An Analysis of the Financial Performance of a Company

The current ratio of a company decreased from 3.33 to 2.16, and the quick ratio decreased from 5.24 to 2.04, indicating a decline in business liquidity. The activity or efficiency ratios also showed a decrease, with total assets turnover ratio decreasing from 3.43 to 3.03 and inventory turnover ratio decreasing from 17.14 to 11.11. This suggests that the organization is not performing well financially and operationally, requiring necessary decisions to enhance its return and financial status.

Managing Financial
Resource Decisions
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Table of Contents
INTRODCUTION......................................................................................................................1
TASK 1......................................................................................................................................1
AC 1.1 Types of finance sources...........................................................................................1
AC 1.2 Implications of different finance sources..................................................................1
AC 1.3 Case study examples for the businesses....................................................................2
TASK 2......................................................................................................................................2
AC 2.1 Cost of finance sources for raising the funds............................................................2
AC 2.2 Importance of financial planning..............................................................................3
AC 2.3 Financial decision making........................................................................................3
AC 2.4 Financial statements..................................................................................................4
TASK 3......................................................................................................................................4
AC 3.1 Analysis of sales budget and cash flow forecast.......................................................4
AC 3.3 Application of different investment appraisal techniques.........................................5
AC 3.2 Calculation of breakeven point, contribution and profitability.................................7
TASK 4....................................................................................................................................10
AC 4.1 Books of prime entry and financial statements of different organizations.............10
AC 4.2 Financial statements of different types of organization..........................................11
AC 4.3 Analysis of financial statements.............................................................................11
CONCLUSION
.................................................................................................................................................12
REFERENCES.........................................................................................................................13
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Index of Tables
Table 1: Calculation of payback period (In £)...........................................................................5
Table 2: Calculation of Accounting rate of return (In £)...........................................................6
Table 3: Calculation of net present value (In £).........................................................................6
Table 4: Calculation of internal rate of return (In £)..................................................................6
Table 5: Calculation of contribution per unit and profit (In £)..................................................7
Table 6: Profit and Breakeven point by changing the selling price (In £).................................8
Table 7: Profit and Breakeven point by changing the fixed cost (In £).....................................8
Table 8: Profit and Breakeven point by changing the material price (In £)...............................9
Table 9: Profit and Breakeven point by changing the labour price (In £)..................................9
Table 10: Calculation of profits (In £)......................................................................................10
Table 11: Ratio analysis ..........................................................................................................11
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INTRODCUTION
Every business organization establishes with the purpose of survival for a long time
period. Therefore, it becomes necessary for the organization to have adequate amount of
finance availability so as to run its operations in an effective manner. Finance is termed as the
lifeblood of the business for all the organizations whether new or old and large or small scale
organizations. This report helps in identifying a variety of finance sources that are available
to different type of organizations. Moreover, it describes the way that how organizations can
take effective business decisions through proper financial planning.
TASK 1
AC 1.1 Types of finance sources
Finance sources influence the business operating activities to a great extent. The types
of finance sources that is available to the organizations that are described below:
New and old: New business start ups can use its personal savings and loans from
others such as friend and family members. Moreover, they take loans from banks to a limited
extent. However, old business organizations can use internal and external sources. They can
use its retained earnings, banks loans and share capital.
Large and small: share capital and debt capital are considered as major finance source
available to large business organizations. Moreover, it can use venture capital and profits
from other businesses to expand its business operations (Davies and Crawford, 2011).
However, small business organizations can use overdrafts facilities, retained earnings and
short term and medium term bank loans. Moreover, it can sale its disposable assets and cash
can be squeezed through its operations.
AC 1.2 Implications of different finance sources
Every business organization use a combination of available finance sources at least
cost. Therefore, they consider its advantage, disadvantage and legal aspects.
Bank loans: It is a major source of finance the advantage is that available for different
time period at chargeable interest rates? The disadvantage is that in case of failure to pay the
bank loans the security kept against the loan can be disposed off. Moreover, banks charge a
higher rate of interest on loans for new business start ups. Many legal requirements have to
be fulfilled by the enterprises.
