company’s spreadsheet

Step 5

Commentary & Discussion

Compared to the Fleetwood company studied in ACCT1059, I have been lucky enough to study Nanosonics. It has a clearer entry, especially in notes. Some items that are difficult to judge whether it is financial or operating are clearly stated in the note. Nanosonics clearly describes their financial and operating income, expenses, assets and liabilities in a note. This makes it easier for me to actually make the form.

To be honest, setting up a Restated Income Statement is more of a challenge for me than setting up a Restated balance sheet. Because in the income statement, there are many items that I am not sure whether they are financial or operating, such as Effective portion of changes in fair value of cash flow hedges and Income tax on items of other comprehensive (loss) / income. To my sadness, I didn’t find any notes about these two projects, so I posted a question about these two projects on Facebook in our course, hoping that some students can help me answer.

Of course, I also found something interesting. For example, in my research on Nanosonics’ financial statements for four years, I found that this company has no financial income, and all the company’s income belongs to operating income. This means that all of Nanosonics’ revenues depend on sales of goods and business services. Everything has two sides. In a period when the market prospects and the world economy are booming, Nanosonics can rely on the sale of high-tech medical equipment to obtain a large amount of sales. For example, in 2019, Nanosonics’ operating income reached $86,190,000. Operating profit after expenditure was $ 15502,000. But in 2016, when the economy was bad, the company’s operating profit was -$359,000. The root cause is a significant reduction in operating income. Specific data can be seen in the table.

In the restated balance sheet, I also encountered a problem, the classification of derivative financial instruments. My original intention was to classify it in the financial category. Although in the final result, I learned that derivative financial instruments should indeed be classified in the financial category, I was still confused during the production process. I noticed a description of derivative financial instruments in the notes. I found that when the fair value of a derivative financial instrument is positive, the derivative is treated as a financial asset. When the fair value of a derivative financial instrument is negative, the derivative is treated as a financial liability. In other words, derivative financial instruments are financial items.

Another problem I encountered was borrowing. From my experience in daily life, I initially thought that borrowing was an operating liability. Because if my friend asked me to borrow money for business reasons, I lent it to him because of poor management, which logically should be operating liability. But when I saw the borrowing in the notes, I found that I was wrong. First of all, in the most obvious way, the borrowing project in the note belongs to a secured financial lease, that is, I thought wrong from the beginning.

Second, borrowing costs include interest and other costs associated with the borrowing of funds by the entity. Involving interest, that is, borrowing is a financial liability.

When it comes to financial liabilities, I have a problem that has not been resolved. Why are financial liabilities written as Financial Obligations in the rested balance sheet?

Chapter 4

The main content of this chapter is what the title says, recognising the past. The past is basis of present and future. Without an analysis of the past, there is no more accurate judgment of the future. I prefer the references to Machiavelli in the text, use the past as an important foundation to predict the future.

KCQ: Abnormal Earnings

The first important piece of knowledge in this article is abnormal earnings. Literally, abnormal earnings refer to stock earnings after deducting normal returns from the actual purchase salary of the share. As we have said in daily life, events such as mergers and acquisitions, dividend announcements, and company lawsuits may bring abnormal returns. If the abnormal earning is “positive”, we can assume that the affair has a useful influence on the price of share; for example, the company acquired another company through normal legal business channels, and this event caused the company’s stock price to rise. Excluding the company, if the abnormal earning is “negative”, we can affair that the event has a bad influence on the share price

The calculation of Abnormal Earnings formula is “AE = [ROE – (ρE-1)] x BV“.

Of these, what interests me most is the required return on equity expressed by the abbreviation and the number. Why are other projects only represented by abbreviations, and the required return on net assets requires a rate of return minus 1. According to the example in the article, the required rate of return is 10%, and we express ρE as 1.10. To get back to 10%, we subtract 1 from the formula. I can’t understand this explanation, so I reviewed the GST knowledge I learned before and found that the two knowledge points have something in common. If a product is included GST, then if I want to know how much the original price of this product is, I need to divide the price of the product by 1 + 10%. Here, the 10% GST prescribed by the Australian government is equivalent to ρE, which is a fixed value. I don’t know if I understand it this way.

KCQ: Restating financial statements

The second point is restating financial statements. The aim of financial statements restated is to make our task of analysing abnormal income drivers more effective. Restatement of financial statements is the re-preparation of the company’s financial statements, which plays a role in checking for omissions. The previous financial statements are like a draft. After re-preparation, they will become more complete and then become a formal draft. In the process, you can find incompleteness and errors in previous financial statements. The article also mentions the course ACCT11059. Although I have not studied this course, I understand that the principles of learning are all the same. There is no shortcut to doing and learning by doing.

The most important and fundamental step to restate financial statements is to clearly detect the company’s managing and economic activities I think. In this regard, I can talk about my experience. First of all, I would like to thank Martin for his guidance on my restated financial statement, because when I first prepared this assignment, I had no clue. The financial statement of the company I researched is very complicated. There are some items that are difficult to distinguish between business and finance, such as cash and cash equivalents. This project literally means that it is a financial asset, but after I watched the video that Martin shared to me, I realised that cash and cash equivalents belong to financial assets and operating assets. Because of some reasons, I couldn’t go to class, so I lacked face-to-face interaction with the teacher. Thanks again for Martin’s help.

I uploaded a draft of the restated financial statement I made as a screenshot. As can be seen from the figure, the restatement of the financial statements subdivided the previous financial statements into several categories. This method can ensure that investors can see the true situation of the company’s operations. I put the specific steps that I made a restated financial statement in the next point, and interested readers can continue reading.

