Financial Statement Analysis of Limited Company

This assignment requires students to analyze the financial statements of a limited company, including the income statement, balance sheet, and cash flow statement. Students need to understand key accounting concepts and ratios to interpret the company's financial performance and position. The analysis should cover aspects like profitability, liquidity, solvency, and overall financial health.

Unit 2 MANAGING FINANCIAL
RESORCES AND DECISION
1

Table of Contents
INTRODUCTION...........................................................................................................................3
TASK 1............................................................................................................................................3
1.1 Identification of sources of finance available to a business.............................................3
1.2 Implication of different sources of finance......................................................................4
1.3 Evaluation of appropriate sources of finance for a business project................................7
TASK 2............................................................................................................................................8
2.1 Analysis of costs of different sources of finance identified in task 1.3............................8
2.2 Importance of financial planning......................................................................................8
2.3 Assessing information needs of different decision makers..............................................9
2.4 Impact of finance on financial statements........................................................................9
TASK 3..........................................................................................................................................11
3.1 Analyzing budget and making appropriate decision......................................................11
3.2 Calculation of unit costs and making pricing decisions.................................................13
3.3 Assessing the viability of a project using investment appraisal techniques...................14
TASK 4..........................................................................................................................................15
4.1 Explain the content of Financial statement....................................................................15
4.2 Comparison between different formats of financial statements for different types of
business.................................................................................................................................16
4.3 Interpretation of financial statements.............................................................................19
CONCLUSION..............................................................................................................................21
REFERENCES..............................................................................................................................22
2

INTRODUCTION
Management of financial resources means planning, organizing, controlling and directing
the financial activities of the organization. In simple words it means getting the most from the
resources available. It deals with procurement of financial resources from appropriate sources
and utilizing the same in an optimum manner. Effective and efficient management of financial
resources ensures long term growth and profitability of the organization and it will also ensure
adequate and regular supply of funds to the organization (Beck and Demirguc-Kunt, 2006).
Sweet menu restaurant ltd is a reputable restaurant and it was founded by three students
ten years ago. The owners of sweet menu want to open two new branches so as to take advantage
of this fast growing and dynamic food industry. According to its new business plan, it will
require £ 300000 to £ 500000 to open the proposed new branches. The present report
emphasizes on analyzing different sources of finance and their implications, costs of finance and
importance of financial planning for the sweet menu restaurant.
TASK 1
1.1 Identification of sources of finance available to a business.
Long Term Sources Of Finance Description
1. Issue of equity share capital
2. Retained earnings
3. Loans
A company can offer its shares to the general
public to raise huge amount of capital. Equity
shares are permanent in nature and equity
shareholders are considered as owners of the
company. Part of profits of the company is
distributed among equity shareholders (Baker and
Mukherjee, 2007).
These are earnings of the previous year’s which
were accumulated by the company instead of
distributing them as dividend.
Loans mean money borrowed by the company
from the financial institutions in exchange for
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4. Third party investment
future repayment of principle amount along with
interest (Nanda, 2008). Loans can be secured or
unsecured.
When an individual or entity lends its money to
the company. However, money lending is not
principle business of the entity (Duxbury, 2015).
Short Term Sources Of Finance Description
1. Hire purchase
2. Leasing
3. Factoring
4. Cash management
Hire purchase is a method where assets are
purchased and payment is made in installments
over a period of time. Under hire purchase
contract; ownership is not transferred to the buyer
until full amount of the contract is paid (Mayer,
Schoors and Yafeh, 2005).
Lease is an agreement under which one party
agrees to rent his property to another for regular
periodical payments.
It is a financial transaction in which company sells
its business invoices (accounts receivables) to the
third party (factor) at a discount.
Cash management is a process of collecting,
managing and investing cash. It will ensure
company's solvency and financial stability
(Grzegorz, 2010).
4

