Financial Statements Analysis and Project Evaluation

This assignment involves analyzing financial statements to understand their importance and role in decision-making. It also requires evaluating two investment projects (A & B) by calculating their Net Present Values (NPVs). Furthermore, students must determine the total cost of producing 40,000 puppets, calculate the cost per puppet, and establish the selling price based on a 15% markup.

Contents
Introduction........................................................................................................................................1
Task 1A................................................................................................................................................ 2
Task 1B................................................................................................................................................ 8
1.1 Discuss the purpose of these financial statements......................................................................8
1.3 Examples of financial planning and significance of financial planning........................................10
1.4 Information requirements of different shareholders of the firm................................................11
1.5 Discuss how different forms of financing affects the format of the financial statements............12
1.6 Ratios and comment on the activit of the firm..........................................................................14
Task 2A.............................................................................................................................................. 21
Task 2B..............................................................................................................................................23
Task 2C..............................................................................................................................................25
Conclusion.........................................................................................................................................25
References.........................................................................................................................................27
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·Introduction

A humble attempt has been made through this paper to throw light on the requirements and the
usefulness of financial statements. Financial statements are used by a lot of interested parties
such as the government, creditors, stakeholders and board of directors. As a consequence
financial statements should portray the true and fair view of the organization.

Task 1A
Capital is not only required by a business at start up or at the expansion phase but a business
may require funds to fund its daily operations. The capitals can be of various shapes like
working capital, hire purchase, leasing etc.
The source of capital to be chosen depends upon a lot of conditions such as:
1.Time frame for which the funds are being borrowed: If the funds are required for a
very long time equity capital is chosen over other forms of finance. The money of the
shareholders can be repaid only after the winding up of the organization. However
issue of too many shares might dilute the control in the organization and also affects
the EPS (Earnings per Share).(Brigham & Houston, 1998)
2.The purpose of the funds: If the funds are required for normal day to day operations
i.e. for funding its working capital requirements the organization might resort to short
term or medium term debts.
3.The type and the form of business: The source of finance also depends on the form
of the organization. A partnership firm can never issue shares to the public whereas a
public limited company can issue shares to the public. Debt can be obtained by almost
all the forms of entities.
For investing its needs for fund, the firm may select resources such as:
l壱Capital market.
l壱Loan stock.

l壱Retained earnings.
l壱Loans from bank.
l壱It can knock into government resources.
l壱It may utilise the model of franchising.
However, sources of finance are basically categorized under three categories:
1.Own Funds: Money received from the issue of equity shares, preference shares,
stocks and owner’s contribution fall under this category. No interest is required to be
paid on such monies but an organization has to pay dividends on such amounts. The
leading benefit of utilising these capitals is that the firm does not require paying these
during its lifetime though, the firm cannot go on issuing these shares as that would
reduce the control in the association and also deteriorate the capital. The cost of equity
is the dividend paid on such shares and is denoted by Ke.(Brigham & Houston, 1998).
Advantages of own capital
It is basically a risk free fund.
Interest free.
No time period for return back.
Its own general saving money no obligation on debt security.
Disadvantages of own capital
Loss the opportunity cost for making own contribution.
No tax benefit.
1.Retained Earnings: Retained earnings are the past years profit. The organization can
use such funds to meet various requirements. Though these funds do not have a
specific cost but the opportunity cost can be considered to be the interest forgone had

the money been spent elsewhere. As per a few scholars the cost of retained earnings
may be considered to be same as cost of equity.
Advantages
l壱Cheaper source of financing for the organisation
l壱Financial stability
l壱Market value as compare to other company
l四Stable dividend for the shareholder
Disadvantage
l壱Over capitalization
l壱Low rate of dividend
l四Improper utilization of fund
1.Debt Funds: Debt funds are the reasonable source of finance since the interest is
given on such finance is tax deductible. For example if the rate of tax is 40% and the
organization has paid $100 as interest the cost of debt would be 100(1-40%)= $60.
Which means the organization was able to save $40 in the $100 paid as interest.
However the organization cannot resort to debt funding all the time as it impact the
capital structure and also the rate of interest keeps on increasing with an increase in the
amount of debt.

