Analysis of Financial Statements and Ratio Analysis

A company needs to prepare financial statements, such as cash flow statements, profit and loss account, income statement, etc., to analyze its financial position. The company should also calculate different ratios to find out its assets, liabilities, and whether it has earned a profit or faced a loss condition. In this report, the author emphasizes the importance of financial planning and various accounts required by decision makers to take necessary decisions. The report analyzes different companies' financial positions using various techniques, methods, and ratios.

MANAGING FINANCIAL
RESOURCES AND
DECISIONS

Table of Contents
INTRODUCTION ..........................................................................................................................1
Task 1...............................................................................................................................................1
1.1 Sources of finance available to the business. .......................................................................1
1.2 implication of various sources..............................................................................................2
1.3 Sources of finance available to fulfill the following needs...................................................3
Task 2...............................................................................................................................................3
2.1 Cost of different sources of finance. ....................................................................................3
2.2 Importance of financial planning..........................................................................................4
2.3 Types of financial information required for decision making purposes..............................4
2.4 Sample templates of profit and loss account and balance sheet............................................5
Task 3 ..............................................................................................................................................8
3.1 Finding and recommendation for the budgets analyzed.......................................................8
3.3 Calculation of various ratios in order to find out the best project.........................................8
3.2 Calculation of different types of unit cost. .........................................................................10
Task 4.............................................................................................................................................13
4.1 Uses and purpose of various types of accounts...................................................................13
4.2 Difference between different types of organization............................................................14
4.3 Calculation of different ration in order to find out the companies positions......................14
Conclusion ....................................................................................................................................16
References......................................................................................................................................16

INTRODUCTION
Finance is a science that describes the management of money, credit, investments, banking and
assets and liabilities. Finance consists of financial system and financial instruments. Finance is
divided into three categories (i.e. public, personal and corporate finance). The following report
interprets the various sources of finance available to the business in order to raise capital for the
expansion or starting a new business. This report shows the various implications of finance faced
by the business at the time of allocation of the resources. In this report various financial
decisions are also taken after analyzing the various financial accounts. At last financial
performance of the business are also evaluated considering the fixed, variable cost and break
even.
Task 1
1.1 Sources of finance available to the business.
There are different types of sources available with the business in order to raise their
capital. These available sources help to meet short term and long term funds requirement of the
organization.
Short term sources of finance
Bank Loan: - in case of bank loan bank lends small amount of money to the company by
charging the high interest rate (Anheier and Winder, 2007). This method is used by the company
who want to start up a new business or expand its business.
Trade Credit: - This is another method used by the company in order to raise its funds.
In this case company purchases the assets from the vendor without making him any due
payment. The period for trade credit runs for 28 days only. This method can be used by the in
order to meet its quick requirement of the assets.
Long term sources of finance
Issue of Shares: - Company can raise its funds by issuing shares to the general public.
This method is used by the company in order to expand its business which requires a large
amount of capital.
Leasing: - It is a contract made between two parties in order to borrow the assets for some
time period without making the full payment (Barth, 2008). Leasing is a type of rental. It is used
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by the company in order to expand its business. Company leases the property, machine, vehicles
and so on.
1.2 implication of various sources
Sources Advantages Disadvantages Costs Suitability Legal Aspects
Bank Loan Tax
advantage.
High interest
rates need to be
paid.
Company
profit margin
will be
reduced
because they
need to pay
high interest
to the bank.
For starting up
of new
business or to
pay dividend
to the share
holders.
Bank can seal
the collateral
security
provided by
the bank.
Trade Credit Company need
to pay interest
Company is not
able to avail
cash discount
(Beaver,
McNichols and
Rhie, 2005).
Not able to
available
various types
of discount
provided by
the suppliers.
For meeting
quick
requirement of
the cash.
Supplier can
file a case
against
customer for
not paying the
money on
time.
Issue Of
Shares
Permanent
sources of
capital,
company does
not require to
refund the
amount taken.