The next key point is the statement of changes in equity. Without say more, this knowledge is still related to the excel form. Recently, because of this form, I especially want to return to the school to go to class, so I can ask the teacher about how to classify the problem. Closer to home, the company’s assets can be divided into several categories, of course there are current assets and non-current assets, and the classification I am talking about here is divided into operating assets and financial assets. Operating assets are the income earned by the company from producing products and services for customers, such as operating revenue, Gain on disposal of plants, equipment and property. A characteristic of these assets is that if the company suspends operations for some reason, there will be no change in growth or reduction of these assets. Financial assets refer to the stored value that a company applies to its operations. For example, interest.

I quote a picture in the article that can clearly express the relationship between operating assets, financial assets and various factors.

Net operating assets funds are made by producing services and product for customers. At this part, operating revenue are produced. At the same time, net operating assets will give part of the funds to suppliers to produce products and generate part of operating expenses. Net financial assets involves interactions with debt and equity capital markets, that is, debt investors (F) and equity investors (d) showed. Because net financial assets refer to assets that enterprises do not invest in operating funds, most companies deposit this part of funds in banks. But if the funds are invested in banks, what does it have to do with equity investors and debt investors?

Balance sheet, income statement and cash flow are the three most important financial statements. The balance sheet usually shows company’s assets, which is divided into current assets or non-current assets. Income statement indicates the income and expenses of the company during this period. The purpose of the income statement, except recording the income and expenses of the company, another purpose is distinguishing business and financial income and expenses, in order to determine net financial expenses and after-tax operating income.

I started to describe the KCQ of this article before I prepared the restated financial statement. At that time, I was just describing the surface meaning of the text, but when I really started to prepare the restated financial statement, I found that I was not sure about each of these. Whether it belongs to operating or financial, it really stumped me. Then my question is very simple. Is there a way to judge accurately, which one is about operating and which one is about financial?

KCQ: Restate Two Financial Statements

Although I have already mentioned some of my experience with the restate balance sheet and Income statement in the Restating financial statements project, I still want to exchange some experiences of this content, because this is the knowledge about step 4 and 5. According to what I said before, the essential to restate two financial statements is to correctly divide all the items in the two reports into financial and operating. I take the company I analyse as an example.

• Separate the items with income and the items with expenses.  

Income	Expenses
Revenue	Cost of sales
Other income	Selling and general expenses
Other gains-net	Research and development expenses
	Administration expenses

• Check every project of income, expenses and other comprehensive income, and distribute between operating activities and financial activities.  

• Immediately following the distribution of taxes in the operating and financial portion of the income statement, this is the most important stage, because this will be linked to net financial expenses.

• Finally, the company’s net financial expenses (NFE) and operating income (OI) are calculated after tax. The same applies to restated balance sheets.  

• In the end, I was inspired by the video that the restated balance sheet is successful when net operating assests (NOA) project equal the total NFO + Equity project.  

KCQ: Analyse ROE: Leverage, Profitability

Let me study leverage. As we all know, the lever uses the long extremity to drive the short extremity.

This means that in a period of good economy, the leverage ratio will show a good direction, but in a period of economic downturn, the leverage ratio will cause trouble to the managers of the enterprise. Leverage is divided into financial leverage and operating liability leverage. The calculation formula for financial leverage is “FLEV = NFO/Equity“.

Financial leverage is a tolerance of the influence financing certain corporate operating assets through the debt markets net debt rather than shareholder equity. One example vividly describes leverage: I would ideally have 100 cows. In this way, I can expand production and sell more milk, move to larger farms, do bigger businesses, and make more money. But the reality is, I only have 50 cows. So, I loaned 50 more cows to the bank and realized my life ideal. This is the essence of leverage-liabilities. That is to borrow funds, put into operation, and use a small amount of principal (50 cows) to pry larger assets (100 cows).

A leverage is composed of two parts, the financial leverage is the long end, and the short end is the operating liability leverage. Operating liability leverage is a method of the effectiveness of creditors like suppliers or customers to finance certain total operating assets of a company through products and inputs to the market. What I understand is that when the leverage of financial assets is long enough at the same time the leverage of debt is short enough, the company’s return can be maximised. High leverage means that during the economic prosperity, financial institutions can obtain higher returns on equity, but when the market reverse, they will confront the risk of a major decline in returns. The return that leveraged companies can generate for their stock investors can be calculated by

“ROE = ROOA+ (RNOA-ROOA)+ (ROE-RNOA)“

Just like the leverage I have seen in daily life, the section that lifts a heavy object also has its maximum value, and the same is true for the leverage ratio. Although the leverage ratio can ensure that some high-quality levels’ capital be owned by bank in a good economy, because leverage does not differentiate between assets with distinct hazard and all assets need claims the same capital, so stimulate banks to effectively command asset hazard is difficult.

Profitability is also an important factor in return on equity. In layman’s terms, profitability is the company’s ability to make money. Without profitability, the company would soon go out of business. Therefore, it is regarded as the core of corporate activities to some extent. In this chapter, profitability can be calculated by

“PM = OI ÷Sales“ to calculate. The calculation of profitability is like how many bosses I can beat in a limited time when I play a game. Using operating income ÷ sales income, I can accurately observe the company’s sales revenue as a percentage of total operating income in a fixed period of time. Of course, the larger the profitability ratio, the better. The larger the ratio, the more the company relies on selling products to obtain funds. One of the typical representatives in my heart is Disney, and Disney has launched a lot of characters that children love. These characters were first launched from the theater, and later developed again through DVD. Then the company collected a TV network license fee, launched a sequel for it, and derived products, which eventually became attractions in the theme park. Every step of this means that the company’s profitability is growing. Because each newly developed franchise has become a valuable added value, making Disney’s huge content library richer, and in the next few decades, it will be able to create revenue for the company like a money printer.

