Cooperative Accounting System -3Rs-(Records, Reports, and Ratios) (Extracted from Ojijo’s Successful Saccos - Managers' Guide to Acquire, Retain and Grow Membership, Savings and Assets) Introducing Co-Op Book Keeping In most cooperatives, trained accountants will take care of the financial reports and more difficult accounts, such as depreciation expense. However, all board members should understand the bookkeeping functions and be able to interpret financial reports. By understanding all components of bookkeeping and the financial documents, the board will be better able to design an accounting system for their cooperative, maintain accurate bookkeeping records, and make prudent business decisions based on the financial reports. Cooperative Accounting System The cooperative’s accounting system is a method of recording, reporting and analyzing the financial results of cooperative’s business transactions. The accounting system is divided into 3Rs: recording, reporting, and ratio analysis. Recording/Bookkeeping The bookkeeper records the business transactions of the cooperative in a daily journal. These records are then used to generate various financial reports that provide an historical record of the cooperative’s business activity. The member records are needed because of the cooperative’s unique role of providing economic benefits distributed in proportion to each member’s use. The recording system includes: Daily Journal General Ledger Member Records Capital Investment Patronage Accounts Reporting The reporting system cover the balance sheet, income statement, and statement of cash flows. These financial statements report the results of the cooperative’s business transactions. This also includes the monthly cash flow statement, a planning tool for management. The reporting system includes: Balance Sheet Income Statement Statement of Cash Flows Monthly Cash Flow Statement Accrual Basis Accounting vis-à-vis Cash Basis Accounting The income statement, balance sheet, and statement of cash flows report the cooperative’s business transactions that occurred during specific time periods on an accrual basis. The business transactions are matched to the accounting period in which they occurred, regardless of when the cash for each transaction is actually exchanged. If a member purchases supplies on credit in December and pays for the supplies in January, the revenue from this sale would be included on the yearend income statement of the cooperative. The uncollected cash payment would be included in accounts receivable on the year-end balance sheet. Accrual basis accounting is important when analyzing the cooperative’s operations, to match the operating revenue to the resulting expenses incurred during the accounting period.  Recording (Book Keeping) Introducing Book Keeping The daily business transactions of the cooperative are recorded for later use in generating financial reports. If the books and accounts are kept accurate and current, the balance of each account can be transferred to the appropriate financial statement whenever needed. Some business transactions occur each day, such as sales to members, merchandise orders, and bill payments. It is important to develop an organized method of collecting the paperwork from these transactions, recording it in the daily journal, and filing it for future reference. The Daily Journal The daily journal is a chronological record of every business transaction of the cooperative. Entries come from sales receipts, invoices, and other paperwork and should be made for every day that the cooperative conducts business to ensure that each business transaction is recorded as it occurs. Dual Entry Accounting A cooperative operates by conducting several business transactions each day. During each transaction, an exchange of resources or obligations occurs between the cooperative and another party. Dual entry accounting is used to record this exchange. Each transaction recorded in the daily journal shows the resource or obligation the cooperative received and the resource or obligation that was exchanged. When a cooperative sells merchandise to a member, it exchanges the merchandise (a resource) for cash (a resource). To record the transaction in the journal, an entry is made to both merchandise sales and cash. If the cooperative purchases supplies on credit, the transaction would be recorded with an entry to supply purchases and one to accounts payable. Recording Transactions in the Daily Journal Every page of the journal should be numbered for future reference. All transactions entered should include the following information: 1. Date of the transaction; 2. Name of each account; 3. Reference number of each account; and, 4. amount, entered as a debit or credit. Using the dual entry system, an entry is made to cash, as the method of payment, and a balancing entry is made to supply sales, as the resource the cooperative exchanged for the cash. In both transactions, an entry is made to the resource the cooperative received and a balancing entry was made to the resource the cooperative exchanged. Transaction Date The date entered in the daily journal should indicate when the transaction occurred, not the date recorded. This will ensure that the date shown coincides with the date on every piece of paper from each transaction. Account Names Each type of business transaction that will likely occur during normal operations should be given an account name. For example, each asset such as cash, accounts receivable, or equipment and buildings. The account names for each balancing entry should be offset from each other. The resource the cooperative acquires during the transaction is recorded on the left and the resource the cooperative exchanges or the obligation it incurs is offset to the right. Account Numbers Each account name should also have a numerical reference. Sequential numbers are typically assigned to similar accounts, such as numbers 100 through 199 used for all assets. Each cooperative will have unique accounts and reference numbers, depending on the particular business and the transactions that occur. The most common category groups used are assets, liabilities, equity, revenue, and expenses. A chart of accounts should be developed for each cooperative that lists all the accounts used and the corresponding reference numbers. Large block of sequential numbers should be designated for each category so that other accounts can be added as operations expand or other needed accounts are identified. Some accounts can be shown in even more detail by including another digit to the account number. For example, a cooperative may want to list the salary expense for each phase of operations by designating 501-l for management, 501-2 for warehouse, and 501-3 for sales personnel. Debits & Credits The amount of each transaction is entered in the last two columns of the daily journal as either a debit or credit. Because each transaction is an equal exchange, the amount entered in the debit column must equal the amount in the credit column. When recording a business transaction in the daily journal, the resource the cooperative acquired during the exchange is offset to the left and the resource the cooperative exchanged or the obligation it incurred