ACCT13017 - Assignment One - Step Six

Assessment 1 – Step 6 – Chapter Four: Understanding the Past

Chapter 4 appears to be all about understanding and analysing the history of a firm and how that can assist us in gaining better insight into their future. Unfortunately, there is no business out there that has a crystal ball in their office that will tell them how well they will be performing in the coming quarters and years, just as none of us have a crystal ball to tell us which companies we should be investing in to get the best return we can. While we will never be able to know for certain what will happen to a firm in the future, we can still gain some insight into what the future holds by analysing the past. An effective way to start this process is by restating the firm’s financial statements. Briefly, restating financial statements means to isolate the operating and financial activities and to make sure that all earnings are included. Once this has been done we are then able to analyse the key aspects of the financials and break them down into smaller and more manageable sections.

I recall restating financial statements for an assignment in ACCT11059: Accounting, Learning and Online Communication. At the time I remember getting quite frustrated with it as I had never done anything like that before and it was a completely new concept to learn, being my first term in University and coming from a very different background to anything accounting related. I found that I had to keep reading and re-reading over the examples given and even then I was not sure about how to allocate some of the accounts. While I am almost certain that I will find restating the financials much easier this time around as I now have a better understanding as to what the financial statements actually hold and what the accounts are, I still find myself being a bit worried as I have not gone through the process again since the completion of ACCT11059, nor at my workplace. This will only be my second time completing this task, but I trust when Martin says that we will find this a much more straightforward task this time around. I am hoping that as my accounting career progresses the next time I need to restate financials it will be even easier again as I will have learnt and understood so much more. I have not yet started restating the financial reports for my company, QANTM, so I will find out if this process is more straightforward very soon!

The term ‘abnormal earnings’ is not a term that I remember having heard before. To me, the word ‘abnormal’ means things that are strange, different to the rest, unusual, etc. However, as I am now learning in accounting it means the earnings that we have left after the required return to investors is taken out. I also understand that the other term for this is ‘residual earnings’, which to me seems to more effectively highlight how it represents the leftover earnings.

What are operating activities and financial activities? To me, the operating activities of a firm are the core business activities that are directly related to providing the goods or services to the market, and the interactions of the firm with the suppliers and customers. This is the revenue based side and an example would be sales revenue. The financial activities of a firm are the dealings with creditors or investors used to fund the firms operations. This is the debt and equity based side of the firm and an example would be a loan to fund more operations.

Reading further through the study guide we begin to delve into all of the acronyms! I have memorised what all of the acronyms stand for (ie NOA = net operating assets, NFA = net financial assets, C = cash flow from operations, ROE = return on equity, and the list goes on…) but I need to ensure that I really understand what all of these terms mean and how to apply them, and right now, I do not know how to do that. I am sure that I will understand eventually but I have a long way to go before that happens! I am hoping that as I work my way through this first assignment I will gain a more in-depth understanding and be able to really understand and not just memorise by rote.

It was interesting to read about how cash can pose difficulties when restating the financial statements, as I imagine that it is not always clear what the cash will be used for. I am curious where the “0.5% to 1% of sales” came from in relation to the level of cash balances. Is this an amount that Martin uses himself when he is analysing financial statements? Is this a widely used figure among accountants and investors? How much would this figure change in different industries? I have a lot of investigating to do.

I decided to look at the financials of a client I have done bookkeeping for when their bank account was at its highest to determine whether I would allocate their cash to operating or financial activities. For the 12 months ending 31 July 2019 this company had $927,000 sitting in the business bank account and had recorded $2,900,000 in sales. Their cash balance was over 30% of their sales! I imagine that this would be an unusually high percentage, and not long after this the company purchased some more large equipment and declared dividends to distribute a large portion of the cash. I can’t imagine that having that much money sitting in a bank account would be a very good investment or would be good for asset protection if things somehow went wrong. With the benefit of knowing where this cash went, I would allocate the dividends paid to financial activities and the purchase of the equipment to investing activities.

I would just like to say that I really do appreciate the examples that are being shown to us through Ryman Healthcare. While there are still a lot of aspects that I don’t fully understand, being able to see what we are learning in relation to a real business does make it easier to comprehend. I am also trying to apply what we are learning to the business that I have access to through work (as I did above).