KCQ: Analyse ROE: Efficiency and Leverage Revisited

Efficiency is the last component of return on equity. In layman’s terms, efficiency is the ability to generate sales or turnover. In our daily life, everything we do appears efficiently. Effective time to get up, effective time to wash, study and work are inseparable from efficiency. The most intuitive example is that step 6 is recommended to be completed in 3-3½ hours, but I completed the same quality KCQ in only two and a half hours, then my efficiency is higher. Efficiency is a top priority in running an enterprise. Efficiency is surveyed by the assets and turnover, it is called (exceeding) asset turnover (ATO). When asset turnover increases, companies will have more funds to invest in production and operations. Conversely, when asset turnover becomes low, companies are constrained by insufficient funds and repayment of loans. This relationship can be written as

“ATO = Sales÷NOA“

The special relationship between profit margin (PM) and asset turnover rate (ATO) is the formula for calculating the return on net operating assets (RNOA):

“RNOA = PM x ATO“

Through this formula, I can see that the connection between RNOA and the other two factors is directly proportional. When one or both of the profit margin or asset turnover rate rises, return on net operating assets RNOA also rises. high. By the same token, when they both fall, return on net operating assets (RNOA) also fall. The most direct message from the RNOA drop is that the business is not doing well.

Another term is called net borrowing costs and it can be showed

“NBC = NFE÷NFO“

Since I have not yet done a systematic classification, I cannot answer most of the questions in this chapter. But I believe that when I thoroughly analyse the financial statements of the company, this guide will be the best reference material that I think other students recommend.

In summary, the focus and difficulty of this article are the memory and calculation of formulas and the expression of abbreviations. At my current level, I need a lot of time to memorize formulas and use formulas in practice. So, I made the formula and all the abbreviations into a table to facilitate my learning and memory.

“AE = [ROE – (ρE-1)] x BV”

“FLEV = NFO➗Equity”

“ROE = ROOA+ (RNOA-ROOA) + (ROE-RNOA)“

“PM = OI ÷Sales“

“ATO = Sales ÷NOA“

“RNOA = PM x ATO“

“ROE = RNOA + (FLEV x SPREAD)“

“NBC = NFE÷NFO”

“AE is abnormal earnings”.	“FLEV is financial leverage”.	“RNOA is the return on net operating assets”.
“ROE is the return on equity”.	“NFO is net financial obligations“.	“PM is profit margin“
“ρE is cost of equity capital”.	“ROE is the return on equity“.	“Oi is Operating Income after tax“
“BV is book value of ordinary shareholders’ equity”.	“ROOA is the return on operating assets without leverage“.	“ATO is asset turnover“
“FLEV is financial leverage“	“NBC is net borrowing cost“	“NOA is net operating assets”
“SPREAD is operating spread”	“NFE is net financial expenses”

All formulas and abbreviations explained from chapter 4

KCQ: strategy

The company’s strategy is the first emphasis of this section. The company’s strategy is the direction it intends to take and how it plans to achieve it. Simply put the company’s strategy is to achieve the goals and directions established for the purpose. For example, the hospital’s first strategy is to treat patients and save people, followed by income. 😀 The primary strategy of the school is to educate students, followed by achieving the world’s top rankings. The person who makes the strategy is the actual manager of the company. I know that Apple’s strategy was developed by Tim Cook, or perhaps another major shareholder, I don’t know. But he gave a speech at every press conference. In order to formulate a strategy that can achieve the goal, managers will consider the economics of the company’s business to begin the analysis of financial statements. We need to understand the company’s competitive environment including its industry and the overall economy and its position in that environment. I still use Apple as an example. The company has the world’s leading mobile phone technology, so every time a new model is released, other brands of mobile phones will always make their own brand phones similar to Apple phones. Apple phones are leading the way in the industry environment. I am a fully fans of Apple🍎. What are the main risks it faces, and which are the key economic factors driving its profitability? This is my first question. I think this part of knowledge can be combined with the fundamental analysis in chapter 1, because the factors for formulating strategies will not be found in the company’s financial statements. Similarly, fundamental analysis will not be reflected in financial statements. Therefore, from a series of details in the article, making a strategy requires premise of fundamental analysis.

As we all know, a good strategy can increase the value of the company, so that the company’s future benefits will exceed the cost of capital it uses. How do managers make a good strategy? I continued to study with this question.

Strategy is essentially our view of the company’s intentions. As I said before, strategy is something subjective. When the company succeeds, we can say that it is a strategic success, but when the company fails, we will say that it is also a strategic failure. I like Rumelt (1987) explains that “strategy is creating conditions for economic rents and finding ways to maintain rents”. This is closely related to the economic profit framework of financial statement analysis.

An example is given in the article about why Ryman Healthcare is building a retirement village. Because the population is aging and the proportion of the population over 75 years of age is increasing, the construction of retirement villages can give these elderlies a comfortable place to live, and on the other hand the village strategy can obtain a lot of economic benefits. This is an example of a good strategy. It equivalent to the medical insurance policy implemented by the Chinese government, because the population is aging, and the pension growth rate of a few elderly people is slower than the price of medical supplies. This has caused some poor elderly not have enough money to treat the disease. Therefore, the Chinese government has implemented a medical insurance strategy and basically achieved the status quo that all citizens can treat diseases. The article also quotes a point that I am very interested in. The French meaning of strategy is “un reve ou un bouquet de reves en quete de realitie”. From my perspective, strategy means dream. The enterprise achieved a good economic purpose because of a good strategy, and I realised my dream because of a good strategy.

KCQ: quantitative measures of value

The focus of financial statement analysis is to understand how to translate a company’s strategy into quantitative measures of value. In other words, it is how the company achieves its economic goals through the formulated strategy, that is, how the company makes money. There are many small examples of such success around me. For example, opening a small restaurant in the downtown area and using deliciousness as the main strategy of the restaurant. There should be a lot of customers who eat, and the restaurant definitely get a lot of income. But I have a problem, once the strategy formulated by the company has a problem, this leads to the company’s strategy has not been converted into a quantitative value, and even to this point, it has lost money. Whether this error is due to the manager’s wrong strategy formulation or to the fast-moving market.