is offset to the right. The same is true for the value of the exchange. Debits are gains to the cooperative and always entered in the left-hand column when a business transaction is recorded. A credit amount indicates a resource the cooperative has given up or an obligation it has incurred and is entered in the right hand column. Each account can have both debit and credit entries, as in the cash account. When the cooperative sold merchandise, it acquired cash and the amount was entered as a debit to indicate a gain to the cooperative. When the cooperative paid the electric bill, the amount was recorded in the right-hand column as a credit to indicate a resource the cooperative gave up. To determine if an entry should be a debit or credit, it is easiest to determine if it is a gain to the cooperative or a resource it gives up or an obligation it incurs. General Ledger The general ledger is used to combine all the transactions from the daily journal, which are in chronological order, into each of the cooperative accounts. It contains the same information as the daily journal, but is used to show the balance for each account. The balance can then be used to generate the financial reports of the cooperative. Transferring entries from the daily journal to the general ledger is called posting. Posting Entries in the General Ledger Each ledger sheet should be labeled with the name of the account and the corresponding account number from the chart of accounts. The information transferred from the daily journal to the general ledger during posting includes: 1. Date of the transaction; 2. Description of the transaction; 3. Reference number to the daily journal; 4. value entered as a debit or credit; and, 5. Account balance, as a net debit or net credit. Date, Description, and Amount The date entered in the general ledger is the same as recorded in the daily journal, which is the day it occurred. The description of the transaction and the amount, listed as a debit or credit, is also shown in the general ledger as it is in the daily journal. However, now all transactions are grouped together into the same ledger account. Reference Number The number in the reference (REF) column is the page number of the daily journal where the transaction is recorded. The reference number can be used to determine where the transaction was recorded in the daily journal and on what day it occurred. This information provides an “audit trail” so the paperwork from each transaction can be easily tracked. Account Balance The last two columns of the general ledger page show the balance for each account as either a net debit or net credit. As each new transaction is posted, the debit or credit amount transferred from the daily journal is added to or subtracted from the balance in the general ledger. The account balance is used to generate the cooperative’s financial reports. Although financial statements are usually generated at specific times, the general ledger should be kept current so that the balance of some accounts, such as accounts receivable, can be checked whenever necessary. Member Accounts Accurate records of each member’s patronage and their benefit from and obligation to the cooperative are important to members and other agencies to show the cooperative is operating within cooperative guidelines and principles. Patronage account-Accurate records of the level of each member’s patronage are needed to determine the distribution of patronage refunds. Member volume is also needed to determine the cooperative’s tax liability because any profit not allocated to members is taxable income for the cooperative. Capital account-Cooperatives usually require some member investment, especially for startup capital. Members will rely on the cooperative to have accurate and current records of their investment in the cooperative. Capital accounts will also be important to banks and other lending institutions. Lenders usually require members to provide some portion of the capital. Retained Earnings-These are used by the cooperative to finance the future operations or supplement startup capital. They are returned to the members in accordance with the bylaws. The retained earnings account for each member should show the amount earned each year, the amount returned, and the current balance. Per-Unit Capital Retains-This is another method of member capital investment. Instead of members making a direct investment or the cooperative retaining a portion of the year-end profits, a set amount is retained by the cooperative for each unit of product it markets for the members. Member Accounts Receivable-Sales on credit to member-users should be monitored closely. High accounts receivable can have a negative impact on the availability of operating cash and the ability of the cooperative to pay its bills. Subsidiary Ledgers When preparing financial reports, the total amount of the accounts is used. For example, the total sales revenue shown on the income statement represents sales to several members. Or, lending institution may request the total amount member capital investment, but not each member’s account balance. However, the cooperative must maintain accurate and current records of each member’s use of the cooperative to properly distribute patronage refunds, maintain accounts receivable and redeem capital stock. Each member should have their own record for all member accounts used by the cooperative. These individual accounts are subsidiary accounts to the general ledger.  Reporting (Financial Statements) Why Financial Reports? Financial reports are used to evaluate past operations and are the basis for management and operating decisions on future projects. The board of directors use the reports for feedback on the financial status of the cooperative, to evaluate progress and to make informed decisions about future operations. Managers need accurate and timely information to run the day to-day operations. Creditors examine the financial reports when considering loans to the cooperative and accountants need accurate records to prepare tax documents. Accurate and current records are also important to members of the cooperative. Records should show the net profit, the level of each member’s patronage account and the amount of equity members hold in the cooperative. This facilitates distribution of patronage refunds and ensures that the cooperative is operating according to cooperative principles. Three Types of Reports Three financial reports commonly used in business are the balance sheet, income statement, and the statement of cash flows. They report the financial position of the cooperative, its performance over a given time period, and its ability to meet cash obligations. They are the basis for planning future operations. Each report contains different, but interrelated information that together give a complete picture of the financial operations of the cooperative. Managers, bookkeepers and board members should be able to understand and interpret these reports so they can make informed business decisions about the future of the cooperative.  