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Formative Assessments Activity 1 1

Formative Assessments
Activity 1
1. Why should organizations collect, file and maintain accurate financial records? Discuss in 50 to 80 words.

Importance of financial records:
Organizations have very definite financial information needs. It is the task of the Managers and the Supervisors to collect file and maintain the financial information that is analyzed to produce details to the employees and the organization. They should also have clear understanding of their organization’s planning functions and the ways in and the ways of monitoring and analyzing the work and keeping performance records and the ability of the organization to achieve new opportunities and pre-empt change in a competitive market place.
2. What are the expectations of managers and supervisors in relation to budget and financial plans? Discuss in 100 to 200 words.
The expectations in relation to budget and financial plans:
The budget and financial plans are used for the successful management and operation of the organization. It is used to monitor current and future actions and needs, current level of success and areas of improvements for both internal and external environments. This information must be disseminated among the team members of the organization. The information collected is used to determine the following:
What to do
How to do it
What it is necessary to do
What it is not necessary to do
How it can best be done
When it should be done
Who should do it?
How well it is currently being done
What resources are being used?
What resources will be needed?
What resources are available?
What are the expected results of work?
Whether the actual results match the expected results
3. What are the reports that can be used for financial planning in an organization? Discuss in 30 to 50 words.

Reports that can be used for financial planning in an organization:
Reports such as profit and loss, balance sheets, revenue and expenditure reports, debtors and creditors reports and cash flow statements are generated from accounting information and allow you to integrate financial considerations into everyday business management. These reports are mainly used for the development of the organization.

4. What is the process for preparing budgets or other financial plans? Discuss in 80 to 100 words.

Process for preparing budgets or other financial plan:
The preparation of the financial plans is the most important task in any business because using that information the management builds future plans and determines its level in the market.

Identify the data that needs to be collected
Identify the appropriate source of data
Ensure correctness, reliability of data
Classify and code the data according to accounting and organizational principles
Calculate costs, profit or loss and/or breakeven analyses where necessary
Assess the results of data analysis and provide formal or informal reports on the outcome
Keep accurate and secure records of financial transactions
5. What two forms of budgeting might be used?
Two forms of budgeting that might be used are fixed and flexible budgeting.

Fixed budgeting:
It means that it relies on the past figures and the present budget is adjusted according to the previous budget. Only slight changes are done. What changes were done previously are noted and analyzed? In this type of budgeting the present budget accommodated to the output and the income will behave as predicted.

Flexible budgeting:
It is designed to allow changes and adjustments to cost level. It recognizes the differences in the behavior of fixed and variable costs in relation to fluctuations in the output. Thus flexible budgeting is more effective to fixed budgeting.

6. Which form of budgeting allows changes to be done? Discuss in 50 to 80 words.

Flexible budgeting allows changes to be done because it is designed to allow changes and adjustments to cost level. It recognizes the differences in the behavior of fixed and variable costs in relation to fluctuations in the output. Thus flexible budgeting is more effective to fixed budgeting because we can make changes with regard to the changes in the market. In fixed budgeting the figures are regulated if market change. The values must attain the estimated result. Thus flexible budgeting changes to be done easily.

7. Explain how contingency planning work. Discuss in 80 to 100 words.

Contingency planning:
It is prepared to address any unexpected situation. This plan provides managers with new ideas during emergency states. This may include supply problems, fire accidents etc. It means that the contingency planning must be ahead of time. We should not wait until the last case we must decide what we should do if any emergency situation occurs. What are the various internal and external factors for the problems? Find the factors that will cause damage. Consider worst case scenarios and develop plans to recover from them. The problem occurred must be solved with minimum disruption to the business. Record the plans for future reference.

8. Why should team or work group members be actively involved in designing and developing contingency planning? Discuss in 80 to 100 words.

Importance of team or work group members’ involvement in contingency planning:
Team or work group members’ should know what the plans are, how to activate them and when to put them into operation. Update contingency planning each year similar to other updates. The team members are responsible for the following works in an organization:
Backup or alternate required materials to use in emergency cases
Renting or hire purchasing or alternatives equipment’s or machinery
Outsourcing human resource and other necessary tasks
Organizational restructuring to reduce labor costs
Strategies for reducing costs, wastage, stock and consumables
Activity 2
1. How can employees be engaged in the preparation of financial reports allowing details to be easily disseminated among team members? Discuss in 80 to100 words.