KCQ: the cost of capital

The next key concept identified from the Study guide was cost of capital for a company.

The cost of capital is a lost return, which is the return of an alternative investment event that was abandoned for investing in the project. Wow, I used to think that the cost of capital was just a cost of investment. I didn’t expect its deep meaning to give up some investment opportunities. I understand that the most ideal use of the cost of capital is to invest limited funds into an unlimited market. However, this cannot be achieved. The author used the example of Sydney Fishing Port to make me understand this concept. From a fishing port perspective, the fish caught is just a commodity. After the commodity is sold, the fish have more uses and can be used for food, medicine or aquaculture. But these by-products have nothing to do with fishing ports, because it only chooses fishing fish resources as investment targets, and other investment directions have not been selected. This is my understanding of the status quo of the cost of capital of an enterprise: exchange finite for limited. I hope my example is correct. If there are errors, I hope Martin can contact me to correct them. 😜

KCQ: assessing strategy

The article mentioned the assessing strategy. In the analysis of financial statements, we need to adopt a strategic perspective. This means we need to think strategically about the company we are analysing. Just like the fish market mentioned in the article, according to the knowledge I have learned from the text, if I want to analyse this market, I will analyse the strategies related to the fish market, such as the price of fish at each stage, and the kind of fish, a variety of fundamental factors related to the fish market, such as species, national fishing policy, and so on. The fundamental purpose is to analyse how this goal adds value and hopefully adds value in the future. In financial statement analysis, we use sources of financial information to help us better understand the companies’ economic and business realities. However, before we start doing this, we had to identify that which financial information should be useful to us. We will consider whether important aspects of a company completely exclude its financial situation. I am not understanding the passage in this article, because one of the company’s financial statements changes, other factors will also change. I hope the teacher can answer this question for me.

KCQ: five ‘P’ strategy

The five ‘P’ strategy is a good way to analyse business strategy, just like PESTEL (Political, Economic, Social, Technical, Environmental, Legal) I used before. The five ‘P’ strategy is short for plan, ploy, pattern, position, perspective.

Plan refers to the strategy formulated by the enterprise for future development. Ploy refers to the strategy you want to achieve the desired goal. Pattern refers to the model of an enterprise, which is not formed in a short period of time, but a long-term operation of the enterprise. Position means the positioning of the company, what are the main products that the company deals with, which all belong to the category of positioning. Perspective is the perspective of managers, which is the decisive factor in the formation of corporate strategy. When I analyse the strategy of a company, the five ‘P’ strategy allows me to clearly see the composition of each part of the company.

KCQ: accounts leave out

The next focus is about accounts leave out. Because financial statements are an abstraction of reality and a simplification of all the complex and diverse things in an enterprise. This means that financial statements are missing a lot sometimes. Although the probability of making an error is very low, once an error is not detected, it will cause errors in each subsequent step, which is a chain reaction. Just like I wrote an assessment, if the middle paragraph does not match the theme, the whole article will have problems, which is why I will double check after I finish writing. Financial statements are mainly omitted in two aspects, first is its ability to generate positive net present value investments in the future; and another is the opportunity cost of its operating, or in other words the cost of capital. I understand that a positive net present value in the future refers to the difference between the present value of future capital income and the future value of future capital expenses. Because this money is positioned in the future, no one can predict what the future will look like, so this uncertain factor cannot be recorded in the financial statements.

KCQ: accrual accounting

Next, I saw a very familiar concept, accrual accounts. I know a language is about the biggest difference between an accrual account and a cash account is that the accrual account is recorded at the point in time when rights and obligations occur, while the cash account is recorded at the point in time when cash is specifically received. I don’t know if the concepts I remember are right, if not, I will review the knowledge I have learned more seriously. In the knowledge point of accrual accounting, there are also certain risks, because managers and accountants may want to manipulate outside perceptions of the company’s economic and business reality. They have considerable discretion in how to use financial statements to reflect these realities. This means that if the accountant wants to modify the amount or the manager wants to pay less taxes, it is entirely possible. Because accrual accounting is based on the recording of rights and obligations, the payee will not know what the specific amount is for the time being, which causes great inconvenience to the supervisor. The article said that regulations in many countries require listed companies to provide financial statements, and the regulations are enforced, which has greatly reduced the occurrence of this situation. According to the news I have seen, the amount of tax evasion due to accrual accounting is very large, which means that this method has a large loophole. So why is there no way to limit this disadvantage? Hope Martin can help me to add this knowledge. I have a question here, because only the supervision method is mentioned in the article, but the punishment measures are not mentioned, so I want to know the punishment measures for this situation in some countries.

Chapter 3

I like the description of the early analysis of financial statements in the article. This behavior originated in ancient Greece in the 19th century, but is not called analysing financial statements there, they are called focusing on financial statements. The ancient Greeks used the idea of ratios to focus on the communication between different businesses. Although use of ratios to analyse the communication between different projects in the financial statements originated early, there has been no clear reason to prove that this will help predict the future prospects of the company for a long time. This has stimulated my interest in learning. Until now, is there any way to accurately predict the future prospects of the company.

KCQ: comparables and P / E (price-to-earnings) multiples

The title of chapter 3 is about the method of assessing value. According to the knowledge learned from the previous two chapters, analysing the financial statements of companies is the most effective method of assessing value. But it’s unclear whether this data is useful for predicting the company’s future results. As the text says, we lack any convincing theory to support a method of analysing financial statements. But even so, people have summarised several methods in practice, such as comparables and especially the use of P / E (price-to-earnings) multiples. Does this mean that if you choose one of the companies in the same field and the same size and compare their financial statements, you can find out the advantages and disadvantages of each company? For example, KFC and McDonald’s? 🍟

But these methods also have limitations. They have no clear theoretical connection with the company’s current and future economic and business realities. They are usually based on speculation. What I understand is to say that these methods summarised by people have not been 100% verified. These methods are just some regular pattern, but these regular patterns will change at any time, because no one can be sure that it will happen in the future.

