Financial Ratio Analysis: A Comparative Study of Wholesale and Retail Businesses

The assignment content is about the interpretation of financial statements by calculating various ratios. The ratios include gross profit ratio, net profit ratio, current ratio, quick ratio, and gearing ratio for both wholesale and retail businesses. The results show that the wholesale business has a higher gross profit ratio and net profit ratio compared to the retail business, indicating that it is more profitable. However, the retail business has a higher current ratio and quick ratio, suggesting that it has better liquidity. Overall, the assignment aims to provide insights into the financial performance of two different businesses.

Managing Financial Resources and
decisions

Table of Contents
Introduction................................................................................................................................1
TASK 1......................................................................................................................................1
AC 1.1 Different sources of finance.................................................................................1
AC 1.2 Legal, Financial and dilution of control implication and bankruptcy risks..........1
AC 1.3 Appropriate source of finance..............................................................................2
AC 2.1 Cost of various sources shown in Income statement and Balance sheet..............2
TASK 2......................................................................................................................................3
AC 2.2 Importance of financial planning.........................................................................3
AC 2.3 Information needs of various decision makers.....................................................4
Task 3.........................................................................................................................................4
AC 3.1 Cash Budget for Four months..............................................................................4
AC 3.2 Calculation of selling price and profit..................................................................5
AC 3.3 Implication of investment appraisal techniques...................................................6
TASK 4......................................................................................................................................8
AC 4.1 Financial statement of the company.....................................................................8
AC 4.2 Appropriate formats of financial statements:.......................................................8
AC 4.3 Interpretation of financial statements by calculating various ratios.....................9
CONCLUSION........................................................................................................................10
REFERENCES.........................................................................................................................12
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List of tables
Table 1: Cash budget for Health Limited...................................................................................4
Table 2: Profit earned with 500 units.........................................................................................5
Table 3: Profit for additional 1000 units....................................................................................6
Table 4: Net present value..........................................................................................................6
Table 5: Cumulative cash flow..................................................................................................7
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INTRODUCTION
Every Business is concerned with production and distribution of goods and services to
satisfy their customer needs. Hence, for carrying out various businesses activity organization
requires money. Therefore, finance is also called the life blood of business. A business cannot
operate well without adequate funds. Initial capital invested by entrepreneur is not always
sufficient to meet financial requirements (Peirson, & et. al., 2014). So, the organization has to
look for other sources from where the need for funds can be met. A clear assessment of
financial needs and the identification of various source of finance is significant aspect for
running a business organization. In the presented report, we will identify different type of
internal and external source of finance along with the cost factor and also the appropriate
source of finance for Green Supplies Ltd. in addition to it, we apply different investment
appraisal techniques for various proposals and also selling price will be decided using cost
based pricing method.
TASK 1
AC 1.1 Different sources of finance
Retained earnings: It is an internal source of finance available for Green Supplies Ltd.
It means reinvestment of profit to earn further return. It can provide return for investors by
ploughing back of the earnings and also help business to grow.
Cash Squeezed: It means that organizations will pay their bills later and receive its
cash earlier from the customers. This internal source of finance provides huge boost to cash
flow to Green Supplies Ltd.
Sale of assets: Disposable assets such as plant and machinery, furniture and land can
be sold out to get financial sources for Green Supplies Ltd (Chandra, 2011). It is also an
internal source which fulfils the temporary requirement of finance.
Loan Capital: The most common way of loan capital is borrowing from bank. It is an
external source of finance available for Green Supplies Ltd. It can be either in the form of
bank overdraft or bank loan. Overdraft fulfils the short term requirement of companies to a
limited extent. Whereas, loan may be for short term or long term period based on the business
requirement.
Share capital: It is an internal source of finance as Green Supplies Ltd. can raise it
funds by issuing additional shares (Hayre, 2013). Venture capital providers are interested in
investing in businesses with dynamic growth prospectus.
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AC 1.2 Legal, Financial and dilution of control implication and bankruptcy risks
Each sources of finance whether internal or external bring many risks to the company.
