Assignment #2 Draft

Step 1 (5 Marks)

Chapter 4 ‘Analysing Financial Statements’

My Key Concepts and Questions

KCQ 1: ‘An equity interest in a firm is not like buying a dead fish in the Sydney Fish Markets’ I find this to be a very interesting and really random analogy. I enjoy when the author makes the discussion relatable to the audience. It makes the reading far more enjoyable rather than just simply discussing accounting terminology.

KCQ 2: ‘If we are wrong about the past, we are unable to predict the future very well.’ I enjoy reading these kinds of quotes. I believe this statement can apply to everyday life and not just accounting.

KCQ 3: What does the discounted cash flow and economic profit framework involve?

KCQ 4: We are not learning about restating financial statements, rather, we will be restating our firm’s financial statements to ‘learn about financial statements’. This statement makes it clear to me that our goal is to learn about our firms and not just simply learn how to restate financial statements. I found that in high school when I did accounting, all we learnt was how to do journals and ledgers. We never learnt about the company which we were doing these statements for and whether or not it was a successful company. It is good to look into the truths behind a firm, rather than just writing up numbers.

KCQ 5: ‘No one ever got rich by simply analyzing the past; no one.’ This is a very true statement that I have never really thought about before. We have to move on from the past and stop looking back.

KCQ 6: Free cash flow (FCF) is driven by two things; cash flow from operations and net cash invested into a firm’s operating assets. I feel like this is going to be a very important thing to know later on in this course.

KCQ 7: What does ‘occupation rights’ mean?

KCQ 8: In the chapter, Martin talks about the Greek symbol ‘delta’. What does this symbol have to do with accounting? This part is getting me really confused?

KCQ 9: When choosing whether or not we should go with Marks Inc or Kings Enterprises, I was confused with what the actual answer was to this. Although, both firms have the same expected operating income, Kings Enterprises expects to invest less each year to achieve the same earnings growth as Marks Inc. But I am still confused as to which company to go with. Do we choose Kings Enterprises because they expect to invest less but achieve the same earnings as Marks Inc?

KCQ 10: What is the difference between operating and financial activities? I feel like this is a really stupid question because the author kept describing about how important it is to know the difference between these two. I don’t recall reading about the differences in the chapter, so I was still really confused. Then the ‘light bulb’ moment hit and I realized that they are exactly what they are called if that makes sense. We have to separate accounts into financial and operational. This was then discussed further in the Kinder Surprise analogy.

KCQ 11: Restating our firm’s statement of changes in equity, helps us identify any other comprehensive income. What does comprehensive income mean? I found that in our spreadsheet, we had a lot of accounts that included this so it seems important.

KCQ 12: Why are we only looking into the group accounts and not the parent accounts? I question I’ve been wondering for a little while now that I am still to find out.

What is the author trying to say?

The author is trying to get across one specific message that really stood out to me. Our goal for all the assessments is to look into the realities of a firm. We want to know how to understand a firm and their activities. In this chapter, we have started to look at a way of viewing business reality. Through this, we then received the knowledge of how to restate financial statements which was the main topic of this chapter. After we learnt how to do this, it became clear as to whether or not our firm’s financial statements could help us understand what is really going on in our firm. It was stated above that, we are not learning about restating financial statements, rather, we will be restating our firm’s financial statements to ‘learn about financial statements’. This statement makes it clear to me that our goal is to learn about our firms and not just simply learn how to restate financial statements.

What do I find confusing?

Reading the chapter, I felt quite overwhelmed. I found with discussions with other students, they were all overwhelmed as well. It gave everyone a headache. There was so much to learn and so much information crammed into one big chapter. I felt whenever the author talked about equations, for example; economic profit = (RNOA – cost of capital) x NOA, I just immediately felt my brain turn into moosh. I find it hard to remember what the accounting terminology means, let alone to remember all the different abbreviations for the equations. One concept that really confused me to begin with was the difference of forecast between Marks Inc and Kings Enterprises. This was briefly stated above in KCQ’s. When you look at their forecast operating income, they seem to be worth the same. We discussed this concept in class, and I sat there for a good five minutes under the belief that it was a trick question and that you could go with either business. I was so confused until Martin explained further into the future free cash flow. Although both firms have the same expected operating income, Kings Enterprises expects to invest less each year to achieve the same earnings growth as Marks Inc. But I am still confused as to which company to go with. Do we choose Kings Enterprises because they expect to invest less but achieve the same earnings as Marks Inc? The main thing I was confused with this chapter is that it talked about how important it is to know the difference between operating and financial activities. I was waiting to find out the definitions and the differences, thinking it was going to be really difficult to understand but it wasn’t! Stupid me! The operational activities means just that, same with the financial activities. You just have to separate the accounts into those groups! Here I was, thinking it was going to be so difficult. The tricky part was really trying to determine if one account was either operational or financial as there were some tricky ones for my company, but I got through it!

