Advice Please - How to appraise financial accounts of a manufacturing business? - The Book-keepers Forum (UK)

Jay3 · Senior Member

Advice Please - How to appraise financial accounts of a manufacturing business?

Cheshire · Master Book-keeper

Hu Jay
Just out of interest - is this a real life scenario or for some studying you are doing?

Jay3 · Senior Member

Real life.... :)

Shamus · Forum Moderator & Expert

Hi Jay,

for ratio analysis try staarting with this thread :

www.book-keepers.org.uk/t35962663/expense-ratio/

breaks key ratio's down nicely between profitability and efficiency ratio's.

Hope it helps,

kind regards,

Shaun.

Cheshire · Master Book-keeper

I still can't get used to calling it inventory instead of stock, how very American!

How about current ratio as well as the others in the thread - current assets / current liabs.

Shamus · Forum Moderator & Expert

Cheshire wrote:
I still can't get used to calling it inventory instead of stock, how very American!

How about current ratio as well as the others in the thread - current assets / current liabs.

And the Quick ratio (current assets - inventory) / current liabilities

I've got a Mnemonic for the basic ratio's. Some of these are more relevant as investor ratio's for PLC's.

The Mnemonic I use is C DEAD PIG PORRAIGE

C - Current Ratio

D - Dividend Yield
E - Earnings Yield
A - Asset Turnover
D - Dividend Cover

P - Payable Days
I - Inventory Days
G - Gross Profit

P - P/E Ratio
O - Operating Profit
R - Return On Capital Employed
R - Receivable Days
A - Acid Test (Quick) Ratio
I - Interest Cover
G - Gearing
E - Earnings Per Share (EPS)

Totally agree on the use of the word inventory but thats the word now in IFRS which of course may have been chosen in the vain hope of convincing the Americans to stop with the Enron / Worldcom allowing rules based system to a more sensible principles based system of financial reporting standards.

Shamus · Forum Moderator & Expert

Ah, are we going for a pics of us as children theme this month... (is that you Jo?).

Lets see what I can find to scan in... Of course, camera's were still quite new when I was a nipper so lets see what I can find.

Cheshire · Master Book-keeper

I used to know about 50 ratios off the top of my head, could tell you them in my sleep, but these days they take a bit more thinking about, especially with all the name changes. I have to have a dictionary in my head due to IFRS.

Oh no that's not actually me.....just represents me sulking!!

Might have to scan the one from when I was about 5 that my son used for my 50th cake. Lol about the cameras......but you are sooooo much older than I am wink

-- Edited by Cheshire on Saturday 18th of April 2015 10:51:59 PM

Shamus · Forum Moderator & Expert

I was just scanning in a photo and my boy looking on with shock exclaimed "I didn't know they have colour photo's back then Dad?".

Well, he just won himself two more mock GCSE's tomorrow!

Cheshire · Master Book-keeper

Haha, only two!! You haven't changed a bit freckle face.

Cheshire · Master Book-keeper

Me this time, complete with dodgy fringe (cut by my Mum)

Shamus · Forum Moderator & Expert

You must have a darn good monitor to be able to see that Jo... Worst part has to be the 1960's filling where dentists used to think nothing of sticking a metal filling (that you usually didn't need) in the front of a tooth.

Good point on the only two. I'll tell him that you've convinced me to up it to three.

Cheshire · Master Book-keeper

If you want to blame it on me that's fine, I'm already known as the wicked witch with revising teenagers.

I was going to suggest you get him to the do the washing up too, but that might be a set too far, so keep him busy with a fourth!

Shamus · Forum Moderator & Expert

What! Do the washing up!!!

I think that the shock of discovering that the house has a kitchen might all be too much for him as I feel he currently believes that food simply magically appears through some magic portal and dirty dishes obviously disappear the same way.

On the exam front I've currently lost track of the number of times that I've heard those somewhat worrying words "But we haven't done any of this at school"!

Cheshire · Master Book-keeper

Sounds like the teachers have slept through the last two years, rather than teach, and that you are probably the most scary teacher he has had. Maybe it's best you keep him away from the kitchen sink, don't want to completely scar him for life!

