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Accounting Information Systems > Performance Reporting > Flashcards

Performance Reporting Flashcards

1
Q

What are the three key areas of performance reporting decisions?

A

Investment
Financing
Asset Management

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2
Q

What does Modern Financial Theory assume to be primary objective of a business? What are the issues with this?

A

Maximise Shareholder’s wealth.
Narrow focus, to survive and prosper (be sustainable) objective needs to be pursued whilst taking into account the surrounding environment. Ethical manner. Sensitive to all stakeholders.

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3
Q

What is the agency problem? How can it be managed?

A

Managers pursuing their own interests at expense of shareholder interests.

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4
Q

Classify the activities that managers do

A

These are all interrelated and overlap. Have to consider all, when considering one.

Strategic Management
Operations Management
Risk Management

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5
Q

What is the finance function? What are its key tasks?

A

The finance function helps managers w Strategic, Operations, Risk management.

Key tasks:

  • Financial Planning
  • Investment Project Appraisal
  • Financing Decisions
  • Capital Market Operations
  • Financial Control

HEAPS of links between managers’ tasks and the finance functions.

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6
Q

Describe Financial Planning function?

A

Financial Planning - managers need to know potential impact of proposals on future financial position & performance. Estimates of financial outcomes i.e. projected financial statements (CF or IS).

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7
Q

Describe Investment Project Appraisal Function?

A

Investment in new long term projects. Appraisals of profitability and riskiness of investment - to make accept/reject decisions, prioritise those that are accepted.

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8
Q

Describe Financing Decisions function?

A

Investment projects and business activities need to be financed. The various sources available need to be identified and evaluated (i.e. dift characteristics and costs). Consider overall financial structure of business (balance long v short term sources). Shareholders (owners) v lenders. Impt source internally generated finance is profit. Distribute or reinvest?

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9
Q

Describe the capital market operations function?

A

Way of raising new finance i.e stock markets, banks.
Managers seek advice on raising finance through markets, how securities (shares and loan capital) are priced and how markets are likely to react to proposed investment.
Capital markets bring together lenders and borrowers. Help investors select appropriate type of investment based on risk requirements. Help to eval. performance of business through its share prices.

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10
Q

Describe the Financial Control function?

A

Once plans are implemented managers need to monitor and evaluate and take corrective action. Require regular reporting of info on actual outcomes. eg profitability of investment projects, levels of working cashflow and capital.

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11
Q

Describe strategic management?

A

Strategic Management: Aims & objectives of business, form strategy to achieve these (long term). Identify and and evaluation options. Choose option with the greatest chance of achieving aims/objectives

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12
Q

Describe Operations Management?

A

Operations Management: day to day control over various business functions, make decisions as required.

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13
Q

Describe Risk Management?

A

Risk Management: Risks identified and managed. To do with nature of operations and business financing.

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14
Q

How is modern financial management described?

A

“Economics of time and risk”
Time, Risk, Capital markets. Branch of applied economics.
Originally off shoot of accounting, now more influenced by economic theories.
Economic theories concerning efficient allocation of scarce resources have been taken and developed into decision making tools for management. Taking into account time dimension and risk associated w management decision making.

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15
Q

Themes and main takeaways of financial management?

A

Discounted cash flow
Risk and Diversification
Market Efficiency

Time is Money - sum of $ received now worth more than same sum paid in future. Discount future cash flows to PV.

Don’t put all eggs in one basket - reduces risk of investment (diversified portfolio). If risks can’t be diversified, only accept if offset by expected higher return.

Can’t fool all the people, all of the time: efficiency of financial markets. Prices reflect new information. Greater risk - greater return.

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16
Q

Why do businesses exist?

A

To create wealth for their shareholders

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17
Q

What are the key characteristics of shareholders?

A

Owners of a business
Bear residual risk and get residual claim (i.e. what’s left after fixed claims made). Ordinary shareholders at bottom of list. Priority given to other stakeholders eg employees, customers, preferential shareholders. Other stakeholders can protect themselves from losses. Ordinary shareholders can’t.
Shareholders have an incentive to increase residual claim through entrepreneurial activity (new & risky). If other stakeholders getting their fixed claims, they won’t want new & risky.
Residual claim = assets - liability (net assets or equity)

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18
Q

What is wealth maximisation?

