FINANCIAL ESSENTIALS

FOR DIRECTORS
CORPORATE GOVERNANCE AND BOARD LEADERSHIP
FACILITATOR: DR JOHN NHAVIRA
INTRODUCTION: THE ROAD AHEAD

• Accounting Fundamentals
• External Financial Reporting Obligations
• Solvency Requirements
• Financial Analysis
• Building Business Value
 MODULE 1 :OBJECTIVES
3
ACCOUNTING
FUNDAMENTALS
By this session’s end, participants will be able to:
• Describe the basic accounting principles involved in financial statement
preparation
• Discuss the purpose different financial reports presented to directors
• Analyse financial statements and their relation to liquidity, profitability,
performance
• Discuss the importance of director having working knowledge of his legal financial
obligations
WHY IS IT ESSENTIAL FOR YOU AS DIRECTOR TO
UNDERSTAND FINANCES?
FINANCIAL STEWARDSHIP
5
AND ACCOUNTING
STANDARDS
“The stewardship objective in financial reporting is about providing information about the past at a level of detail in a
way that enables the entity’s performance to be assessed in its own right …. And it is about providing information
about how the entity has been positioned for the future.”

Accounting Standards Board (UK) (ASB). Stewardship/Accountability as an Objective of Financial Reporting, 2007, London.

“[The IASB] is committed to developing, in the public interest, a single set of high quality, global accounting standards
that require transparent and comparable information in general purpose financial statements. In pursuit of this
objective, the IASB co–operates with national accounting standard–setters to achieve convergence in accounting
standards around the world”.

International Accounting Standards Board (IASB), International Financial Reporting Standards,

2006, London
AGENCY AND STEWARDSHIP
Board
BOARD Role
ROLEIn Financial Stewardship
IN FINANCIAL
STEWARDSHIP
BOARD ROLE IN FINANCIAL OVERSIGHT

• Duty of care (act honestly, in good faith, and for a proper purpose)
• Maintain proper accounting records
• Disclosure of company’s financial position and performance
• Establishing, monitoring proper internal controls
• Ensuring proper external controls and audit
• Skills, knowledge required by directors to fulfil
these roles
ACCOUNTABILITY 9

• Involves the wider impact of company activities on

the community
• For financial, environmental, and societal responsibilities
• For quality, efficiency, and effectiveness
• To multiple regulators on multiple issues (e.g., tax, banking,
insurance, statistics, privacy, environment, etc.)
FINANCIAL STEWARDSHIP
10

• A system of management accountability to ensure that managers operate in the

best interests of the company and the shareowners
• Arises because shareowners contribute capital to the company to make a profit on
their investment
• Shareowners have lost control of their capital to managers, who may operate in their
own interests
• Financial oversight provides accountability to shareowners
OECD PRINCIPLES – DISCLOSURE
11
AND
TRANSPARENCY
“The corporate governance framework should ensure that timely and accurate
disclosure is made on all material matters regarding the corporation, including the
financial situation, performance, ownership, and governance of the company”.