Balance Sheet The balance sheet is used to report the financial position of the cooperative at a given point in time, usually at the end of a month, quarter, or year. It shows the assets owned by the cooperative balanced against its liabilities and member equity. The balance sheet presents a detailed listing of what a business owns, owes and its net worth at a specific point in time. It is a stock measure of the business' financial condition. Two considerations are important: liquidity and solvency. Three methods can be used to interpret a balance sheet: trend analysis 1. over several years 2. year-to-year comparison 3. month-to-month comparison industry analysis - compare the business to others that are similar compare to lender/regulatory requirements or standards The basic equation of the balance sheet is: Assets = Liabilities + Equity Assets are listed on the left-hand side of a balance sheet while liabilities and member equity are listed on the right-hand side. Total assets, or resources owned by the cooperative, must always equal the total liabilities and equity, or obligations of the cooperative. Assets = Liabilities + Equity Assets: Resources owned by the cooperative Liabilities: Debts owed by the cooperative Equity: Member’s interest in the cooperative Assets are shown as current assets and fixed assets. Current assets include cash and those assets that are expected to be converted into cash within one year, such as saleable inventory and accounts receivable. Fixed assets are items the cooperative will use during normal operations, such as buildings, machinery, and equipment. Liabilities are shown in two categories-current or long-term. Current liabilities are those paid within 1year such as accounts payable, short-term operating loans, or the current portion of long-term loans. Those due beyond the next 12 months, such as mortgages, are long-term liabilities. The equity section of the balance sheet shows the amount of capital the members have invested in the cooperative through stock purchases, allocated reserves, and per-unit retains. How Can We Improve Our Balance Sheet? One way to improve the balance sheet is to increase profits, especially useable profits. Useable profitability (net funds generated from operations) is a measure of the cash that is generated by operations. Useable profitability can be put to work to support future growth, repay long term debt, retire member equities and maintain adequate working capital. Sample balance sheet entries is as below: ASSETS Fixed Assets Land Buildings Computers Vehicles Office Block Furniture & Fittings Current Assets Cash and Equivalents Accounts Receivable: Shares Rent Other Prepaid Expenses: Insurance Corporation Taxes Other Other Assets Deferred Mortgage Costs Amortization Investment in Stocks Security Deposits Intellectual Property Net Assets LIABILITIES AND SHAREHOLDERS’ EQUITY Current Liabilities Accounts Payable and Accrued Expenses Security Deposits Payable Prepaid Maintenance Savings Accounts Long-Term Liabilities Debt Financing/Debt Investments Fixed Deposits Total Liabilities Shareholders’ Equity Capital Stock Share Capital (B/F) Capital Contribution/Shares Purchase Treasury Stock P&L Account Total Shareholders’ Equity Net Equities & Liabilities  Income Statement The income statement reports the results of all business transactions of the cooperative that occurred during a certain time period, such as month, quarter or year. It shows the total revenue of the cooperative, the total expenses, and the resulting net income (or loss). Revenue is the amount earned by the cooperative from operations. It can come from several sources, such as selling merchandise in a supply cooperative, charging members for services or marketing their products. In multi-functional cooperatives it is useful to separate the revenue from each function on the income statement. Gross revenue is the total profit the cooperative received from providing goods and services to members that can be used for business expenses. Sources of income include: Membership Fees Rental Income Sublet Fees Storage Fees Service Fees Late Fees Transfer Fees Interest Miscellaneous Income Expenses are the costs incurred to provide services to members. They vary according to the industry, services provided, and structure of the cooperative. They should be categorized to determine the costs incurred to operate each phase of the cooperative. These mainly include administrative, operating, marketing, interest, depreciation, amortization, and tax expense categories. Administrative costs include the salaries of sales staff, management, and office personnel. Others are office supplies, insurance, accountant fees, and advertising. These expenses are not directly linked to operations, but are the support services it provides. Some are considered fixed costs of operations because they do not vary with the level of output. Admin expenses can be summarized as below: ADMINISTRATIVE COSTS Salaries Rent & Utilities Consultancy Fees License Fees Staff Welfare Travel & Accommodation Office Equipment Expenses Tax Expenses Motor Vehicle Expenses Other Finance Costs Office Stationery Expenses Staff Training Other Office Expenses Total Admin Costs In details, admin expenses include: ADMINISTRATIVE COSTS Salaries Item Managing Director Directors Sales Team Administrator Support Staff Project Management Site Supervisors Accounts & Finance TOTAL Rent & Utilities Item Rent Electricity Water Rates Garbage Collection Fuel (Generators) Internet TOTAL Consultancy Fees Item Audit fees Legal Fees Other Consultancy Fees TOTAL License Fees Item NEMA Fees Trading License Others TOTAL Staff Welfare Item Staff Provident Fund Transport NSSF Staff Bonus Medical Insurance TOTAL Travel & Accommodation Item Accommodation & Hotel Expenses Travel (Fuel & Tickets) TOTAL Office Equipment Expenses Item Repairs & Maintenance (% of property value) Insurance (% of property value) Electrical Installations & Repairs Computer Hardware & Software Purchases & Installations and expenses TOTAL Tax Expenses Item Excise Duty TOTAL Motor Vehicle Expenses Item Insurance (% of vehicle values) Fuel Expense Motor Vehicle Repairs TOTAL Office Stationery Expenses Item Pens News Paper, Subscriptions & Periodicals Printing & Photocopies Notebooks TOTAL Staff Training Item Staff Training Staff Retreat Immigration / Work Permit Expenses TOTAL Other Office Expenses Item Telephone & Postage TOTAL Other Finance Costs Item Foreign Exchange Loss Bank charges Other Costs TOTAL Marketing expenses are expenses related to retention, branding, marketing tools, promotion, corporate social responsibility and related expenses. They are as below listed. MARKETING COSTS Corporate Social Investment (CSI) Corporate Branding (PR) Marketing Tools Promotion (Advertising) Customer Retention Total Marketing Costs In detail, marketing expenses include: Corporate Social Investment (CSI) Item Donations TOTAL Corporate Branding (PR) Item Profile/Brochure Calendars Press Releases Staff Uniforms Diaries Website & Social Media TOTAL Marketing Tools Item Letters Stickers/Flyers Business Cards (pack of 100) TOTAL Promotion (Advertising) Item transport fuel phone calls/communication TOTAL Customer Retention Item Customer database management/update Follow Up/ Visits Entertainment (lunch, dinner, coffee, etc) Freebies (Discounts, Gifts, Presents) TOTAL TOTAL MARKETING COSTS Operating expenses can be