2.According to all these three cases mode of investment are different at the various stages of a
business from start up to business expansion. Various sources of fund should be uses at every
level of business. Different sources are to be used at different stages of business. As start-up it
is very hard for the organization to resort to equity funds as without an established track record
no one would be willing to invest in the organization. At the start-up phase an organization can
resort to venture capital and other sources of finance. For a business expansion the
organization can opt for a mix of both debt as well equity funds. The ideal ratio in this case is
considered to be 2:1.
Advantages
l壱Proper fulfilment of short term needs
l壱Tax advantages
l四Future impact forecasting.
Disadvantages
l壱Most lender provide server penalties for the late payment
l壱The amount of money small business may be able to obtain via debt is likely to nbr
limited.
Case 1 Start Up
For the start up the organisation need funds so as to manage operations. Funds are required to
set up assets required for the business. Employees are to appointed so as to manage business
operations. For the purpose of starting a business there are two major sources of finance

available with start up company i.e. bank loan. Banks are available with finance facility that is
available with start up company. They charge interest. Another source of funds can be own
funds or own savings that owner of business have. These are cost free finance that is available
with company’s owner. On more source of funds can be loan from friends and family that
charges some interest on loan amount.
1 Owner’s fund- It is a internal source of fund which are interest free and less risky in order to
effectively start up of business.
2 Bank loan- Bank provides loan for establishing the small business. It may be a kind of
personal loan with some security collateral against the loan amount. This fund can be used for
purchasing real estate, large equipment or inventory. It can used for further purpose as
working capital for daily routine operations. The main disadvantage for this source of fund is
to pay interest on loan.
3 Family and friends- It is one of the most common sources which are easy and early funds for
start up of enterprise because friends and family know very well about his financial status in
way to repayment their fund in a specified time period. they also give enough time to build his
own business.

l壱
l壱Case 2 Expanding Company
In order to expand company funds are required for effective management of business
operations that are to be expanded. There are any new costs or expense that is to be incurred
for new operations. For an existing company, many sources of finance are available with them
since they had stepped up in the funds market. Therefore many sources of finance are available
with them. Major source of finance are issue of debenture or issue of equity shares. Both
requires cost of capital i.e. interest cost of debenture and cost of capital for equity shares.
l壱Debenture

l壱Equity share capital
Cost required for the expansion of the company is £ 200000
1. Debenture- It is a type of debt instrument which are not secured against any physical assets
or collateral. Its value is on the basis creditworthiness and reputation of issuer company. In this
company must liable to pay specified amount with interest. It helps in to raised money by
debenture holders.
2. Equity shareholders- Equity shareholder are the real owner of the company. They have
voting rights to take part parts in meetings and conferences of a company. It is the main source
of finance for working capital. Companies paid dividends to equity shareholder according to
their contribution and profit earn by the company but they get dividend after paying to
preference shareholders.
Case3 A buy out of a medium sized business
Acquisition and mergers are management decisions that are to merger with or acquire existing
company for better management or expanding market share. Acquiring another company
requires funds in order to discharge consideration of the acquisition of company. For this
purpose there are many sources of funds available like preference shares issued to new
company’s shareholders, equity share to new company’s shareholders, debenture issues to new
company’s shareholders or cash payment by acquiring bank loan. These all sources of funds
requires cost or financial implication.
l壱Preference share

l壱Equity share
l壱Debenture
l壱Bank loan
1. Preference share- It have both the characteristics equity shares and debentures. These type
of shareholders have certain rights and firstly dividend is paid to the preference shareholders at
a fixed rate. Second major advantage are at the time of winding up of company shareholders
capital is prior to paid preference shareholders after that equity shareholders.
2. Bank loan- Bank also provides a loan to small scale business and modernization of business
and at the time of merger and acquisition that huge amount of money is required for expansion
of business. It can be taken on basis of existing business inventory and assets or may be taken
on personal loan. Bank loan is always paid with interest.
Cost required for the buyout of a medium sized business£ 60000
·Task 1B
1.1Discuss the purpose of these financial statements.
As per International accounting standard, financial statement is the main tool to analyse the
financial performance of the company. It conducts total business operations as well as
financial management. The financial management groups prepare the financial statement
analysis. There are four steps to calculate financial statement and those are balance sheet,
profit and loss account, cash flow statement and statement of equity. Generally a set of
financial statements include profit and loss statement, balance sheet and cash flow statement.