1.2 Implication of different sources of finance
Sources of
finance
Legal implications Financial
implications
Dilution of
Control
Bankruptcy
implications
1.Equity Share
Capital
2.Retained
Earnings
3. Loans
Prior approval of
stock exchange is to
be obtained before
bringing initial public
offer in the market.
Moreover, the
company has to follow
all rules and
regulations formed by
governing body.
There are no legal
implications where a
company is utilizing
its free reserves.
Obtaining loans from
banks is very difficult
because banks lend to
only those companies
A company can
obtain huge funds
from the general
public by offering
them equity shares
and company has
to pay dividend to
its equity
shareholders
periodically.
If too much funds
are devoted from
the retained
earnings then it
will lower the
liquidity position.
Tax benefit can be
obtained on the
amount of interest
paid.
Ownership
control of the
company will
be diluted
among the
shareholders
(Lau and
Proimos, 2010).
No risk of
dilution of
control because
it is
reinvestment of
earnings of
past.
No risk of
dilution of
control because
lenders do not
There is no
risk of
bankruptcy in
case of
issuance of
equity shares
because it is
not liability of
the company
to repay the
funds to the
equity
shareholders.
This amount is
not added to
the debt
profile so there
is no risk of
bankruptcy.
There is high
risk of
bankruptcy
when company
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4.Third Party
Investment
5. Hire Purchase
6.Leasing
which are capable of
repaying their loans.
They also demand
valuable collateral as
security.
No legal implications.
Very easy to obtain
third party loan.
Contract between
vendor and purchaser
is to be properly
signed before
transaction.
Contract between both
the parties is to be
properly signed before
entering into lease
Usually they carry
low interest rates.
Purchaser has to
pay periodical
installments and
tax benefit can be
obtained on the
amount of interest
paid.
Lessee can use the
assets without
take ownership
position in the
company.
No risk of
dilution of
control.
No risk of
dilution of
control.
No risk of
dilution of
does not have
enough funds
for repayment
of loan
amount.
Usually fewer
amounts are
borrowed from
third parties so
no bankruptcy
implications
are involved.
Risk of
bankruptcy is
involved in
only those
cases where
large amount
of money is
involved in
hire purchase
transactions.
Repayment of
the principle
amount and
finance
6

7.Factoring
transaction.
An agreement is to be
signed between the
company and factor.
investing funds in
the assets. Tax
benefit can be
obtained on the
amount of interest
paid.
Factoring provides
quick boost to cash
flows. It is very
good source of
short term finance.
control.
No risk of
dilution of
control.
charges is
obligation for
the company
so there is high
risk of
bankruptcy.
No risk of
bankruptcy.
1.3 Evaluation of appropriate sources of finance for a business project.
 Long term – Long term sources of finance available to Sweet Menu is issue of equity shares,
obtaining bank loan, third party investment etc. This option is viable only when company has
to invest large amount of funds for the expansion of its business. In this company has to
repay the principle amount along with interest usually in 10 – 20 years. High amount of
interest and dividends are involved in long term sources of finance. So company should go
for this option only when return from the project is higher than interest amount.
 Short term – Short term sources of finance are hire purchase, leasing, factoring and cash
management etc. Usually these sources of finance last up to 5 years. Short term sources of
finance are obtained for meeting day to day expenses or purchasing new asset.
Sweet Menu wants to open new branches in different cities of UK. Therefore it can
obtain long term loans or it can also go for leasing option for financing land and buildings. Due
to good market reputation, no bank will hesitate in giving loan to Sweet Menu and it can also
easily repay the principle amount along with interest due to high sales. Sweet Menu can use its
retained earnings for meeting other expenses related to new branches.
7