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Share capital: The advantage of this source is that the company is not obliged to pay
regular return to the shareholders. However, disadvantage is that shareholders are the owners
of the company so they have voting rights to the company (Romano, Tanewski, and
Smyrnios, 2001). Therefore, they have control over the organizations. Legal aspect is that
company cannot issue more than its authorised share capital.
Overdraft: The advantage is that it fulfils the urgent finance requirement while
disadvantage is that banks charges a higher rate of interest on these facilities. Moreover, it
negatively impacts the corporate image.
AC 1.3 Case study examples for the businesses
Small business start ups: ABC Ltd. wants to establish a small scale business. In order
to fulfil the finance need it use personal savings and take loans from friends and its family
members.
Large business expansion: After achieving the growth ABC Ltd operates its activities
at large market place. Moreover, the company wants to expand its operating activities to
achieve its objectives. For that purpose, it use both short term and long term finance sources
by using bank loans, issuing share capital (Mangan, Hughes and Slack, 2010). Moreover, it
can use profits from other business, sale its unusable assets that causes loss and provide
venture capital.
Buying an existing medium-sized company: ABC Ltd. wants to acquire an existing
medium sized business. It can issue debentures, share capital and take medium and long term
bank loans. Moreover, retained earnings are also available at without any cost to the company
for that purpose.
TASK 2
AC 2.1 Cost of finance sources for raising the funds
In order to ensure long run survival of the company every business needs to raise its
funds to meet its requirements.
Share Capital: Funds can be generated by issuing both equity and preference shares.
The cost of this finance source is that shareholders require dividend on their investment.
Moreover, they also have the objective of capital appreciation.
Debt capital: Another type of finance source is bank loans and issuing the debentures.
The cost of this source is that the company has to pay interest on the amount of loans
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(Managing Financial Resources and Decisions, n.d.). Moreover, it also requires instalment
payments over fixed time duration.
Retained earnings: Business can use its profit balance after paying return to the
shareholders. It does not involve any cost to the company and available as an internal finance
source.
AC 2.2 Importance of financial planning
Financial planning helps the organizations in many ways. It is important due to
different reasons that are described below:
Importance: Financial planning is a significant for the organization to achieve its
financial goals. It determines the amount of capital requirement for different purposes. Then
after, it identifies the available finance sources and selects an appropriate composition of it.
Thus, it can be said that it helps in fulfilling the organization funds requirement at least cost.
Moreover, it ensures that scarce sources have to be optimum utilized to increase business
profitability. Further, it frame policies regarding procurement, investment and for proper
administrating the funds (Manyard, 2013). In addition, it maintains proper balance between
fund inflows and outflows. Thus, it can be said that it ensure proper availability of working
capital for the businesses. This in turn, resulted in increasing the profits and maximizing
wealth and dividends to the shareholders.
AC 2.3 Financial decision making
Effective financial decision making ensures the organization success in a great
manner. Decision making process requires both financial and non financial information.
Financial information can be collected from the financial statements. Decision making
process involves gathering, processing and evaluating the information. Comparative financial
statements and ratio analysis method helps to analysing the financial information reported in
the financial statements (Bebbington, Gray and Laughlin, 2001). It helps in analysing the
business profitability, efficiency, liquidity and solvency position. Therefore effective
decisions can be made to improve its profitability and the business ability to pay its debts.
Moreover, the organization is able to ensure effective use of its assets. Budgets also can be
used for analysing the variance and take correct actions to mitigate it. Cash related
transaction also requires for proper administration of cash flows. It can be done by making
cash flow statements and for managing all the funds information can be collected from fund
flow statement. Moreover, cash flow management evaluates the cash flows regarding
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business operating, investing and financing activities. Thus, it helps in examining both the
revenue and capital expenditures. Therefore, it can be concluded that effective decisions
helps the business in moving upward direction by increasing the business growth.
AC 2.4 Financial statements
The cost of all the applied finance sources shows in the organization's income
statement and balance sheet.
Loan Capital: The cost is the amount of interest that the organization has to pay on
respective loans. It will show in debit side of profit and loss account while it increase the
liability hence, shows in liability side of the balance sheet (Baker, Dutta and Saadi, 2010).