Jay3 · Senior Member

Hi,

Thanks for all the advice it's great. Can I check something else....the business in question has brought out other companies and these would consolidate into the group accounts so on that basis I am using the Holding company accounts for the purposes of my ratio analysis. Is this the correct this to do?

Thanks,
Jay

Shamus · Forum Moderator & Expert

Hi Jay,

You would generally look at the individual companies performance AND the group accounts.

The reasoning behind that is that the individual accounts are too easy to manipulate with inter company trading where of course all inter company transactions, unrealised profits in stock, inter company purchase revaluations, etc. are removed from the group accounts giving a more financially realistic view of the group as a whole.

However, from a management persepctive they still want to know divisional performance figures as well so it's not a matter of choose one but rather do all.

Not really so hard as you would have all of the figures going into the consolidation schedule and you can process them all in a single spreadheet from there.

The real key is in evaluating the figures rather than simply producing them. The receivable days, payable days and inventory days are often the key ratio's to indicate issues and more importantly management attempting to hide issues.

kind regards,

Shaun.

Jay3 · Senior Member

Thanks Shaun, that's great.

The filed accounts do not split out the performance by division so in this scenario I will probably just use the group accounts for now. It's more just to demonstrate that I know how to use the ratios.....it's a test for an interview I have...

Can you expand on the sorts of things management could hide...."The real key is in evaluating the figures rather than simply producing them. The receivable days, payable days and inventory days are often the key ratio's to indicate issues and more importantly management attempting to hide issues."

These are the efficiency ratios I have produced for 2010 - 2014

Efficiency Ratios
Stock Days 142 157 189 168 182
Debtor Days 45 38 34 38 36
Creditor Days 22 25 35 27 23

Paying our creditors before receiving money from our debtors seem wrong to me....I seem to remember from my studies that one should ideally use ones creditors to fund debtors. If money is going out faster than it is coming in then that could cause issues with cash flow couldn't it?

Stock days...Is this the length of time stock is held before it goes out of the door? Are the industry average that I can obtain from anywhere for the purposes of comparisons or should I just find the closest kind of competitor in a similar industry to do this? I find it really hard to talk about this stuff without something to compare it to?

Many thanks,
Jay :)

Jay3 · Senior Member

I reckon Debtor days seems a little out as I would imagine 30 days would be the standard terms.

Cheshire · Master Book-keeper

Hi is this a interview in the commercial banking sector by any chance? Sounds like a case study type of interview.

The problem you have is that you don't know any of the information behind the numbers eg actual debtor and creditor terms, so I would be careful making assumptions unless you can pin it down to comparisons with industry norms and the only way you can do that is by obtaining proper peer group information, rather than just someone else in the same sector, although that could be a start.

I would suggest now you have the numbers you consider a variety of scenarios as to why the figures could look as they are eg debtor days has seen a very slight improvement, although with the data being over 5 years I would suggest it's reasonably static. If you view it as an improvement overall how could that be eg more rigorous credit control, reduced terms to customer etc. problem you have is that one company might have really poor debtor days, another really good ones but the averaging out for the consolidateds looks ok.

Seems to me that the one you should look at more now you have the numbers is stock turn and what is happening here, why the numbers are so high.....why are they holding stock for such a long time. Might be a good reason.....after all we don't know the industry.

Plus your comment about running out of cash.....have you looked at the liquidity ratio/ quick ratio.

Am much better at this with the benefit of the numbers in front of me....used to do this all the time (corporate finance background), although feeling a little rusty trying to explain it without having done all the fun bit!!

When is the interview and have the scoped out for you what is likely to be in the test?

Jay3 · Senior Member

It's manufacturing I imagine it will be a criteria based interview along with asking me to interpret their accounts, it might be a little overkill to go to the lengths I've gone to but need to be prepared. The problem is the accounts are pretty straight forward and the company has a strong balance sheet....just struggling to figure out what to say about them?? Other than that??