Employees in the preparation of financial reports:
Employees who will be affected by the budget should be consulted during the preparation of the budget and should be up to date with regard to monitoring. The budget might be based on spending some amount on the training of the employees so in these cases the employees must attend the training
Objectives reflected in a budget should be obtainable – they must be realistic- and clearly communicated. If the objectives are not reachable then the budget spent will be of no use.

Subsequent evaluations of performance should be made carefully with opportunities to explain apparent deficiencies. The performance must constantly increase and that should be maintained correctly.

2. Why should employees be involved in setting and monitoring the budget? Discuss in 30 to 50 words.

The budget might be based on spending some amount on the training of the employees so in these cases the employees must attend the training. Objectives reflected in a budget should be obtainable they must be realistic and clearly communicated. The objectives created must be obtainable by the employees. The budget might be based on spending some amount on the training of the employees so in these cases the employees must attend the training. The performance of the employees must constantly increase and that should be maintained correctly.

3. What is responsibility accounting and why it is important to an organization? Discuss in 80 to 100 words.

Responsibility accounting is a method of attributing costs to specific department/project within an organization. In this way a fair assessment of an individual and team performance can be based on the resources cost for which the team or section is responsible, and over which its members can exercise control and seek to improve their performance. Hence that team is responsible to the manager for that cost. This is called responsibility accounting.

Responsibility accounting can provide a strong basis for the team’s decision making. The team is responsible for the cost of the project. Hence the decision took by the team must be effective and achievable. If the decision took is not profitable then the team must face the consequences. Hence it is the responsibility of the team to choose the least cost technique.

4. What are cost centres? Discuss in 100 to 200 words. Give examples of cost centres that might be encountered.

Cost centres:
Cost centres are unit, section or division of an organization which carry accountability for their own expenditure. Such responsibility might relate to day-to-day operation or to the management of specific projects. The employees in the cost centres are responsible of collecting, collating and recording the data that will support financial plans.

Examples of cost centres in an organization are the following departments:
Administration:
In administration the cost is spent for all the storage process, salary for the employees, travel expenses and all the other management purposes. All the purchasing is also done.
Manufacturing:
It is the most important department of a core industry. This department consumes the majority of the budget. It includes the expenses of market research, purchasing of raw materials, production of the new product, delivery of products and deploying it in the customer area.
Marketing:
It is another area which consumes more finance. The product which the industry developed must be marketed. Only then it will be sold out. The marketing technique must be effective that the products reach the customers easily.
Sales:
For the sale to be effective the marketing and the manufacturing must be effective. Here only the delivery charges will be present.

Production:
It is the most important department of an industry. This department consumes the majority of the budget. It includes the expenses of purchasing of raw materials, production of the new product and deploying it in the customer area.
Activity 3
1. What is the importance of cash flow budget or report? Discuss in 100 to 120 words.

Importance of cash flow budgets:
In business planning activities the development of cash flow budget or report is an important tool used
First in planning is sales forecast
The sales forecast indicates the organization’s projected income over the budgeting period
From the sales forecast we can construct the cash flow report
The cash flow report denotes the profit and loss of the company
The cash flow report shows the inflows and outflows of an organization
Cash inflow-sales and receipts
Cash outflow-paying expenses
A six month cash flow report is not sufficient
For example: if we plan for new machinery we must not only include the purchasing cost we must also include the installation cost and the service cost that will be faced ahead of time.

2. What data do you need to collect and from whom in order to construct a cash flow budget? Discuss in 30 to 50 words.

The cash flow data must be collected from the sales department regarding the sales and the production department regarding the expenses paid for the raw materials and the production of the products. These details will be used for the preparation of the cash flow report or budget which in turn will be used for the profit or loss analysis of the organization.
3. Discuss in 100 to 120 words how the budget is used to monitor, work, performance, variation and team/division outputs.

Use of budget to monitor:
The organizations’ budget is used to determine to what extent business operations are meeting expectations. Marketing and operational strategies and performance standards should be constantly monitored to determine how well they are impacting on the organizational business objectives.

Use of budget in work:
The budget framed is used to monitor the work done. If the work is completed within the budget profit will be incurred, if the work exceeds the budget loss will be incurred. Hence the budget framed is to detect the state of the business.

Use of budget in performance and variation:
The budget framed is used to analyze the performance of the company. The production, sales and market are meeting the budget level then profit else loss. Thus the performance and the variation can be assessed.

Use of budget in team/division outputs:
Each team/division/section will be holding a part of the budget to complete their task. How each team utilizes their part is analyzed. Based on the output the level of the team is determined.
Activity 4
1. What is the meaning of the following terms?
Assets:
All the properties that earn an income for the person are termed as assets. For example: running an own business.