Dividend has to
be paid to the
shareholders.
No tax
benefits will
be availed by
the company
on the
dividend paid
to the
shareholders.
For expanding
its business.
Shareholders
can file a case
against the
company if
dividend is not
paid to them
even in the
case of the
profit.
Leasing Company can
avail the
Total
installment cost
Monthly or
yearly
For meeting
quick
Lessor can sue
the lessee if
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benefit of
assets without
purchasing it.
at the end of the
leasing period
may be higher
than the
purchasing
cost.
expenses of
the company
will increase
(Bellas,
Toudas and
Papadatos,
2007).
requirement of
cash without
purchasing it
at the same
time.
any damage
caused to the
property or if
lessor is not
able to pay
installments
on time.
1.3 Sources of finance available to fulfill the following needs.
Different types of sources of finance available in order to meet the following case:-
Start up of the new business: - In order to start up a new business an individual or a
group of individual can raise their capital by going through the venture capital or bank loan
(Bentz, 2007). These two sources of finance will assist the owner to the business to easily full the
quick requirement of cash and assets for a long period of time.
Expansion of large business organizational: - One of the best methods which company
can consider is issue of shares and debentures. Company can meet the funds by issuing shares
and debentures. This in turn also assists the benefit to the company for not paying again the
amount of money raised by the public.
Takeover of the medium scale company by the small group of people: - A small
group of people can raise funds by using hire purchase or leasing method in order to take over
the medium scale company (Dontoh, Ronen and Sarath, 2008). Use of this method will aid the
company to avail the benefits of the asset without purchasing it and without paying any
maintenance cost.
Therefore, these are some of the sources of finance through which company or individual can
raise their money for meeting short term, medium term and long term business requirements.
Task 2
2.1 Cost of different sources of finance.
Bank loan: - Bank loan assist the company to meet its short term requirements of the cash
quickly. Company simply raises funds by paying the interest to the bank. But at the same time
use of this method increases the cost of the business. Company need to pay high interest rates to
the bank in order to avail the cash from the bank.
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Trade credit: - It also said He Company to meet its short term requirement of the fund.
Company can avail this method according to their needs and wants (Eccles and Holt, 2005).
Company does not require paying any interest. But at the same time it is also seen that this type
of credit facility is available to the business for a small time period only.
Issue of shares: - issue of shares will assist the company to meet it s long term
requirement of the cash. It also helps the company to expand its business by attracting more
customers. But at the same time it increases the cost of the company. Company need to pay
dividend to this shareholders and also the decision making power.
Leasing: - It said the company to meet to quick requirement of assets. Company can easily
use the asset without purchasing it (Efendi, Srivastava and Swanson, 2007). But at the same
time it reduces the profitability of the company because company need to pay installment on the
regular basis to the lessor which in turn increases the cost of the cost.
2.2 Importance of financial planning
Maximum utilization of funds: - Planning of all the financial activities in advance assist
the company to utilize the available resources and funds with the organization to the full extent.
Advance planning also said the company to reduce the wastage of the resources.
Avoid shocks: - Planning of all the financial activities assist the company to avoid shocks
and alteration which could be faced by the company due to sudden change in internal and
external environment.
Helps in maintaining balance between inflow and outflow of cash: - Financial planning
aids the company to maintain the balance between the inflow and outflow of the cash from
within and outside the organization (Mahotra and Malhotra, 2008). Advance planning help the
company to reduce the expenses by generating more income.
Helps in achieving organization objectives: - Advance planning of all the financial
activities aids the company to move towards the achievement of the organizational objective.
Planning of all the activities helps the company to maintain balance between all activities which
in turn assist the company to achieve the set target.
2.3 Types of financial information required for decision making purposes
Decision maker of the company wants the financial statements and company's audit report in
order to take various decisions.
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Financial statements: - It is a type of statements which aid the company to know the
actual position of the business. It helps the company to analyze the inflow and outflow of the
cash (Penman and Penman, 2007). Different types of financial statements which are required by
the profit and loss account, balance sheet, cash flow statements, income statements and many
more.