I have loads of data now, just need to figure out how to interpret it all....it's been a while! :)

Current ratio 4.70 4.25 3.90 4.54 5.09
Quick or acid test ratio 1.04 0.95 0.73 1.26 1.25
Long-term debt ratio 0.01 0.01 0.02 0.02 0.02
Debt to equity ratio 0.17 0.21 0.24 0.21 0.19

This is what I have so far in terms of liquidity.

Profitability Ratios
Return on equity 5% 8% 10% 8% 9%
Gross profit margin 39% 61% 40% 39% 39%
Profit Margin 4% 6% 8% 7% 7%
Asset turnover ratio 1.58 1.69 1.68 1.56 1.57

Anything jump out at you?

Shamus · Forum Moderator & Expert

Didn't you tell Joanne that this was real life rather than study?

Anyway, I digress.

Whilst cashflow is a good argument if you don't pay your creditors in a timely manner they can switch off your supply of goods for sale / materials then you will be looking at the going concern basis of an entity rather than its profitability

Once you have any variances it's not simply a matter of determining that an isolated figure is out of trend but rather why is it out? i.e. Has there been a change in credit terms?

You can check figures against direct competition from their filed financial statements although where they publish ratio's themselves never use those ratio's but rather recalculate from the financial statements.

Its too big a subject to say to someone this is what you need to look out for. You will onl ge there with a lot of practice using scenario based questions.

How long do you have before the interview as if you want to understand how to evaluate group accounts you need to work your way through the type A questions for the old ACCA paper 3.1 (pre 2007) sylabus which was much more calculator based than later papers.

It doesn't matter that you are not an auditor, financial statement analysis comes under Audit (which is why I did advanced audit even though I wouldn't go near that area of accountancy).

You can pick up paper 3.1 practice and revision kits from Amazon resellers for pennies. Either Kaplan or BPP are fine but make sure that you get the UK variant where such is specified.

kind regards,

Shaun.

p.s. inventory days can be a number of things dependant upon which fields you use to calculate it. the common one that I use is ((closing stock / cost of sales) * 365) indicating how many days stock is remaining at he period end. Other methods include ((average stock level / cost of sales) * 365) telling you the average stock days or (Cost of sales / Average Stock) which gives the number of times stock is turned over in the period.
As mentioned previously ratio's are there to help you with very few set in stone (investor ratio's such as EPS are set in stone). The one's the seem to have the most different ways of calculating them are the Gearing ratio's. The key is that you must calculate the ratio's that you need consitently. If you need to cange then you must also recalculate all ratio's calculated previously that may be used for comparative purposes.

Jay3 · Senior Member

I have found a similar company that I could compare it against but the balance sheet is much smaller but the year end and profile is identical. I guess profit margins and efficiency could still be compared.

What do you think?

Shamus · Forum Moderator & Expert

Sorry, got waylaid with a Computing GCSE. Jo's answer is far better than mine.

Love that you say all of the fun bit Jo and completely concur.

Shaun.

p.s. Jay. Jo and myself come from similar backgrounds.

Shamus · Forum Moderator & Expert

Ratio's don't care about the size of the numbers they care about the variances between them... Thats both a strength of them and a weakness.

Jay3 · Senior Member

Hi Shamus and Jo,

Thanks for your advice on this it's much appreciated.

Can I ask a question on Stock days.... I have included Work in Progress which I think is potentially an issue? Should I exclude WIP for this ratio? I feel like I should potentially :)

Thanks,
Jay

Shamus · Forum Moderator & Expert

Its another of those variances in ratio's that I mentioned in that you may want to show stock days with WIP, without WIP and perhaps WIP only. All depends on what figures are meaningful to the clients management.

Generally I would go for inclusive of WIP but as I say, look at each requirement individually rather than ratio's being a form of perspcriptive sollution.

Hope that helps,

Shaun.

Cheshire · Master Book-keeper

Totally agree with Shaun, tend to include it, but you can do lots of variations as long as you are consistent. Consider what each of the component companies actually do, given you are using consolidateds....might skew the analysis too much. Have you managed to work through some reasonings as to why there are variances as that is what they will be looking for, plus (depending in what role you are going for) maybe even some suggestions how to improve any adverse ones.