OECD – Principles of Corporate Governance

COFFEE BREAK
LOCAL ACCOUNTING REQUIREMENTS

What are the local accounting and disclosure

requirements in:
• Company law
• Accounting standards
• Listing rules
• Other requirements?
 DIRECTOR’S OBLIGATIONS PERTAINING TO
COMPANIES ACT 24:03 [GAZETTED NOV.2019]
• S182-Maintenace of books of accounts
-Every company shall maintain proper books of accounts with regard to:
money received and spent by the company
Every purchase and sale of goods and services
Assets and liabilities of the company
-The books should reflect a true and fair view of the firm’s affairs and explain such
transactions. Such books should be available for inspection by the directors at all times.
DIRECTOR’S OBLIGATIONS PERTAINING TO
COMPANIES ACT 24:03 [GAZETTED NOV.2019]
• S183-Profit and loss account and balance sheet
- The directors are responsible for preparation of both the profit and loss account and
balance sheet in compliance with section 142.
• S184 Contents of and form of Accounts
-Every balance sheet and profit and loss account of a company must present a true and fair
view of the state of affairs of the company as at the end of each year.
-A company’s balance sheet and profit and loss account shall be in compliance with any
prescribed regulations.
DIRECTOR’S OBLIGATIONS PERTAINING TO
COMPANIES ACT 24:03 [GAZETTED NOV.2019]
• Failure by a director to ensure compliance by the firm shall be guilty of an offence.
• Notes shall form part of the accounts i.e balance sheet and profit and loss.
DIRECTOR’S OBLIGATIONS PERTAINING TO
COMPANIES ACT 24:03 [GAZETTED NOV.2019]
• S186 Obligation to lay group accounts before holding company AGM
• -Group accounts to be presented at the AGM.
• -Directors responsible for compliance
• S187 Form and content of group accounts
• S188 Accounts and auditors report to be annexed to signed balance sheet.
DIRECTOR’S OBLIGATIONS PERTAINING TO
COMPANIES ACT 24:03 [GAZETTED NOV.2019]
• S189 Directors Report to be attached to balance sheet
• The Report must contain the following:
• (a) state of the company’s affairs
• (b) Dividends, already paid or declared or recommended
• (c) Reserves, amount of retained income to be transferred thereto
• (Directors remuneration- the amount recommended
• S190 Right to receive copy of balance sheet and auditors Report.
 AUDITORS REPORT

• Section 193
• The auditor shall report to members on the accounts he has examined before the company
in a general meeting and the report shall state whether the financial statements give a true
and fair view of the company’s affairs as at a particular date.
• [An auditor is appointed for the purpose of reviewing the financial statements of a company
due to the fact that there is separation of ownership (shareholders) and control (managers)]
• The report’s purpose is to express the view whether the financial statements reflect a true
and fair view and by implication whether managers have aligned their interests with those of
shareholders or whether they are “feathering their own nests”.
AN AUDITOR’S REPORT SHALL INCLUDE ANY ONE OR
MORE OF THE FOLLOWING STATEMENTS BASED ON HIS
OBSERVATIONS:
• H e or she has not obtained all the information and explanations necessary for the
purpose of his or her audit.
• Proper financial records have not been kept by the company.
• Proper returns adequate for his or her purpose have not been received.
• Firm’s financial statements disagree with the financial records and returns from branches.
• HE shall qualify his report with the nature of the qualification and te facts or
circumstances preventing him from reporting without qualification.
DIRECTORS FUNCTIONS AND RESPONSIBILITIES

• Section 195
• Section 195 (4) states:
• Each or every director (as the case may be ) shall exercise independent judgment and
shall act within the powers of the company in a way that he or she considers, in good
faith, to promote the success of the company for the benefit of its shareholders as a
whole.
THE ACCOUNTING ENVIRONMENT

• GAAP
• Accounting Standards
• Trans–national differences
• Intra–national differences
• Local applicable accounting standards
• Accounting assumptions
• Accrual basis
• Going concern basis
• Qualities of financial information
• Relevance
• Reliability
• Others qualities contributing to relevance and reliability
ACCOUNTING RULES DO THEY MATTER?

• Audience to respond
 RULES OF ACCOUNTING

Account Type Debit Credit

Personal The Receiver The Giver
Real What Comes in What goes out
Nominal All expenses & all losses All incomes and gains
 BASIC ACCOUNTING RULES

• CREDIT DEBIT

• INCOME EXPENDITURE

• LIABILITY ASSET
 FLOW OF ACCOUNTING

• Understanding the Transaction

Voucher Entry

Posting

Balancing

Trial Balance

Profit and Loss Balance sheet

Account
 MODULE 2: OBJECTIVES
27
EXTERNAL
REPORTING
By this session’s end, participants will be able to:
• Understand the director’s roles and responsibilities for external financial reporting
• Identify key legislation that governs directors duties
• To discuss the purpose and requirements of an external audit
• To describe non-financial reporting
 WHAT ARE FINANCIAL STATEMENTS AND WHY
ARE THEY IMPORTANT?
• Audience to respond
FINANCIAL INFORMATION: USERS,
INTERESTS
Employees Ability to pay salaries, wages, and benefits