TASK 2
2.1 Analysis of costs of different sources of finance identified in task 1.31. Retained earnings - When the company uses its retained earnings then the concept of
opportunity cost cannot be ignored. It means profits avoided by the company if it spend
those money in some other proposals There are no tax implications when company
utilizes its retained earnings (Brammer, Brooks and Pavelin, 2006).2. Loans and third party investments - Interest paid to the banks and third parties will be
cost of this source of finance. Interest cost is allowed as deduction from the profits of
company for the purpose of calculating tax.3. Hire purchase – Cost of hire purchase will be payment of interests charges to the vendor.
Interest charges will be allowed as deduction from the profits of company for the purpose
of calculating tax.4. Lease – Cost of the lease will be payment of periodical lease rentals to the lessor. Lease
rentals will be allowed as deduction from the profits of company for the purpose of
calculating tax.
2.2 Importance of financial planning
Sweet menu should try to adopt optimal capital structure because it will minimizes its cost of
finance and maximize the profitability of the company. It will also ensure adequacy of funds and
stability in the company. Following are the benefits of financial planning.
1. Financial planning ensures adequacy of funds in the organization.
2. Planning helps in maintaining reasonable balance between inflow and outflow of cash
and cash equivalents which ensures stability of the organization.
3. Planning helps in achieving optimal capital structure (Frank and Goyal, 2009).
One of the most important part of financial planning is preparation of cash budget. Cash
budget includes estimation of cash inflows and outflows which can highlight the company's
probable surplus or deficit position. So cash budget helps in planning the most efficient usage of
cash. Sweet menu wants to open new branches of its restaurant so company should prepare cash
budgets and carefully monitor the estimated cash inflows and outflows because it is very helpful
in projecting future profitability and stability of the company. Sweet menu should also consider
8

the market trend. If the cash budget reflects negative cash flows then then it should not open that
particular branch.
2.3 Assessing information needs of different decision makers.
Decision Makers of sweet
menu restaurant Information Required
1. Shareholders
It is statutory requirement to circulate annual reports which
includes profitability statement and future projections to the
shareholders of the sweet menu so that they can take decision on
the basis of results of the company whether to retain or sell the
shares(Chia and et.al, 2007).
2. Government
Government requires the tax audit report of the sweet menu to
know the amount of direct tax and indirect tax paid by the
company in a particular financial year and to check whether the
sweet menu directly or indirectly is not involved in activity of tax
evasion.
3. Bank
Bank requires the audited financial statements of previous years
and future projections for the purpose of decision making
regarding granting of loan.
4. Management
Cost audit report, cash flow statements and future projections are
the information needs of managers of sweet menu. Cost reports
are analyzed by them for the cost cutting purpose. Cash flow
statement is analyzed by managers to prepare cash budgets and
management of working capital.
9

2.4 Impact of finance on financial statements
Table 1: Profit and Loss Account for the Year Ended 31st December 2014
Particulars Amount Amount
Revenue 350000
Less: Cost Of Sales 127500
Gross Profit 222500
Less :
Administration Expenses 92000
Selling and Distribution Expenses 14500
106500
Operating Profit 116000
Less : Interest 10000
Profit Before Tax 106000
Less : Tax 21000
Profit After Tax 85000
Less : Proposed Dividend 80000
Retained Profit For The Year 5000
Table 2: Balance sheet as at 31st December 2014
Non Current Assets
Equipment 125000
Delivery Vans 52000
Furniture And Fittings 38000
215000
Current Assets
Inventories 44000
Receivables 13000
Cash And Bank 111000
168000
Current Liabilities
10

Payables 38000
Net Current Assets 130000
Net Assets 345000
Equities
160000 Ordinary Share Capital @ GBP 1 per share 160000
Revenue Reserves 104000
Noncurrent liabilities
Long Term Loan 81000
Net Assets 345000
The company has issued equity share capital of GBP 100'000 so “equities” on the
liability side will be increased by GBP 100'000 and on the other hand cash/bank balance will be
increased by GBP 100'000.
Company has also obtained long term bank loan of GBP 50'000 so long term loans under
head noncurrent liabilities will be increased by GBP 50'000 and company utilizes those loans in
purchasing equipment so amount of equipment under head noncurrent assets will be increased by
GBP 50'000.
TASK 3
3.1 Analyzing budget and making appropriate decision
Cash Budget
Receipts
Septem
ber
£
Octobe
r
£
Novem
ber
£
Decem
ber
£
Total
£
Cash sales 15000 13000 15000 18000 58000
Total 15000 15500 18000 20000 58000
Payments
Van 12000 12000
Furniture & Fittings 18000 10000 28000
Salaries & wages 7500 7500 8500 9000 32500
11