After a long period of practice, people have found that profitability and liquidity or solvency are useful aspects of checking the company’s financial statements. But this is one of them, not a consensus. I fully understand the meaning of this sentence, just like the example given in chapter 2, Ryman Healthcare made its own company’s financial statements excellent by constructing a retirement village. But I believe that the company’s internal view is not only about building a senior citizen’s village. Perhaps some managers think that introducing some medical devices is a better way. Until now, some ratios have proven useful, or the wrong ratios won’t last that long. These methods are not based on practical experience, but on methods that appear to work in practice. This passage in the text has shocked me. Since the emergence of the situation of analysing financial statements of enterprises, people have been analysing financial statements with no “most correct answer.” A hundred people have a hundred opinions. But what struck me the most was that many companies rely on this analysis method without the right answer to gradually expand their business scale. This status quo without the right answer does not satisfy the managers of the company. As stated in the article, they have been looking for reasons to believe that the company’s financial statements can assist us predict the future performance of the company; Many attempts have been made to determine which of the various ratios that can be calculated from the financial statements is the most useful. Seeing here I have a question, why some methods that are useful in analysing financial statements have not been promoted?

KCQ: business reality and economy

In the next paragraph, the author emphasised again that the key aspects of a company’s business reality and economy. It should be decided by the financial statement analysis. Although I said that analysing the financial statements of a corporate cannot include all the issues facing the corporate, the ratios and data appearing in the financial statements will definitely indicate the events it contains. Suppose a company is facing failure. It may not contain all the reasons for its failure, but the reasons contained in the file must have happened to the company. This is represented by the arrow:

financial statement        business reality and economy

business reality and economy         financial statement

I have a question, which of the company’s questions about the economy and the question of business reality is a key aspect? The text does not mention the answer to this question. Does this mean that what belongs to the key aspects need to be managed by manager their own judgment?

Concept: accounting and financial thinking

Financial statement analysis is where accounting and finance are combined. However, more importantly, this is where accounting and financial thinking can be realised. Financial statement analysis is the practical application or use of accounting and financial thinking. I know this very well. In the last term, the company I studied was Fleetwood, a construction company. In its financial statements in 2019, its expenditure was greater than its income, which means that it was losing money in 2019. My task is to study why it is a loss. I regard this stage as the application of my financial thinking. After analysing most of Fleetwood’s figures, I have concluded that the raw materials are too expensive, and the inventory backlog is too heavy. I call this process my accounting thinking. So, analysing financial statements is indeed where accounting and financial thinking can be realised. Of course, the article also mentions a commonly used technology widely used in practice, use of comparables. I understand that the comparable company analysis method can provide a market benchmark, so that investment bank analysts can analyse the value of listed companies at any time. In fact, the company to be analysed is compared with other benchmarks. But this method may not accurately represent the true value of the target company, because it does not consider every aspect of the company. So, if this method of comparison cannot be considered comprehensive, what method should we use to evaluate the company?

Immediately after that, several difficult formulas were pointed out in the article. This is also the focus of this article: ratios

Equity value = PV of expected future dividends

I don’t understand the formula, but I know asset-liability=equity. So, what different between equity and equity value. And then the article extends this formula.

“Equity value = DIV1÷ρE + DIV2÷ρE2 + DIV3÷ρE3 + … ” I’m sorry I’m confused, it’s hard for me to understand. “This is called the dividend discount (DD) model”. This is the theoretical basis for our evaluation of company equity. But this is the most ideal model for dividends, because the author assumes that dividends can always be received. This is unrealistic, because the company will have a life, so the company will terminate the dividend someday. If company managers use this method to evaluate company equity, financial statement analysis will focus on predicting the company’s future dividends. So according to my understanding, if the company’s managers want to evaluate the company’s dividend in a certain period in the future, they can use the dividend discount (DD) model.

Another formula is the relationship between cash flow and dividends, which is usually written as

“Dividends (d) = Operating cash flow (C) – Capital outlays (I) + Net cash flow from debt owners (F)“

The expected book value of the equity at the end of the period is equal to the opening book value of the equity plus the expected comprehensive income, minus the expected dividend on this basis. It can be expressed as:
“BV1 = BV0 + CI1 – DIV1“

I have listed a table summary and some basic formulas learned by this chapter. I understand them more difficult now, but after studying, I believe I will eventually master them.

“Equity value = PV of expected future dividends”

“Equity value = DIV1÷ρE + DIV2÷ρE2 + DIV3÷ρE3 + …”

“Dividends (d) = Operating cash flow (C) – Capital outlays (I) + Net cash flow from debt owners (F)”

“BV1 = BV0 + CI1 – DIV1“

Preface

When I started reading the Preface, the first thing that attracted me most was its title: To Know What Adds Value. Because this subject is about accounting, I understand the value here as the value on the asset. On the other hand, I am also curious whether the value here includes other meanings that I did not expect. With this question in mind, I continued to understand.

In the first paragraph of the Preface text, I summarise it as the history and importance of the company’s financial statements. From before the end of the 19th century to the present, the company’s financial statements have evolved from being accessible only to internal staff to sharing with external staff. From this process, I can clearly feel that external people, such as customers, equity investors, are more and more concerned about the company’s financial information. Because I studied accounting in the last term, I know very well that the company’s financial statements can reveal a series of situations such as the company’s profit or loss. So, as the text says, suppliers, customers, employees, taxation authorities, regulators, competitors and the general community all have a genuine interest in analysing the financial statements of firms. The company’s financial statements have attracted more and more attention.