The mirror of the firm’s performance is financial statement. Financial statements are the
mirror of the company’s performance. Without the financial statements it would be very hard
to gauge the financial performance and health of the organization. Financial statements are
made within the accounting framework of the nation within which the organization operates.
Any deviations from the same which have a material effect on the financial statements should
be properly disclosed and the effect has to be quantified. Financial statements are used by the
board of directors, investors, government and other interested parties. Considering the same it
is of paramount importance that the financial statements are disseminated in a timely and
efficient manner. The financial statement requirements for different forms of entity are
different. For example a partnership concern might or might not have to prepare a cash flow
statement. On the other hand a non-profit organization only prepares an income and
expenditure account and balance sheet. (Lumby, 1994)
1.2 Factors need to consider by the boards while taking decisions relating to the
source of finance.
There are various modes of finance available to an organization. The two basic categories are:
1.Loan Funds: These are the funds that have been procured from sources outside the
organization. Debentures, Short Term loans, Medium Term loans and Trade Credit fall
within the ambit of loan funds. Generally interest is paid at a fixed rate on the sum
borrowed. The loan is repaid as per the terms of the loans i.e. in X number of
instalments. However this basis of finance is cheaper as the interest payable on these
loan is a tax deductible cost. So if the rate of taxation is 40% the cost of debt would be
Kd=Interest Paid (1-40%).

2.Own Funds: Own funds are those funds that have been procured from within the
organization. Money raised from the issue of equity is considered as own funds as
shareholders are considered as the owners of the organization. Retained profits also fall
within the scope of own funds. Generally dividends are paid to the shareholders
against the money that they have invested and that is considered to be cost of equity.
According to the conventional theories, cost of retained earnings is equal to the cost of
equity however; some scholars consider that the cost of retained earnings is the interest
forgone had they been invested some place.(Brigham & Houston, 1998)
l四1.3 Examples of financial planning and significance of financial planning.
For every organisation, financial planning is one of the most important techniques to
increase financial growth. Without financial planning the organisation cannot meet his
goal. It is very important for an organization and the main purpose of the financial
planner is to increase the capital of the organization. The increasing of wealth is a wider
theory than maximization of incomes as wealth takes into the dividend policies and the time
value of money. Correct financial plan can work wonders for the organization. Various
financial plans have different implications. Too much debt can affect the leverage position of
the firm and too much equity can dilute the control of the organization. Hence the financial
plans have to devise very carefully. Finally, financial planning mainly ensures the investors
to invest in this organisation and this is the most important features of the organisation.
Importance of financial planning
l四Financial planning mainly decreases the uncertainty and increase profitability
of the company.

l四It helps in fixing the most suitable capital structure for the organisation in the
right place.
l壱It facilitates collection of optimum funds for the various sources of financing.
l壱It links present with future.
l壱Helps in proper utilization of finance in various projects.
l壱Help in avoiding business shock and surprises.
l壱Base of financial control.
l壱It helps in investing finance in right project for the organisation.
l壱Link between financing and decisions.
l壱壱It is very helpful for coordination.
l壱壱Financial planning determines the short term and long term goal of finance which
effectively coordinate the present financial needs with future growth plan of the company.
It also helps in to achieve cost effective business goal. It also provides best plan for
overcoming the wastage and over capitalization situation. Financial planning should be
appropriate because success and failure of any organization depends on it by proper
functioning of operation and distribution. Optimum utilization resources could be
achieved through proper planning of assets. Capital of an organisation should be
appropriately divided in to all the departments like production, sales promotion and other
activities.