A

NOT the same as profit maximisation.
Shareholder wealth maximisation is not susceptible to same weaknesses as profit maximisation.
Interests of shareholders prevail due to competition for S/H funds and managers’ jobs.
Business is assumed to pursue the goal of S/H wealth maximisation.
Wealth = market value of ordinary shares. Market value, in turn, reflects future returns S/H expect to receive over time from the shares & level of risk faced.
Highest possible returns over the LONG TERM.
EPS - earnings per share shows S/H wealth maximisation.

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19
Q

What are the problems with profit maximisation?

A 
Lack of precision 
Lack of objectivity
Time period
Risk
Opportunity cost
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20
Q

Problems with profit maximisation?

Lack of Precision

A

Different measures of profit & profitability exist. Don’t move in lockstep. Different profit measures provide different narratives of financial performance.

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21
Q

Problems with profit maximisation?

Lack of Objectivity

A

Profit measures cannot be objectively determined.
Influenced by particular accounting policies and estimates e.g. inventories, depreciation, bad debt. Vulnerable to manipulation.

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22
Q

Problems with profit maximisation?

Time Period

A

Period over which profit should be maximised is unclear. Conflict between short v long term profit maximisation. i.e. do you maximise short term profit at expense of long term? e.g. reducing R&D expenditure, cutting staff training, lower quality materials.

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23
Q

Problems with profit maximisation?

Risk

A

Goal of profit maximisation takes no account of risks involved. S/H are very concerned w risk.

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24
Q

Problems with profit maximisation?

Opportunity Cost

A

Profit takes no account of opportunity cost.

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25
Q

What are the criticisms of shareholder wealth maximisation?

A

Can lead to excessive cost cutting, redundancies, forcing suppliers to lower prices, serious conflict between various stakeholders.
May undermine status of other stakeholders, encourage unethical behaviour (child labour, pollution, bribes, tax evasion, market power abuse, bad working conditions)
Could result in weakened business, incapable of exploiting profitable opportunities.
HOWEVER S/H wealth max is long term, all of above would undermine achievement of goal.
To survive and prosper long term, businesses need approval of society in which they operate. Society expects standard of ethics. Ethics have to be considered.
Over the long term S/H wealth, intrinsically linked to corporate governance.
Need to balance the needs of all stakeholders to remain sustainable.
To maximise S/H wealth, may be best to pursue passion to develop best possible product or service for customers. Financial rewards usually follow.

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26
Q

What is the stakeholder approach? What are the problems with it?

A

Not clearly defined.
“a business should serve those groups who may benefit from, or who may be harmed by, its operations”
Need to mediate all stakeholder interests. S/H interests shouldn’t dominate. S/H could be more remote.
ISSUES - no clear cut obj for mgrs, increase accountability problems (too many objectives), mgrs could use multiple objectives to smokescreen own interests.
Questions about identification & treatment of stakeholder groups.

27
Q

Explain the concept of balancing Risk & Return

A

Always a risk things will not turn out as planned.
Need to take risk into account when making financial decisions.
The more risk, the higher the return.
Even 0 risk, certain level of return required.
S/H will require a minimum return to get them to invest & additional return to compensate for taking risks.
Mgrs should choose highest returns in relation to risks involved.

28
Q

Explain the relationship between ethics & financial performance

A

Due to global deregulation of markets & technological change - investors have more opportunities.
Increased global competition for investment.
Mgrs under pressure to produce attractive returns. Could result in unethical behaviour. If discovered = damaging to entire business community.
Businesses want to demonstrate they are honest & ethical - develop & adhere to a code of ethics.
Links between high ethical standards and financial performance.
When all stakeholders treated fairly & w integrity, businesses flourish.

29
Q

What ethical standards should finance function staff uphold?

A

Code of standards for finance staff

  • act w integrity, maintain confidentiality, follow govt laws, rules, regs.
  • comply w acc & auditing stds and company policy
  • high standard of business ethics
  • avoid conflicts of interests
30
Q

What is corporate governance?

A

The ways in which businesses are directed and controlled. Impt b/c S/H are remote from the day to day operations.
Directors (Mgrs) run the business and are therefore (agents) of the S/H (principals)

31
Q

Describe the agent-principal relationship issues?

