Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. In simple terms, audit risk is the risk that an auditor will issue an unqualified opinion when the financial statements contain material misstatement. ISA 200 states that auditor should plan and perform the audit to reduce audit risk to an acceptably low level that is consistent with the objective of an audit. (Auditing and Assurance Standard) AAS-6(Revised), “Risk Assessments and Internal Controls”, identifies the three components of audit risk i.e. inherent risk, control risk and detection risk. Audit Risk Model: AR = IR x CR x DR Where, AR= Audit risk (the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated) IR = Inherent risk (the risk that an assertion is susceptible to a material misstatement, assuming there Continue reading
Financial Management Tools
Value Creation – Definition, Implementation and Principles
The idea of value creation is to capitalise on what, as an organisation, you already possess. The organisation may be a business, a school, a corporation, a government department — anywhere, in fact, where the main asset of the company is the people within it. Establishing value creation as a way of life for both managers and workers can help define the role of each more precisely, whilst simultaneously making both feel more integrated and involved within the day to day running of a place of work. Making everyone within an organisation feel that they are more than just ‘cogs in a wheel’ establishes a new feeling of unity and cooperation in organisations and can be a great asset in moving a company or other organisation forward because if everyone feels that they are part of the decision-making process then carrying out the aftermath of those decisions is more likely Continue reading
Importance of Price to Earnings Ratio (P/E Ratio)
Price to Earnings Ratio The most popular ratio used to assess the value of the equity is the company’s price equity ratio abbreviated as P/E ratio. It is calculated as the ratio of the firm’s current stock price divided by the earnings per share (EPS). The inverse of the P/E ratio is referred to as the earnings yield. Clearly the price earning and the earnings yield are required to measure the same thing. In practice earnings yield less commonly stated and used than P/E ratios. P/E Ratio = Market Value per Share/ Earnings per Share (EPS) Since most companies report earnings each quarter annual earnings per share can be calculated as the most recently quarterly earnings per share times four or as the sum of the last four quarterly earnings per share figures. Most analysts prefer the first method of multiplying the latest quarterly earnings per share value Continue reading
Earnings Management Practices and Techniques
What are earnings and what is earnings management? Simply stated, earnings are the accounting profits of a company. Stakeholders (current or potential providers of debt and equity capital, employees, suppliers, customers, auditors, analysts, rating agencies, and regulators) use earnings to make important financial decisions. Many investors view earnings as value relevant data that is more informative than cash flow data. Others have suggested that current earnings are better predictors of future cash flows than are current cash flows. In the US, these profits are derived using Generally Accepted Accounting Principles (GAAP) – a system based on the accrual method, which measures the performance and position of a company by recognizing economic events regardless of when cash transactions occur. The general idea is that economic events are recognized by matching revenues to expenses at the time in which the transaction occurs rather than when payment is made (or received). This method Continue reading
Cash Flow Ratios – Tools for Financial Analysis
In many cases, cash flow ratios signify a more accurate measurement of a stock’s value than the price to earnings ratio, P/E. Cash flow ratios examine the flow of money into a company, it can help to identify struggling companies and in turn, struggling stocks. Price to earnings is a very important ratio because when is very high or low, it usually makes a splash on the financial pages. Price to earnings ratio is valuable metric and can help a successful investor with his or her stock technical analysis, but it is only one technical analysis tool and should be considered as such. While the same can be said for each of the cash flow ratios, these give insight into the money coming in and going out of a company. A company can demonstrate earnings, but if more money is pouring out a company than pouring in, there will fiscal Continue reading
Payback Period Method of Capital Budgeting
Payback Period Method The Payback period method of capital budgeting is popularly known as pay-off, pay out or replacement period methods also. It is the most popular and widely recognized traditional method of evaluating capital projects. Payback period method represents the number of years required to recover the original cash outlay invested in a project. It is based on the principle that every capital expenditure pays itself back over a number of years. It attempts to measure the period of time, it takes for the original cost of a project to be recovered from the additional earnings of the project. It means where the total earnings (or net cash inflow) from investment equals the total outlay, that period is the pay-back period. The standard recoupment period is fixed the management taking into account number of considerations. In making a comparison between two or more projects, the project having the lesser Continue reading