l四四1.4 Information requirements of different shareholders of the firm.
The extracts of the financial statements given above are not sufficient to gauge the
performance of the organization. As mentioned before, the information presented is an extract
of the financial statement and are not proper financial statements. The financial statements
give a very unclear picture of the organization’s performance. Neither the assets nor the debts
have been clearly shown in the extracts. All the information has been provided in a
summarized form and is not enough to draw a conclusion from the same. From the given
information we can only learn about the turnover and the other expenses. Only selected pieces
of information can be calculated from the above. The investors can only understand the gross
profit margin, stock turnover, return on equity and a few other things. This can help the users
of the financial information to understand if the organization is profitable or not however does
not give a clear idea about the cost of debt and the cost of equity. The extracts also don’t
provide any information about the taxes paid by the organization. (Whiteley, 2004)
The various needs for the stakeholder are in terms of information needs are as follows:
l壱It is essential that there be a dialogue between users of information and suppliers of
information.
l壱The communication of information is critical to an effective response to the potential
impact of climate change in the Great Plains.
l壱Various information should be disclosed by the company in front shareholders like
Notice of meeting and company financial report. Company discloses information about
their holding shares and relative deal. They also announce about any new development

and movement in the security prices and movement in the business performance.
Company also have responsibility to notify the customers about any merger and
acquisition with another business. Organization should provide information about how
dividends is paid with which procedure to be used mostly companies provide dividend
once in year after the company annual report are drawn. Material transaction of the
company should be notify to its shareholders what product to be manufactured under
this process. Shareholders have every information about when company jump from one
kind of business to another or any expansion in existing business. Shareholders always
informed about the winding up or life cycle of the company.
l四1.5 Discuss how different forms of financing affects the format of the financial
statements
Each and every source of finance impacts financial statements of the company. There are four
financial statements that will be impacted when funds are taken i.e. source of finance. Types of
financial statements are balance sheet, income statement, cash flow statement, statement of
change in equity and note of accounts.
Balance sheet is the major financial statement that records assets and liabilities of the
company. Balance sheet represent financial position of the company on the reporting period.
Assets are owned and controlled by the company and liabilities shown is debt taken and other
current obligation of the company.
Following is the impact of finance on balance sheet and income statement of the company:

FINANCE BALANCE SHEET INCOME STATEMENT Bank Loan Bank loan will
increase assets of the company as cash is increased in bank account. On the other hand it will
be shown as bank loan in the non-current liability side of the balance sheet. Payment of
instalments will reduce amount of bank loan on propionate basis. Bank loan has interest as its
financial cost and these cost are to be charged to current year’s profit. Interest charges on bank
loan will show on debit side of the income statement. Equity Shares Equity shareholders are
owners of the company and they are reflected on separate section in the balance sheet of the
company. Issue of equity shares will increase equity shareholders fund in both value and
quantity i.e. no of shares. Issue of equity shares will not impact income statement of the
company. But when dividend is paid to equity shareholders are to be charged to income
statement. Debentures Debentures are debt acknowledged by company and issued to public.
Generally debentures are issued for long term i.e. for 10-15 years. Therefore they are non-
current liabilities of they will be shown in liabilities side as non-current liabilities. On the
contrary cash received from issue will be reflected in the bank account. Debentures has interest
cost as its financial implication and this interest will be charged to current year profit of the
company. Interest on debentures is shown in debit side of the income statement. Own Funds
Own funds are capital that are invested by proprietor of the company for the start of company.
These are sources of funds will be shown separately in the balance sheet of the company.
Capital is not shown for the company but for sole trader and in partnership firm it will be
shown separately in balance sheet. Since there is no cost on the use of amount of own funds in
the company. In case of partnership firm or sole trader there will be drawings charged from the
capital. Equity and debt are two financial sources in capital market. Capital structure is a
composition of cost of capital, leverage ratio and income ratio all these elements affects the

company financial position. In most condition cost of equity are higher than cost of debt so
that equity financing makes a larger contribution in capital structure what usually increases
weighted average cost of capital. Equity financing play an important role when net income is
divided in to large number of shareholders it also mentioned in cash flow statement as well as
increase the liability on balance sheet. Equity financing fund is generated by the sale of
company stock which not be refundable to shareholders because in debt financing fund is paid
in form of dividend but cost of equity financing is more than debt financing. Equity financing
calculation based on capital asset pricing model.