In the second paragraph, the first half is about books that can help me understand the company’s financial statements. The part that interests me most is in the second half. According to the article, the study guide focused our attention on business reality, not on the financial statements themselves. I have a question: What does business reality represent? I simply understood it. According to my accounting experience last term, the company’s financial statements not only reflect the changes in the numbers, but also reflect the economic changes in the region and the world during this period. Because the company cannot exist independently, it must depend on the world economy and rely on the upper and lower companies to survive. The financial statements of an enterprise change, and the factors on which it depends must also change. This is the business reality I understand.

At the beginning of the third paragraph said that the importance of fundamental analysis of the company itself will be emphasised. Does the article meaning of this sentence is to start with the basic factors that make up the company, such as the company’s business, etc., not directly from the company’s higher-level factors such as income and expenses? In addition, it has been mentioned more than once that over-reliance on the opinions of others can hurt our sense of reality. What does this sentence have to do with my study of accounting and analysis of the company’s financial statements? I can get a series of information from the company’s financial statements, but the meaning of this sentence seems to make me not just focus on the financial statements, because this will damage my reality sense. In my perspective, these are two conflicting things. I hope teacher can answer me. The next paragraph seemed to explain my doubts. It says that if you only analyse financial statements, it is easy to disconnect from any coherent theory or ideas about increasing business value. The capital market needs some common ideas and values to help it stay closely connected with reality. The first sentence is easy to understand, because when I get a company’s financial statements, I don’t just look at the numbers, I also pay attention to the economic changes hidden behind the numbers. But in the second sentence, I still have some doubts. What do common ideas and values represent mean? In the end, two methods of valuation are mentioned: discounted cash flow (DCF) and economic profit. These two methods are unfamiliar to me, and certainly make me more interested in learning this subject.

Chapter 1

Fundamental analysis

The first knowledge point of chapter 1 is fundamental analysis. According to the articles, I have a very interesting analogy about fundamental analysis in the article. Fundamental analysis is to check the performance of this car from many aspects before we buy it. Of course, the metaphor in the text is turning over rocks, kicking the tyres, checking under the bonnet. Although it will take a certain amount of time, I can form my own judgment on this product, instead of judging the quality of this product based on the purchase manual or salesperson’s description. The purpose of fundamental analysis is to seek to understand the reality of a company to determine its value. Therefore, the characteristics of fundamental analysis is understand      determining. This means that if I use fundamental analysis to understand a company’s financial statements, I should first understand the various factors that may affect the value of the company, including information about economic and industry conditions, the company’s financial information , competitors and suppliers and other generally qualitative information. But after that I have a question, the article says that our focus will be on two frameworks that can help us do this efficiently and in a way that can give us real insights into the value of businesses. I did not find the so-called two frameworks. I will keep learning until I find the answer I want.

The next paragraph is about the shortage of fundamental analysis. So, I summarise it and make a table.

Doing fundamental analysis on a listed company is a waste of time

Fundamental analysis lacks credibility and rigour

Critics base the first argument on the fact that the stock price of listed companies already reflects public information, so it is irrelevant to start with the basic factors of the company. I can fully understand this view, because I have been exposed to the financial statements of some companies, and indeed the content of the statements can reflect a lot of information. Because financial statements are basically the sum of all financial information. This view is called efficient market hypothesis.

The second argument is based on the fact that the value of an enterprise is difficult to better understand with basic analysis, because it is extremely difficult to decompose many of the qualitative factors of the enterprise into numbers to derive the value of the enterprise. What I understand is that some of the factors in the composition of the enterprise are of great help to the value of the enterprise, but it is difficult to measure with numbers, such as the company’s staff resources, customer resources, and future market prospects. Human resources are the premise of creating value for enterprises, but human resources cannot be measured by money. For example, employees’ salaries can be recorded, but the value created by employees is immeasurable.

One of the most baffling questions of finance is why it is possible to consistently outperform the ‘average investor’ by buying shares that have low prices relative to an assessment of fundamental value. My understanding of this sentence can only be limited to the fact that I have purchased a stock of a company that is now low in value and has a lower consumer evaluation, but as its value gradually increases, the actual value which I have has exceeded Average investor. My question is whether teacher can translate this sentence into something I can understand more easily. The following paragraph may also prove the validity of my interpretation. When a company’s stock continues to grow for a period, consumers may think that it will continue to grow for another period, but the probability of growth and decline is 50%. Buyers of stocks only observe the increase or decrease of the stock price from the changes in the numbers and the trend of the stock price curve. They did not use fundamental analysis to examine most of the company’s factors, which led to their failure in the stock market. So, it’s important to have a framework for analysing financial statements or a way of thinking.

What follows is an explanation of my previous question, which two frameworks can help me analyse my company’s financial statements? These two frameworks are economic profit and the discounted cash flow (DCF). Reading with questions may be a new way for me. Although there are many ways to analyse financial statements, the DCF and economic profit framework are comprehensive, well thought out, and can provide us with a powerful way to understand the actual situation of the enterprise. These are the two professional frameworks that I must grasp to studying accounting. But applying these frameworks in practice need requires many judgements, assessments, and entirely correct guesses. Like the example of a stock I gave before, numbers and curves may lead me to speculate on stock price changes, but to really get a correct judgment of stock prices, more investigation, association and guessing are needed. As the text says, different guesses, different judgments, and different assessments will give us different answers.

Return on net operating assets= Operating income ➗ Net operating assets (including both working capital and non-current assets such as Property, plant and equipment).

This is the first formula for this term. Return on Net Operating Assets (RNOA) represents the return on capital used or invested in the business. After my understanding, this equation can be interpreted as the more value of a company invests above the cost of capital, the higher of the value in a company can create. But this is difficult to achieve because the managers of the company do not know whether this area will exceed the cost of capital in the future. It may be lower, and this result will make the company’s investment loss. Therefore, assessing the cost of capital is challenging.