Liabilities:
All the properties for which we have to spend are called liabilities. For example: if the business is incurring loss for a long period it is a liability.

Expenses:
All that we spend through our income is our expenses. If the expenses exceed the income then the person will be trouble.

Equity:
Equity=asset – liabilities
Equity is one’s ownership in any asset after all debts associated with that asset are paid off. For example, a car or house with no outstanding debt is considered entirely the owner’s equity because he or she can readily sell the item for cash, with no debt standing between the owner and the sale.
2. Describe in 30 to 50 words (each) what the following budget/report are and how they might be used to inform a team’s operation.

Variation analysis:
Variation analysis is the process of comparing the current/actual profit/cost statements or cash flow with the budgeted profit/cost figure. If this analysis is not done then small issue or problem cannot be identified. For example: tightening of cash flow.

The general ledger:
The general ledger displays the account balance in the beginning of a period, total debit and credits and the balance at the end of the period.

Sales analyses report/budget report:
Sales analyses report/budget report displays the sales, revenue, cost of sales, gross profit, units sold, average cost and percentage within a selected period. It compares this year’s sales with the figures of the same period of the last year. This could also be in a spreadsheet format.
Variation analysis report:
Variation analysis report is the report in which the current/actual profit/loss statements or cash flow within the budgeted profit/loss figures. This report is submitted to avoid small mistakes and risk in the business.

The revenue and expenditure report/budget:
This budget forecasts the sales and expenditure over a defined period, such as 12 months. Most of the other budgets produced within an organization will draw on this budget, as it determines the number of people employed, level of raw materials stock, rent, leases, and so on.

3. Explain (30 to 50 words) why reports must be made to:
Management:
The financial reports submitted helps the management to inform policies and procedures, identify risks and areas of success, design and develop budgets, provide instruction to employees, develop KPIs and controls, measure performance, inform reports to stakeholders.

Investors:
You may want to invest in a company for a return and you can determine what type of growth the company may have by looking at its’ financials. The investors management wants to see what operating segments of their company are doing well and which ones are not. 
Creditors: A bank may want to loan business money so they must be able to determine if the company can pay them back. The creditors must know the actual scenario of the company thus this report will be useful for their analysis.

Government: The government wants to make sure they get their portion of the companies’ net income via taxes. Most importantly this statements are audited by an independent person who ensures the public the financial statements are accurate.

4. What details might be provided in financial reports? Discuss in 120 to 150 words.

A clear statement of purpose
Methods of data collection, sources, etc.

Details on how the information included in the report was collected
Data related directly to the area being reported on, for instance
To costing trends (wages, materials, overheads, etc.)
Identification of shifts in supplies in market
Financial data and information presented in a suitable format for use in the draft cash flow forecast and for budget reports
Contingency plans suggestions with possible options for sourcing other markets
Details of how shifts impact product costs, cash flow forecasts
Relevant information relating to:
Sales information
Bills to be paid
Profit made
Items selling well
Items selling poorly
Condition of equipment
Maintenance required
Opportunities
Analysis of problems and improvement recommendations
Problem solutions and the list of the report
Recommended distribution list for report, such as senior administration, sales, production departments
Summative assessment 1
1. What is GST and how is it implemented? Who is requested to register for GST? What piece of legislation primarily governance GST?
The GST Council will decide on the tax rate, will recommend the taxes to be subsumed and exempted from GST, the rates of taxation and the model Central, State and Integrated GST laws. It is the council’s responsibility to have one uniform rate of GST tax to be introduced all over India. It will also decide the threshold for levy of the tax, as well as the dispute resolution mechanism. Apart from these, it will also decide special rates during adversities and special provisions for some states. Voluntary registration. If your turnover is under $60,000 you can voluntarily register for GST, but bear in mind: you have to account for GST on all of your taxable goods and services, including grants and subsidies. All Australian businesses whose turnover is above the minimum threshold (currently $75,000 per annum) are required to register for GST. Businesses whose turnover is below the threshold may register if they wish to.

A GST-registered business must charge its customers GST on taxable goods and a service it provides, but is entitled to a credit for any GST it has paid for its expenditures on these goods and services as well as capital purchases (called input tax credits). A registered business must periodically lodge Business Activity Statements (monthly, quarterly or annually), and at the same time pay the net amount of GST owed to the tax office (if more GST is paid than collected, a refund is paid by the tax office instead).

