SAMPLE SAMPLE CHAPTER ACCOUNTING FOR MATRICS CAPS APPROVED STUDY GUIDE {BOOK ONE OF FOUR}

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1 SAMPLE SAMPLE CHAPTER ACCOUNTING FOR MATRICS CAPS APPROVED STUDY GUIDE {BOOK ONE OF FOUR} ALKA KOOBLAL DILAN KOOVERJEE

2 COMPANIES 3Ratio Analysis 30

3 RATIO ANALYSIS A lot of you probably thought that we were all done with companies and could move on to a new and exciting section. Well I got some good (or bad) news for you there s more! Up until now we have been focusing on the mechanical, bookkeeping side of things but now we are going to dive deeper into the realms of actual financial accounting and what accounting truly is. What does Ratio Analysis and Interpretation even mean? The formal definition of it would be: To obtain information from the financial statements of a company and interpret them to tell the story of the financial situation of a company and what it means for the future. Memorising the definition of this is not important; it s the understanding of it that will have a more significant impact in this section. Understand why we do it, and everything will make more sense. Note: Ratio analysis and interpretation can actually be broken up into 2 distinct sections which we will look at in more detail throughout this chapter. Ratio analysis is primarily calculations. Luckily for us most of them have already been covered in Grade 11! There are only a few more financial indicators to familiarise ourselves with in matric. So let s firstly refresh the ones we already know, and then add the new ones. 31 Presto Matric Accounting Sample

4 SAMPLE GRADE 11 RATIOS Calculation Formula Answer is Explanation 1) Profitability/ efficiency 1.1) Gross profit % on sales/turnover Gross profit Sales A percentage Known as gross margin. Shows what % selling price is available to cover operating expenses. 1.2) Gross profit on A This should be the mark cost of sales Gross profit Cost of Sales percentage up used. If not, you need to know the reasons for these difference e.g. seasonal sales or stolen stock. 1.3) Operating expenses as a % of sales Operating Expenses Sales A percentage Compare to last years figure to see if expenses are being controlled. 1.4) Operating profit as a % of sales Operating Profit Sales A percentage Compare to last year to see whether business is improving. A This shows how efficiently 1.5) Net profit as % of sales (net margin) Net Profit after Tax Sales percentage the business is being managed. If answer way less than answer to 1.4, interest expense is the problem. 2) Solvency 2.1) Degree of solvency 3) Liquidity 3.1) Current ratio Total Assets: Total Liabilities Current Assets : A ratio X : 1 A ratio X : 1 Divide total assets (noncurrent + current) by total liabilities. Answer should be as high as possible. It shows the ability of the company to meet its short-term obligations. It Current should be around same Liabilities as previous year and 32 perhaps close to 2:1

5 3.2) Acid test ratio 3.3) Rate of stock turnover 3.4) Number of months (days) stock on hand 3.5) Debtors average collection period 3.6) Creditors average payment period 4) Gearing 4.1) Debt: equity ratio (Current Assets - Inventories): Current Liabilities Cost of Sales Average Inventory Average Inventory Cost of Sales x 12 (or 365 if days) Average Debtors Credit Sales x 365 Average Creditors Credit Purchases x 365 Non-current Liabilities: Shareholders Equity A ratio X : 1 x times per year x months or days x days x days A ratio x : 1 We exclude inventory, as it is the least liquid of our current assets. Answer should be around 1:1 for a liquid business. This tells us how fast stock is being sold. Answer should be as high as possible. This is inversely related to 3.3 i.e. answer should be as low as possible This assists with determining stock orders. This works out how long on average debtors take to settle their accounts. Ideally answer should be around 30 days This works out how long it takes to pay our creditors and should be as high as possible e.g. 60 days or more This shows creditworthiness and ability to raise additional capital Wow, can you believe we covered all of this already? Luckily we only have 5 more financial indicators to learn for matric and you re ready for action! 33 Presto Matric Accounting Sample

6 SAMPLE GRADE 12 RATIOS Calculations Formula Answer is Explanation 5) Returns 5.1) Return on shareholders equity (ROSHE) 4.2) Return on total capital employed (ROTCE) *ROTCE falls under gearing not returns!! Net Profit after Tax Average Shareholders Equity Net Profit before Tax + Interest Average Capital Employed A percentage A percentage This calculates what percentage return shareholders are getting on their investment. Compare to alternate investments/ companies This answer must be higher than the interest rate paid on the loans. *Capital employed= shareholders equity + non-current liabilities 5.2) Earnings per share (EPS) 5.3) Dividends per share (DPS) 5.4) Net asset value per share (NAV) Net Profit after Tax No. of Shares Issued Interim + Final Dividend No. of Shares Issued Ordinary Shareholders Equity No. of Shares Issued Cents per share Cents per share Cents per share This shows amount earned on every share issued. It should improve every year to keep shareholders and NAV increasing. Compare this to last year and EPS to see whether company is distributing profits to shareholders or retaining them. This will always be higher than par value and should be higher than last years NAV. Compare to market value=investors confidence. 34