The article also mentions two technical terms economic profit and cash flow. They are important factors in predicting future profitability and future growth of net operations. According to my experience, economic profit is a prerequisite for a company to have enough cash for turnover. If the company has enough economic profits, it can expand its business scale in a certain area. The information necessary for a company to evaluate the economic benefits of an investment plan is cash flow. In summary, use of DCF and the economic profit framework will allow me to have my own ideas to analyse the financial statements of companies and look at the business world in different ways.

When I have learned this, I have a doubt. As we all know, a corporate cannot survive alone, and it will be surrounded by many factors that are related to the corporate, such as employees, customers, governments, subsidiaries and parent companies. I call them business associates. Then my question is how the company handles its relationship with all its affiliates.

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Cash sales (GST exclusive) of goods for 11/09/2019 to various customers at $100,000

Sales construction (GST exclusive) for 09/09/2019 at $50,000.

Charges the customer a fee of $40,000 for rental equipment at 08/09/2019 exclusive of GST.

Because Fleetwood is a company that focuses primarily on construction and sales equipment, the company’s main income comes from selling products, construction and rental equipment.

Receive bank deposit interest of $10,000 in 11/09/2019.

As a publicly traded company, Fleetwood will deposit some of its funds in banks for management, and banks will issue interest on a regular basis based on the amount deposited. These interest rates will also bring a certain income to Fleetwood.

Paid material fees to raw material company (for the period 01/09/2019) of $20,000 exclusive of GST.

As a construction company, Fleetwood consumes a lot of raw materials every year to build buildings and tools. Fleetwood’s income statement has clear material expenditure data. In 2018, the company’s material expenses were $100,738,000, so I chose to add material expense items to my transaction.

Paid expenses as sub contract costs for other construction companies of $40,000 exclusive of GST in 02/09/2019.

When Fleetwood’s human resources are not enough to support all projects, it will contract some of the projects to others, which is why I chose sub-contract cost as a transaction detail. Moreover, there is also a sub-contract cost project in the enterprise’s income statement. In 2018, Fleetwood’s sub-contract cost is $822.3 million.

Paid equipment owner for equipment and plant rent of $40,000 on 3th September.

According to the main business of Fleetwood I mentioned above, it can be concluded that corporation need to rent some equipment to produce goods, and of course they need to rent a certain amount of plants to store these equipment and goods.. In Fleetwood’s notes of balance sheet, there is a description of rent plant and equipment.

Fleetwood corporation paid monthly owner $50,000 (GST exclusive) to all employees in 04/09/2019.

Employee salaries are an essential expense for every company that has employees. In 2018 Fleetwood’s employee benefits expenditure was $39,11,000, so I chose employee salary as a transaction item.

Paid $70,000 for some rental products to product owner in 01/09/2019 without GST.

In the actual operation of the company, a certain number of operating lease relationships, such as personnel, funds, equipment, etc., will be generated. In 2018, Fleetwood’s operating lease expenses were $6,934,000. So I chose to operating lease expenses as one of my transaction journals.

Paid $100,000 at 02/09/2019 to upgrade the product exclusive of GST.

According to Note 1.19 in the Fleetwood Annual Report, expenditures for research activities are recognized as expenses during the production period. Fleetwood will use certain funds for product development, and the ultimate goal of product development is to increase the sales revenue of new products. I chose product development cost as one project for the transaction.

Fleetwood’s real financial statement

First, I found some interesting projects in Fleetwood’s balance sheet. Through experience, I know that Non-current assets held for sales to the above project is current assets, below is Non-current assets. The amount of Non-current assets is greater than current assets. This shows that companies use most of their assets to purchase intangible assets such as factories, equipment and goodwill. Noncurrent assets are capitalized rather than expensed, meaning that the company allocates the cost of the asset over the number of years for which the asset will be in use instead of allocating the entire cost to the accounting year in which the asset was purchased. Because Fleetwood is a construction company in a broad sense, this situation is normal. Because of the special nature of the company, there are many fixed assets.

Secondly, from the company’s income statement, Fleetwood corporation’s income items are relatively small, and mostly from sales revenue. Probably because Fleetwood is a company with construction, sales and rental equipment as its main business, the source of income is relatively simple. Fleetwood’s expense items are relatively abundant. The largest amount of expenditure is the materials used, which is related to the nature of the company. Material is required for both construction and equipment. Of all the projects in the expenses, the most special one is loss from discontinued operations. An explanation of this can be found in Fleetwood’s corporate annual report in 2018: Fleetwood sells its loss-making business to Australian company Aeroklas.

Fleetwood’s hypothetical financial statement

It can be clearly seen from Fleetwood’s financial statements that during this time, the company is losing money. The overall reason is that spending is greater than income. Because it is hypothetical data, it cannot be said that the company is also losing money in actual situations. But in terms of data analysis, in most cases, construction companies are losing money before they receive full construction revenue. Let’s take a look at the income statement, which has a product development cost. Because Fleetwood’s revenue is also related to sales of products, product development is also a must for companies. But the problem is that Fleetwood sells some low-tech products, so the frequency of product development is relatively high, which adds some expenses to the company.

Quiz

Set up

Training

According to the note of financial statement, the depreciation method for property, plant and equipment is historical cost less any accumulated depreciation and impairment losses. Depreciation on the same basis as other property assets for production, supply or administrative purposes or for an undetermined use is carried at cost less any recognised impairment losses. Depreciation is recognised so as to write off the cost or valuation of assets (other than freehold land and properties under construction) less their residual values over their useful lives, using the straight-line method. The estimated useful lives, residual values and depreciation method are reviewed at the end of each reporting period, with the effect of any changes in estimate accounted for on a prospective basis. Freehold land is not depreciated. The method of depreciation of a credit asset is to use the straight-line method to reduce the residual value during its useful life. The estimated useful lives, residual values and depreciation methods are reviewed at the end of each reporting period, and the estimated This concept can be understood as calculating the remaining time of the asset when calculating the remaining value of the asset, and combining the value of the depreciation with the remaining usage time. An item of property, plant and equipment is derecognised upon disposal or when no future economic benefits are expected to arise from the continued use of the asset. Any gain or loss arising on the disposal or retirement of an item of property, plant and equipment is determined as the difference between the sales proceeds and the carrying amount of the asset and is recognised in profit or loss.