Each financial source has a set of legal as well as financial restriction such as bankruptcy and
so on.
Share Capital: Equity shareholders are owners of the company so legal implication
for Green Supplies Ltd. is that the shareholders have voting rights which they can use to
manage the company (Brigham, & Ehrhardt, 2013). Moreover, Green Supplies Ltd. is not
legally obliged to pay dividends to its shareholders. Moreover, the paying investment is not
obligatory. Diluted control exists in case of equity financing for the company and bankruptcy
implication means that the Green Supplies Ltd. has to pay return to shareholders from its
residual asset.
Debt financing: In case of debt financing, legal implication for Green Supplies Ltd. is
that it has to pay tax over the loan borrowed and interest paid. On other hand, financial
obligation for the company is about paying the interest and loan instalment periodically.
Moreover, bankruptcy implication is that assets can be sold out to repay bank loan in case of
default of the company. k. No diluted control exists in case of debt financing for the company
because creditors are not the owner of the organization.
AC 1.3 Appropriate source of finance
Retained earnings: It may be considered as an appropriate source of finance for Green
supplies Ltd. since it does not include any explicit cost such as interest and dividend.
Immediate requirements for funds can be met out by retained earnings. It has a greater degree
of freedom and flexibility (Van Horne, & Wachowicz, 2008). However, disadvantage is that
it provides funds to a limited extent. Moreover, excessive ploughing back may cause
dissatisfaction among shareholders as they will get limited amount of dividend.
Loan Capital: Green Supplies Ltd. can meet its financial requirements by borrowings.
It is considered to be an appropriate source because the company can take loan for short,
medium and long term. In addition to it, interest is an allowable expenditure for tax purpose.
Whereas, disadvantage is that the organization has to pay interest and instalment periodically.
The company has to mortgage a security against their loan. Secured assets can be sold out by
bank in case of default by the firm.
Share capital: Green Supplies Ltd. can raise its funds by issuing both equity and
preference shares. It is advantageous for the company because business is not obliged to pay
dividend and repay the capital to the shareholders (Sin ha, 2012). On contrary, disadvantage
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is that equity shareholders are owners of the company. So, they have the voting rights and
substantial part of the ownership in the company.
AC 2.1 Cost of various sources shown in Income statement and Balance sheet
Cost of Debt: Cost of debt means the interest rate which is merely paid by the
company on such loans. In Income statement, interest will be shown in debit side of profit
and loss account. Moreover in balance sheet the interest expenses will be deducted from the
cash and loan amount will be added. Loan will also be shown in debt capital in liability side
of the balance sheet (Pike, & Neale, 2006). The loan instalment paid by the company is
deducted from cash and debt respectively.
Cost of share capital: Cost of equity is rate of return demanded by shareholders on
their investment. Dividend and flotation cost paid by the company is an indirect expense
hence, it will be shown in the profit and loss account (Haka, 2006). Moreover, the share
capital issued by the company will be shown as equity and preference share capital in liability
side. Moreover, issued share capital will be included in cash and dividend paid will be
deducted.
Cost of retained earnings: It includes the return which shareholder require on
company's common stock (Götze, Northcott, & Schuster, 2008). The amount of retained
earnings utilised will be deducted from equity. Moreover, it will be deducted from cash in
assets side.
TASK 2
AC 2.2 Importance of financial planning
Financial planning is the process of estimating capital required and identifies the
appropriate source of finance (Siano, Kitchen, & Confetto, 2010). It is the process of framing
financial policies in relation to procurement, investment and proper administration of funds.
Importance of financial planning is given below:
 It determines the amount of finance which is needed by an enterprise to carry out its
operations smoothly.
 It evaluates various sources of funds so as to identify appropriate source of finance.
 It helps in making policies for proper utilisation and administration of funds.
 It acts as a source checking financial activities by comparing its actual and estimated
revenue (Sian, & Roberts, 2009). It is also important controlling cost by comparing
actual cost with estimated amount.
