ASSESSING FUTURE AND CURRENT PERFORMANCE OF ORGANISATIONS USING RATIO ANALYSIS George Rabar ABSTRACT This paper provides

a critical review of the theoretical and empirical basis of analysing a business performance by the use of financial ratios analysis from accounting statements. The balance sheet is one of the accounting statements used in ratio analysis. This paper will present a critical evaluation with examples of the limits of the balance and the implication of these limitations with regard to assessing and improving business performance. INTRODUCTON For any business to be successful, it needs to constantly evaluate the business performance by comparing the companys historical figures with its competitors and even with businesses from other industries. To complete an effective, examination of companys business functions, you need to examine more than just the attainable numbers like sales, profits and total assets and read between the lines of the financial statements to make seemingly inconsequential numbers accessible and comprehensible. Using well tested ratios, seemingly massive staggering data can be analysed and interpreted to churn out meaningful information. Comparative ratio analysis helps identify and quantify a businesss strength and weaknesses, evaluate its financial position and measure the risks of the undertakings. According to Salmi and Martijainen (1994), a common feature of all financial ration analysis seems to be that while significant regularities can be observed, they are not stable across the different ratios, industries and time periods. This clearly point out that there still much space for development of a more theoretical basis and for further empherical research, RATIO ANALYSIS Ratios are computed from one or more pieces of information from a businesss financial statement form an important profit assessment tools in financial analysis. Ratio analysis is primary used to compare a businesss financial figures over a period of time, a method sometimes called trend analysis. Through ratio analysis you can identify trends and adjust business practises accordingly. It can also be used to compare against other businesses both in and out of the industry. Financial ratio analysis groups the ratios into categories which tell us about different facets of a company's finances and operations. Some of the categories of ratios are: Liquidity Ratios presents a picture of a company's short term financial situation or solvency. Leverage Ratios shows the extent that debt is used in a company's capital structure. Operational Ratios use turnover measures to show how efficient a company is in its operations and use of assets. Profitability Ratios use margin analysis and show the return on sales and capital employed. Solvency Ratios presents a picture of a company's ability to generate cashflow and pay it financial obligations.

BALANCE SHEET Accounting can basically be differentiated into managerial accounting and financial accounting. The purpose of both is to assess the financial position of the organization and accordingly engage in future financial planning. Financial accounting has an internal focus and it deals with planning, implementation, and control of internal financial matters of the organization. Managerial accounting has an external focus and involves recording and documenting the financial operations and position of the organization. The financial accounting branch consists of the balance sheet, income statement and cash flow statement. The balance sheet displays the resources available, obligations, and worth of the organization at a given point of time. This paper discusses the issues contained in the balance sheet. A balance sheet is a financial statement that summarizes a company's assets, liabilities and shareholders' equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by the shareholders. According to Chand (2000) a balance sheet is often described as a snapshot of a company's financial condition. Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time. The balance sheet must follow the following formula: Assets = Liabilities + Shareholders' Equity Table1: Nyumbani Childrens Home Balance Sheet Nyumbani Childrens Home Balance Sheet as at 31/12/2007
ASSETS Long-Term Assets Fixed Assets Property Equipment, Net Investments Total Long-Term Assets Current Assets Cash Marketable Securities Accounts Receivable, Net Inventory Prepaid Expenses Total Current Assets TOTAL ASSETS LIABILITIES Long-Term Liabilities Mortgage Payable Total Long-Term Liabilities TOTAL LIABILITIES NET ASSETS Liabilities Current Liabilities Wages Payable Accounts Payable Notes Payable Current Portion - Mortgage Payable Total Current Liabilities TOTAL LIABILITIES

40,000 35,000 8,000 83,000

12,000 12,000 26,000 119,000

1,000 3,000 55,000 2,000 1,000 62,000 145,000

2,000 2,000 6,000 4,000 14,000 145,000

From Table 1

Total Assets (145,000) = Total Liabilities (145,000)

USES OF BALANCE SHEET The Balance Sheet gives a brief overview of the financial strengths and capabilities of the business. It is used as a guide to access: Current Ratio - The companys ability to meet its current financial obligations using current assets. The higher the ratio, the more liquid the company is.