Cheshire · Master Book-keeper

Shamus wrote:
Sorry, got waylaid with a Computing GCSE. Jo's answer is far better than mine.

I don't think so Shauny, but thanks for saying so!!! Hope you didn't do too much torturing of teenagers today. Reckon you might as well sit the GCSEs as well........well it will be more easy exams under your belt given all the effort you've put in so far!

Jay3 · Senior Member

Hi,

I have another question =D

I cannot for the life of me find a competitor in the same industry to compare against with the sam niche focus. Does it matter if two companies produce the same product but one factory focuses on high end niche products (and is doing well) and the other focuses on high volume cheap products is three times the size but is doing really badly....or does this just give me more to talk about when comparing the two? Is it a good thing or a bad thing??

Thanks
Jay

-- Edited by Jay3 on Monday 20th of April 2015 08:27:08 PM

Cheshire · Master Book-keeper

Hi Jay
I did mention peers, rather than just similar product. Plus Shaun did say it doesn't matter about the size of the company as you aren't comparing eg £x profit v £xx profit......that's not possible, but the reason why you do ratios.

I am a bit confused though as you say these two companies are producing the same product but the go on to say one is niche. So either it is the same or it's not. Your company producing niche products might create an explanation of stockturn or lack thereof (hint)

When you are saying one is doing really badly in comparison to the other....what are you basing that analysis on?

Did you manage to seek out/price up that book Shaun mentioned?

Out of interest ...when is your interview? Also, being nosey as I am.....what have they told you you will be doing? Have you had some specific instructions already?

Sorry for any typos, not got glasses!!

-- Edited by Cheshire on Monday 20th of April 2015 08:51:39 PM

Shamus · Forum Moderator & Expert

Just to add to Jo's reply which is a great roadmap to where you want to be.

From the sound of what you are attempting to achieve why are you restricting yourself to ratio's?

What about applying the Boston Consulting Group matrix and also looking at the product positioning of direct competitors. What about looking at Porters five forces when trying to analyse what might be going wrong with this business.

Where doing comparrisons to other businesses you are looking for simalies which may not even be in the same field. For example I'm sure that I read that Wembley is benchmarked against Aintree.

Add to the book that I advised yesterday a copy of a pre 2010 ACCA paper P5 practice and revision kit which will require you to properly analyse the performance of businesses.

Shaun.

p.s. those are jolly nice looking rum balls Jo

-- Edited by Shamus on Monday 20th of April 2015 09:22:00 PM

Jay3 · Senior Member

HI Both,

Thanks for everything. I like the tips about buying practice and revision kits I guess that's a really good way to keep all my skills up to date if I don't get exposure day to day =D

Interview is on Thursday :( I'm not required to do all of this work but want to impress and be prepared.....they only really want an analysis of their own accounts but ratios work best when you have something to compare to.

Jo - I see your point....if it's the same industry i.e. if they're two widget producing factories it doesn't really matter if Factory A sells Niche Widgets at a higher price and lower volume than Factory B who sells cheaper lower quality widgets to the masses. Is that correct? A Widget factory is still a Widget factory....it will just come out in the ratio analysis anyway. The interview will be criteria based and will focus on my CV where they ask me questions about stuff I have done in the past but they are also very likely to ask me to tell them about what I made of their accounts.

Jo- So far I have done trend and ratio analysis, 5 years worth and done the same for a competitor in the same industry. Not sure if the competitor analysis is a good thing as it feels pretty rushed given the time constraints.....sometime less is more! Im a little concerned that in trying to be clever (with the competitor analysis) I could end up making a mistake which costs me the job.....if you see what I mean.

Jo- Stockturn or lack there of....yes possibly but their competitor who is high volume run of the mill and cheap has an average of about 126 days.

Shamus - Thanks for the tips but for now Im keeping the brief a little more restricted due to time constraints I will no doubt look at those models you mentioned when I get the job =D but for now I just need to make sure I'm prepared for this week.

QUESTION - My competitor has not filed accounts for 2014 yet?? so I have accounts for 2010 - 2014 for the company Im analysing but only have accounts to 2013 for the competitor comparison?? What can I do about this?