directly linked to the delivery of service and vary with output, such as in a cooperative that packs and sells vegetables. Operating expenses would include vegetable boxes, wages of packers, and machinery maintenance. These are variable costs because the total amount varies with the level of day-to-day operations. OPERATING/SALES COSTS Sales Commissions VAT Service delivery fees Manufacturing expenses Brokerage Expenses TOTAL Interest expense is the cooperative’s cost of borrowing money. Depreciation represents the cost of using high value items such as machinery and equipment. This expense allows the cooperative to write down the cost of machinery or equipment over the useful life of the item and is usually included on the income statement at the end of each fiscal year. Other expenses are amortization, or repayment of principal amounts loaned to the cooperative. Subtracting total expenses from gross revenue gives the net income (or loss) of the cooperative over the given period of time. The year-end income statement should note the portion of net income distributed to members as cash patronage refunds and the portion that remains as allocated reserves. Below is sample profit and loss statement: P&L Statement Income Membership Fees Rental Income Sublet Fees Laundry Income Storage Fees Service Fees Late Fees Transfer Fees Interest Miscellaneous Income TOTAL INCOME Operating/Sales Expenses OPERATING INCOME COST OF OPERATIONS Marketing Expenses Administrative Expenses (Including Depreciation) GROSS PROFIT Interest Expense INCOME BEFORE TAX Taxes Expense NET INCOME  Cash Flow Statement As its name indicates, only those accounts that result in cash flowing in or out of the cooperative during the accounting period are included on the statement of cash flows. This report shows the change that occurred in amount of cash from the opening to the closing of the cooperative’s balance sheets. There are three categories on the statement of cash flows: operations, investment transactions, and financing transactions. Cash flow from operations gives the net cash from providing goods and services to members and all other cash flows not from investment or financing transactions. This includes net income, adjustments to net income, and changes in balance sheet items. Adjustments to net income offset the non-cash items included on the income statement that do not result in an actual inflow or outflow of cash, such as depreciation, a gain (loss) from the sale of an asset, and deferred taxes. Changes in balance sheet items are assets and liabilities where changes result in positive or negative cash flows, such as accounts receivable, accounts payable, patronage refunds payable, or other accrued expenses. Cash flow from investment transactions include the purchase or sale of property and equipment, the purchase or redemption of equity in other organizations, and payments from long-term investments. Cash flow from financing transactions include the acquisition or redemption of loans, the sale of capital stock, redemption of member equities or payment of patronage refunds. Cash basis accounting recognizes that the exchange of cash does not always occur at the same time as the business transaction. This can affect the liquidity of the cooperative or its ability to meet cash obligations. The amount of cash received by a cooperative during a given month often does not equal the amount paid, especially for seasonal businesses or those providing credit sales to members. The monthly cash flow statement is an important management planning tool to indicate the cooperative can meet monthly cash obligations. Using the monthly cash flow statement as a planning tool, the cooperative manager can determine if an operating loan will be needed during those months that have projected negative cash flows, or schedule payments on accounts payable during months with positive cash flows. Below is sample cashflow statement for cooperatives. Statement of Cash flows CASH FLOWS FROM OPERATING ACTIVITIES: Net Income (Loss) From Operations Adjustments to Net Income (Loss): Depreciation Gain (Loss) on asset disposition Deferred income taxes Changes in Balance Sheet Items: Accounts receivable Accounts payable Patronage refunds payable Other Net Cash Flow Provided From Operations CASH FLOWS FROM INVESTING ACTIVITIES: Capital Sales Equity Redemption Payments From Long-term Investments Capital Purchases Equity Purchases Other Net Cash Provided by Investment Transactions CASH FLOWS FROM FINANCING ACTIVITIES: Capital Stock Sales Loan Acquisition Loan Principal Redemption Member Equity Redemption Patronage Dividends Payable Redemption Other Net Cash Provided by Financing Activities Net Increase (Decrease) in Cash and Cash Equivalents: Cash and Equivalents at Beginning of Year: Cash and Equivalents at End of Year:  Schedules to Financial Statements The financial statements derive data from tables, or schedules, as below: Membership Fees Schedule Late Payment Fees Schedule Other Income Sources Schedule Administrative Expenses Schedule Operating Expenses Schedule Marketing Expenses Schedule Interest Expense Schedule Amortization Schedule Fixed Assets Schedule Depreciation Schedule Stocks Schedule Debtors Schedule Creditors Schedule Share Capital Contribution Schedule Long Term Liabilities/Fixed Deposits Schedule Short term Liabilities/Savings Accounts Schedule Debt Financing/Outsiders Deposits/Debt Investments Schedule Capital Stock Schedule (including Par Value of Shares, Authorized Shares, Shares Issued, Shares Outstanding, Paid-In Capital, Treasury Stock, and Accumulated Deficit)  Notes to Financial Statements Notes to financial statements (notes) are additional information added to the end of financial statements. Notes to financial statements help explain specific items in the financial statements as well as provide a more comprehensive assessment of a company's financial condition. Notes to financial statements can include information on debt, going concern criteria, accounts, contingent liabilities or contextual information explaining the financial numbers (e.g. to indicate a lawsuit). Financial accountants use the terms footnote, note, and explanatory note pretty much interchangeably as all three terms represent the same explanatory information. Notes to the financial statements report the details and additional information that are left out of the main reporting documents, such as the balance sheet and income statement. This is done mainly for the sake of clarity because these notes can be quite long, and if they were included, they would cloud the data reported in the financial statements. The notes clarify individual statement line-items. For example, if a company lists a loss on a fixed asset impairment line in their income statement, notes could corroborate the reason for the impairment by describing how the asset became impaired. Notes are also used to explain the accounting methods used to prepare the statements and they support valuations for how particular accounts have been computed. At the very least, the explanatory notes should include what depreciation methods are in use, how a company values its ending inventory, the basis of consolidation, accounting for income taxes, information about employee