7 A few other important formulas: 1) To calculate the selling price (SP): SP= CP x (100 +mark-up/100) 2) To calculate the Cost price (CP): CP= SP X (100/100 + mark-up) How this is Examined: All formulas must be learnt off by heart! This isn t maths, accountants are very mean! You may have also noticed the financial indicators were divided into 5 different categories. The reason for this will be discussed in more detail during the interpretation section. We have covered all the material now in the ratio analysis section, however, sometimes it can be easy to know something but difficult to actually apply it. We will now go through an exam type of question in this section, try it out for yourself before looking at my answers (the right ones of course): Required: You are provided with information relating to Kalidas Limited for the year ended 28 February Use the given information to calculate the following financial indicators for % Gross profit on cost of sales (mark-up) 2. %Net profit on sales 3. % Operating profit on sales 4. Current ratio 5. Acid-test ratio 6. Debt/equity ratio 7. Solvency ratio 8. Net Asset Value per share 9. Earning per shares 35 Presto Matric Accounting Sample

8 Information: SAMPLE Kalidas Limited Extract from Income statement for the year ended 28 February 2014 Kalidas Limited 2014 Sales Cost of sales Operating profit Income tax Net profit after tax Balance sheet as at 28 February Assets Non-current assets Tangible assets Financial assets Current assets Inventories (all trading stock) Trade and other receivables (all trade debtors) SARS (Income tax) 0 Cash and cash equivalents Total assets Equity and liabilities Ordinary shareholders equity Ordinary share capital (R2.00 per share) Share premium Retained income Non-current liabilities Mortgage loan: UCT bank (15% p.a.) Current liabilities Trade and other payables (all trade creditors) Hint: Remember that Gross Profit = Sales- Cost of sales SARS (income tax) Shareholders for dividends Current portion of loan Total equity and liabilities Caution: Only round off final answers. If there is a number that you worked out that you need for further calculations (i.e. not a final answer) make sure you don t round that number off. You can t be rounding off willy nilly at each calculation peeps. The standard is to round off to 1 decimal places (unless stated otherwise).

9 Answers: 1) ((Sales- cost of sales)/cost of sales) = ( / ) =( / ) = 60% 2) (Net profit after tax/sales) = (904000/ ) = 10% 3) (Operating profit/ sales) = ( / ) = 15,81% 4) Current assets: current liabilities : ,37: 1 5) Current assets- stock: current liabilities : : ,85:1 6) Non- current liabilities: ordinary shareholders equity : ,48:1 Hint: Remember to include the unit in your answer, for example cents per share in this example. 7) Total assets: Total liabilities : ( ) : ,35:1 8) (Ordinary shareholders equity/no. Shares issued) =( /( /2)) = ( / ) X 100 = 374, 81 cents per share 9) (Net profit after tax/ No. Of shares issued) = ( / ) = 82,18 cents per share 37 Presto Matric Accounting Sample

10 SAMPLE INTERPRETATION Profitability is a measure of how efficient the company is in its normal operating activities. A profitable business is always a better off business, which is why these ratios are calculated to check how well the business is operating from year to year. Profiitability Gearing is a measure of what extent a company is financed by loans (borrowed money) compared to its own capital. Both ratios/calculations are very important and is guaranteed to be asked somehow in the finals. Gearing Why do people invest in companies and the stock market? To make a favorable return on their investment obviously! Returns are important in interpreting shareholders satisfaction in a company and are another favorite for examiners! Returns 38 Solvency The ability of a company to pay off all its debts. This is similar to liquidity but is a reflection of both the short term and long term financial position of a business. Only one ratio is provided (solvency ratio) but another calculation you can use is net assets. Liquidity This is a measure of the ability of a company to pay off its immediate (short-term) debts. Liquidity is very important for a business and is a reflection on its current financial position. Examiners love asking questions on these ratios so look out! These are the same 5 categories of ratios that you have always been studying (you can find them on that grade 11 ratio table above), but here we have gone into more detail so you understand the ratios better.