Company audit report:- Company audit report is prepared by the company in order to
find out whether any fraud or illegal practices is taking place within the business organization. It
also aid to find out various measures which are not included in the financial statements.
Company audit is done by the auditor appointed by the organization or the government depends
upon the size of business.
2.4 Sample templates of profit and loss account and balance sheet.
Format of profit and loss account
In trading account all the income generated and expenses made at the time of
manufacturing process are recorded (Ross, 2008). By preparing trading account company is able
to find out the gross profit or loss of the company. Similarly continuing the profit and loss
account net profit or loss of the company is calculated. In this all the income earned and
expenses made after the manufacturing process are recorded. Net profit or loss calculated assists
them to find out the financial position of the business. After the calculation of net profit or loss
company decides the amount of tax and dividend and need to be paid to government and
shareholders.
Trading and Profit and Loss account of.... (Company name)
For the year ending on …. (Year)
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Format of balance sheet
Balance sheet as on …. (Date)
Balance sheet is prepared by the company in order to find out the assets and liabilities of the
company. In balance sheet assets and liabilities of the company are divided into different heads.
At liabilities side share capital, long term liabilities and current liabilities are recorded. In share
capital; capital available with the company, drawing, net profit or loss are included under this
head. In long terms liabilities loan or advance taken by the company are recorded. Similarly, at
assets side, fixed assets, investments and current assets are included. Under the head of fixed
assets all the assets available with the company which cannot be easily transferred into cash are
included. In investments; any investments made by the company are included. At last under the
head of current liabilities and current assets; all assets and liabilities which can easily be
transferred into cash and easily repayable are included.
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Task 3
3.1 Finding and recommendation for the budgets analyzed
As a Financial accountant considering the sales budget it is find out that company’s position is
not good. Every month company inflow is less as compared to its outflow (Serafeim, 2011).
Company monthly budget is less than the actual budget set by the company. In this case variance
of the company is constantly increasing in a negative terms. In simple words it can be said that
every month inflow of cash is decline and outflow of cash is increasing. Similarly, taking into
consideration cash flow forecast it can be find out that company position is constantly
fluctuating. Company inflow of cash is less than its outflows in many months. In total it can be
conclude that company inflow of cash is less as compared to its outflow. Thus company is facing
the problem of accumulative deficits. Therefore, in order to overcome this problem company
should properly analyses the financial statements of the company and find out where the
company is lacking behind. After analyzing various statements company should prepare various
strategies in order to reduce the outflow of the cash and increase the inflow of the cash. In order
to improve its financial position company can also change its working strategies.
3.3 Calculation of various ratios in order to find out the best project.
Calculation of payback period (In £)
Project A Project B
Year Amount Cumulative Amount Cumulative
1 180000 180000 60000 60000
2 230000 410000 120000 180000
3 280000 690000 250000 430000
4 120000 810000 250000 680000
810000 680000
Payback period= A+ (B/C)
Where,
A= last year negative cumulative cash flow.
B=abstract value of cash flow at end of the year
C= cash flow in next year
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Payback period (A) =2+ (450000-410000)/280000
=2.14 years
(B)=3+ (450000-430000)/250000
=3.08 years
Payback period of project B is more than that of project A. Therefore, ABC Engineering
should go with project A. Because the lower payback period helps in gaining back the initial
investment within a short period of time.
Net present value:
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
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
Total 810000 701200 680000 564130
Less- Initial
Investment 450000 450000
Net Present
value 251200 114130
Net present value of project A is more as compared to project B. therefore, ABC Engineering
Company should go with project A.
Internal rate of return:
Calculation of internal rate of return
Year Project A Project B
0 -450000 -450000
1 180000 60000
2 230000 120000
3 280000 250000
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4 120000 250000
IRR 29.20% 15.02%
IRR ratio of the project A is more as compared to project B. Therefore, ABC Engineering
Company should go with project A. Because higher rate of return aid the company to quickly get
back the amount invested.