benefits, and accounting for intangibles. The financial statements have fourteen common notes, as below: 14 Common Notes to the Financial Statements Notes That Show The Nature Of Operations/ Basis For Presentation The first order of business when preparing explanatory notes is explaining, in general, the business. The note gives a thumbnail sketch of the business. Common topics for discussion include what the company is in the business of doing and how it does that work. This should indicate the name of company, year of registration, countries of registration and operation, and address of the company. These notes should also indicate the principal activity, in terms of industry segment, that the company deals in, for instance, steel manufacturing, accountancy services or food processing, as well as listing the specific business activities, or products sold by the company. Notes That Advise On Significant Accounting Policies Information about accounting policies assists financial readers in better interpreting a company's financial statements, thus resulting in a more fair presentation of the financial statements. A note is needed for each significant accounting choice by the company. The notes should indicate the accounting standard used for the preparation of the financial statements, with preference being the International Financial Reporting Standards (IFRS) developed and published by the International Accounting Standards Board (IASB). I will indicate whether or not I follow the Generally Accepted Accounting Principles (GAAP), which is set forth by the Financial Accounting Standards Board, the private-sector organization responsible for setting financial accounting and reporting standards. Notes About Depreciating Assets (Property, Plant And Equipment-PPE) Depreciation is spreading the cost of a long-term asset over its useful life (which may be years after the purchase). A business values its ending inventory using inventory valuation methods. The methods a company opts to use for both depreciation expense and inventory valuation can cause wild fluctuations in the amount of assets shown on the balance sheet and the amount of net income (loss) shown on the income statement. For instance, depreciation rates for computer and electronic items will be different from depreciation rates for furniture and fittings, and different from depreciation rates of plant (industrial buildings), and also different form depreciation rates for machinery. Further, other assets, like land, will not be depreciated. Differences in net income could merely be a function of depreciation or valuation methodology, and the user would be unaware of that fact without the footnote. Notes That Explain Intangibles Intangible assets aren’t physical in nature, like a desk or computer. Two common examples of intangibles are patents, which are licensing for inventions or other unique processes and designs, and trademarks, which are unique signs, symbols, or names that the company uses. Besides explaining the different intangible assets the company owns via an explanatory note, the business needs to explain how it has determined the intangible asset’s value showing on the balance sheet. Notes About Valuing Inventory Companies have two inventory issues that must be disclosed in the notes: the basis upon which the company states inventory (lower of cost or market) and the method in use to determine cost. GAAP allows three different cost flow assumptions: specific identification; weighted average; and First In, First Out (FIFO). Accounting for depreciation and inventory is usually addressed in whichever note gives a summary of accounting policies. Even property that cannot be sold due to legal restrictions, but which may either be donated or destroyed, shall be subject to the disclosure requirements; no financial value shall be recognized for these items. Inventory and related property includes: Inventories Operating materials and supplies Stockpile materials Forfeited property Goods held under price support and stabilization programs Notes About Reporting Debt The notes to the financial statements also must disclose claims by creditors against the assets of the company. The note shows how the company is financing present and future costs. It also gives the user of the financial statements a look at future cash flows, which can affect the payment of dividends. It should indicate there is a provision for debt, and that bad debts are written off after all reasonable attempts are made to collect them without results Notes That Consolidate Financial Statements Consolidation refers to the aggregation of financial statements of a group company as a consolidated whole. In this section of the footnotes, the company confirms that the consolidated financial statements contain the financial information for all its subsidiaries. Any deviations, including deviations from all subsidiaries, also must be explained. Notes That Spell Out Employee Benefits Employee benefit plans provide benefits to both employees and former employees. One example is a health and welfare benefit plan that provides medical, dental, vision, vacation, and dependent care (just to name a few) benefits to employees and former employees. The footnotes also spell out details about the company’s expense and unpaid liability for employees’ retirement and pension plans. These details include the obligation of the business to pay for post-retirement health and medical costs of retired employees. Notes That Spell Out Account Receivables This asset account represents the amounts due from others when the right to receive funds accrues. This may result from the performance of services, the delivery of goods or court-ordered assessment. This note should list all the debtors and the amounts demanded. Notes That Spell Out Loans The notes should also provide an analysis of the reporting entities’ direct loan and loan guarantee portfolios. Collect data pertaining to all loan activity even if it is immaterial to ensure that department-wide disclosure is complete. I will indicate the loan type (long term or short term), and the source of the loan. I should also indicate the loan terms. Notes That Spell Taxation The note should also indicate the taxation charges affecting the company, and the various policies, etc, which are affecting the company, including tax breaks, tax deductions, and other tax practices like advance payment of taxes. Notes That Spell Risk Management These notes cover risk management, objectives and policies (e.g., credit risk, currency risk, liquidity risk and market price risk). I should indicate whether or not the company is exposed to foreign exchange risk (that is, dealing with foreign currency either in export, or import); exposed to credit risk (that is, non-paying clients); exposed to liquidity risk (that is, long term debt obligations); and or exposed to market price risk (that is, the risk of losses in positions arising from movements in market prices. Some market risks include: Equity risk, the risk that stock or stock indexes (e.g. Euro Stoxx 50, etc.) prices and/or their implied volatility will change. Interest rate risk, the risk that interest rates (e.g. Libor, Euribor, etc.) and/or their implied volatility will change. Currency risk, the risk that foreign exchange rates (e.g. EUR/USD, EUR/GBP, etc.) and/or their implied volatility will change. Commodity risk, the risk that commodity prices (e.g. Corn, Copper, Crude Oil, etc.) and/or their implied volatility will change. Notes That Spell Share Capital The notes should spell out the amount of share capital, types and or classes of shares, and whether they are issued and paid up or not. This section should also include a section on share deposits by the shareholders. Notes That Spell Revenue Sources And Recognition The notes should also indicate when revenue is recognized, that is, whether at the time goods are supplied and accepted by the customer, or when payment is made. The notes should then list the revenue sources, by segment, being the product, unit prices, and sales for the period under consideration.  