Example for Nyumbani Childrens Home Total Current Assets -62,000 Total Current Liabilities -14,000 Current ratio -62000 / 14000 = 4.43 which would make it relatively good short-term financial standing. The amount of money and resources that have been so far been invested in the company Debt - Assets ratio The extent to which a firm is relying on debt or loans to finance its investment and operations. The lower the ratio the more conservative a company is judged as it may foregoing investment and growth opportunities The kind and amount of assets the company has purchased overtime with its financing Identify and analyze trends in receivables and payable Debt- Equity Shows the firms degree of leverage or its reliance on external debt financing

Balance sheets, along with income statements, are the most basic elements in providing financial reporting to potential lenders such as banks, investors, and vendors who are considering how much credit to grant the firm. BALANCE SHEET LIMITATIONS The balance sheet though providing crucial information still has some limitations, ad an element of caution should be exercised in analysing balance sheet information. Some of reasons for this caution are: Delay - When the company releases his balance sheet, it's already old news and the structure could have changed drastically. Consistency There is not always consistency between the information included I one companys balance sheets compared to that of another company .Two companies even in the same industry are usually very difficult o compare. Historical Costs The assets and liabilities of the institution are recorded at the exchange price of the transaction in which the asset was obtained or the liability incurred. These costs does not represent the amount of future cash inflow that the business will obtain through the use of the asset or save should be liability be paid before its due date. Alternative valuation methods include current cost, current exit value, net realizable value, and present value. These various alternative valuation methods are used in certain circumstances for selected assets or liabilities reported on the balance sheet. For example, current cost used for valuing inventory, current exit value for marketable securities, net realizable value for receivables, and present value for bonds payable. As increased emphasis placed on reporting financial information that communicates the businesss liquidity, financial flexibility, and operating capabilities, there could be an increased use of valuation methods other than historical cost on the institutions balance sheet. Economic resources or obligations not included. For example, human resources such as high-quality faculty, administrators, and staff are not included as assets because of the lack of consistent means to measure their intellectual capital value.

Use of estimates, which are subject to change over time. Estimates are used in the determination of amounts such as the expected uncollectible accounts receivables, depreciation expense and postretirement and post-employment benefits expense. In periods of inflation, the amounts reported in the balance sheet do not reflect the purchasing power of the assets. Window dressing - Even if the companies have to follow the general accounting guidelines and are controlled for that, the balance sheet is anything else that the position during the last day of the quarter (or the year) and some companies do some 'cleanings' of their balance sheet to make them look as good as possible. Example A firm can borrow 5 million shillings at the latter part of the year and hold the amount as cash deposits and then pay back just before reporting so as to give a false impression of its debt repayment ability. Leased Assets that the company is using on hire are expensed and not reflected on the balance sheet. Therefore showing a more favourable liquidity ratio on inventory. Foreign Currency transactions may impact the valuation of all asset types and liabilities depending on the fluctuating nature of exchange rates. Example Goods delivered invoiced at $10,000.00 Value of goods in local currency k.shs.10,000.00 x 65.00 = k.shs 650,000.00 Value of goods at sale 2 months later k.shs 10,000.00 x 68.00 = k.shs 680,000.00 Value of goods at reporting months later k.shs 10,000.00 x 72.00 = k.shs 720,000.00 What amount should be attributed to the account receivable at the balance sheet date? As the companies have to follow the accounting guidelines and because the balance sheet is anything else but historical records, it's possible that some of the assets are under or over estimated. These estimations are linked to the valuation method used by the companies. RECOMENDATIONS Due to the above limitation it is recommended to offer discloses or additional information in the notes to the financial statements to assist financial statement. This is normally in the form of an auditor's report and at the note. CONCLUSION As like any other form of analysis, comparative ratio techniques are not definitive and their results should not be viewed as gospel truth. Many of the balance sheet factors can play a role in the success or failure of a business. But when used in conjunction with other various business evaluation processes, comparative ratio analyses are invaluable. Analyzing a balance sheet is fundamental knowledge for anyone who wishes to carefully select solid and profitable investments. The balance sheet is the basic report of a firm's possessions, debts and capital. The composition of these three items will vary dramatically from firm to firm. As an investor, you need to know how to examine and compare balance sheets of different companies in order to select the investment that meets your needs.