What do I find hard to believe or something that surprised me?
When I reading about Kinder Surprise and Martin stating that it was an Italian company, I was really shocked! The word ‘kinder’ is the german word for ‘children’, so I was under the impression it was an Germany company because that made sense. I was really surprised to find out that it was an Italian company. Who would have thought?! Another concept that really surprised me was the statement Martin made about liquidity. He stated the reason behind catergorizing assets and liabilities and how it can be traced to the influence of the banking sector in the early development  of financial statements. It facilitates an assessment of the long term and short term liquidity of a firm. It was interesting reading about this as it provides a reason why we separate assets and liabilities. I had no idea!

What do I find boring?

I personally wished that the chapter could have been more condensed as I found that there was so much information to process and understand. From previous experiences in high school, I found myself getting really bored when there is too much information in one reading. The main parts of the chapter I found particularly boring was the explanation of equations, e.g economic profit = (RNOA – cost of capital) x NOA and so on. I find myself zoning out as I just couldn’t understand. Another part I found quite boring was the overview of each section and what will be explained in the next part. I found this to become quite repetitive and not necessary as it is just more reading to do and we would have found out what was in the next section soon anyway.

What do I find exciting?

One thing I really find enjoyable about this chapter is the analogies that the author uses to try and explain something. The author uses an everyday concept that is relatable to the readers to understand accounting. One concept Martin used was chocolate again. I remember from another chapter, Martin used the example of cadbury to explain production costs. Well once again, he discussed kinder surprise in regards to explaining the difference  between operating and financial activities. It made me hungry and crave chocolate! It was also exciting reading about the Sydney Fish Markets in comparision to capital markets. I find this to be a great learning method and much more exciting and relatable. Not only was I able to learn about restating financial statements, I also learnt a bit about history. I had never heard about Marc Bloch, so it was interesting to learn that he was shot in World War 2 by the Gestapo. I wanted to learn more about this, so I did some further reading into the subject. Very cool to know, as I take a strong interest in history.

Step 2 (18 Marks)

P.S. SORRY FOR THE BLURRY SCREENSHOTS :(

Commentary on issues I had and discussions with others

Throughout the task of restating my financial statements, I had a lot of fun. NOT. It was a very time consuming and difficult task but I got there in the end with a lot of questions asked along the way. Firstly, it took me a while to understand that all I was doing was shifting around different items in the statements. Took me a while to realize this as I read the task sheet for the assignment last. Silly me.

Movements in Equity

SCREENSHOT

Firstly, I had to figure out what was operating and what was financial. As the statement of equity was quite a short statement, I thought it would be easy. I commenced by printing out the statements and I writing an ‘O’ and a ‘F’ next to each account so I knew what was what.

However, I wasn’t sure what to do with a couple of things regarding this statement. We have an item called 'opening balance' and then I noticed from other examples that there was an item called 'profit of the period'. In my movements of equity, I didn’t have this item but instead, I had 'profit after income tax benefit for the year'. I wasn’t sure what this meant and if it meant the same thing. I posted on the ASS #2 forum but I unfortunately got no answers.

SCREENSHOT

I then posted on the Facebook group and Bridget Mallory was able to respond to my answer and tell me that it was the same.

SCREENSHOT

Luckily now, I was able to continue restating my financial statements by following other examples. I was a little confused as to what the ‘transactions with shareholders’ meant as I didn’t have to put these into two accounts but under this account. Besides these little issues and thoughts I had, I found restating the equity accounts quite easy and somewhat made sense to me.