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 It ensures balance between fund's inflow and outflow so that financial stability is
maintained.
 It helps in making growth and expansion programmes which in turn help in long run
survival of the company.
 It reduces uncertainties with regards to changing market trends. This helps in ensuring
stability and profitability of the business.
For the success of Green Supplies ltd, financial planning is very important so as to
determine its short term and long term capital requirements. The company can decide its
capital structure which includes decision regarding both debt and equity capital. Moreover, it
also assists the business for cost controlling purpose (Ellwood and Newberry, 2007).
Through financial planning, business can survive for long run by proper management of their
funds. It ensures financial stability for Green Supplies Ltd. by reducing uncertainties. Finance
manager ensures that scarce financial resources are optimally utilized at least cost. This in
turn provides maximum returns on investment.
AC 2.3 Information needs of various decision makers
Financial statement satisfies the need of different decision makers by providing
useful information to them (Claessens, 2006).
Managers: Managers are liable to manage all operations and growth of the company.
They require financial statement to manage affairs of the company by assessing financial
performance of the business.
Shareholders: They invest in the company with the objective of high return.
Therefore, they use financial statements so as to analyse risk and return of their investment so
as to make better investment decisions.
Investors: They require financial statements to assess viability of investment in the
company. They predict future dividend on the basis of profits because fluctuation in profits
indicate higher risk. Furthermore, they analyse risk associated with their respective
investment and take necessary decisions.
Financial Institutions: Lending decisions are based on sufficient assets and liquidity
position of the business. Therefore, banks use financial statements to analyse financial health
of a business.
Employees: They use financial statements for assessing profitability and its
consequences on their future remuneration and job security.
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TASK 3
AC 3.1 Cash Budget for Four months
Cash budget is a financial budget prepared to calculate the budgeted cash inflows and
outflows during a period. It helps the health limited to identify any excessive cash or cash
shortage in order to maintain sufficient level of cash (Ismail and Mohsin, 2013).
Table 1: Cash budget for Health Limited
(Amount in £’s)
Particular June July August September
Opening Cash Balance 50000 -447000 -306000 -135000
Cash Sales 45000 50000 65000 82000
Credit sales 750000 812000 970000
Total cash available for use 95000 353000 571000 917000
Cash Purchase 410000 480000 510000 550000
Credit purchase 76000 82000 86000
Rent 30000 30000
Other Expenses 82000 83000 94000 110000
Loan instalment 20000 20000 20000 20000
Total cash payments 542000 659000 706000 796000
Cash Surplus (or Deficit) -447000 -306000 -135000 121000
From the prepared budget, it is clear that in the month of June, July and August
Health Ltd. bear a loss of 447000£, 306000£ and 135000£ respectively. However, in the
month of September, company will gain a profit of 121000£. Therefore, Health Ltd. should
collect its debts earlier as possible and in case of surplus amount company can make further
investment.
AC 3.2 Calculation of selling price and profit
Cost plus pricing method: It is a cost based method for setting the prices of goods and
services. Under this approach, appropriate mark up percentage will be added into total cost in
order to derive price of the product.
Particular Amount ( In £)
Fixed Cost 200
Variable cost 100
Total cost 30
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Mark up percentage = 33%
Selling price = Total cost + Mark up percentage on profit
= 300 + 33% of 300
= 300 + 99
= 399£
Table 2: Profit earned with 500 units
Particulars per unit amount (£) Total amount (£)
Sales 399 199500
Fixed Cost 100 50000
Variable cost 200 100000
Total cost 300 150000
Profit( Sales- Total cost) 99 49500
Selling price if mark up percentage is 30%
Selling price = Total cost + Mark up percentage on profit
= 300 + 30% of 300
= 300 + 90
= 390 £
Table 3: Profit for additional 1000 units
Particulars Amount (in £)
Sales 390000
Variable cost 200000
Fixed Cost ( being constant ) 50000
Total cost 250000
Profit( Sales- Total cost) 140000
AC 3.3 Implication of investment appraisal techniques
Net Present Value: It calculates the present value of cash flows associated with an
investment by using an appropriate discount factor. The main advantage of this method is that
it considers time value of the money. Moreover, it calculates profitability of the projects
(Riley, 2015). However, disadvantage is that this is very complicated way of evaluating
potential investment. Therefore, business should invest their funds in such project which has
higher Net present value.
