Genesis Management Services Pty Ltd gmservices.com.au
genesis
SERVICES
EXPERIENCE
UNIT 8. WRITING MANAGEMENT REPORTS
Financial managers and other operating managers are often asked to write management reports concerning their analysis and interpretation of the financial statements and the underlying performance of the business.
It is important first of all to clarify who the report is to be addressed to because the needs of various users tend to differ. In fact the whole standard reporting system has to be designed with user needs in mind.
Normally the management report is for internal users including top management and the board. However in some cases external users may ask for reports and management may even ask you to prepare reports suitable for their needs. This would include creditors, bankers, lenders and potential investors.
Writing management reports is therefore an exercise in communication and at the outset we have to be clear on the needs of the reader and this will help us define our objectives for the report.
These reports should be written in such a way as to de-mystify the figures. Many people have a negative reaction to numbers and accounting. Your task will be to make your reports factual and motivational in content. This is an important part of the management process.
Remember too that your readers will have a lot of questions in the back of their minds eg.
Is the agency facing any short term financial problems?
Is the agency's profit adequate?
What about the return on shareholders' investment?
Are the agency's assets being managed efficiently to generate sales?
How does the agency's operating efficiency compare with its competitors?
Remember that the calculation of ratios is just the first step and is meaningless without correct interpretation and presentation of the most significant results and trends.
Sample Management Report
To illustrate the style of management report required we will use as a base the financial statements for Tourism Development Corporation set out on the next page.
TOURISM DEVELOPMENT CORPORATION
Profit & Loss Statement for Year Ended 30.6.88
Sales 3,000,000
less Cost of Goods Sold 2,555,000
Gross Profit 445,000
less Expenses
Depreciation 100,000
General & Admin Exp. 40,000
Interest - Notes Payable 10,000
- First Mortgage 40,000
- Debentures 20,000
Lease Payments on Office Bldg 28,000
Selling Expenses 22,000 260,000
185,000
plus Sundry Income 15,000
NET PROFIT (Before Tax & Dividends) 200,000
less TAX (40%) 80,000
NET PROFIT (After Tax, Before Dividend) 120,000
less Dividend 100,000
NET PROFIT (After Tax & Dividend) 20,000
Comparative Balance Sheets as at 30.6.87 & 30.6.88
Assets 1987 1988
Current Assets
Accounts Receivable 250,000 200,000
Cash 52.000 50,000
Investmts in Shares (shrt tm) 175,000 150,000
Inventories 355,000 300,000
832,000 700,000
Fixed Assets
Plant & Equipment (at cost) 1,610,000 1,800,000
less Provision for Deprec. 400,000 500,000
1,210,000 1,300,000
TOTAL ASSETS 2,042,000 2,000,000
Liabilities
Current Liabilities
Accounts Payable 87,000 60,000
Accrued Expenses 10,000 10,000
Notes Payable 110,000 100,000
Provision for Taxation 135,000 130,000
342,000 300,000
Long-Term Liabilities
Debentures 200,000 200,000
First Mortgage 520,000 500,000
720,000 700,000
Shareholders' Funds
Paid up Capital 600,000 600,000
Retained Earnings 380,000 400,000
980,000 1,000,000
TOTAL LIABILITIES 2,042,000 2,000,000
You may care to attempt a financial analysis for this organisation before reading on to see if you agree with the conclusions contained in this report.
Tourism Development
Corporation
MANAGEMENT REPORT
Profitability Analysis
The following ratios were calculated:
1987 1988 Industry Av. Comparison
History Industry
ROI (internal) 10.00% 10.00% fav.
ROI (external) 12.00% 15.00% unfav.
EPS $0.20
DPS $0.17
P/E 10.00 15.00 unfav.
Fixed Asset T/O 2.65 2.30 5.00 unfav. unfav.
Total Asset T/O 1.57 1.50 2.00 unfav. unfav.
Net Margin 6.60% 5.00% fav.
Gross Margin 15.00% 40.00% unfav.
From a management viewpoint our ROI is the same as the industry standard indicating we are as efficient as the industry average. From an investor's viewpoint our ROI is unfavourable at 12% compared with the industry 15%. Since profitability is up to industry standard it seems that shareholders' funds may be higher than the industry average and therefore more use should be made of long term borrowing’s. This will be examined when we look at security.
Our operating profitability indicates that our gross profit margins are unfavourable yet our net profit is favourable indicating a lower overhead structure. We must examine why our gross profit percentage is so low to see if it can be improved. For example, if gross profit were 40% it would be $1,200,000, which is an extra $755,000 and if overheads were constant would represent an extra $755,000 more net profit before tax and an ROI for an investor of 57.3% ($573,000 divided by $1,000,000).