Petrol 280 280 280 840
Lighting &Energy 500 600 650 1750
Insurance 350 350 350 350 1400
Purchases - inventory 3000 3000 3500 4000 13500
Total 40850 11630 13230 24280 89990
Net balance (25850) 3870 4770 (4280) (21490)
Balance b/fwd 18500 (7350) (3480) 1290 8690
Balance c/fwd (7350) (3480) 1290 (2990)
(12530
)
Trade payables budget (Inventory)
Septem
ber
£
Octobe
r
£
Novem
ber
£
Decem
ber
£
August purchases 40% 1200
September purchases
60% 1800
September purchases
40% 1200
October purchases
60% 1800
October purchases
40% 1200
November purchases
60% 2300
November purchases
40% 1380
December purchases
40% 2620
12

Total payments 3000 3000 3500 4000
 After analyzing cash budget of four months it can be concluded that there is insufficiency
of working capital in the given four months. Sweet menu also faces difficulty in meeting
current obligations, meeting day to day expenses and procurement of raw materials.
 Main reason of negative working capital is that payment made for purchasing van and
furniture/fittings both are in the month of September. If anyone payment is deferred to
the next month then cash balance will be positive for the month of September.
 Another reason for negative working capital is that salary expenses were increased by
1000 in the month of November but there is no growth in the sales.
 Company should focus on maintaining same level of growth in its sales to avoid negative
balance of working capital because there is no reliable trend in the figure of sales.
 Company has also made improper financial planning decisions because in-spite of low
cash balances they purchased 2 different types of assets in the same month. So, the
company should focus on making proper financial planning decisions.
 Company should manage the cash availability in the business to eliminate deficit cash
balance. It can be done by enhancing business incomes through increasing the sales.
Moreover, Blue Island Business needs to control the business expenditures through
regular monitoring. Further, managers need to make strategic business policies that help
to maintain effective control over the expenses. This in turn, business will be able to have
positive balance.
3.2 Calculation of unit costs and making pricing decisions
PARTICULARS AMOUNT(In GBP)
Sale Price per meal (Including VAT)
Less : VAT (20% of GBP 10)
Sale Price per meal (Excluding VAT)
Less : Mark Up (40% of GBP 10)
COST PER MEAL
16
(2)
14
(4)
13