The method of depreciation of assets and non-assets of enterprises is the straight-line method. All non-financial assets of the entity (except land) have limited useful lives and are depreciated/amortised using the straight-line method over their estimated useful lives to their estimated residual values. Assets are depreciated or amortised from the time an asset is ready for use. Depreciation and amortisation rates and methods and residual values are reviewed annually for appropriateness. When changes are made adjustments are reflected in current and future periods only. Depreciation and amortisation are expensed, except to the extent they are included in the carrying amount of another asset as an allocation of production overheads.

Depreciation/amortisation rates used for each class of asset are as follows:

	2018	2017	2016
Buildings	2.5%	2.5%	2.5%
Leasehold property and improvements	2%-25%	2%-25%	2%-25%
Plant and equipment	2.5% – 50%	2.5% – 50%	2.5% – 50%

	2018	2017	2016
Depreciation and amortisation	$6,336,000	$7,256,000	$9,305,000

As can be seen from Fleetwood’s balance sheet, from 2016 to 2018, the company’s depreciation and amortisation expenditures were $6336,000, $7256,000 and $9305,000, respectively. Fleetwood’s depreciation and amortisation expenses have decreased year by year. In Fleetwood’s note of financial statement, depreciation and amortisation are divided into four journal entries: building, leasehold improvement, plant and equipment, product development. Except that the expenditures of the four projects are different each year, the project itself has not been modified or replaced. At the same time, Fleetwood uses the straight-line depreciation method, which means that the annual depreciation rate is the same, so this is information related to each year. Specifically, in the depreciation of buildings, the expenditures for 2016 to 2018 are all $34,000, which means that the buildings owned by Fleetwood are depreciated every year according to normal wear and tear. Among the depreciation expenses of leasehold improvement, expenditures from 2016 to 2018 were $747,000, $748,000 and $1921,000, respectively. The value from 2016 to 2017 has not changed much, it is a normal depreciation expense. However, from 2017 to 2018, the sudden increase in depreciation expenses may mean that the loss of leasehold improvement in this year is relatively large, affecting its useful life and residual value. In the depreciation of plant and equipment, the three-year expenditure was $5504,000, $5761,000 and $6602,000. The trend of this project is an upward trend. As the sales volume of products continues to rise, Fleetwood needs to increase the number of plants and equipment. When the number of products produced increases, the loss of equipment will also increase. This is the a reason that increase in depreciation of plant and equipment. The last item is the depreciation expense of product development. The three-year data are respectively $748,000, $713,000 and $51,000. The gap between 2016 and 2017 is relatively large. I understand the depreciation of product development. When a new product is developed, the old product is eliminated and depreciated. From 2016 to 2017, the most likely reason for the increase in depreciation of product development is the large number of new products listed, resulting in the old products cannot be sold, only depreciation.

According to what I said above, Fleetwood’s depreciation method is the straight-line method. In my survey of 2016 to 2018, there was no change in the depreciation method. Because the depreciation rate of each project has not changed from 2016 to 2018. Please see the form for details. If the depreciation method is changed, it will directly affect the profit of the company.

Depreciation is a major expense for the company. From Fleetwood’s financial statement appendix, you can see that the cost of a building on a building is $1342,000, and the accumulated depreciation expense is $408,000, which is close to one-third of the cost. The cost of engineering and equipment is $8,4501,000, and the accumulated depreciation is $4,6522,000, which is one-half of the cost.

Depreciation journal of buildings
Cost	$1,342,000
Accumulated depreciation	($408,000)
	$934,000

Depreciation journal of plant and equipment
Cost	$85,451,000
Accumulated depreciation	($46,522,000)
	$38,929,000

Depreciation journal of leasehold property and improvements
Cost	$50,391,000
Accumulated depreciation	($40,623,000)
	$9,768,000

According to what I said above, Fleetwood subdivided depreciation and amortisation into three journal entries: building, leasehold improvement, plant and equipment. Because these three journal entries are separate accounts for depreciation and amortisation, their most direct impact on the company’s financial statement is the affect balance statement. When the depreciation amount recorded in the journal entries rises, the company’s expenses will also increase, and when the depreciation amount decreases, the company’s expenses will decrease. The purpose of setting up these journal entries is to let consumers and shareholders see Fleetwood’s depreciation details more directly. Depreciation items are affected by a variety of factors, such as the original price of depreciable assets, the useful life of the assets, the expected production capacity of the assets or the physical output, the expected tangible losses and intangible damage of the assets and the depreciation rate of each country.

Goodwill:

Goodwill is an intangible asset associated with the purchase of one company by another. Specifically, goodwill is recorded in a situation in which the purchase price is higher than the sum of the fair value of all identifiable tangible and intangible assets purchased in the acquisition and the liabilities assumed in the process. The value of a company’s brand name, solid customer base, good customer relations, good employee relations, and any patents or proprietary technology represent some examples of goodwill.

According to my search, Goodwill=P−(A+L)

Where:

P=Purchase price of the target company

A=Fair market value of assets

L=Fair market value of liabilities

The goodwill reduction illustrates two cases, the Purchase price of the target company decreases or the fair market value of assets + Fair market value of liabilities increases. In either case, the reduction of goodwill is a bad situation for the company. Goodwill, as an intangible asset, will also rise when the company’s operating conditions are good. Because the company’s total assets are at a loss in 2018, goodwill is also falling.