Suppliers Capacity to pay a debt for goods or services provided

to the entity
Creditors Future cash flows, the security of debts

Governments, agencies, Efficient allocation of economic resources, regulating,

and regulators taxation, national statistics

Customers Continued supply of goods or services

Equity investors Cash flows and share price

The public Variable interests

INTERNAL USERS OF ANNUAL REPORTS

User Potential Utilisation

Board of Directors Currently what resources are available? Current
position of existing loans? Are they being paid
regularly as scheduled?
What is the profitability trend? Based on actuals,
what are the forecasts for the future?
Is it time to expand/invest or buy new assets?
Which markets are we present in? What is our
share of that market? What are the future plans
for markets?
Buy or lease decisions?
What is the ability of the company to raise new
loans? If so to what level?
Whether it is still viable to self produce or to
outsource?
 FINANCIAL STATEMENTS

• These are summarised Reports regarding a company’s financial results/performance,

financial position and cashflows.
How are they used:
-To determine the capacity of a firm to generate cash, and the sources and uses of that
cash.
-To determine the capacity of a firm to meet its debt obligations
-To track financial results along a trend line in order to identify any profitability issues
-To review the details of a particular business transaction
 WHAT ARE THE CONTENTS OF FINANCIAL
STATEMENTS?
• Balance sheet
• Income statement
• Statement of cashflows
• Supplementary notes
ACTIVITY: FINANCIAL STATEMENTS
33

• Form four groups to discuss a financial statement’s components:

• Income Statement
• Balance Sheet
• Cash Flow Statement
• Statement of changes in equity (SOCIE) and Notes

• Explain the information provided in each component, using examples

• Develop five questions that a director may ask regarding information in the
document
FINANCIAL STATEMENTS – COMPONENTS
Income statement Income – expenses = Net profit

Balance sheet Assets – liabilities = equity

Cash flow statement Cash in – cash out + opening cash = cash

SOCIE Change in net assets over the period (all gains

Statement of changes in and losses)
equity

Notes Watch the notes!! Read carefully.

CONTENTS OF A SET OF FINANCIAL STATEMENTS

• Balance sheet: Highlights the firm’s assets, liabilities, and shareholder’s equity as of the report
date.
• Income Statement: Highlights the outcome of the firm’s operations and financial activities for
the reporting period. It includes revenues, expenses, gains, and losses.
• Statement of cash flows: Highlights sources and applications of funds and changes in the
company’s cashflow during the period.
• Supplementary Notes: Highlights explanations of various activities, additional details on some
accounts, and other items as mandated by the applicable accounting framework worldwide.
CASH FLOW STATEMENT
36

• Cash from operations

• + Cash from investing activities
• + Cash from financing activities
• + Opening cash
• = Cash available

• Issues and director questions

 MODULE 3: OBJECTIVES
37
IN SOLVENCY
REQUIREMENTS
By this session’s end, participants will be able to:
• Define solvency
• Discuss the necessity for company solvency
• Describe the requirements of legislation pertaining to solvency and the director’s
duty
• Analyse financial statements with a view to conducting the solvency test and
interpret the results
 COMPANIES ACT 24:31
SOLVENCY AND LIQUIDITY TEST
• Section 102 of the companies Act sets out the criteria for a satisfactory solvency and
liquidity test for a firm. Financial statement upon which it is based must comply with
section 182 and section 184 of the Act. The emphasis is on the authenticity of the
records.
 SOLVENCY RATIOS

• These highlight a firm’s capacity to make payments and pay offits long term obligations to
creditors, bondholders, and financial institutions.
• These reveal going concern issues and a firm’s capacity to pay its creditors in the long
term
• Solvency ratios are also known as leverage ratios
• Typically they are used in securing long term loans from banks for large projects such as
factories etc.
 POPULAR RATIO