Asset turnover is also unfavourable compared with the previous year and industry for both total assets and fixed assets. This indicates convincingly that we are not utilising our resources as efficiently as our competitors and that our asset base is capable of producing higher volumes of business. For example, we could sustain $4m sales on existing total assets and our fixed assets could sustain twice the current level of sales. We must decide whether there is potential to expand sales and if not then we should reduce our asset base by closing down and weeding out idle capacity areas (lazy assets).
Liquidity
The following ratios were calculated:
1987 1988 Industry Av. Comparison
History Industry
Current Ratio 2.43 2.33 2.50 unfav. unfav.
Acid Test 1.39 1.30 1.00 unfav. fav.
Stock Turnover 7.80 5.00 fav.
Debtors Turnover 28.50 24.30 20.00 fav. unfav.
There are signs that the liquidity situation is drifting lower than previously and compared with the industry. Short term liquidity as measured by the "acid test" ratio shows some slackening compared with the previous year yet surprisingly is better than the industry average. The stock turnover is favourable compared with the industry but the debtors turnover needs attention to bring the average days outstanding down from 24.3 days to the industry standard 20 days.
In these circumstances management must clearly watch liquidity and prepare the necessary cash flow budgets and budgeted balance sheets to ensure that future performance will be in line with industry standards. Ratios should be calculated for the yearly budgets and a budgeted funds statement should also be prepared to ensure that the proposed investments can be reliably financed by the proposed funding sources.
Security
The following ratios were calculated:
1987 1988 Industry Av. Comparison
History Industry
Debt/Assets 52.00% 50.00% 33.00% fav. unfav.
Debt Equity 0.73 0.70 0.50 fav. unfav.
Times Interest Cov. 3.85 8.00 unfav.
Fixed Commitments Cv. 3.04 5.50 unfav.
Net Tangible Asset $1.63 $1.66 fav.
Gearing is higher than the industry but gradually improving. We need to get down to a ratio of .5 which means debt must fall by $200,000 from $700,000 to $500,000. If liquidity is tight then we cannot finance that fall from increased current liabilities (short term debt). The only solutions are extra profit and/or capital or selling fixed assets. If liquidity is tight then the company must take immediate action to overcome this security weakness in order to meet any future contingency that might cause a sharp decline in sales.
Profits need to be increased significantly to meet industry standards for covering fixed commitments, eg. to meet the industry standard for times interest covered of 8 we would need to increase profit to $560,000 ($70,000 interest x 8) which would be an increase of nearly double. Alternatively if some of the debt could be retired with extra capital then this magnitude of profit increase would not be required, eg. hold current profits the same ($200,000 plus $70,000) and therefore interest should only be $33,750 which means that debt should be halved.
Executive Summary
Whilst our return on investment (ROI) measured against assets is in line with industry, when measured against capital, we have a problem. We need to lift it from 12% to a minimum of 15% in the short term.
We seem to have a lower overhead structure compared with our competitors but of major concern is our shortfall in gross profit terms. Our gross profit percentage is only 15% when it should be at least 40%. If we reached 40% our net profit would be up $755,000 although we expect that additional overheads would be necessary for earning a higher gross profit percentage. We must therefore examine the gross profit earning power of our major customer and product groups to ensure our estimating, costing and pricing are in line with industry standards. This is our top priority because we need to dramatically increase profits as a source of funds to improve our liquidity and security, which are showing warning signs.
If our profit analysis, marketing plans and forward budgets do not produce extra profit we will be forced into immediately increasing our capital base to lighten the load of our debt repayments and associated interest costs. We are in no condition to survive a sudden downturn in sales through industry or competitive reasons.
This is not a healthy situation to be in and so I must urge the board to take swift and decisive action to raise capital if at the next meeting the Board concludes that our profit forecasts show no significant prospects for improvement.
We must also watch our short term liquidity very closely. I have instituted a monthly cash flow budgeting system to ensure that our immediate commitments are adequately financed.
We will endeavour to reduce our debtors from an average 24.3 days outstanding to 20 days and examine if further gains are possible.
Our gearing situation is weak. Unless we double profits we will need to halve our debt because we can't carry the fixed commitments safely. Because of our tight liquidity we can't finance debt retirement through short term liabilities, and because additional profits might be slow in coming, we must look seriously at raising more capital. I suggest a committee of the Board look at this prospect immediately so that we are prepared in advance for quick action after the next Board meeting if that action is approved.
As your new chief executive I want to stress the importance of forward planning. All executives will be required to achieve financial management targets as part of their job descriptions and to develop creative plans for helping us to achieve our objectives. In my opinion this will present a severe cultural change for our management team and they will need strong commitment for change from the Board and I invite that commitment today.
Copyright © Bill Wright 1994