Ratio Analysis Do I have enough working capital? Will I be able to make payroll and the next flock of bills? Is my debt too high? Will I have any difficulty meeting long-term obligations? Am I using my assets wisely? Is my inventory too large, or does it take too long to turn over? How profitable is my business? Financial ratios help me answer these questions. The massive amount of numbers in a company's financial statements can be bewildering and intimidating to many investors. However, through financial ratio analysis, I will be able to work with these numbers in an organized fashion. Financial ratios are indicators used to analyze an entity’s financial performance. Financial ratios are used by bankers, creditors, shareholders and accountants to evaluate data presented on an entity’s financial statements. Depending on the results of the evaluations, bankers and creditors may choose to extend or retract financing and potential shareholders may adjust the level of commitment in a company. Financial ratios are important tools that judge the profitability, efficiency, liquidity and solvency of an entity. A financial ratio (or accounting ratio) is a relative magnitude of two selected numerical values taken from an enterprise's financial statements. Financial ratios may be used by managers within a firm, by current and potential shareholders/investors (owners) of a firm, and by a firm's creditors. Financial analysts use financial ratios to compare the strengths and weaknesses in various companies. If shares in a company are traded in a financial market, the market price of the shares is used in certain financial ratios. Ratios can be expressed as a decimal value, such as 0.10, or given as an equivalent percent value, such as 10%. There are four main categories of financial ratios: Liquidity, Profitability, Leverage/Solvency, and Activity/Efficiency  Profitability Ratios Profitability ratios help users of an entity’s financial statements determine the overall effectiveness of management regarding returns generated on sales and investments. Profitability ratios are designed to evaluate the firm's ability to generate earnings. Analysis of profit is of vital concern to stockholders since they derive revenue in the form of dividends. Further, increased profits can cause a rise in market price, leading to capital gains. Profits are also important to creditors because profits are one source of funds for debt coverage. Management uses profit as a performance measure. There are several ratios that may be used to measure profitability and the income statement contains several figures that may be used for profitability analysis Return on Member Equity A measurement of the co-op's rate of return on member investment. Always given as a percentage. It shows the interest rate net profits yield on member equity. Formula: Net Savings X 100 / Member Equity Net Profit Margin (NPM) Net Profit Margin measures how much out of every of Sales a company actually keeps in earnings, and hence, our measure of profitability. Profit margin, net margin, net profit margin or net profit ratio all refer to a measure of profitability. It is calculated by finding the net profit as a percentage of the revenue. Profit margin is displayed as a percentage; a 20% profit margin, for example, means the company has a net income of $0.20 for each of sales. It is also known as Net Profit Margin. If the company has a high average net profit margin, it is a high margin of safety, hence, a decline in sales, or lower pricing, will not negatively affect our profitability. Gross profit margin The average gross profit on each of sales before operating expenses:  It will depend on the industry I am in, so it is important to measure yourself against industry benchmarks. It is an excellent way of assessing the profitability of each product.  Return on Assets (ROA)/Return on Investment (ROI) This ratio is an indicator of how profitable a company is relative to its total assets. The greater a company's earnings in proportion to its assets, the more effectively that company is said to be using its assets. ROA/ROI gives an idea as to how efficient management is at using its assets to generate earnings. An average ratio of above10% is acceptable shows that the company is better at converting its investment into profit, making large profits with little investment. Return on Equity Return on Equity measures the efficiency with which stockholder’s investment has been used. In essence, it measures the company profitability by revealing how much profit a company generates with the money shareholders have invested. Also known as "return on net worth" (RONW). Net income is for the full fiscal year (before dividends paid to common stock holders but after dividends to preferred stock.) Shareholder's equity does not include preferred shares. From the above ratio, the company is efficient at generating profits from every unit of shareholders' equity (also known as net assets or assets minus liabilities). A high ROE shows that the company uses investment funds to generate earnings growth. A higher average of above 20% means that the company is a lean, mean profit machine. For example, if I have invested $200,000 and the business is generating a net income of $100,000 a year, my return on owner’s equity is 50 per cent. It tends to increase over time as the business grows, especially if my personal investment remains the same. It is a useful way to compare what you’ve earned from my business to what I may have earned from another investment. Efficiency /Activity /Asset Turnover Ratios Activity ratios also known as efficiency or turnover ratios are used to measure how efficiently a business uses its assets. Asset turnover ratios consist of the sales figure in the numerator and the balance of an asset in the denominator. These ratios measure the effectiveness of management’s decision making. Inventory Indicates the desirable inventory level for the working TO WORKING CAPITAL: capital employed. Formula: Inventory / Net working capital Accounts Receivable Turnover An indicator of how quickly the firm is collecting from its credit sales. This calculation is Average Gross Receivables, divided by the Net Sales, divided by 365. The results from this ratio may cause the firm to rethink its credit terms. Most firms invest a significant amount of capital in accounts receivable, and for this reason they are viewed as