• The (D/E) ratio is computed by dividing a firm’s total liabilities by its shareholder equity.
• It assists in pinpointing the extent to which debt has been employed in comparison to its
equity contribution.
• D/E Ratio= Total Debt/ Total equity
• In practice this is the basic ratio which any Banker will watch while granting a loan.
• An ideal D/E ratio is around 1 to 1.5
• The ideal may also vary from industry to industry since some employ more debt
financing than others.
MODULE 4: OBJECTIVES FINANCIAL ANALYSIS

By this session’s end, participants will be able to:

• Define trend analysis
• Conduct trend analysis using Annual financial Reports
• Define financial ratios
• Apply financial ratios to Annual reports
 FINANCIAL ANALYSIS

• What is financial analysis?

• What purpose does it serve?
 FINANCIAL ANALYSIS

Explaining Analysis
This is the process of establishing the relationships of the data in sch a way that rational
and credible conclusions can be drawn.
Financial statement analysis
- Is purpose driven, as its results can be employed to make both investment and lending
decisions.
- Is used to interpret financial data
- It clears a path to an understanding of the firm’s financial situation
 AIMS OF FINANCIAL ANALYSIS

-To forecast the future prospects of the company

-Assess managerial effectiveness and operational efficiency
-Assess the SOLVENCY position of the firm
-To facilitate comparison with peers
-To facilitate decision-making and control
-To facilitate the assessment of the profitability and financial soundness of the company
-To facilitate analysis that satisfies the needs of a particular user
Visit this site for an interactive financial ratio analysis:https://www.westga.edu/~bquest/2000/dowjones.html
TECHNIQUES FOR FINANCIAL STATEMENT
ANALYSIS
• Horizontal Analysis/trend analysis
• Vertical analysis/common size analysis
• Ratio analysis
 HORIZONTAL ANALYSIS

• Also known as trend analysis

• Is the comparison of line items in comparative financial statements or financial ratios
over a number of years in a bid to track the history and progress of the firm’s
performance.
• Employing the previous year’s data/actual figures, trend analysis can be used to observe
percentage changes overtime in selected data.
• The purpose of trend analysis is to compare performance metrics over a period of time
to observe whether the company is improving or declining.
 HORIZONTAL ANALYSIS
COMPARATIVE INCOME STATEMENT
Particulars 2019-2020 $ 2020-2021 $ Absolute Percentage
Change $ Change %
Revenue from 10 000 000 15 000 000 5 000 000 50
operations
Add: Other 2 000 000 3000 000 1 000 000 50
Income
Total Revenue 12 000 000 18 000 000 6 000 000 50
Less: Expenses 7 000 000 9 000 000 2 000 000 28,57
Profit before Tax 5 000 000 9 000 000 4 000 000 80
Less: Tax 900 000 1 200 000 300 000 33,33
Profit after tax 4 100 000 7 800 000 3 700 000 90,24
 VERTICAL ANALYSIS

• Uses percentages to analyse financial statements

• Each line item is listed as the percentage of another line item in the financial statements.
• This framework makes it comparatively easier to compare the financial statements of one
company with another and across industries.
EXAMPLE: EXPENSE ITEMS ARE DISPLAYED AS A PERCENTAGE OF
SALES. THIS HIGHLIGHTS HOW THESE ARE CONTRIBUTING TO
PROFIT MARGINS AND WHETHER PROFITABILITY IS IMPROVING
OVER TIME.
Description Amount Percentage %
Sales 5 000 000 100%
Cost of goods sold 1 000 000 20
Gross Profit 4 000 000 80
General Admin Expenses 2 000 000 40
Operating Income 2 000 000 40
Taxes 25% 500 000 10
Net Income 1 500 000 30
 RATIO ANALYSIS

