Accounting - Understanding and using accounting information - example

Example

For example, let us select the profit to sales ratio. In a hypothetical
example, net profit to sales may fall in the budgeted year.

This may be due to a fall in profit or a rise in sales and reasons may
include:

* an increase in the unit cost of items sold

* reduced prices; for example, discounting

* increased operating expenses

* an increase in competition

The Profit and Loss statement may be broken up to show both a vertical and
horizontal analysis. For instance, the revenue section may be presented as
follows:

Table 1

2000
Actual 2000
2000
Actual 2000
2000
Budget 2000

$
%
$
%
$
%

REVENUE

Cash sales
367 125
78.09
351 450
76.83
366 000
76.57

100

95.73

99.69

Credit sales
103 000
21.91
106 000
23.17
112 000
23.43

100

102.91

108.74

Total revenue
470 125
100.00
457 445
100.00
478 000
100.00

100

97.30

101.68

This process may be repeated for the entire Profit and Loss statement.

Several other graphs and tables may be presented to complete the
identification task. Profitability ratios may be shown as:

Table 2

2000
2001
MAGNITUDE AND DIRECTION
Fav/
Unfav 2002
MAGNITUDE AND DIRECTION
Fav/
Unfav

NP/OE ROI
80.2%
40.9%
Decrease by 49%
Unfav
45.9%
Increase by 12.2%
Fav

GP/sales

NP/sales

Legend

NP/OE
= Net profit to owner's equity ROI

GP/sales
= Gross profit to sales

GP/sales
= Net profit to sales

It is important to note that the percentage change is not arrived at by
direct deduction alone. For NP/owner's equity the percentage in 2000 is
80.2% and in 2001,40.9%. Many students then deduct 40.9% from 80.2% and say
that this ratio has decreased by 39.3%. However, the 39.3% must then be
divided by 80.2% to find the actual percent change.

Having completed the table above, you should then show this data in a line
graph for each profitability measure

Suppose the issue is liquidity. Once again Table 1 would be repeated, this
time selecting ratios relevant to liquidity.

The ratios to select include:

* working capital

* quick asset ratio

* creditors turnover

* debtors turnover

* stock turnover

* bank balance ( not a ratio but could be plotted)

These figures can then be converted into line graphs. Remember to
correctly label all graphs.

Relevant reasons have to be given for changes to liquidity.

Reasons for deterioration of liquidity include:

* deterioration in cash cycle such as slow paying debtors, slow
moving stock items

* buying of non-current assets for cash

* excessive cash drawings

* loan repayments

* specific costs such as unexpected legal expenses

* new and increased expenses without commensurate selling price increases

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