11 We have made it finally to the end of ratio analysis; hopefully most of you remain rather unscathed. The question in the previous section is a prime example of the type of question they could test you on in the final exam and its easy marks! But the problem is that the question will be a mixture of some ratio analysis and some interpretation! So now that we have mastered ratio analysis lets move on to the more accounting part of this section, which is the interpretation. So you re in the final exam, having just breezed past all the ratio analysis calculations that someone so masterfully taught you when you encounter a 10 mark question to comment on the liquidity of the business given a couple figures and percentages. What do you do? If we were in grade 11 we probably would just waffle on and on till the block is all but filled! However, in matric there is a method to the madness, which can make our lives much easier! On the page to the left we have covered the theory behind this entire section lets put it to practice with a few exam style examples, which I feel will best give you an idea of the type of questioning for this section in the exams. But first Important steps to follow when commenting on financial indicators/calculations: 1. Consider what the question is asking you to analyze (e.g. profitability, liquidity etc.), and choose the relevant financial indicators. This will ensure you get some marks because the examiner can see you understand what to look for. 2. Name the financial indicators giving their relevant figures. 3. Compare the current years indicators with previous years or in some cases alternate investments/companies and identify a trend i.e. whether figures have increased or decreased from previous years 4. If possible, provide a general comment at the end of your answer to tie everything together 39 Presto Matric Accounting Sample

12 SAMPLE TYPICAL QUESTIONS Now lets dive right in to the heart of this section, at first these type of questions may seem overwhelming because of how much is expected of us to write but stay calm, follow my instructions, look at these examples and in no time this entire section will be simple to you. 1) Comment on the liquidity position of this company Financial indicator Current ratio 1,3:1 2,1:1 Acid test ratio 0,6:1 1,4:1 Current ratio has improved from 1,3:1 in 2013 to 2,1:1 in Acid test ratio also improved from 0,6:1 to 1,4:1 The company overall is in a good liquidity position and will be able to pay off its short-term debts easily. 2) Comment on the earnings per share(eps) and dividends per share(dps) of the company Financial indicator Earnings per share (EPS) Dividends per share (DPS) 40 35c per share 25c per share EPS has declined from 35c to 15c per share DPS has also declined from 25c to 20c per share 15c per share 20c per share In 2013, the EPS was 35c per share while DPS was 25c per share which means the company retained 10c of every share for future growth. In 2014, the EPS was 15c per share while DPS was 20c per share meaning the company gave more to the shareholders than they actually earned and also lead to no retained earnings for the year, which could hinder future economic growth. Hints: Watch your dates! Make sure you are looking at the right year sometimes with all these figures you might read the information wrong which will lead to you answering the question wrong!

13 3) Comment on the financial gearing of this company Financial indicator Debt/equity ratio 0,6:1 0,4:1 Return on total capital employed (ROTCE) *Note: Interest on loans is 15% currently 14% 22% Debt/equity ratio decreased from 0,6:1 to 0,4:1 This means the company is funded less by borrowed money and more by its own capital which will lead to a decrease in financial risk ROTCE increased from 14% in 2013 to 22% in In 2013, the loan was having a negative gearing effect since the ROTCE was less than the interest on loan. However, in 2014 the loans are having a positive gearing effect, as it is much higher than the interest on loan. 4) Comment on the Return on Shareholders equity (ROSHE) of the company Financial indicator % return on shareholders equity (ROSHE) ROSHE improved from 18% in 2013 to 24% in % 24% The shareholders should be pleased, as a return of 24% is much higher than the return on an alternate investment like a fixed deposit, which on average gives a return of around +/- 10%. You can see the method has been used in all of the above examples. As you do more and more examples this type of question will become almost formulaic! That s the beauty of accounting; everything has a method to it! We almost at the finish line for this chapter but before we close the book on ratio analysis and interpretation lets take a quick look at 3 different type of auditing reports which we are sometimes also asked to comment on! Presto Matric 41 Accounting Sample

14 SAMPLE TYPES OF AUDIT REPORTS 1) Unqualified Audit report Although unqualified sounds bad, don t panic this is the best audit report you can get from an auditor! An unqualified opinion is often called a clean opinion; it is an audit report that is issued when an auditor determines that each of the financial records provided by the small business is free of any misrepresentations. In addition, an unqualified report indicates that the financial records have been maintained in accordance with GAAP. 2) Qualified Audit report This is not the best report to get but it isn t the worse. Its kind of like that average middle child that people tend to forget. All you need to know about this report is that it is extremely similar to that of an unqualified report. A qualified report, however, will include an additional paragraph highlighting the reasons why the audit report is not unqualified, this could be due to the financial records not being maintained in accordance with GAAP or maybe one or two misrepresentations are identified. 3) Disclaimer Audit report This is the worst possible case we cover in the matric syllabus. An auditor issues a disclaimer when they feel they are unable to accurately comment on the financial position for a number of reasons, such as an absence of appropriate financial records. When this happens, the auditor issues a disclaimer audit report, stating that an opinion of the firms financial status could not be determined. 42

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