A

Best interests of S/H should guide directors’ decisions - doesn’t always happen.
Dir’s may focus on pursuing own interest = conflict. i.e. increase pay and bonuses, negotiating perks, increasing status and power.
Competition for S/H funds and Director jobs - agency probs shouldn’t prevail, S/H interests will.
Agency problems increased by weak competition, S/H not aware/alert to Director activities.
If S/H reluctant to invest - problem for all society - shortage of funds. Cost of finance increases. Effects health of entire economy.

32
Q

Describe the framework of rules?

A

To avoid agency problems, most competitive market economies have framework of rules to help monitor and control the behaviour of directors. 3 guiding principles:

  • DISCLOSURE (adequate, timely)
  • ACCOUNTABILITY (defined roles and duties of Dirs, establish adequate monitoring process. Act in best interests of S/H).
  • FAIRNESS directors shouldn’t benefit from inside info not avail to S/H. e.g. Dir can’t buy or sell shares before significant event.
33
Q

What are the key features of the NZX Corporate Governance Code?

A

Aims to ensure that powers & responsibilities of Director are clearly delineated and appropriate checks and balances in place.
Issuers must comply or give good reason why not in writing.
Balance needs to be struck between protecting S/H and stakeholders and the need to encourage entrepreneurial behaviour.

34
Q

Explain Shareholder activism?

A

S/H need to actively monitor & control behaviour of directors. Financial Institutions hold large portion of shares. Large voting power. Significant influence in way listed businesses are directed and controlled.
Forms of Activism:
- EXERCISING VOTING RIGHTS
- MEETING w DIRECTORS/BOARD OF DIRECTORS
- DIRECT INTERVENTION IN BUSINESS AFFAIRS
Shareholder activism generally regarded as a force for good.

35
Q

Describe performance reporting?

A

Should help promote a “continuous improvement” feedback loop, where reports on activities and performance provide important information to allow for the best possible decision making in the next planning cycle.

36
Q

What is the importance of performance reporting?

A
  • vital to organisation’s long term survival and sustainability
  • informs future decision making process based on evaluations of prior events and outcomes.
  • performance reporting that provides timely, reliable, clear and meaningful info allows users to make informed decisions, increases efficiency and effectiveness, ensures alignment with strategic objectives and continuous improvement.
  • Effective performance reporting presents a narrative that is easily engage-able, achieving increased accountability and transparency for stakeholders, ensuring investor commitment, attracting new capital.
37
Q

What is the importance of financial management?

A

Synonymous with cash management. Cash is life blood. Cash is king. A company will fail without ability to maintain solvency and settle current obligations as they fall due.
Financial management facilitates strategic, operational and risk management tasks through financial planning and control, investment appraisal, financing and capital market decisions.

38
Q

Identify the overlap between performance reporting and financial management?

A

Financial management and performance reporting operate in a continuous cycle or “feedback loop” and can be considered “two ends of the same process”.
Financial management - prospective. Performance reporting retrospective. Outcome of evaluation completed in perf reporting informs next planning stage of cycle and shapes future financial mgmt.
Financial Mgmt provides the tools and info needed to execute performance reporting.

39
Q

Is “to survive” a good primary objective?

A

Survival = breaking even. Having ability to cover operational costs and current liabilities, maintain S/H approval and ensure continued operations year to year.
Imperative but shouldn’t be main singular objective when aiming for long term growth and prosperity.
Incorporating non financial and financil strategic objectives, focussing on long AND short term success outcomes would likely result in a more sustainable, thriving business and increased S/H wealth maximisation.

40
Q

Projected Statements - Key things

A
  • always start with projected sales revenue
  • short forecast horizons = detailed
  • long forecast horizons = simplified assumptions
41
Q

Projected Cashflow Statement

A

Monitors future changes in liquidity. Records cash in and outflows.
Identifies when cash surplus’ and cash deficits are likely to occur. Surplus - invest. Deficit -seek finance/plan.

Sources of Cash Flows

  • Issue and redemption of long term funds (taking loan and making payments)
  • Operating activities
  • Purchase and Sales of NCA’s (if inflows here -why?)
  • Tax and Dividends

DOES IT INVOLVE CASH IN OR OUTFLOW? NO = ignore eg bad debts, depreciation.
If YES - WHEN DID THE CASH IN/OUTFLOW occur.