10
Food cost percentage = Total ingredients cost / sales prices
= (10)/(16)*100 = 62.5%
Blue Island Restaurant business is deciding the selling prices by adding mark up
percentage of 40% and VAT of 20% on the total meal cost. From the basis of above statement, it
can be said that food cost percentage for the Blue Island restaurant business is 62.5%. Therefore,
it can be concluded that company is getting 37.5% of profit percentage of total sales. The profit
margin is good hence, it can be interpreted that business is performing better in the market.
3.3 Assessing the viability of a project using investment appraisal techniques
Net present value technique – This technique considers time value of money. NPV is the
difference between present value of cash outflows and present value of cash inflows (Why net
present value is better measure for investment appraisal. 2015.). A single proposal is accepted
when NPV is more than zero and in case of mutually exclusive proposals, that proposal will be
accepted whose NPV is highest (Cetorelli and Strahan, 2006).
Payback period technique – This technique do not consider the concept of time value of
money. Payback period calculates the time period required to recover the initial investment made
by the company or time period required to reach the breakeven point (DeBondt and et.al, 2010).
Table 3: Cash inflows of the proposals
Year Proposal 1 Proposal 2
0 -1200 -1200
1 800 300
2 600 400
3 400 500
4 200 600
5 50 550
Table 4: Proposal 1
Year Net Cash Flows Pvf @ 10% Pv Of Cash Flows
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0 -1200 1 -1200
1 800 0.909 727.273
2 600 0.826 495.868
3 400 0.751 300.526
4 200 0.683 136.603
5 50 0.621 31.046
Net present value 491.315 £
Payback Period 1.8 years
Table 5: Proposal 2
Year Net Cash Flows Pvf @ 10% Pv Of Cash Flows
0 -1200 1 -1200
1 300 0.909 272.727
2 400 0.826 330.579
3 500 0.751 375.657
4 600 0.683 409.808
5 550 0.621 341.507
Net Present Value 530.278 £
Payback period 3 years
From the above calculations it is to be concluded that proposal 2 is considered as viable
from the point of view of NPV technique and proposal 1 is considered as viable from the point of
view of payback period technique. Therefore proposal 2 will be selected because NPV technique
is more reliable and accurate than payback period technique and it also consider the concept of
time value of money (Austin, Stevensonand WeiSkillern, 2006).
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TASK 4
4.1 Explain the content of Financial statement
Profit and Loss account: It is a profitability statement that records all the revenues and
business expenses for a given period of time. It records all the operating expenses and generated
business incomes. The statement mainly aims at identifying the results of the operating
functions. Gross profit, net operating profit and net profit can be determined from the statement.
The excess of total sales over the cost of goods sold is known as gross profit. However, net profit
is the results of difference between gross profit and all the indirect business expenditures.
Balance sheet: It is a statement that records all the financial transaction of the business.
All the business assets and liabilities are summarized in the statement. Assets include all the
current and noncurrent assets while liabilities involve all the equity as well as debt funds and
current liability. The statement helps to measure financial health of the business by determining
the financial performance.
Cash flow statement: It is a statement that includes all the cash affecting business
transaction. Both the cash inflows and outflows from operating, investing and financing activities
are combined in the statement. Operating activities combines all the operating functioning of the
business while investing activity combines purchase and sales of assets. However, financing
activities combines’ new sources of finance through which funds has been generated. Moreover,
it includes the discharged financial obligations such as redemption of debentures and paying off
the equity. The statement aims at determining the changes in cash prevailing in two different
balance sheet dates.
4.2 Comparison between different formats of financial statements for different types of
business
Particulars Different Types Of Entities
Limited Company Partnership Firm Sole Trader
1.Changes in
reporting requirement
Limited company has
to report its financial
Mainly they have to
report to tax
Mainly they have to
report to tax authorities
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statements to its
stakeholders.
authorities and banks. and banks.
Table 6: Format of financial statements of sole trader
17

Table 7: Format of financial statements of partnership firm
18

19
Table 8: Format of financial statements of limited company

4.3 Interpretation of financial statements
Accounting ratios Formula
Sweet Menu
Restaurant
Blue Island
Restaurant
I Profitability Ratios
1. Gross Profit
Margin Gross Profit / Net Sales 0.636 0.662
2. Operating Profit
Margin Operating Profit / Net Sales 0.331 0.424
3. Net Profit Margin Net Profit / Net Sales 0.243 0.317
II Liquidity Ratios
1. Current Ratio
Current Assets / Current
Liabilities 1.789 0.631
2. Quick Ratio
(Cash + Account
Receivables) / Current
Liabilities 0.632 0.154
III Efficiency Ratios
1. Total Asset
Turnover
Net Sales / Average Total
Assets 1.502 1.590
2. Accounts
Receivable Turnover
Net Sales / Average Gross
Receivables 26.923 59.800
IV Investment ratios
1. Earnings Per Share Earnings Attributable to 1.417 2.709
20