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Table 4: Net present value
Year factor project A Project B Project C
cash
flow
PV of cash
flow
cash
flow
PV of cash
flow cash flow
PV of cash
flow
1 0.909 30000 27270 55000 49995 33000 29997
2 0.826 48500 40061 55000 45430 40000 33040
3 0.751 56000 42056 55000 41305 55000 41305
4 0.683 70500 48151.5 55000 37565 58000 39614
Total 205000 157538.5 220000 174295 186000 143956
Net present Value = Present value of future cash flow – Initial Outlay
Project A = 157538.5 - 150000 = 7538.5 £
Project B = 174295 - 175000 = (705) £
Project C = 143956 - 160000 = (16044) £
Calculation of payback period for various projects
Pay Back Period: It is the time period which project will take to earn amount of the
initial investment on it. Business has to accept the proposal which has payback period. It is
simple to calculate, minimise risk and maximize profitability. It helps in growth of the
company and also uses cash flow rather than accounting profit. However, disadvantage is that
this method ignores returns after payback period. Moreover, it ignores the time value of the
money and Post pay back profitability. It is the best method at the time when technology is
changing rapidly.
Table 5: Cumulative cash flow
year cash flow Cumulative cash flow Cumulative cash flow Cumulative
0 -150000 -150000 -175000 -175000 -160000 -160000
1 30000 -120000 55000 -120000 33000 -127000
2 48500 -71500 55000 -65000 40000 -87000
3 56000 -15500 55000 -10000 55000 -32000
4 70500 55000 55000 45000 58000 26000
Project A= 3 + 15500/70500 year
= 3 + 0.22 year
= 3.22 year
Project B = 3 + 10000/55000 year
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= 3 + 0.182 year
= 3.182 year
Project C = 3 + 32000/58000 year
= 3 + 0.552 year
= 3.552 year
Recommendation: By applying the net present value method, it is identified that net
present value of project A is 7538.5£ whereas project B and project C has negative NPV of
704£ and 16044£. Therefore, Day choice Ltd. should invest in project A. Moreover, the
payback period is 3.22, 3.182 and 3.552 respectively. It is lowest in project B, but if company
invest in this project then it will get a loss of 704£. Thus, by taking both the techniques into
consideration, it is clear that as finance manager of the company should invest in project A.
TASK 4
AC 4.1 Financial statement of the company
Financial statement includes both Income statement and balance sheet which is
produced by a business. Every business prepares financial statements periodically to know
the profitability as well as financial position of the business.
Income statement: It includes both Trading and Profit and loss Account of the company.
Trading Account: It is prepared by a trading company so as to identify gross profit of
the business. Gross profit is excess of sales over cost of goods sold. All the purchase and
direct expenses are shown in debit side and in credit side; sales and closing inventory are
shown in this account.
Profit and loss Account: It is prepared to identify the net profitability of the business.
The indirect expenses are shown in its debit side such as stationery, rent, Salary etc whereas
indirect income are shown in the credit side. Therefore, the excess of indirect income plus
gross profit over indirect expenses are termed as net profit. On contrary, excess of indirect
expenses over income is termed as net loss.
Balance sheet: Balance sheet is prepared at end of company's accounting period. It is
prepared to know financial position of the company. It shows liability and asset position of
the business (Paramasivan and Subramanian, 2010). Liability includes equity and preference
share capital, debt capital and current liability of the business. However, Assets includes all
fixed as well as current assets of the company.