Salmi and Martikainen (1994) concludes that there is still an opportunity to improve on the generalisation of ratio analysis. A systematic framework of financial statement analysis along with the observed separate research trends might be useful for furthering the development of research. For financial ratios to be useful to decision makers, the results must be theoretically consistent and empherically generizable.

REFERENCES Bernstein, L & Wild J. (2000) Analysis of Financial Statements, McGraw Hill Chand, S. & Company (2000) Management Accounting Davies, T. & Bozko, (2008) T. Business Accounting and Finance. 2nd Edition The McGraw Hill Companies http://www.asset-analysis.com/equities/fund_bslimit.html, Fundamental Analysis: Limitations of the balance sheet http://www.va-interactive.com/inbusiness/editorial/finance/ibt/ratio analysis.html Press, E (1999) Analysing Financial Statements , Lebahar Freidman Salmi, T. & Marikainen, T (1994), A Review of the theoretical and empherical basis of Financial Ratio Analysis, The Finnish Journal of Business Economics 4/94

PART B COSTING IN MANAGERIAL DECSION MAKING ABSTRACT This paper highlights the importance of management accounting and identifies for discussion four managerial decision making situation in relation to cost determination. The various cost determination approaches are then highlighted with emphasis on Activity Based Costing as the preferred approach. INTRODUCTION Businesses continue to face rising pressure to cut costs and increase profitability while also improving customer satisfaction and partner relations through efficient processes. Management accounting is concerned with the provisions and use of accounting information to managers within organizations, to provide them with the basis to make informed business decisions that will allow them to be better equipped in their management and control functions. Cost accounting has long been used to help managers understand the costs of running a business. Modern cost accounting originated during the industrial revolution, when the complexities of running a large scale business led to the development of systems for recording and tracking costs to help business owners and managers make decisions. In the early industrial age, most of the costs incurred by a business were what modern accountants call "variable costs" because they varied directly with the amount of production. Money was spent on labour, raw materials, power to run a factory, etc. in direct proportion to production. Managers could simply total the variable costs for a product and use this as a rough guide for decision-making processes. Costing in Managerial Decision Making According to Weber (2005).the basic tasks of a manager is to track, record and analyse costs associated the products or activities of an organisation so as to make decisions which respond to opportunities and threats by analyzing options and making decisions about goals and courses of action. Many organizations produce mountains of cost data but provide management with little or no useful information on cost and performance. This leads to wrong decisions. In many organizations, the management doubt the traditional cost figures and often end up with unofficial cost analyses. (Walker 1999.) Some situations where managers need to ascertain the cost of a product or service are: Product Pricing - Determine the true cost for cost object Investment Decision - To discover opportunities for cost improvement Production Volume Decision on whether to reduce or increased production output Production Costs Determine are the true elements contributing to the production of a product or service. Cost Allocation How to charge costs of service departments and in-directs In contrast to financial accountancy information, management accounting information is usually confidential and used by management, instead of publicly reported; forward-looking,

instead of historical; pragmatically computed using extensive management information systems and internal controls, instead of complying with accounting standards. This is because of the different emphasis: management accounting information is used within an organization, typically for decision-making. Product Pricing An asset is a resource of the company that gives a future economic benefit. Inventories are assets because they give future benefits to the company in the terms of sales revenue. Where the cost incurred by a business varies directly with the amount of production it is recommended to use Marginal Costing. Table 1: Calculating contribution using Marginal Costing
Units Sales Variable Costs Contribution Fixed Costs Profit Increase in Profit 100 1,000,000.00 250,000.00 750,000.00 6,000.00 744,000.00 200 2,000,000.00 500,000.00 1,500,000.00 6,000.00 1,494,000.00 750,000 300 3,000,000.00 750,000.00 2,250,000.00 6,000.00 2,244,000.00 750,000 400 4,000,000.00 1,000,000.00 3,000,000.00 6,000.00 2,994,000.00 750,000 500 5,000,000.00 1,250,000.00 3,750,000.00 6,000.00 3,744,000.00 750,000