l四1.6 Ratios and comment on the activit of the firm
1)Calculation of Return on Capital Employed (ROCE):
ROCE = Net operating Profit / earning before interest and tax
Capital Employed
Net Operating Profit = Total Turnover – Cost of goods Sold- Expenses – Interest Payable
For 2003 = 2, 05,157 - 1, 72,065 – 27,342 – 1,925
= £ 3,825
For 2002 = 1, 82,530 – 1, 53,730 – 22,285 – 1,220
= £ 5,295
Capital Employed = Total Assets – Current Liabilities (Given)
Return on Capital Employed
For 2003 = (3,825 / 47,505) X 100
= 8.05% (approx.)
For 2002 = (5,925 / 34,912) X 100
= 16.97% (approx.)
1)Calculation of Gross Profit Ratio:-

G/P Ratio = (gross profit / Net sales) X 100
Gross Profit = Total Turnover – cost of selling goods
For 2003 = 2, 05,157 – 1, 72,065
= £ 33,092
For 2002 = 1, 82,530 -1, 53,730
= £ 28,800
G/P Ratio:-
For 2003 = (33,092 / 2, 05,157) X 100
= 16.13%
For 2002= (28,800 / 1, 82,530)X100
= 15.78%
1)Calculation of Stock Turnover Ratio (STR):-

STR = Net Sales – G/P
Stock
= Cost of Goods Sold
Stock
For 2003 = 1, 72,065/ 12,482
=14 times (approx.)
For 2002 = 1, 53,730 / 11,862
= 13 times (approx.)
1)Debtors Collection Period ( Debtors Days):-
Average Collection Period = debtor / sales
For 2003 = (32,287 / 2, 05,157) X 360
= 57 days (approx.)

For 2002 = (28,410 / 1, 82,530) X 360
=56 Days (approx.)
1)Creditors Payment Period:
Net Credit Purchases = Sales + Closing Stock – Gross Profit
For 2003
Net Credit Purchases = 205157+12482-33092
= 184547
Creditors payment period = 365 / net credit purchase x average payables
365 / 184,547 x 13,388 = 26 days
For 2002
Net Credit Purchases = 182530+11862-28800
= 165592
Creditors payment period = 365 / net credit purchase x average payables
365 / 165,592 x 30,436 = 67 days

From the profit and loss account for the year endedIncrease/Decrease£000
£00020032002Turnover20515718253012%Cost of goods
sold17206515373012%Expenses273422228523%Interest Payable1925122058%
From the balance sheet as at 31 March 2003 31 March 2002 Increase/Decrease£000
£000Stocks12482118625%Trade Debtors322872841014%Trade
Creditors170481358525%Total Asset less current liabilities 475053491236%Creditors
Due after more than one year13388687095%Share Capital ( 25p share)6782428258%
Analysis
Though the sales have increased by 12% the expenses of the organization has increased by
23%. The organization should look to keep a tab on the same. It is also evident from the above
that the organization is facing credit crunch issues. As a consequence the creditors not paid for
more than a year have increased by 95% which is not a very positive sign. Though the gross
profit ratio has increased the net profit has gone down as a result of increase in other expenses
and interest payments. The organization should reassess the impact of the same on the
financial performance.

·Task 2A
The cash status of the firm represents cash flow statement. It helps the user in gauging the
liquidity position of the organization. Based on the study of the cash flow of the following
observations have been made:

The main problems for the cash budget are given below:
1.The organization has been facing problems with collection from consumers. As the
complete financial statements have not been presented it two things can be assumed.
First, the organization faces huge fluctuations in sales or the collections have not been
good.
2.The organization has a conversion cost of £2340 against the sales of £3325. This
accounts for almost 70% of the sales. This is extremely high.
3.The cash flow statement has been classified in the wrong way. The cash flow does
not inform the user about the income or the expenditure. It only informs about the
inflow and the outflow.
4. It is the estimation of future cash receipts and payments of cash. All the income like
cash from sale, interest, dividends and other receipts and all expenses like divided paid,
purchase of material and sales must be equal. If any differences are generate create
problem in future expenditure plan.
5.In this all the expenditures and income are not correctly mentioned so that
mismanagement for assigning and allocating the budget for an individual activity.
6. Cash statement should be proper when all the collection from sales can be
effectively achieved and makes an equal statement about the cash payment and
receipts.