Some goods and services (notably salaries, wages, fresh food, and real estate) are exempt from GST. Other goods and services (rental income and financial services) are “input-taxed”, which means that GST is not charged on the sale, but GST paid by that part of the business is not eligible to be claimed as an input tax credit.

New residential and commercial properties are subject to GST but re-sale of existing properties is not. All real estate agent fees on either new or second-hand property are subject to GST. Processed foods such as biscuits, soft drinks, restaurant meals and take-away foods are also subject to GST.

Registered enterprises for GST must complete a Business Activity Statement (BAS) for reporting to the Australian Taxation Office for each quarter ending March, June, September and December. Businesses must lodge their Statements with the ATO within twenty working days of the end of each quarter.

1. What are audits and how are they carried out?
An audit is an activity that evaluates a person, a process, an organization, or product. In finance, an audit is geared specifically towards the evaluation of the financial records of a company – in part or as a whole. This is also termed financial audit or audit of financial statements. The goal of an audit is to validate or ascertain information. When a company audits financial statements, the aim is to perform checks and counterchecks to determine whether or not the stated data is consistent with reality.
Companies, especially those owned by shareholders, place high value in financial audits because they promote accountability. Financial audits ensure that the actual expenditure and actual income match the stated figures. Financial audits are designed to determine misstatements. Misstatements are instances of false or missing information. The reason behind a misstatement is immaterial – it could be due to fraud (something done on purpose) or to error. Financial audits are usually carried out by independent entities. This ensures that the gathered information and subsequent analysis are not marred by subjectivity. The independent auditing company must remain objective while maintaining a good business relationship with the company being audited. Improvements are made on a continuing basis to ensure quality audits of financial statements.

3. What are?
1. Budgets
Budgets are financial plans. The budgets framed must be achievable. Historical data and reports from the organization’s information system will contribute to the realistic and achievable budgets and for the financial plans for the organization.

2. Cash flow
Cash flow is used to predict the business ability to take in more cash than it pays out indicating the businesses ability to create the resources necessary for expansion. It can also predict cash flow gaps.
3. The general ledger
The general ledger displays the account balance in the beginning of a period, total debit and credits and the balance at the end of the period.

4. Profit and loss statements
Profit and loss statements show the gross and net profit/loss for a reporting period in accordance with organizational policy and procedures and accounting requirements.

4. There are several ways organization maintain financial records. They include manual systems (hard copy) and computer based systems (electronic). How do computers and manual systems operate?
Manual systems operation:
Data and reports are collected
The allotted officer writes the data in the respected ledgers and places them in order
If the data is needed the respective officer refer the data from the ledgers
It is a long process and also if any paper is missed or damaged then it will be a problem for the organization
Computer based systems:
The staff collects the data and the reports and feeds into the computer and performs the necessary actions
Stores them in the respective place so that only authorized persons can access the data for security
The data can be shared via internet
Backups can be taken for future reference
5. Why do organizations need accurate and timely financial information? What is required to manage the organization’s finance? Who is usually responsible for an organization financial management?
The organizations need accurate and timely financial information because financial information submitted helps the management to inform policies and procedures, identify risks and areas of success, design and develop budgets, provide instruction to employees, develop KPIs and controls, measure performance, inform reports to stakeholders. When establishing any financial management system, a business needs to determine if the management of the system will occur in-house or if it will use an outside entity. Any accounting system should measure, identify, record and communicate all of the financial information about the organization. The foundation of an effective accounting system is good bookkeeping.
A bookkeeper gets the complete and accurate financial information to the accountant. While the accounting system looks at the overall financial picture of the organization, bookkeeping deals with the specific transactions that take place on a day-to-day basis. Financial managers are responsible for the financial health of an organization. They produce financial reports, direct investment activities, and develop strategies and plans for the long-term financial goals of their organization. Financial managers work in many places, including banks and insurance companies. Financial managers increasingly assist executives in making decisions that affect the organization, a task for which they need analytical ability and excellent communication skills.

Summative assessment 2
Project 1
For this project I have submitted the annual reports (2015 -16) of Australian national audit office.

Refer the link asic.gov.au>corporate-publications reports for the complete annual report.

1. to who is this report disseminated and how is this done?
This report is disseminated to Management, Investors, Creditors, Government. It is done either by sending reports to them directly or by post and sending it by mail. Sometimes all the stakeholders are called for a meeting and the report is presented as a presentation by the director of the organization. In this way the stakeholders are pleased and there is opportunity to increase the business.