Marginal costing is the presenting of cost data wherein variable costs and fixed costs are shown separately for managerial decision-making. It should be clearly understood that marginal costing is not a method of costing like process costing or job costing. Rather it is simply a method or technique of the analysis of cost information for the guidance of management which tries to find out an effect on profit due to changes in the volume of output. Advantages of Marginal Costing Marginal costing is simple to understand. By not charging fixed overhead to cost of production, the effect of varying charges per unit is avoided. It prevents the illogical carry forward in stock valuation of some proportion of current years fixed overhead. The effects of alternative sales or production policies can be more readily available and assessed, and decisions taken would yield the maximum return to business. It eliminates large balances left in overhead control accounts which indicate the difficulty of ascertaining an accurate overhead recovery rate. It helps in short-term profit planning by breakeven and profitability analysis, both in terms of quantity and graphs. Comparative profitability and performance between two or more products and divisions can easily be assessed and brought to the notice of management for decision making. Disadvantages of Marginal Costing The separation of costs into fixed and variable is difficult and sometimes gives misleading results. Normal costing systems also apply overhead under normal operating volume and this shows that no advantage is gained by marginal costing. The exclusion of fixed costs from inventories affect profit, and true and fair view of financial affairs of an organization may not be clearly transparent. Marginal cost data becomes unrealistic in case of highly fluctuating levels of production, e.g., in case of seasonal factories.

Application of fixed overhead depends on estimates and not on the actuals and as such there may be under or over absorption of the same. A system which ignores fixed costs is less effective since a major portion of fixed cost is not taken care of under marginal costing. In practice, sales price, fixed cost and variable cost per unit may vary. Thus, the assumptions underlying the theory of marginal costing sometimes becomes unrealistic.

Marginal costing is not a method of costing but a technique of presentation of sales and cost data with a view to guide management in decision-making. Investment Decision The evaluation of investment proposal represents one of the greatest challenges faced by business managers (Oliver 2001). Evaluating investments in emerging economies is an even more difficult task, due to the generally even less predictable changes in the social, political and economic infrastructure. To derive the most value form an investment and to increase overall efficiency, an understanding of the impact of the investment on the business operations and procedures within a company is crucial. This challenge arises as man companies still rely on traditional cost accounting which fails to provide the true cost of their operations (Ness and Cucuzza , 1995) Table 2: Current Cost Structure versus Projected Cost Structure after Three Years
Cost Type Direct Cost Operating Costs Capital Costs Total Costs Current Level 500,000 300,000 200,000 1,000,000 Projected 800,000 800,000 400,000 2,000,000 Change 60% 167% 100% 50%

The most substantial increase can be seen in operating expenses, which are projected to more than double in size, and are expected to make up approximately 40 percent of the total expenses. Ultimately, the operating cost could be expected to increase even further and become the largest portion of the overall costs (many manufacturers in developed countries, show operating expenses of 70 percent and higher (Miller and Vollmann, 1985)). Activity Based Costing is employed to transform the aggregated view of operating costs into more useful information for decision-making. This involves identifying the major business activities and assigning costs to these activities. The current costs for each activity are used to derive estimates for costs after three years. Table 3 summarizes the expected (hypothetical) expenses for carrying out the major business activities.