• Avital tool for financial analysis

• The rationale is that a single accounting figure by itself may not communicate any
meaningful information (kurotomoka) but when expressed as a relative of some other
figure, it may reveal some useful significant information.
• It involves a comparison of various numbers from the balance sheet, income statement
and cashflow statement against the figures of previous years, other firms, the industry or
even the economy in general for the purpose of financial analysis.
 IMPORTANCE OF RATIO ANALYSIS

• It presents facts on a comparative basis thereby enabling the drawing of inferences concerning the
company’s performance.
• It is crucial in the assessment of a company’s performance in respect of the following:
-Liquidity position-speed of conversion into money
-Long term solvency (long term/short term)
-Operating efficiency (measure of how effectively assets are used)
-Overall profitability (periodical trend-when high/low
-Inter-firm comparison-(within same industry-compare against peers and against the
industry)
 LIQUIDITY POSITION RATIOS

• These are used to determine the capacity of a firm to pay off its short term debt within
one year.
• Also used by prospective creditors and lenders to make decisions to extend credit or
debt to firms. (company short term funding, long term funding).
 BALANCE SHEET
AS AT 31-12-2021
Particulars Amount $ Ratios
Capital 4 500 000 4 500 000 Debt 11 000 000
Reserves and Surplus 1000 000 1 000 000 Equity 4 500 000
Non current liabilities Debt equity ratio 2.44
Secured loans-term 7 000 000
loans
Unsecured loans 4 000 000 11 000 000 Total outside 17 000 000
liabilities
Current Liabilities Total Net Worth 5 500 000
Working capital loan 2 400 000 TOL/TNW ratio 3.09
Trade payables 2 000 000
Short term provisions 700 000 Current assets 6 700 000
Other current liabilities 900 000 6 000 000 Current liabilities 6 000 000
22 500 000 Current ratio 1.12
MERGER, ACQUISITION, DIVESTMENT:
VALUATION
THE “NET ASSET” BASIS
FOCUSES ON THE VALUE OF THE ASSETS
OWNED BY THE COMPANY.

AN “EARNINGS” BASED VALUATION

CONCENTRATES ON THE NET PRESENT VALUE
OF INCOME AND EARNINGS GENERATED BY A
PARTICULAR COMPANY – HISTORICAL AND
PROJECTED (THE POTENTIAL TO EARN INCOME
IN THE FUTURE)
COFFEE BREAK
MODULE 5: OBJECTIVES BUILDING BUSINESS
VALUE
By this session’s end, participants will be able to:
• Define business value
• Describe methods of business valuations
• Discuss investment and their appraisal techniques
• Analyse cashflow forecasting techniques
• Apply the seven step forecasting technique
• Analyse the 12 considerations for forecasting earnings
 BUSINESS VALUATION METHODS

Income Based Framework Asset Based Framework Market Based Framework

Ideal for discovering the intrinsic Business valued on the basis of This captures the sentiments in
value of any business through the market value of assets, the market based on peers and
evaluation of cashflows, NPV, replacement costs and comparative trading stats.
Equity method and economic liquidation value of the assets. -Direct market data
profit model. -notional realisation of assets -Rules of thumb
-adjusted book value
Earnings based is founded upon
anticipated cashflows-capitalised
earnings, capitalised dividends,
discounted cashflow and
multiple discretionary earnings
also excess earnings-superior
profits
 FORECASTING METHODS

Quantitative Qualitative
Causal (explanatory) Delphi
Time series Scenario writing
Smoothing Expert Judgment
Trends & Seasonal
 FORECASTING TECHNIQUES

Judgmental models Time series methods Causal methods

Delphi method Moving average Regression analysis
Exponential smoothing
Seasonal models
 SEVEN STEPS IN FORECASTING

1. Identify the purpose/use of the forecast

2. Choose the variables to forecast
3. Select the time horizon of the forecast
4. Choose the forecasting model(s)
5. Gather the data.
6. Make the forecast
7.Validate and implement the results
 BUSINESS VALUATION-CAPITALISED EARNINGS