Accounting rate of return
Accounting rate of return (ARR) = Average profit/Initial Investment*100
Project A Average Profit = Total Profit/number of year
= 810000£/4
= 202500£
ARR = 202500£/450000£*100
= 45%
Project B
Average Profit = 680000£/4
= 170000£
ARR = 170000£/450000*100
= 37.78%
Average rate of return of project A is more than that of project B. Therefore, ABC Engineering
Company should go with project A. Because higher average return of return will aid the
company to increase its profitability.
Therefore, at last it can be concluded taking into consideration all the above ratios it could be
said that ABC Engineering Company should go with project A.
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3.2 Calculation of different types of unit cost.
Contribution per unit (CPU) = 21.55£
Contribution to sales ratio
= 161625£/900000£*100
= 17.96%.
Break-even point (In units) = Total Fixed Cost/CPU
= 120000£/21.55£
= 5568.45 Units
Break-even point (In £)
= 5568.45Units *120£
= 668213.46£
Margin of safety (In £)= Total sales - BEP Sales
= 9000000£ - 668213.46£
= 231786.54£.
Margin of safety per unit = 231786.54£/7500
=30.90£
Calculation of profit and BEP by varying the sales price
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Calculation of BEP by varying the fixed cost
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Calculation of BEP by varying the material Cost
13

Calculation of BEP by varying the labor cost
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Calculation of profit under two proposals from different customers
On the basis of the case scenario Southwod Electricals and Westbrook Engineering have
placed their orders to the company. In this situation, calculation of the profit of an organization is
as follows:
Southwood Electricals:
Selling price = 120£ - 120*15%
= 120£ - 18£ = 102£
Westbrook Engineering:
Selling price = 120£ - 120*25%
= 120£ - 30£ =90£
Calculation of total profit
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After analyzing the market condition of the both the companies it can be concluded that ABC
Engineering company should expect the order of Southwood Electricals. Because the profit
margin of the Southwood Electricals is more as compared to that of Westbrook Engineering.
Task 4
4.1 Uses and purpose of various types of accounts.
Debit and Credit: - Debit and credit are the entries which help to record the value of the
business transactions in accounts ledger according to the nature (Stent, Bradbury and Hooks,
2010). All increase in assets and decrease in liabilities are recorded on debit side. Similarly, all
decrease in assets and increase in liabilities are recorded on credit side.
Journals and ledgers: - Journals and ledgers are prepared by the organization in order to
record day to day transactions made in the business. The reason behind this is that at the end of
the year or at the end of the month all transactions cannot be recorded.
Trial balance: - Trial balance is prepared by the company in order to monthly accounts in
yearly form by differentiating the accounts according to its nature in debit and credit form. Trial
balance in turn assists the company to easily prepare various types of financial accounts.
Income statements: - Income statements are prepared by the company in order to find out
the inflow and outflow of the cash at the end of every month. This in turn aids the company to
develop its various strategies in order to achieve its desired objectives.
Balance sheet: - Balance sheet is prepared by the company to find out the actual position
of the business at the end of every financial year (Sullivan, 2009). It also said the company to
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find out the assets and liabilities available with the business and whether has earned the profit or
has faced the loss condition.
Cash flow statements: - Cash flow statements are prepared by the company in order to
find out the inflow and outflow of the cash at the end of the financial year. It also assists them to
find out the cash and cash equivalents available with the company.
4.2 Difference between different types of organization.
Some traders: - that organization working under the sole proprietorship does not required
to prepare financial statements. It simply depends upon the desire of the company if they whether
they want to prepare the financial accounts (Paramasivan and Subramanian, n.d.). These
organizations simply prepare journal, ledger and trial balance.
Partnership:- According to Partnership Act, Partnership firms need to prepare all type of
financial accounts along with the capital account which shows the share of profit of all the
partners.
Limited Company: - Limited company is the government owned company who need to
prepare all types of financial statements like profit and loss account, cash flow statements, and
income statements and so on.