Equity Sh. Holders / No.
Of Sh.
Financial Data
Net Sales 350000 299000
Gross Profit 222500 198000
Operating Profit 116000 126800
Net Profit 85000 94800
Inventories 44000 31000
Cash Balance 11000 5000
Accounts Receivables 13000 5000
Current Liabilities 38000 65000
Total Assets 233000 188000
No. of Shareholders 60000 35000
Gross profit ratio – It indicates amount of gross profit earned per pound of sales
(Whittington, 2007). Here, GP ratio of Blue Island is better than sweet menu because Blue Island
incurred less direct expenses with respect to sales as compared to sweet menu.
Operating profit ratio - It indicates amount of operating profit earned per pound of sales.
Operating profit ratio of Blue Island is better than sweet menu because Blue Island has incurred
less operating expenses with respect to sales as compared to sweet menu.
Net profit ratio - It indicates amount of net profit earned per pound of sales. Here, NP
ratio of Blue Island is better than sweet menu because Blue Island incurred fewer expenses with
respect to sales as compared to sweet menu.
Current ratio – This ratio measures the liquidity of business. Generally companies prefer
current ratio of at least 1. Here, Blue Island restaurant should improve its current ratio by
keeping high value of liquid assets.
Quick ratio – The purpose of calculating this ratio is same as current ratio but it does not
include inventory and prepaid expenses in the calculation. Blue Island restaurant should improve
its quick ratio by keeping high value of liquid assets.
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Total asset turnover – It measures capability of the company to generate sales through the
use of assets. Both the companies are having asset turnover ratio of more than 1 which is ideal
for any company.
Accounts receivable turnover – It measures payback period cycle of accounts receivables.
Blue Island restaurant needs to improve its accounts receivable turnover ratio in order to improve
its liquidity position by changing its credit policies.
Earnings per share – EPS means earnings attributable to each number of equity shares.
Higher the profitability leads to higher value of EPS. EPS of Blue Island is higher than sweet
menu because Blue Island has generated higher profitability by reducing its expenditure as
compared to sweet menu.
CONCLUSION
From the above discussion, it is concluded that sweet menu should adopt ideal capital
structure in order to minimize its cost of capital and to maximize its return on investment.
Financial tools should be adopted to evaluate various mutually exclusive projects such as NPV
technique and payback period technique. Pricing decisions are also very important for the
success of the sweet menu so managers should adopt prices of their products according to the
market situations. Managers should also prepare and present their financial statements as
applicable financial reporting framework. At the yearend, managers should compute applicable
accounting ratios and compare them with the previous year’s figures and any abnormal deviation
should be properly treated.
22

REFERENCES
Books & Journals
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International Journal of Managerial Finance. 3(1). pp. 11 – 25.
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Cetorelli, N. and Strahan, P.E., 2006. Finance as a barrier to entry: Bank competition and
industry structure in local US markets. The Journal of Finance. 61(1). pp. 437-461.
Chia, Y.M. and et.al., 2007. Choice of auditors and earnings management during the Asian
financial crisis. Managerial Auditing Journal. 22(2). pp. 177 – 196.
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markets. Review of Behavioral Finance. 7(1). pp. 78 – 96.
Frank, M.Z. and Goyal, V.K., 2009. Capital structure decisions: which factors are reliably
important?. Financial management. 38(1). pp. 1-37.
Grzegorz, M., 2010. Planning optimal from the firm value creation perspective: Levels of
operating cash investments. Romanian Journal of Economic Forecasting. 13(1). pp.
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Gustafson, C.R., 2004. Rural small business finance: evidence from the 1998 survey of small
business finances. Agriculture Finance Review. 64(1). pp. 33 – 43.
Lau, B. and Proimos, A., 2010. The underperformance of equity‐financed bidders. International
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Mayer, C., Schoors, K. and Yafeh, Y., 2005. Sources of funds and investment activities of
venture capital funds: evidence from Germany, Israel, Japan and the United Kingdom.
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Nanda, R., 2008. Cost of external finance and selection into entrepreneurship. Harvard Business
School Entrepreneurial Management Working Paper. (08-047).
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