Balance Sheet

SCREENSHOT

Moving onto the next statement, I had no issues as I found the process of this one logical and flowing. After reading about all these equations and abbreviations in chapter four, it finally made sense to me what all this meant and how I can apply it. I once again, put all the items into two accounts.

One thing I couldn’t understand was the item called ‘financial obligations’. Although I didn’t have any, it came before the account called ‘financial assets’. I just couldn’t understand if this was the opposite of financial assets. I asked some other peers of mine and they didn’t know this either. I am yet to find someone who can answer this.

Income Statement

The big and tough statement of course came last. This was by the most frustrating and time consuming one and considering, I have 8 marks for this, I had to put my best effort into it. Firstly after deciding what was operational and what was financial, I realized there were a couple of unclear things.

SCREENSHOT

In this statement, I had an account called ‘revenue from continuing operations’ that is right at the top of the document, I was unsure if was to put this under ‘operating revenue’ or if this was a separate account that still belongs at the top of the statement. I was very confused so I posted on Facebook.

SCREENSHOT

My question for this was then answered by Martin and John but by then, I had another issue which was finding out my company’s reported tax. I couldn't find this anywhere in my financial statements and I wasn’t sure whether I was to work something out or just copy and paste from the financial statements. However, Martin was able to answer this for me and tell me that it was the tax expense from my financial statements. I was able to find this then, as it was just worded a little different.

I found the income statement by far the most challenging statement to restate. I became very confused as a lot of accounts were worded differently to the examples given. There was also a lot of adding and multiplying that became a bit overwhelming. I found Anna Towan’s and Martin’s examples very helpful throughout restating my financial statements. In conclusion, I think I have done everything correctly and I have now learnt about restating financial statements. Chapter 4 makes so much more sense to me now when I read over it.

Step 3 (4 Marks)

Estimated selling price, variable cost and CM

	1.  Individual consultant service	2.  General set up fee for the billing service	3. Emergency secretarial cover
Selling price	$300	$250	$350
Variable Cost	$150	$125	$175
Contribution Margin	$150	$125	$175

Commentary on contribution margins

When I was searching for services that my company provides, I was really stuck in a rut. My company is in investment with very limited information on the website. However ICS Global owns and manages a company called Medical Billing and Collections (MBC) which provides billing services to UK medical consultants. I went to their website and found a whole lot of pricing and information in regards to what they offer.

Contribution Margins are the difference between what a products cost (variable and fixed costs) for the cost of the end product.  Contribution Margins are calculated using this equation:

Contribution Margin (CM) = Sales (S) – Variable Costs (VC)

An example is with the general service fee. This service will sell for $250, after subtracting the variable costs ($100), I am left with a contribution margin of $150.

The variable costs for this service can include:

• Size of the practice and how it operates – every practice will be different so this must be considered when doing this service for them.
• Labour costs – how hard does every consultant work?

The fixed costs are costs that will not change with the increase or decrease in production of the service. These can include:

• Administration, advertising material;
• Lease of storage facility charges
• Rent

The contribution margins are all a little different from one another because the costs from each service are different. From the reading, the main reasons for differences in similarities are because variable cost vary when the level of activity of sale changes. The reason why my firm produces a range of services with different margins is mainly due to the quality of service. A general set up fee service has the lowest variable cost as there are limitations to what the service offers. In saying that, the emergency secretarial cover has a lot of extra benefits that the general set up fee wouldn’t have. This allows the variable fee to increase thus differing the contribution margins. The company needs to have a variety of services and not just have the highest contribution margin. This is so it can cater for a large amount of clients and adhere to their specific wants.

Constraints – identify & commentary

When I sat down to consider what constraints the company might have. I found it to be very difficult. However, I did think of a few constraints. Firstly, there is inaccuracy of the bills. If a client has errors in their bill, this could create a lot of hassle for the practice and unnecessary drama. From this, it could lead to a drop in profit for the company. Also, it is important to consider growing market demand. How many other medical billing companies are growing out there that are going to slowly liquidate this one? They may offer more services at a competing price. The last constraint is a very strange one but there could be an increase in health. If a lot of patients do not have health problems, there is no reason to bill them then is there? In all honesty, we need patients to have health problems so the practice has a business and therefore, this company does.