42
Q

Projected Income Statement

A

Insight into likely future profits or losses which represent difference between predicted level of revenue & expenses for a period.
COGS could include freight inwards, purchase returns, custom duties.
Trade Discount NEVER comes into the books.

43
Q

Projected Statement of Financial Position

A

Projected end of period balances for assets, liabilities & equity.
Last statement to be prepared. Need CF and IS to do it.

44
Q

Per Cent of Sales Method

A

Assumes most items appearing in the IS and SOFP vary w level of sales. Hence these statements can be prepared by expressing most items as a % of sales revenue forecast.
Financing gap easily identified in per cent of sales method - bc projected SOFP won’t balance. Finance requirement will be amount to make it balance. Way to fill gap = PLUG (various forms - borrowings, injections of equity share cap).

45
Q

Financing Gap

A

Where sales revenue increasing over time, a business may outgrow amount of finance committed.
Additional assets required to sustain the increased sales may exceed the combined increase in equity (net earnings and liabilities) = financing gap.

46
Q

Long Term Cash Flow Projections

A

Determine sales revenue for each year of planning horizon.

  • then calc operating profit as % of sales revenue figure
  • adjustments to annual profits to derive annual operating cash flows.

Net Cash Flows (Indirect method)

Operating Profit
Plus Depreciation Expense
Plus or minus increase or decrease in inventory
Plus or minus increase or decrease in trade receivables
Plus or minus increase or decrease in trade payables
Less Interest paid
Less Tax Paid
Less Dividends paid
= Net cash flows from operating activities.

47
Q

How do we deal with the problem of risk in the context of projected financial statements?

A

SENSITIVITY ANALYSIS - “what if”, take a single variable and examine the effect of changes in the chosen variable on the SOFP and IS. e.g. what if sales volume is lower/higher.

SCENARIO ANALYSIS - “optimistic view” “Pessimistic view” “most likely” view involves changing number of variables simultaneously.

48
Q

What is Financial Gearing (aka Financial Leverage)? Explain…..

A

When a business is financed at least in part, by borrowing or other funds w a fixed rate of return.
The higher the proportion of borrowing in relation to finance provided by ordinary S/H - the higher the financial gearing level.
Higher level of financial gearing = more sensitive to changes in level of operating profit.
Movement in operating profit causes more than proportionate movement in shareholder returns.
Borrowing increases risk, commitment to pay interest increases volatility of returns to ordinary S/H.
Risk of borrowing outweighed by increased returns to ordinary S/H (when returns exceed the cost of paying interest charges).
Where a business is able to generate a rate of return greater than the interest rate on the borrowings, effect of financial gearing is to magnify returns to ordinary SH and vice versa.
More borrowing - higher returns to S/H but increases risk. Have to work harder to generate profit BUT maintain cash flow.

49
Q

Degree of Financial Gearing

A

Measures an aspect of financial risk which arises from the financing methods employed.
Measures the sensitivity of earnings per share to changes in the level of operating profit.
Degree of fin. gearing = Operating profit / Operating Profit - Interest payable
Result more than 1% = financial gearing.
Show that for a 1% increase in operating profit, what the increase in EPS will be.
To lower levels: repay borrowings from future profits, replace borrowings w newer ones at lower rates, repay borrowings from issue of ordinary share proceeds, convert borrowings into equity (ordinary) shares.

50
Q

Operating Gearing (aka operating leverage)

A

When a business has fixed costs as part of its total costs.
Relationship between fixed costs and variable costs known as operating gearing.
Relatively high fixed costs compared w total variable costs = high operating gearing.
High level of operating gearing makes operating profits more sensitive to changes in sales output.
Increase in sales output causes more than a proportionate movement in operating profit.
Fixed costs - constant regardless of change in volume of activity
Variable Costs - vary according to changes in level of activity.

