Financial Accounting: Analysis of Accounting Ratios and Preparation of Financial Statements

This essay provides an analysis of accounting ratios of four consecutive years and preparation of income statement and balance sheet of Ovid ventures. It also explains the impact of adjustments on income statement and balance sheet and the reason for adding or subtracting items from cash flow statement.

Essay

Contents
INTRODUCTION.....................................................................................................................................3
MAIN BODY...........................................................................................................................................3
Section: A...............................................................................................................................................3
Section: B...............................................................................................................................................4
CONCLUSION.........................................................................................................................................7
REFERENCES..........................................................................................................................................9

INTRODUCTION
Financial accounting is a process in which there are several transactions which takes place in
an accounting year. These events are to be recorded in a systematic manner. Financial
accounting is a process which involves various activities such as documenting, summarising
and reporting. It helps various internal and external users to take financial and operational
decisions of the organisation. This report is divided into two sections. In section one, it
includes the interpretation of various accounting ratios of four consecutive year starting from
2018 (Churyk, Reinstein and Smith, 2018. ). The financial ratios helps in comparing the
financial performance of own enterprise with other competitors. In part two, it includes the
preparation of income statement and balance sheet of a firm named Ovid ventures. These are
the main financial statements which are written records of the transactions of the enterprise. It
also encompasses the explanation for the adjustment of certain items such as prepaid
expenses and income, accrual expenses and income. There are various items of cash flow
which are added or subtracted from the cash flow, the reason for the same is also entailed in
this report.
MAIN BODY
Section: A
1. Analysing the accounting ratios of four consecutive years.
Financial ratio: These are the numerical figures taken from the different financial statements.
It assists in comparing the financial performance of two different firms. There are various
accounting ratios such as liquidity ratios, profitability ratios, solvency ratios and activity
ratios (Dadkhah, 2019). The ASOS plc, ratios can be interpreted in the following way:
a.) Profitability ratios: It reflects the ability of an enterprise to effectively create the
profits and utilising them in the effective manner. There are various profitability ratios
such as gross profit margin, operating profit margin, net profit margin and return on
capital employed.
 Return on capital employed (ROCE): This ratio is used to measure the
organisation’s complete return on the investment of shareholders and
bondholders. It considers earnings before interest tax and capital employed.
From the above ratio, it can be interpreted that In the year 2018 it was 22.72%.
It indicates that capital is utilising effectively. From the year 2019, it started
falling and in the year 2021, it reached to 9.39%.
B.) Efficiency ratios: It shows the ability of an enterprise to effectively utilise the assets of
the organisation. There are various activity ratios such as debtor collection period, stock
turnover ratio and creditor collection period.
 Stock turnover ratio: From the given information of stock turnover ratio, it
was observed that in the year 2018 it was 5.93% and it starts decreasing in
year 2019. The higher inventory turnover ratio signifies that firm is capable to
sell its inventory in less time and more goods are demanded by the consumers.

 Debtor collection period: From the above ratio, it can be observed that in the
year 2018 the debtors have paid their dues on time and collection was made on
time. From the year 2019, the company debtor collecting period starts
increasing it signifies that debtors were not able to pay dues on time.
 Creditor’s payment period: This ratio reflects the duration taken by the
enterprise to pay off its obligations. In the year 2020, it was 39.5 and in 2018
it was 14.8. The more time taken by the organisation is favourable situation
because enterprise is able to ratio the level of liquidity for day to day
activities.
C.) Liquidity ratios: This ratio signifies the ability of a corporation to pay off its short
term debts
(Heo and et.al.,2021.)
. There are various types of liquidity ratios such as current ratio, acid test ratio and
cash ratio.
 Current ratio: It shows the proportion of current assets and current liabilities.
The standard ratio is 2:1. In the year 2018, it was captured at 0.9 but in the
year 2020 and 2021, it was approximately near the ideal current ratio.
 Liquidity ratio: It helps in identifying the amount of liquid assets in the
organisation. The higher liquidity ratio indicates the effective working of the
day to day affairs of the organisation.
d.) Financial structure ratios: It helps in knowing the structure of capital used by the
enterprise.
 Gearing ratio: It helps in knowing the proportion of debt and equity used in the
enterprise (Lone and Bhat, 2018)
.
Section: B
1. Representing income statement of the Ovid ventures.
Income statement for the year ended 31st December 2021.
Particular Amount Particular Amount
Opening sales 14000 sales 280000
Purchases 160000 Closing stock 18000
Wages and salaries 21000