Table 3: Projected Operating costs without and with investment

Activity Receive Orders Schedule Jobs Purchase Materials and Subparts Handle Inventory Manage Production Assure Quality Ship Final Products Administrate Payments Perform Engineering Work Manage Customers Total Projected Operating Cost 60,000 50,000 80,000 70,000 160,000 30,000 100,000 40,000 110,000 100,000 800,000 Projected Operating Cost with Investment 50,000 20,000 50,000 50,000 120,000 30,000 80,000 20,000 90,000 90,000 600,000 Difference -16.70% -60.00% -37.50% -28.60% -25.00% 0.00% -20.00% -50.00% -18.20% -10.00% -25.00%

Table 3 compares the projected activity costs after three years with and without the proposed investment. Due to the proposed investment, the total overhead costs are expected to be 25% less at 600,000. This kind of derived information will allow managers to decide if the proposed investment is cost effective. However, when projected cost savings are expected to be modest, management may consider other, less tangible benefits of the proposed investment, such as increased flexibility. Allocation of Costs Direct labour and materials are relatively easy to trace directly to products, but it is more difficult to directly allocate indirect costs to products. Where products use common resources differently, some sort of weighting is needed in the cost allocation process. The measure of the use of a shared activity by each of the products is known as the cost driver. Traditional costing based on production volume and allocating overhead costs as a percentage of direct costs have increasingly become less reliable as many manufacturing firms have seen a marked increase in overhead and declines in direct labour costs.(Johnson , 1987) Allocation of overheads is the charging to a cost centre of those overheads that result solely form the existence of that cost centre. Activity Based Costing which uses various activities to trace overheads directly to cost objects avoids the distortion of traditional cost systems. Indirect costs (often large) are usually allocated in proportion to either labour cost, other direct costs, or some physical resource utilization.

Table 4:Table Allocating Overheads

Activity Receive Orders Schedule Jobs Purchase Materials and Subparts Handle Inventory Manage Production Assure Quality Ship Final Products Administrate Payments Perform Engineering Work Manage Customers Total Operating Cost 60,000.00 50,000.00 80,000.00 70,000.00 160,000.00 30,000.00 100,000.00 40,000.00 110,000.00 100,000.00 800,000.00 Allocated Overhead 7,500.00 6,250.00 10,000.00 8,750.00 20,000.00 3,750.00 12,500.00 5,000.00 13,750.00 12,500.00 100,000.00

Activity Based Costing which uses various activities to trace overheads directly to cost objects avoids the distortion of traditional cost systems. Organizations with a wide range of products or services have processes which are common to several finished items, making cost allocation irrelevant or misleading. Activity Based Costing Activity-Based Costing estimates the resources required to operate an organization's business processes, produce its products and serve its customers.. It is generally used as a tool for understanding product and customer cost and profitability. As such, it has predominantly been used to support strategic decisions such as pricing, outsourcing and identification and measurement of process. Limitations Even in activity-based costing, some overhead costs are difficult to assign to products and customers, for example the chief executive's salary. These costs are termed 'business sustaining' and are not assigned to products and customers because there is no meaningful method. This lump of unallocated overhead costs must nevertheless be met by contributions from each of the products, but it is not as large as the overhead costs before ABC is employed. Although some may argue that costs untraceable to activities should be "arbitrarily allocated" to products, it is important to realize that the only purpose of Activity Based Costing is to provide information to management. Therefore, there is no reason to assign any cost in an arbitrary manner. CONCLUSION Some costs tend to remain the same even during busy periods, unlike variable costs which rise and fall with volume of work. Over time, the importance of these "fixed costs" has become more important to managers. In the early twentieth century, these costs were of little importance to most businesses. However, in the twenty-first century, these costs are often more important than the variable cost of a product, and allocating them to a broad range of products can lead to bad decision making. Managers must understand fixed costs in order to make decisions about products and pricing. Drucker contends the shift from cost led pricing to price led costing where as the price the customer is willing to pay will determine the allowable costs, beginning with the design

stage. This will only be possible if the company knows and manage all of their costs within their supply chain which may not be quite feasible. REFERENCE Davies, T. & Bozko, (2008) T. Business Accounting and Finance. 2nd Edition The McGraw Hill Companies Drucker, P.F. (1995) The Information Executives Truly Need, Havard Business Review, pp pp.56-57 La Londe, B. J & Ginter, J.L (1996) A Summary Activity Based Costing Best Practises, The Supply Chain Management Research Group, Rozocki, N. & Weistroffer, H. R, (2004) Using Activity Based Costing for Evaluating Information Technology Related Investment in Emerging economies: Framework; Proceedings of the 10th Americas Conference on Information Systems, New York.