Share capital: Total amount of dividend that is paid to the shareholders shows in debit
side of profit and loss account. However, in balance sheet it shows in liability side under the
capital head.
Cash squeezed: The delayed payments to the creditors shows in liability side under
the current liability head. However, received amount of debtors is deducted from total debtors
in assets side.
Retained earnings: it does not have any cost so it is not shown in the income
statement. However, the amount of retained earning that is used for getting the funds is
deducted from reserve and surplus in liability side (O' Bryan, 2010). Moreover, it shows in
statements of retained earnings.
Overdrafts: The amount of interest paid shows in debit side of profit and loss account.
However, in balance sheet it shows in liability side in the current liability head.
TASK 3
AC 3.1 Analysis of sales budget and cash flow forecast
Sales budget: The presented sales budget indicates that actual sales are less than the
forecasted or budgeted sales volume. Therefore, negative variances occur from July to
December. Moreover, the variances are increasing continuously indicate that company is
facing some difficulties that results in lower sales. The reason for such variances may be
increasing the product price, lowering the product demand and availability of substitute
products. Moreover, if the company is not adopting an effective marketing strategy than it
also results in declined the sales (Blocher and et. al., 2008). On contrary, the product quality
and customer services also impact the sales. In order to eliminate all the problems and
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improving the sales it is considered advisable that organization has to improve the product
quality by innovations. Moreover, qualified customer services at reasonable rates helps to
increase the product demand and sales. Further, effective and strategic market planning and
product differentiation helps for such purpose.
Cash flow forecast: To enhance the cash surplus and minimize the cash deficit the
organization has to increase its sales and decrease its expenditures. Moreover, the available
cash surplus may be further invested so as to get extra return on it (Longneck, 2011). This in
turn, helps in avail significant cash balance at the end of the period.
To
The Director of ABC Ltd.
Date 4/11/2015
After making a proper analysis it can be reported that organization sales is
declining continuously. It may be because of high level of competition, available substitute
products and higher the prices. Therefore, it is considered advisable that business has to
decide the prices by considering their competitor prices. Moreover, quality can be improved
by using better quality of material. Further, organization has to decrease the cost so as to
increase the cash availability. On contrary, to improve the cash balance it can reinvest its
previous cash balances and earn return on it.
AC 3.3 Application of different investment appraisal techniques
Investment appraisal techniques help to select an appropriate investment proposal that
yield maximum profits to the business (Gervais Heaton and Odean, 2011).
Payback period: It is considered as the time period to earn the initial cash outflow of the
proposal.
Table 1: Calculation of payback period (In £)
Project A Project B
Year Cash Flow Cumulative Cash flow Cumulative
0 450000 -450000 -450000 -450000
1 180000 -270000 60000 -390000
2 230000 -40000 120000 -270000
3 280000 240000 250000 -20000
4 120000 360000 250000 230000
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Total 810000 680000
Project A = 2 Year + 40000£/280000£
= 2.143 year
Project B = 3 year + 20000£/250000£
= 3.08 year
Decision: Project a take less time to earn the initial investment of 450000£.
Therefore, project A is more beneficial for the company.
Accounting rate of return: It identifies the accounting profit return on total investments.
Decision: The ARR of project A is 45% while project B has ARR of only to 37.78%.
It is higher in case of project A indicates that it provides more return to the company.
Net present value: It is the difference between discounted cash inflows and cash outflow
using an appropriate discount rate.
Table 2: Calculation of net present value (In £)
Project A Project B
Year Amount
Discounted
value@6%
Discounted
cash inflow Amount
Discounted
value @6%
Discounted
cash inflow
0 -450000 1 -450000 -450000 1 -450000
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1 180000 0.943 169740 60000 0.943 56580
2 230000 0.89 204700 120000 0.89 106800
3 280000 0.84 235200 250000 0.84 210000
4 120000 0.763 91560 250000 0.763 190750
Net present
value 251200 114130
Decision: The net present value of project A is 251200£ while B has net present value
amounted to 114130£. It is higher in case of project A so it is better for the company.
Internal rate of return:
Decision: The internal rate of return on both the projects is 29.20% and 15.02%. It
shows that project A provide higher return than compare to project B.