Gross profit 103000
Total 298000 Total 298000
Auditing and
accounting
500 Gross profit 103000
Advertising 900
Delivery 8500
Electricity 2800
(+) Outstanding 250 3050
Insurance 1700
(-) prepaid 400 1300
Depreciation on
Fixture and fitting
20000
Depreciation on Motor
vehicle
21285
Office expenses 700
Rent 7500
Bank interest 200
Net profit 39065
2. Preparation of balance sheet of Ovid ventures.
Balance sheet: It shows the comprehensive view of the assets and liabilities owned by
the enterprise. It helps in knowing the financial health of the organisation.
Balance sheet as at 31st December 2021.
Cost £ Accumulated depreciation £ Carrying amount £
Non current assets:
Fixtures and fittings 80000 (16000+8000)=24000 24000

Motor vehicle 25000 (25000-1350*10%)=2365
(25000-2365) 22635
Total 28635
Current asset:
Bank 1500
Prepayment for insurance 300
Debtors 41350
Total 43150 43510
Current liabilities:
Creditors 8900
8900 8900
Net Current Assets 9610
Long term liabilities:
Long term bank loan 7400 -7400
£1 share (issued and fully paid) 25000 2210
Financed by:
Capital 13200
Net profit 20300
33500 33500
3. Describing the impact of adjustments on income statement and balance sheet
Prepaid expenses: there are certain expenses of the firm which are paid in advance (Makrelov
Davies and Harris, 2022)
. It is deducted from the specific expenses of the firm. In balance sheet, it is
shown on the liability side. For example: prepaid rent and insurance.

 Accrued expenses: it is the situation when expenses are paid but not earned yet. It
is shown on the liability side of the balance sheet. Examples are accrued expenses
and wages account (Ryabinkin and Virtanen, 2018.)
.
 Prepaid income: It is the income which is received but not earned yet. For
example rent received in advance and income received in advance. For example,
prepaid rent account will be debited and cash will be credited.
 Accrued income: It is the income which is earned but not received yet is known
as accrued income. For example, rent, insurance received in advance.
4. Explanation for adding or subtracting items from cash flow statement.
There are certain items of cash flows which are added or subtracted from cash flow.
The reason for doing the same is explained as given below:
 Depreciation: It is a non-operating expense of the organisation. It cannot be
expressed in money because it just reduces the value of the fixed assets. It
does not have direct effect on the cash flow. While computing the net profit it
is added in the profits.
 Disposal of non-current assets: The cash flows are divided into three
categories: one of the category is investing activities. It includes the
adjustment for sale and purchase of fixed assets. The disposal of non-current
assets is an inflow for the enterprise (Tepoyan, 2018)
. It increases the level of cash in the organisation. It is added in the investing
activities of the cash flow.
 Increase in inventories: While computing the cash flow from operating
activities, it also encompasses adjustment for the working capital. When there
is increase in the current assets and decrease in the current liabilities, it will be
deducted from the operating activities.
CONCLUSION
From the above report, it can be concluded that financial accounting helps in
summarising the several transactions of the business. The financial statements such as
income statement and balance sheet helps to revel ate true and fair view of the
organisation. Profit and loss helps in knowing the actual level of profitability and balance
sheet reflects the total assets and liabilities owned by the owner of the firm. There are
various items of the profit& loss and balance sheet which require separate adjustments.
There are few items of the cash flow such as depreciation, disposal of current assets and

increase in inventories are added to the cash flow. Therefore, each item require different
adjustments.

REFERENCES
Books and Journals
Churyk, N.T., Reinstein, A. and Smith, L., 2018. Jones Enterprises Real Estate Investment
Trust: Comparing US and Canadian Acquisition Accounting, Balance Sheet and
Security Commission Reporting, and Initial Public Offering Location. Issues in
Accounting Education, 33(2), pp.35-42.
Dadkhah, M., 2019. Gradation of Islamic bank balance sheet for increase the share of
payment of loan without interest (wages). Islamic Economics & Banking, 8(28),
pp.173-184.
Heo, W and et.al.,2021. Using Artificial Neural Network techniques to improve the
description and prediction of household financial ratios'(vol 25, 100273,
2020). JOURNAL OF BEHAVIORAL AND EXPERIMENTAL FINANCE, 29.
Lone, F.A. and Bhat, U.R., 2018. Does the tag “Islamic” help in customer satisfaction in dual
banking sector?. Journal of Islamic Marketing.
Makrelov, K., Davies, R. and Harris, L., 2022. The impact of higher leverage ratios on the
South African economy. Studies in Economics and Econometrics, pp.1-24.
Ryabinkin, S.V. and Virtanen, K.S., 2018. COMPARISON OF BALANCE SHEET
RESULTS BY THE ARITHMETIC MEAN METHOD WITH THE RESULTS OF
CALCULATIONS BY THE GEOMETRIC MEAN METHOD. In VI International
Symposium “Biogenic-abiogenic interactions in natural and anthropogenic
systems” (pp. 76-78).
Tepoyan, V., 2018. Comparative Analyses of Financial Stability Ratios. Bulletin of Yerevan
University G: Economics, 9(3 (27)), pp.62-75.