2. Why do these people need the information contained in the annual report?
Management:
The financial reports submitted helps the management to inform policies and procedures, identify risks and areas of success, design and develop budgets, provide instruction to employees, develop KPIs and controls, measure performance, inform reports to stakeholders.

Investors:
You may want to invest in a company for a return and you can determine what type of growth the company may have by looking at its’ financials. The investors management wants to see what operating segments of their company are doing well and which ones are not. 
Creditors: A bank may want to loan business money so they must be able to determine if the company can pay them back. The creditors must know the actual scenario of the company thus this report will be useful for their analysis.

Government: The government wants to make sure they get their portion of the companies’ net income via taxes. Most importantly this statements are audited by an independent person who ensures the public the financial statements are accurate.

3. What financial information does this report offer? Describe the contents of the report and explain what it tells you about the business activities-success and non-successes during the year.

The following financial information and contents are described in the report. They are as follows:
Statement by the Accountable Authority and Chief
Statement of Comprehensive Income;
Statement of Financial Position;
Statement of Changes in Equity;
Cash Flow Statement;
Administered Schedule of Comprehensive Income;
Administered Schedule of Assets and Liabilities;
Administered Reconciliation Schedule;
Administered Cash Flow Statement;
Notes comprising a summary of significant account
There were both success and non-successes business activities during the year.
4. Examine the financial summaries for information about the financial condition of the company. Did the company show a profit?
On examining the financial summaries of the report the financial condition of the company is that:
All administered revenues are revenues relating to the course of ordinary activities performed by ASIC on behalf of the Government.

Administered taxation revenue is generated from fees and fines under the Corporations (Fees) Act 2001, Corporations (Review Fees) Act 2003, National Consumer Credit Protection (Fees) Regulation 2010, Business Names Registration (Fees) Regulation 2012 and Superannuation Industry (Supervision) Act 1993. Administered fee revenue is recognized on an accruals basis when:
?the client or the client group can be identified in a reliable manner;
?an amount of prescribed fee or other statutory charge is payable by the client or client group under legislative provisions; and
?the amount of the prescribed fee or other statutory charge payable by the client or the client group can be reliably measured.

Administered taxation revenue is recognized at its nominal amount due and an expense is recognized for impaired debts. Collectability of debts is reviewed at balance date. Impairment allowances are recognized when collection of the debt is no longer probable.

5. What sort of recommendations is made and what suggestions are made regarding the business activities for the upcoming year?
Recommendations:
The financial statement clearly explains that In the process of applying the accounting policies listed in this note, ASIC has made assumptions or estimates in the following areas that have the most significant impact on the amounts recorded in the financial statements:
The fair value of leasehold improvements and property, plant and equipment is assessed at market value or depreciated replacement cost as determined by an independent value and is subject to management assessment between formal valuations.

Suggestions:
ASIC currently has nine lease agreements (2015: nine) for the leasing of premises which have provisions requiring ASIC to restore the premises to their original condition at the conclusion of the lease.

ASIC has made a provision to reflect the present value of these obligations.

All payables are expected to be settled within 12 months. Settlement is usually made within 30 days.
Settlement is made according to the terms and conditions of each grant. This is usually within 30 days of performance and eligibility.
1. Compare the two reports and report on whether the projections from the first report were accurate.

Administered Budgetary Reports-2014 15
The following tables provide a comparison of the original budget as presented in the 2014–15 Portfolio Budget Statements (PBS) to the 2014–15 final outcomes as presented in accordance with Australian Accounting Standards for the entity. The budget is not audited. Explanations of variances greater than 10% are provided.

Budget Estimated Actual Original Variance Schedule of income and expenses 2015 2015 2015 administered on behalf of Government $’000 $’000 $’000 EXPENSES Grants 3,067 3,571 (504) Write-down and impairment of assets 45,343 43,495 1,848 Other 142,495 79,336 63,159 Total expenses 190,905 126,402 64,503 LESS: Own-source revenue Taxation revenue Fees and fines 823,579 762,743 60,836 Total taxation revenue 823,579 762,743 60,836 Non-taxation revenue Unclaimed monies 209,371 124,300 85,071 Total non-taxation revenue 209,371 124,300 85,071 Total revenue 1,032,950 887,043 145,907 Net contribution by services 842,045 760,641 81,404
Administered budgetary reports-2015-16
The following tables provide a comparison of the original budget as presented in the 2015–16 Portfolio Budget Statements (PBS) to the 2015–16. Final outcomes as presented in accordance with Australian Accounting Standards for the entity. The budget is not audited. Explanations of variances greater than 10% are provided.