crucial corporate resources. Accounts receivable turnover is a measure of how these resources are being managed and is computed as follows:   Annual Sales Accounts Receivable Turnover = ------------------- Accounts Receivable A fairly high number by most standards would be considered very strong. Inventory Turnover An important resource that requires considerable management attention is inventory. Particularly useful if you have trading stock. Shows how often my business’ inventory is sold and replaced in a particular period. This is another powerful ratio. It indicates the liquidity of the inventory. This is calculated by dividing the Cost of Goods Sold by the Average Inventory. Although monthly inventory totals would generate the best average, they are usually unavailable to an outside investor. Often times the beginning and ending inventory totals are the best available numbers. Control of inventory is important and is commonly assessed with the inventory turnover measure:   Annual Sales Inventory Turnover = -------------   Inventory Generally, the higher the number the better. The less time goods spend in inventory the better the return the company is able to earn from funds tied up in inventory. A large stale inventory can distort the asset position of the company and should be monitored for that reason also. For example, if you’ve spent $200,000 on stock over the year and you keep an average of $20,000 worth of stock on hand, your inventory turnover is 10 times a year. As a general rule, it is better to have a higher than lower inventory turnover. A low turnover indicates you have a lot of money tied up in stock for long periods, which is not good for cash flow. Too high a figure could indicate that you don’t have enough stock on hand. Accounts Payable Turnover Cost of Sales Average Accounts Payable The higher the turnover, the shorter the period between purchases and payment. A high turnover may indicate un-favourable supplier repayment terms. A low turnover may be a sign of cash flow problems. Operating Expense Ratio Compares expenses to revenue. Operating Expenses Total Revenue A decreasing ratio is considered desirable since it generally indicates increased efficiency. Earnings Per Share Profits after taxes -Preferred stock dividends Number of shares of common Stock outstanding Shows the earnings available to the owners of each share of common stock Days Receivable Ratio Another measure of a business' liquidity is how long it takes for the company to collect payments from clients, also known as days receivable ratio. Figure the days receivable of a business by dividing its average gross receivables by its annual net sales divided by 365. For example, a company with annual net sales of $365,000 and average gross receivables of $40,000 would have a days receivable ratio of 40 days.  Liquidity Ratios Liquidity is a measure of the business' ability to pay its bills on time. It is the relationship between current assets and current liabilities. Liquidity is a sensitive barometer of month to month operations. Liquidity ratios help financial statement users evaluate a company’s ability to meet its current obligations. In other words, liquidity ratios evaluate the ability of a company to convert its current assets into cash and pay current obligations. Common liquidity ratios are the current ratio and the quick ratio. The current ratio is calculated by dividing current assets by current liabilities. A general rule of thumb is to have a current ratio of 2. The quick ratio, or acid test, helps determine a company’s ability to pay obligations that are due immediately. Net Working Capital The difference between total current assets and total current liabilities. It indicates the extent to which short-term debt is exceeded by short-term assets. Formula: Current Assets - Current Liabilities Current Ratio/ Liquidity Ratio The current ratio is a financial ratio that measures whether or not a firm has enough resources to pay its debts over the next 12 months. Also known as "liquidity ratio", "cash asset ratio" and "cash ratio". It compares a firm's current assets to its current liabilities. If an entity cannot maintain a short-term debt-paying ability, it will not be able to maintain a long-term debt-paying ability, nor will it be able to satisfy its stockholders. It is safe to assume that current liabilities will be paid with cash generated by current assets. A profitable company still may have difficulty paying its short-term debt. Many companies use accrual accounting and are able to report high profits but are unable to meet its current obligations. The liquidity ratios look at aspects of the company's assets and their relationship to current liabilities. Net Working Capital The difference between total current assets and total current liabilities. It indicates the extent to which short-term debt is exceeded by short term assets. Formula: Current Assets - Current Liabilities Quick Ratio The quick ratio of a business is a measure of its financial liquidity. It determines how easily a business could convert assets into cash to cover its liabilities. Companies that have a low quick ratio present a higher risk to investors. Figure the quick ratio of a company by deducting the value of its inventory from its current assets and dividing the total by its current liabilities. For example, if a company has $2 million in assets, of which $1 million is tied in its inventory, and $500,000 in liabilities, it has a quick ratio of 2 to 1.  Solvency/Leverage Ratios Solvency is the relationship of long term debt to owners' equity. It is a measure of the proportion of long term capital being provided by the creditors (debt) versus the owners (equity). It indicates who is financing the permanent assets of the company. Solvency, or leverage, ratios, judge the ability of a company to raise capital and pay its obligations. Solvency ratios, which include debt to worth and working capital, determine whether an entity is able to pay all of its debts. It is important to ensure the entity can maintain operations during difficult financial periods. The debt to net worth ratio calculation is total liabilities divided by net worth. Working capital is calculated by subtracting current liabilities from current assets. Solvency Ratio Indicates the amount invested in the business by the creditors with that invested by the members. The lower the ratio, the higher the creditors' claims on the assets, possibly indicating the cooperative is extending its debt beyond its ability to repay. However, an extremely high ratio may indicate that the cooperative is managing its assets too conservatively. Long-Term Debt to Working Capital Indicates creditor contribution to liquid assets. Formula: Long-term Debt / Net Working Capital Long-Term Debt to Capitalization Indicates the proportion of total capitalization provided by long-term debt. Formula: Long-term Debt / Total capitalization Adjusted Solvency Ratio Tangible net worth divided by Long Term Debt. Tangible net worth equals total net worth minus investments in other companies and other intangibles such as goodwill, non-compete agreements, etc.). Formula: Tangible Net Worth / Long Term Debt Debt to Equity Ratio/Financial Leverage/Gearing/Risk