Recommendation: On the basis of above decisions, it can be concluded that ABC
Engineering Ltd. has to make investment in project A because of lower pay back period and
higher return (Bierman and Smidt, 2012).
AC 3.2 Calculation of breakeven point, contribution and profitability
Table 3: Calculation of contribution per unit and profit (In £)
Particular Per unit Total Amount on 7500 Units
Sales 120 900000
-Material cost 52.5 393750
labour cost 35.75 268125
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Variable overhead 10.2 76500
Total Variable cost 98.45 738375
Contribution 21.55 161625
-fixed cost 120000
Profits 41625
Contribution/sales ratio = 161625£/900000£*100
= 17.96%
Break-even Point = Total Fixed Cost/CPU
= 120000£/21.55
=5568.45 (5568, Approx)
Breakeven Point (In £) = 5568 Units *120
= 668160£
Margin of Safety = Total sales – break even sales
= 900000£ - 668160£
= 231840£
M/S per Unit = 231840£/7500 Units
= 30.91£
Break-even Chart:
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Impact on profits and breakeven point by varying the selling price and cost factors
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Table 4: Profit and Breakeven point by changing the material price (In £)
5000 Units 8000 Units 10000 Units
Particular
5£
increase 5£ decrease 5£ increase 5£ decrease 5£ increase 5£ decrease
Selling price
per unit 120 120 120 120 120 120
Total sales 600000 600000 960000 960000 1200000 1200000
-Material cost 287500 237500 460000 380000 575000 475000
labour cost 178750 178750 286000 286000 357500 357500
Variable
overhead 51000 51000 81600 81600 102000 102000
Total Variable
cost 517250 467250 827600 747600 1034500 934500
Contribution 82750 132750 132400 212400 165500 265500
CPU 16.55 26.55 16.55 26.55 16.55 26.55
-fixed cost 120000 120000 120000 120000 120000 120000
Profits - -119973.45 -119983.45 -119973.45 -119983.45 -119973.45
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119983.4
5
BEP 7250.75 4519.77 7250.75 4519.77 7250.75 4519.77
Comparative analysis of two orders
Table 5: Calculation of profits (In £)
SouthWood Electricals Westbrook Engineering
Particular 7500 Units 500 Units 8000 Units 1000 Units 8500 Units
Sales 900000 51000 951000 90000 990000
-Material cost 393750 26250 420000 52500 446250
labour cost 268125 17875 286000 35750 303875
Variable
overhead 76500 5100 81600 10200 86700
Total
Variable cost 738375 49225 787600 98450 836825
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Contribution 161625 1775 163400 -8450 153175
-fixed cost 120000 120000 120000
Profits 41625 43400 33175
Decision: ABC Engineering Ltd. has to accept order of Southwood Electrical because
of higher profitability to 43400£ comparatively than Westbrook Engineering profits of
33175£.
TASK 4
AC 4.1 Books of prime entry and financial statements of different organizations
Prime entry books: Every accounting transaction is recorded in prime entry books
initially by following double entry book keeping system. It include sales book, purchase
book, purchase return book, sales return book, journal proper, day book, ledger and cash
book. This are considered as main source of financial information and basis of preparation of
the company's financial statements.
Debit and credit: Double entry book keeping system says that every transaction is
recorded in both the side debit and credit. Transactions are debited when it increase the assets
or expenses and decrease the liability. However, credit transaction indicates that either
decreases in assets or expenses or increase the liability.
Trial balance: It is prepared by combining the closing balance of all the ledgers. The
purpose of this statement is to identify the arithmetical accuracy and preparation of final
accounts (Bennouna, Meredith and Marchant, 2010).
Income statements: Every business need to determine the results of their operations.
Income statements prepared for such purpose. Trading account helps in identifying gross
profits or loss. However, profit and loss account is prepare to determine the net results such
as net profit or net loss.
Balance sheet: A part from business operation results, business also need to determine
its financial position. The purpose of balance sheet is to determine the financial status of the
organization by comparing its assets and liabilities.
