Financial statement analysis

BUSINESS DECISION
MAKING FOR THE
HOSPITALITY INDUSTRY

Question 1
The statement of the profit and loss account is one significant financial statement for a
specific period of time that provides a summary of all the revenues, expenses and the costs.
The said financial statement of any entity highlights the ability of the entity in the generation
of the revenues and profits out of the core business operations. The yet another financial
statement that is of utmost importance is the statement of financial position. The statement of
the financial position of the entity presents the financial position of the entity at a given point
of time. Thus the varied risks such as the liquidity risk, credit risk, financial risk and overall
business risk can be analysed from the study of the above mentioned financial statements
(Delen, Kuzey and Uyar, 2013). There are various ratios that are calculated and used for the
analysis of the financial statements. Some of the ratios and their significance is stated as
follows.
a) Gross, operating and earnings margins: The analysis of the gross, operating and the
earning margins fall in the category of the profitability ratios. The aim behind the
computation and analysis of the above ratios is to determine the ability of the entity to
generate the earnings at different levels. The above stated margins are calculated against
the revenues and expressed in the percentage form to determine the percentages, the
profits form out of the total profits (Fridson and Alvarez, 2011). While the gross profit
margin highlights the efficiency of the core business operations, the operating margin
highlights the profits with the inclusion of the operating expenses. The net profit margin
is further calculated to review the impact of the indirect expenses of the entity, such as the
administrative and the marketing expenses. The comparison of the stated ratios is
conducted in relation to the industry benchmarks as well as the past year performances to
study the impact of the expenses on the earnings of an organisation.
b) Return on capital employed and return to equity: The operational efficiency of the
company is analysed through the computation of the above mentioned ratio, and thus the
future potential of growth is reviewed. The return on capital employed is calculated to
analyse the efficiency of the company in the generation of the earning against the amount
invested in the form of capital (Edmonds, 2013). Thus, the shareholders equity as well as
the long term liabilities are considered to gauge the efficiency of the company. In contrast
to this, the return on equity is focussed only on the money invested by the shareholders of
the company.

c) Acid Test: The acid test ratio or the quick ratio is the expression of the analysis of the
short term liquidity position of an organisation. The liquidity position must be
significantly analysed by the management as well as the stakeholders to get the useful
insights about the working capital or the management of the day to day business
operations. A sound liquidity situation of an enterprise highlights the positive fact that the
organisation is comprised of sufficient short-term assets such as the cash to cover the
payment of the current liabilities in the form of creditors and other short-term obligations.
The quick ratio is devoid of the inventories, which are further complex to liquidate as
compared to cash and the other short term investments that are readily convertible into
cash (Williams and Dobelman, 2017). Thus, the ratio aids in the presentation of a reliable
picture of the cash position of the company.
d) Financial gearing and interest cover: These ratios are the part of the analysis of the
capital structure and the involvement of the risk therein. These ratios are of the utmost
interest of the prime stakeholder groups of the investors and the regulators that are
concerned of the financial risk involved before the extension of the financial assistance
and determination of the vitality of the business operations and the type of financing
(Robinson, et. al, 2015). The financial gearing ratio or the debt to equity ratio highlights
the levels of the outside borrowings in the financial structure of the company. The interest
cover ratio is indicative of the levels of the profits available for the servicing of the cost
of the debts of the entity. Thus, both these ratios highlight the various aspects of debt
financing within the entity.
Question 2
The holding cost refers to the cost incurred by an entity for the storage of the inventory that
remains unsold with the entity. Thus, the holding costs of the inventory together with the
shortage costs and the ordering costs form the total inventory costs. The holding costs of the
inventory is inclusive of the components like price of the spoiled or the damaged goods, rent
cost for the storage space, cost of the insurance, taxation, transportation, depreciation and the
labour charges. Thus, all the business expenses that are related and are necessary for the
carrying of the inventory are included here.
The Economic order quantity (EOQ) represents an ideal order quantity that should be
purchased by a company in order to minimize inventory costs that is further comprised of
shortage costs, holding costs, and order costs. The economic order quantity can be
determined by the use of the following formula.

EOQ = √ 2 DS
H ,
Where
S=Order cost (per purchase order)
D=Demand in units (generally in annual terms)
H=Holding costs (per unit, per year)
The EOQ for the given data is computed as follows.
Annual
Demand = 40000 units
Order cost = € 178 per order
Holding costs = € 1.25
EOQ = SQRT((2*40000*178)/1.25)
EOQ = 3375.203698
Thus, the optimal number of the products to be ordered as per the given data has been
determined as computed above, using the stated formula.
Question 3
There are various methods of the investment or the project appraisal to assess whether it is
worth or not to invest in a project. Thus, the various methods prescribe various methods to
review the cash inflows and outflows, and the overall utility of the project is adjudged.
Net Present Value (NPV)
The Net Present Value method is regarded as the most useful technique of the project
appraisal and is regarded as advantageous over the other techniques of the project evaluation,
because of its consideration of the time value of money (Baker and English, 2011). In light of
the business environment of an entity a suitable cost of capital rate is determined, and an
estimation is made of the cash flows over the project life. These cash flows are then
discounted to arrive at the Net Present Value. The formula for the Net Present Value formula
is expressed below:
NPV=∑
i=1
n CFi
(1+ d)i