Administered Schedule of Comprehensive Income
Original Actual Budget Variance
2016 2016 2016
$’000 $’000 $’000
EXPENSES Grants 3,192 3,580 (388)
Write-down and impairment of assets 49,470 45,542 3,928
Other 100,806 40,572 60,234
Total expenses 153,468 89,694 63,774
LESS: Own-source revenue Taxation revenue Fees and fines 876,225 834,230 41,995
Total taxation revenue 876,225 834,230 41,995
Non-taxation revenue Unclaimed monies 45,942 41,966 3,976
Total non-taxation revenue 45,942 41,966 3,976
Total revenue 922,167 876,196 45,971
Net contribution by services 768,699 786,502 (17,803)
2. Were the recommended changes/improvements made and how did they impact on next year’s report?
All the recommended changes were done and improvement has been made. Thus the impact from the previous year is noted and all the changes are done. The changes were to be done in the imports because few resources were available inside but were imported from out. Those resources were identified and bought from localities. Therefore the imports cost were reduced. Few changes that was also resolved. Few changes were done in the travel expenses. The employees were asked to choose the road travel if the distance was less. Thus all the changes that were mentioned were done and few more are in process. As a result the variance is shown in the budget.
Project 2
Explain in 500 to 900 words for the following statement:
“Ratio analysis can help in measuring business performance and setting objectives/goals”.

Ratios are calculated from organization financial statements and are an effective business tool in measuring its performance. By comparing the ratios to those of the previous year it is possible to determine whether a business is doing better this year than last year. It is also possible to compare ratios of one organization against those of another in a similar industry. This helps identify areas in which one business is either underperforming or indeed is out performing another. Undertaking ratio analysis and making comparisons to market leaders within your industry will help focus on areas which require attention. By carefully selecting the most suitable ratios business owners and managers can use the results to gain a better understanding of how their organization is performing. The same ratios can also be used to set future targets. Ratios are calculated from an organization’s financial statements and are an effective business tool in measuring its performance. By comparing the ratios to those of the previous year it is possible to determine whether a business is doing better this year than last year. It is also possible to compare ratios of one organization against those of another in a similar industry. This helps identify areas in which one business is either underperforming or indeed is out performing another. Undertaking ratio analysis and making comparisons to market leaders within your industry will help focus on areas which require attention. By carefully selecting the most suitable ratios business owners and managers can use the results to gain a better understanding of how their organization is performing. The same ratios can also be used to set future targets. Ratios are calculated from an organization’s financial statements and are an effective business tool in measuring its performance. Financial ratios are one of the most common tools of managerial decision making. A ratio is the comparison of one numbers to another—mathematically, a simple division problem. Financial ratios involve the comparison of various figures from financial statements in order to gain information about a company’s performance. It is the interpretation, rather than the calculation, that makes financial ratios a useful tool for business managers. Ratios may serve as indicators, clues, or red flags regarding noteworthy relationships between variables used to measure the firm’s performance in terms of profitability, asset utilization, liquidity, leverage, or market valuation. There are basically two uses of financial ratio analysis: to track individual firm performance over time, and to make comparative judgments regarding firm performance. Firm performance is evaluated using trend analysis calculating individual ratios on a per-period basis, and tracking their values over time. This analysis can be used to spot trends that may be cause for concern, such as an increasing average collection period for outstanding receivables or a decline in the firm’s liquidity status. In this role, ratios serve as red flags for troublesome issues, or as benchmarks for performance measurement.

Another common usage of ratios is to make relative performance comparisons. For example, comparing a firm’s profitability to that of a major competitor or observing how the firm stacks up versus industry averages enables the user to form judgments concerning key areas such as profitability or management effectiveness. Financial ratios are used by parties both internal and external to the firm. External users include security analysts, current and potential investors, creditors, competitors, and other industry observers. Internally, managers use ratio analysis to monitor performance and pinpoint strengths and weaknesses from which specific goals, objectives, and policy initiatives may be formed. Asset utilization ratios provide measures of management effectiveness. These ratios serve as a guide to critical factors concerning the use of the firm’s assets, inventory, and accounts receivable collections in day-to-day operations. Asset utilization ratios are especially important for internal monitoring concerning performance over multiple periods, serving as warning signals or benchmarks from which meaningful conclusions may be reached on operational issues. An example is the total asset turnover (TAT) ratio.