Cash Flow statement: The purpose of such statements is to ensure proper and
significant balance between cash inflow and cash outflow from different activities. It analyse
the net changes in cash flow from operating activities, investing activities and financing
activities.
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AC 4.2 Financial statements of different types of organization
Sole trader: It prepares its financial statements according to its own requirements. It
prepare trading and profit and loss account in order to determine the profitability. However,
balance sheet is prepared to determine the financial status.
Partnership: It prepares its final account according to the partnership act
requirements. It prepares partner's capital account, profit and loss appropriation account and
partner's current account under fixed and fluctuating capital account (Zimmerman and
Yahya-Zadeh, 2011).
Company: It prepares its final accounts according to the provisions of companies act.
In the final accounts of the company, all the required information is shown under proper
heads.
Non profit organization: It does not prepare trading and profit and loss account as it is
not established for profit maximization purpose (Financial Management of Not-For-Profit
Organizations, 2011). Income and expenditures, receipts and payments account and balance
sheet are prepared by such organization.
AC 4.3 Analysis of financial statements
Analysis of financial statements helps in taking effective business decisions. Ratio
analysis is the best method for this purpose.
Table 6: Ratio analysis
Ratios Formula 1995 1996
Profitability ratios
Gross profit 40000 50000
Net profit 30000 35000
Net Sales 120000 200000
Gross Profit Ratio (Gross Profit/ Net Sales) *100 33.33 25.00
Net Profit Ratio (Net Profit/ Net Sales) *100 25.00 17.50
Liquidity ratios
Current Assets 20000 54000
Current Liabilities 6000 25000
Closing Stock 7000 18000
Current Ratio
Current Assets / current
Liabilities 3.33 2.16
Quick ratio Quick Assets/Current liability 5.24 2.04
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Activity ratio
Net Sales 120000 200000
Total Assets 35000 66000
Total Assets
Turnover Ratio Net Sales/ Total Assets 3.43 3.03
Inventory turnover
ratio Net sales/ Inventory 17.14 11.11
Profitability ratio: It helps in evaluating and examines the business operational
performance. Higher the profitability ratios indicate that business performance is gets
improved and vice versa. In the year 1995, the gross profit ratio was 33.33% get turned into
25% in the following year. Moreover, net profit ratio also gets declined from 25% to 17.50%.
It implies that business performance is getting declined due to less profitability.
Liquidity ratio: It measures the business ability to discharge its short term liabilities
(Malmi and Granlund, 2009). The current ratio of the company was 3.33 get decreased to
2.16. While quick ratio turned out to 2.04 from 5.24. Both the ratios show a decreasing trend
implies that business liquidity position is decreased.
Activity or efficiency ratio: These ratios are calculated to determine the business
ability to use its assets. Total assets turnover ratio and inventory turnover ratio was 3.43 and
17.14 in the year 1995 get declined to 3.03 and 11.11. It shows that organization is using its
assets and inventory at less efficiency compare to the previous year.
Decision: From the above analysis it can be said that business is not performing better
in 1996 due to less operational and financial performances. Therefore, it is considered
advisable that company has to take necessary decisions so as to enhance its return and
financial status.
CONCLUSION
On the basis of presented report we can conclude that adequate availability of finance
helps to meet the organization requirements. Financial planning is considered as the best way
of selecting an appropriate composition of debt and equity capital. It also assists in different
financial decisions such as capital budgeting decisions. In addition to it, the report describes
that preparation of financial statements helps in determining the operational results and the
business financial performance.
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REFERENCES
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Principles. Cengage Learning EMEA.
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making: evidence from Canada. Management decision. 48(2). pp. 225-247.
Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of
investment projects. Routledge.
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Davies, T. And Crawford, I., 2011. Business accounting and finance. Pearson.
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capital budgeting. The Journal of Finance. 66(5). pp. 1735-1777.
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O' Bryan, W. D., 2010. Financial Accounting: A Course for All Majors. IAP.
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310.
Zimmerman, J. L. and Yahya-Zadeh, M., 2011. Accounting for decision making and control.
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Managing Financial Resources and Decisions, n.d. [Pdf]. Available through
<http://www.thecreativewriters.co.uk/uploads/e604ca73eeb8b8373461a5cdae831b54ee
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