Thanks
Jay

-- Edited by Jay3 on Monday 20th of April 2015 10:07:01 PM

Cheshire · Master Book-keeper

You are dying to get your sticky mits on these Accounts aren't you Shaun? Plus the rum balls. Oh go on then.....do you want me to make you some??

Anyone else? (Just need to wait until I get a new fridge as mine has died!)

Cheshire · Master Book-keeper

So for the interview, I'm assuming you have all your answers ready on the STAR basis (situation, Task, Action and Result....if you structure your responses on that basis for every competently quoted in the job advert and your CV in that formet you won't go far wrong.

Now normal widgets cannot be compared with niche widgets, by virtue of them being niche. You can only compare normal widgets with normal widgets as the niche profiles are very different....manufacturing process could be vastly different, customer base certainly will be and potentially saleability. They might take longer to make. They might be sticking in stock longer than the normal widgets because they have relatively few potential customers or have lost a big client to a competitor or one who has gone bust.

you will have to be careful to not be too critical as they won't want their business model ripping apart....they will think they are doing a wonderful job, even if they aren't. hence why I suggested you consider solutions to any potential issues you see so you can't try to focus on what added value you can provide to make their business even better.

I guess you could say that you understand a normal widget maker competitor turns their stock quicker, but then explain why theirs would/could be higher. Is there any press comment that might help?

I seems to recall the stockturn incensed quite a bit for a couple of years and dropped back .... Maybe some reasoning behind why you think that might be and an idea as to how it can be reduced or controlled for that not to happen again. Do that raw v split v finished split and try to work out why each of those might be different eg raw.....higher stock holdings due to problems sourcing? Where do they source from.

Sorry I've lost my thread a bit now, tired!!!

Jay3 · Senior Member

Thanks Jo,

I might scrap my competitor analysis....

Ratio and Trend Analysis on 5 years of their out accounts should still exceed their expectations and at I will perhaps avoid making errors with the competitor selection. What I have learned from all of this is that they have very few competitors and those which operate in the same niche don't file full accounts because they are too small. Perhaps the company I am applying to already has ideas about buying those smaller companies out as this is what they have done in the past? So I've learnt quite a bit with this whole process.

Jay =D

Cheshire · Master Book-keeper

Good luck tomorrow Jay - let us know who you get on, especially with your ratio test!

Jay3 · Senior Member

Hi Jo,

Thanks! I most definitely will let you know how I do!

As I am still preparing do you think you can help me with another question?

I am putting some graphs together to demonstrate trends and wondered if you had any ideas for any good ones perhaps where I could include two elements to show relationships?? I thought perhaps T/O and CoS would be a good one so that I could talk about cost controls i.e. if the Cost of Sales is escalating faster than T/O then this is bad.

Do you think this is a good idea and if so what other elements could I plot on one graph? Any suggestions?

Thanks,
Jay =D

Cheshire · Master Book-keeper

Hi Jay
Sorry will have missed your deadline - not been on BKN for a a couple of days as I was bombed with work! Hope it went ok. Didnt realise you had to do a presentation as well!!

Jay3 · Senior Member

Hi Jo,

Found out today that I didn't get the job =(

But I'm feeling really positive as it made me realise what Im capable off. The feedback was really positive and I was the closest they've had to date, but they have been recruiting for this role for a very long time.....6 months.

Part of me thinks I might have had a lucky escape as if they're that particular their might have been no pleasing them if I had actually got the job. I did a load of analysis and research and I identified key issues and talked about all their competitors as well as commenting on non financial issues......I could not have done any more!

Thanks for all you advice though it was really helpful.

I have so many ideas in my head just not sure what to do with them all. I think the ultimate freedom is to work for yourself so just considering what to do at the moment....

I have completed the training for my practice certificate so still contemplating opening my own practice.....it seems, on the face of it, difficult to get to the £40,000 ish profit bracket. I'm currently looking for jobs that pay around that figure.

The other thing I'm contemplating is mobile app development / project management.

Hmmmmm......decisions decisions :o)