The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of shareholders' equity and debt used to finance a company's assets. Closely related to leveraging, the ratio is also known as Risk, Gearing or Leverage. Whereas the optimal debt-to-equity ratio is considered to be about 1, i.e. liabilities = equity; the maximum acceptable debt-to-equity ratio is 1.5-2 and less. The more non-current the assets (as in the capital-intensive industries), the more equity is required to finance these long term investments. An average reducing D/E Ratio means the company is being financed from its own financial sources rather than by creditors which is a positive trend. Lenders and investors usually prefer low debt-to-equity ratios because their interests are better protected in the event of a business decline. Thus, with low debt-to-equity ratios, the company can be able to attract additional lending capital. Further, the low debt-to-equity ratio indicates that the company will be able to generate enough cash to satisfy its debt obligations. It also provides opportunity to exploit financial leverage. Debt/EBITDA Ratio This ratio gives the investor the approximate amount of time that would be needed to pay off all debt, ignoring the factors of interest, taxes, depreciation and amortization. Ratios higher than 5 indicate that a company is less likely to be able to handle its debt burden, and thus is less likely to be able to take on the additional debt required to grow the business. At a ratio of below 5, the company is able to pay off its debts. This high ratio suggests that the company may want take on less debt, unless the cost of capital is greatly reduced. A high debt/EBITDA ratio suggests that a firm may not be able to service their debt in an appropriate manner and can result in a lowered credit rating. Conversely, a low ratio can suggest that the firm may want take on more debt if needed and it often warrants a relatively high credit rating. Debt Service Coverage Ratio (DSCR) The debt service coverage ratio (DSCR), also known as "debt coverage ratio," (DCR) is the ratio of cash available for debt servicing to interest, principal and lease payments. It is a popular benchmark used in the measurement of an entity's (person or corporation) ability to produce enough cash to cover its debt (including lease) payments. The higher this ratio is, the easier it is to obtain a loan. The phrase is also used in commercial banking and may be expressed as a minimum ratio that is acceptable to a lender; it may be a loan condition or covenant. The average DSCR of above 1 indicating that the company is producing income which is sufficient to pay back its debts. In essence, the company will have cash flow available to meet annual interest and principal payments on debt. A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1, say .95, would mean that there is only enough net operating income to cover 95% of annual debt payments. For example, in the context of personal finance, this would mean that the borrower would have to delve into his or her personal funds every month to keep the project afloat. Generally, lenders frown on a negative cash flow, but some allow it if the borrower has strong outside income. Debt Ratio Debt Ratio is a financial ratio that indicates the percentage of a company's assets that are provided via debt. It is the ratio of total debt (the sum of current liabilities and long-term liabilities) and total assets (the sum of current assets, fixed assets, and other assets such as 'goodwill'). The higher the ratio, the greater risk will be associated with the firm's operation. In addition, high debt to assets ratio may indicate low borrowing capacity of a firm, which in turn will lower the firm's financial flexibility. Like all financial ratios, a company's debt ratio should be compared with their industry average or other competing firms. Total liabilities divided by total assets. The debt/asset ratio shows the proportion of a company's assets which are financed through debt. A debt ratio of greater than 1 indicates that a company has more debt than assets; meanwhile, a debt ratio of less than 1 indicates that a company has more assets than debt and most of the company's assets are financed through equity. Companies with high debt/asset ratios are said to be "highly leveraged," not highly liquid as stated above. A company with a high debt ratio (highly leveraged) could be in danger if creditors start to demand repayment of debt. ………………………….. Ojijo’s Profile Ojijo is the Founder & Lead at GoBigHub.com, an African franchise that connects local entrepreneurs to local investors, the solution to the ever present cry by entrepreneurs that they lack capital for doing business. Our vision is to help businesses get capital which leads to creating jobs, which leads to improving livelihoods through employment, which leads to tax payment and improved economic growth for African countries, and Africa as a continent. GoBigHub is promoting trade, not aid, and creating scalable, sustainable, and profitable businesses. Ojijo is privately a consultant in communications (public speaking, strategic planning, and writing); an expert lawyer specializing in ICT law, financial services law, law firm management, and legal rhetoric); a public speaker and coach on financial literacy and personal branding; and a consultant in collective investment schemes (investment companies, investment clubs, provident funds, and cooperatives). In this area, he has also authored two leading texts on collective investment schemes, with one on Cooperatives, Successful Cooperatives - Managers' Guide to Acquire, Retain and Grow Membership, Savings and Assets and one on investment clubs, Making Money Together - Ojijo's Investments Club Manual. Over a period of 15 years, Ojijo has worked with a broad scope of clientele including Ministry Of Foreign Affairs Cooperative; National Environmental Management Authority(Uganda); Kenya Association of Investment Groups (AKIG); Kawanda National Agriculture Research Organization; Gender Ministry (Uganda); Nsamizi Institute(Mpigi-Uganda); 4Cs-Kenya; CREDO-Kenya; KHRC-Kenya; Foundation for Human Rights; Africa Youth Development Link; Technoserve; AIESEC; AYDL; UMYDF; CCEDU; FOWODE; PEDN; and over 20 investment clubs, over 50 individual clients, at least 15 cooperatives; and several other universities, companies, and individuals on various areas of expertise. He offers advisory support in legal and or strategic areas in various boards of various investment clubs, cooperatives, Bank of Uganda Financial Literacy Advisory Group, Uganda Financial Literacy Sharing Group (FLISG), and Competitiveness Secretariat of Uganda Ministry of Finance supported Investment Clubs Association of Uganda-ICAU. Ojijo is an author of 51 books; Inua Kijana Fellow; Performance Poet’ Armature Pianist; speaker of 17 languages including French, English, German, Portuguese, Dutch, Zulu, Chinese, Spanish, Hausa, Luganda, Kiswahili, Luo, Kikuyu, Hindi, Somali, Jamaican Patois, and Arabic; and entrepreneur owner of luopedia.com, commonsenseapp.net, lawpronto.com, naniwapi.com, gobighub.com, allpublicspeakers.com, gosacco.com, ugstick.com, uzimafoods.com, chapchap.com, and achibela.com. M: +256776100059. E: ojijo@gobighub.com