• Remember PRICE is what you pay and VALUE is what you get.
(a) Capitalisation rate
Cap rate = Discount rate-growth
Discount rate (weighted Average cost of capital)
Growth rate (Between 1-5 percent)
(b) Enterprise Value
Average Earnings/Cap rate
14 THINGS TO BEAR IN MIND WHEN
FORECASTING EARNINGS
Business model
1. Market position 8. Asset based
2. Cost structure 9. Barriers to entry
3. Product position 10. Strength of competition
4. SWOT 11. Presence of substitutes
5. Strength of management 12. Government actions/business cycle
6. Location and accessibility 13. supply chain
7. Customer base 14. Competitive advantage
CAPITAL INVESTMENT
APPRAISAL METHODS
PAYBACK
ACCOUNTING RATE OF RETURN (ARR)
DISCOUNTED CASH FLOW, WHICH SPLITS INTO:
Net Present Value (NPV)
Internal rate of return (IRR)
PAYBACK
LENGTH OF TIME REQUIRED TO RECOVER THE INITIAL INVESTMENT.
ACCOUNTING RATE OF
RETURN

ACCOUNTING PROFIT AS A PERCENTAGE OF

THE CAPITAL EMPLOYED
 DISCOUNTED CASH
I / (1+R) N
FLOW
WHERE:
I = INVESTMENT
R = DISCOUNT RATE OF INTEREST
N = NUMBER OF YEARS
CASE STUDY: ADVANTAGES,
DISADVANTAGES
OF APPRAISAL METHODS
PARTICIPANTS WORK IN THEIR GROUPS TO DEVELOP A
BOARD PRESENTATION OUTLINING THE ADVANTAGES
AND DISADVANTAGES OF ONE OF THE FOLLOWING
CAPITAL APPRAISAL METHODS:
Payback
Accounting rate of return (ARR)
Discounted cash flow, which splits into:
Net Present Value (NPV)
Internal rate of return (IRR)
RED FLAGS (1)
RECEIVING BOARD INFORMATION LATE, ESPECIALLY IN PROBLEM AREAS

DELAYS IN ACCOUNTS PAYABLE

AN INCREASE IN STOCK LEVELS COMPARED TO TURNOVER

DECLINING TURNOVER

GROWTH RATE BELOW THE INFLATION RATE

SMALL NET CURRENT ASSETS OR AN INCREASE OF CURRENT LIABILITIES OVER CURRENT ASSETS

INADEQUATE EXPLANATIONS FOR VARIANCES OF ACTUAL TO BUDGET

HIGH GEARING, ILLIQUIDITY OR AN INABILITY TO MEET THE TERMS OF LOAN AGREEMENTS

NEGATIVE CASH FLOW

LACK OF FINANCIAL CONTROLS

DISSATISFACTION OF STAFF CAUSED BY SLOWNESS IN OBTAINING APPROVALS AND DECISIONS

 RED FLAGS (2)
CONTINUING TREND OF LOSSES
MAJOR UNEXPECTED LOSSES
IRREGULAR OR NO CONTACT WITH EXECUTIVE STAFF
RESISTANCE TO ABANDONMENT OF A MARGINALLY PROFITABLE
VENTURE
OVER-TRADING WITH LITTLE CASH, CONVERTING WORKING
CAPITAL PRIMARILY INTO STOCK AND DEBT
WORSENING CONDITION OF DEBTS OWED TO THE COMPANY
EXPOSURE TO INTEREST AND CURRENCY FLUCTUATIONS
RECENT FALL IN SHARE PRICE
NEGATIVE MEDIA COVERAGE OF COMPANY PERFORMANCE
SHORTAGES OF RAW MATERIALS RESULTING IN LATE DELIVERY
OF ORDERS
AUDITORS IDENTIFYING SIGNIFICANT CONTROL PROBLEMS AND
DISAGREEING WITH MANAGEMENT ON MATERIAL ISSUES
EPILOGUE –THE ROAD TRAVELLED

• A summary