The causes for the problems are:
l壱Collection and factoring work is not properly assigned.
l壱There are various causes relation to the cash flow statement
l壱The value of sale has been over stated.
l壱 Balance sheet are not properly matched with respect to assets and liabilities so that
income statement is not properly generate which can not identify the company financial
statement of a year which doesn't show the profit and loss of the company. Allocation
of fund should be equal and according to their requirements in order maintain their
working efficiency.
l四Through this financial statement of a company are wrongly generate which makes an
negative impact on the shareholders of a company and may get destroy the company
image in market place.
Recommendations
The organization should look to reduce the conversion cost. It should either find substitutes for
the materials being used or different techniques of production. The organization should also
keep a tab on the salary and sundry expenses. To avoid situations where the cash outflow is
more than the cash inflow the organization should plan its activities more carefully. If the
organization is facing problems collecting the debts it can factor the debtors. The organization
can also get debt collection agencies to do the job for them. Company should maintain their
cash equivalent budget in order to maintain strengthen in financial statements of a country. All

the activities are coordinated with each other to gain efficiency in order to achieve get cash
budget.
·Task 2B
Memorandum Report
Project A: The project aims to introduce high tech machinery into organization’s production
unit. With the implementation of this project the organization would benefit from savings in
maintenance and production cost.
Project B: This project is aimed at the improvement and expansion of the organization’s
techniques of marketing. One of the most influential organizations of the region would be
appointed to take care of the same.
Analysis
l壱Both the projects have an initial outlay of £45000, however the cash inflow of differs for
various years. The cost of capital for both the projects has been assumed to be at 6%. Based on
the NPV project A should be considered over project B as project A has a higher NPV. NPV is
the worth of the project. It equals to discounted cash inflow minus the discounted cash
outflows. In this case the NPV of project A is more than project B by £133160.(Houston
chronicle, 2014)
Calculation of Net Present ValueYearCash FlowDiscounting factor @6%Discounted
Cash Flow Project AProject B Project AProject B 0-450000-4500001-450000-

4500001180000600000.9431697405658022300001200000.8892044701066803280000250000
0.83923492020975041200002500000.79295040198000 NPV254170121010

·Task 2C
Calculation of Total Cost of Producing 40000
puppets ParticularsCalculationAmounts(£)Direct Material40000*3120,000Direct
Labour40000*1.1044,000Variable cost40000*.7028,000Fixed cost6500065,000257,000
Cost per Puppet = 257,000 / 40000
= £6.425
Calculation of Selling Price of each puppet:
Cost of each Puppet = £ 6.425
Add: 15% Mark-up Profit = £ 0.964
Selling Price of each Puppet: £ 7.389
Therefore, after the above calculation, selling price of Puppet is £ 7.389.
Note- Selling price will not be included in the calculation of per unit production cost of the
puppet. Selling price is not included because this cost is not incurred on the production process
but they are incurred for the purpose of selling product.
·Conclusion
The above discussions help us in developing a clear understanding of the requirements of
financial statements. Financial statements are very important and are an integral part of the
responsibilities of the management. Financial statements should be prepared within the
accounting framework of the nation of operation and should be disseminated in a timely
manner.

·References
Brigham, F E & Houston, F J, 1998, 8th edn, Fundamentals of Financial Management, South-
Western, Thomson Learning, Ohio.
Lumby, S, 1994, 5th edn, Investment Appraisal and Financial Decisions, Chapman & Hall,
London.
Whiteley, J, 2004, Mastering Financial Management, Palgrave Macmillan, New York.
University of Kent website, 2014, Decision Making skills, [Online}, Available at:
https://www.kent.ac.uk/careers/sk/decisionmaking.htm [Accessed on 9th April 2014].
Houston chronicle website, 2014, The impact of Financial Statements, [Online], Available at:
http://smallbusiness.chron.com/impact-financial-statements-23794.html [Accessed on 6th
April 2014].