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AC 4.2 Appropriate formats of financial statements:
Financial statement in case of sole trader: It comprises of both income statement and
balance sheet. In income statement both trading and profit and loss account are prepared by
sole trader. It shows the income and expenditure which business has received or paid over a
given period. Sole trader receives income by selling the product and services provided to
others such as rent and interest income. However, expenditure includes both direct as well as
indirect expenditure. Direct expenses are expenses which are incurred for trading purpose
whereas indirect expenses are incurred for the purpose of running business. Profit is
computed by subtracting company's expenses from income. Hence, it shows overall
profitability of the business (Llias, 2010). Balance sheet indicates the financial position of
the business by showing its assets and liabilities respectively. Assets include fixed assets such
as plant and machinery, building and current assets include debtors, stock and cash.
Liabilities include long term liability and current liability such as creditors and provisions.
Capital is computed by subtracting liability from assets.
Financial statement of Public Ltd. Company: A company is a legal body in its own
right with an existence that is separate from its owners. They have to prepare their financial
statements according to requirement of respective companies act. They prepare only profit
and loss account to know its profitability. Gross profit is calculated by subtracting cost of
goods sold from the turnover. Moreover, operating incomes are added and expenditures are
subtracted to know the net profit. In addition to it, dividend paid to shareholders is also
shown in the balance sheet. It collects its funds by issuing shares and debt capital. Therefore,
balance sheet shows the assets and liability together with debt and equity capital. Moreover,
they also prepare the statements of changes in equity, cash flow and fund flow statement.
Profit = Revenues – Expenditures
Assets – Liabilities = Equity + Long term debt
AC 4.3 Interpretation of financial statements by calculating various ratios
Gross profit ratio = Gross profit / sales *100
Wholesale Business = 150000/580000*100
= 25.86%
Retail Business = 101000/426000*100
= 3.71%
Interpretation: Gross profit ratio of wholesale business and retail business are 25.86%
and 23.71% respectively. Thus on the basis of profitability ratio, Wholesale business is more
profitable because of higher gross profit ratio.
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Net Profit Ratio = Net Profit/sales*100
Wholesale Business = 85000/580000*100
= 14.66%
Retail Business = 61000/426000*100
= 14.32%
Interpretation: Net profit ratio of both the business is 14.66% and 14.32%
respectively. Hence, Wholesale business is more profitable because of higher net profit ratio
as compare to retail business.
Current ratio = Current Assets/Current Liabilities
Wholesale Business = 2510/1550
= 1.62
Retail Business = 5070/2950
= 1.72
Interpretation: Current ratios of both businesses are 1.62 and 1.72 respectively.
Hence, retail business is more profitable because ratio between current assets and current
liabilities is higher in this business as compare to wholesale business.
Quick ratio = current assets – stock/ current liability
Wholesale Business = 2510-1420/1550
= 1090/1550
= 0.70
Retail Business = 5070-2370/2950
= 2700/2950
= 0.92
Interpretation: Quick ratio evaluates company's ability to meet its short term debts.
This is 0.70 in case of wholesale business and 0.92 in case of retail business. Therefore, it
shows that retail business is more profitable because of high availability of liquidity compare
to that of wholesale business.
Gearing Ratio = Long term debt/Equity capital
Wholesale Business = 2400/3000
= 0.80
Retail Business = 3170/5500
= 0.58
Interpretation: Gearing ratio indicates combination of funds through debt and equity.
It is 0.80 in wholesale business and 0.58 in the retail business. It indicates that wholesale
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business use more debt capital and less equity as compare to retail business. On other hand,
retail business collects its funds through more equity capital and less through debt capital.
CONCLUSION
From the presented report, it is clear that every business conducts financial planning
activities to identify their financial requirement and collect funds from sources which have
lowest cost of capital. In addition to it, capital budgeting is the technique through which
management can determine such project which has the maximum yield. Cost based pricing is
the method of setting price by adding an appropriate mark up percentage. Moreover, Payback
period and Net present value are the methods for investment appraisal. Company can evaluate
various investment proposals so as to make profitable investment.
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REFERENCES
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liberal principles?. Accounting, Auditing & Accountability Journal. 20(4). pp. 549-573.
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