Non-profit organization: - Non-profit organization is the types of charitable institutions
who do not required to prepare any type of financial statements. These organization simple
prepares receipt & payment account and income and expenditure statements.
4.3 Calculation of different ration in order to find out the companies positions.
Ratio analysis of XYZ ltd. is as follows:
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After calculating the various ratio and financial statements, it can be concluded that company
position has been decreased from year 1995 to 1996. Company gross profit and net profit ratio
has been reduced as compared to that of previous year (Managing Financial Resources and
Decisions. 2010). The reason behind this could be that company's expenses are increasing as
compared to income generated. It is also found out that current ratio and quick ratio of the
company is also decreasing which is not good. Decrease in quick ration indicates that availability
of liquid cash with the company is less. Similarly, it is also see that company's total assets
turnover and inventory turnover ratio of the company is declining as compared to previous year.
This decline indicates that fixed and current assets of the company are decreasing and on the
other hand liabilities of the company are increasing. Therefore, at last it is suggested that
company should focus on changing their strategies in order to reduce its expenses and increase
the income generated. Strategies should also be developed in such a way that company's
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liabilities should be less as compared to the assets. It should also focus keeping more liquid
assets in hand in order to meet sudden requirement of cash due to change in the environment.
Conclusion
The following report emphasis on the various sources of finance available with the business in
order to raise its capital. In this report importance of financial planning are discussed and various
accounts required by the decision makers of the company in order to take necessary decision are
conclude. In this report various companies’ financial position is analyzed and various decisions
are taken by using various techniques, methods and ratios. In this report break-even point,
margin of safety are also calculated taking into consideration the material, labor and overhead
cost. At last uses and purpose of various financial accounts are conclude and different accounts
prepared by different organization are also discussed
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References
Books and Journals
Anheier, H. K. and Winder, D., 2007. Introduction (pp. 3-6). Springer US.
Barth, M. E., 2008. Global financial reporting: Implications for US academics. The Accounting
Review. 83(5). pp. 1159-1179.
Beaver, W. H., McNichols, M. F. and Rhie, J. W., 2005. Have financial statements become less
informative? Evidence from the ability of financial ratios to predict bankruptcy. Review
of Accounting Studies. 10(1). pp. 93-122.
Bellas, A., Toudas, K. and Papadatos, K., 2007. The consequences of applying International
Accounting Standards (IAS) to the financial statements of Greek companies. In 30th
Annual Congress of European Accounting Association, Lisbon-Portugal.
Bentz, R. P., 2007. Acquiring and managing financial resources.
Dontoh, A., Ronen, J. and Sarath, B., 2008. Financial statements insurance.
Eccles, T. and Holt, A., 2005. Financial statements and corporate accounts: the conceptual
framework. Property Management. 23(5). pp. 374-387.
Efendi, J., Srivastava, A. and Swanson, E. P., 2007. Why do corporate managers misstate
financial statements? The role of option compensation and other factors. Journal of
Financial Economics. 85(3). pp. 667-708.
Mahotra, D. K. and Malhotra, R., 2008. Analyzing Financial Statements Using Data
Envelopment Analysis. Com. Lending Rev. 23. pp. 25.
Penman, S. H. and Penman, S. H., 2007. Financial statement analysis and security valuation (p.
476). New York: McGraw-Hill.
Ross, S. A., 2008. Modern financial management-/Stephen A. Ross...[et al.]. New York [etc.]:
McGraw-Hill/Irwin.
Serafeim, G., 2011. Consequences and institutional determinants of unregulated corporate
financial statements: Evidence from embedded value reporting. Journal of accounting
research. 49(2). pp. 529-571.
Stent, W., Bradbury, M. and Hooks, J., 2010. IFRS in New Zealand: effects on financial
statements and ratios. Pacific accounting review. 22(2). pp. 92-107.
Sullivan, D. T., 2009. Managing financial resources. Advanced Practice Nursing: Essential
Knowledge for the Profession. pp. 203.
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