 Asset turnover Ratio 0.21 1.7 The current ratio of the company shows that company have enough current assets to repay its all the current liabilities which shows that company is in good condition but not enough good as it was in 2007 The absolute liquid ratio shows that company has 34.26% highly liquid assets to repay its current liabilities. This shows bad impact of the company. Although company has more liquid assets in 2007 to clear its liabilities this shows that companys performance is going worse day by day. The quick ratio shows that company have enough funds available to repay its current liabilities. This is good sign for investors. But as we compare it with ratios of previous two years it shows that it is also decreasing. Company has not enough funds available as they were available in 2007. The GP margin ratio shows that our gross profit is 34.26% of total sales. This is increasing with the increase of sales. As we compare GP margin ratio of last three years, we see that GP margin is in very good in 2008. This attracts the investors. The NP to Net Sales ratio shows that the margin of net profit of total sales is 9.8% is quiet low as compared to previous two years. This shows that company has increased it administrative and marketing expenses this year. The share holders of the company are not getting enough earning this year as much as they have earned in previous years. This makes investors to withdraw their investment from business. And business goes down without having investment. The Debts to total assets shows that the company has 2 assets to repay its 1 Liability or debts. The company is in good position to clear its debts. As we compare it with past two years the company was in better condition. Company increased it debts this year. The debtor turnover ratio shows that we have made 4.91 times credit sales than avg. debtors. In past years company made more credit sales than this year. It means company prefer to make more cash sales. The avg. collection period shows that company recovers debts from customers in 74.33 days. As we compare this with last two years than we come to know that company recovered its debts in fewer periods than this. It means company made soft debts recovery policies. The inventory conversion period shows that company converts it stock/inventory into sales in 29.62 days. But in previous years company took 23.9 days and 21.19 days to convert its stock into sales. This year company took more time for conversion into sales. This means that company policies need urgent attention.