51
Q

Degree of Operating Gearing

A

Measures an aspect of business risk which arises from the cost structure adopted. Measures the sensitivity of operating profit to level of sales volume.
For a business w operating gearing, any change in sales output will result in a disproportionate change in operating profit.
Higher operating gearing - more sensitive operating profit becomes to changes in sales volume
Degree of op gearing = Sales - Variable Costs / Operating Profit.
Show that for a 1% change in sales output, what the effect on op profit would be.
Result more than 1% = presence of fixed costs. Higher figure = higher fixed costs and gearing.
TO LOWER -cut fixed costs - share services w other businesses, hiring temp v perm staff, reward staff w bonuses rather than higher salaries, negotiate lower service costs, move to smaller place, outsource.

52
Q

Combined Gearing Effect

A

Most businesses have both financial gearing and operating gearing.
Effect of combining the two on returns to SH measured by degree of combined gearing.

= Degree of Fin Gearing x Degree of Op Gearing

Shows that a 1% increase in sales will result in a ? increase in EPS.
Degree will vary according to level of sales output.
Both op gearing and and fin gearing lead to aspect of business risk linked to volatile SH returns.
High degree of combined gearing could lead to high volatility in SH returns (reflected in share price movements).
If high op gearing - shy away from fin gearing to reduce risk. If combined gearing too high, take steps to reduce degree of either fin or op gearing or both.

53
Q

How can the agency problem be managed?

A

Managed through regulation and active involvement of shareholders. Align interests of S/H with Mgrs - bonus payments based on share price perf. Awards of shares in business.

54
Q

What are the 8 principles of the NZX Corporate Government Code?

A

8 principles

  • Ethical Standards
  • Board Composition and Performance
  • Board Committees
  • Reporting and disclosure
  • Remuneration
  • Risk Management
  • Auditors
  • Shareholder Relations & Stakeholder Interests
55
Q

Explain the use of financial ratios

A

Financial (accounting ratios) can help to assess financial performance and position of a business.
Can be used to examine various aspects of financial health.
Very helpful for comparing fin. health of different businesses.
Widely used for planning and control purposes
Helpful to managers in wide variety of decision areas:
- profit planning
- working capital management
- financial structure
- dividend policy
Can be difficult to interpret. Help us identify which qns to ask, don’t provide the answers. Highlights strength and weaknesses but don’t explain. Starting point for further analysis.
Importance lies in consistency for comparisons & decision making.

56
Q

What is a ratio?

A

A ratio relates one figure in the financial statements to another figure in the financial statements, or to some resource.
Eliminates problem of scale b/c not comparing absolute figures.
Can be expressed in various forms eg percentage, proportion.

57
Q

What are the financial ratio classifications?

A

Key aspects of financial health

  • Profitability
  • Efficiency
  • Liquidity
  • Financial Gearing
  • Investment
58
Q

Explain the relationship between the target users and the particular ratios…

A

Need to be clear WHO the target users are and WHY they need the info.
Different users have different needs, therefore different ratios will be useful to different users.

59
Q

What ratios would shareholders be interested in?

A

Interested in returns in relation to the level of risk associated with investment

  • profitability
  • gearing
  • investment
60
Q

What ratios would long term lenders be interested in?

A

Interested in long term viability of business

  • profitability
  • gearing
61
Q

What ratios would short term lenders be interested in?

A

Interested in ability of business to pay amounts due in short term
- liquidity

62
Q

Describe the need for ratio benchmarks & different examples

A

Ratios on their own don’t tell us much. Ratios need to be compared with something so we can interpret & evaluate the info:

  • past periods for the same business
  • similar businesses for same or past periods
  • planned performance for the business
63
Q

Describe the use of “past periods” for benchmarks and associated issues

A

Allow you to identify improvement, deterioration, track particular ratios to see emerging trends over time

  • Problematic due to dift trading conditions
  • Operating conditions may not be clearly exposed
  • Inflation can cause distortion. Overstatement of profit, understatement of asset values.
64
Q

Describe the use of “similar businesses” for benchmarks and associated issues

A

In a competitive environment, businesses need to consider performance in relation to that of other business’ operating in the same industry.
Survival may depend on comparable performance.
Compare ratio to same ratio achieved by similar business during same period.
Issues:
- trading conditions may not be identical eg dift y/e
- different accounting policies (effect reported profit and asset values)
- information may not be available or be hard to obtain, or not enough detail

Accounting Information Systems (3 decks)

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