Accounting for Business: Financial Ratios and Performance Analysis

This report provides a detailed financial analysis of a business, covering key aspects of accounting for business. It includes an income statement and balance sheet for the year ended 31st March 2020. The report also calculates the payback period, net present value (NPV), and internal rate of return (IRR) for an investment decision, justifying the advice based on these calculations and stating qualitative factors that should be considered. Furthermore, the report computes various financial ratios such as gross profit ratio, net profit ratio, current ratio, and quick ratio for two companies, A Ltd and B Ltd, commenting on their financial performance based on these ratios, and offering comparative insights.

Accounting for business

TABLE OF CONTENTS
SECTION A.....................................................................................................................................1
Question 1........................................................................................................................................1
a. Income Statement for the year ended 31st March 2020............................................................1
b) balance sheet............................................................................................................................2
SECTION B.....................................................................................................................................3
QUESTION 2..................................................................................................................................3
a) Calculating Payback period.....................................................................................................3
b) computing net present value....................................................................................................4
c) Justifying the basis of advice...................................................................................................4
d) stating 5 qualitative factor that should consider in decision making procedure.....................5
e) Computing IRR........................................................................................................................5
QUESTION 4..................................................................................................................................6
a) Calculating ratio......................................................................................................................6
b) Commenting on financial performance on the basis of computed ratios................................7
REFERENCES................................................................................................................................9

SECTION A
Question 1
a. Income Statement for the year ended 31st March 2020
Particulars Amount Amount
Sales 20,000
Cost of sales
Opening inventory 2000
Purchases 16000
Less: Closing inventory [3000] [15000]
Gross Profit 5000
Expenses
Administration expenses 900
Salaries & wages [600 + 10] 610
Selling and distribution expenses [1000 - 100] 900
Depreciation on machinery 625
Depreciation of Building 100
Debenture interest [20 + 10] 30
Audit fee [100 + 40] 140
Bad debt 20
Directors’ remuneration 200
[3525]
Profit Before Tax 1475
Provision for taxation [200]
Profit After Tax 1275
Dividends – interim paid
-- final proposed [8000 x £0.10]
50
800 [850]
Retained profit for the year 425
Retained profit b/f 1610
Retained profit c/f 2035
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Working note:
 Depreciation on machinery = machine at cost – accumulated depreciation * 25%
 Depreciation on machinery = 3000 – 500 = 2500 * 25% = 625
 Depreciation on building = Building at cost * 5% = 2000 * 5% = 100
 Debenture interest = 600 * 5% = 30
 Outstanding interest = 30 – 20 = 10
b) balance sheet
Assets
Receivables 1200
Closing stock 3000
Prepaid selling expense 100
Cash 50
Land 5000
Building 2000
Machinery 3000
Total 14350
Liability
Bank overdraft 30
Payable 700
Bad debt 20
Accrue salary 10
Audit fee 40
Accumulated depreciation of machine 625
Accumulated depreciation on building 100
£1 Ordinary share capital 8000
Retained profit 2035
Share premium 300
5% Debenture 600
Dividend payable 800
Total 14350
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SECTION B
QUESTION 2
a) Calculating Payback period
year
cash
inflows depreciationEBIT
net cash
inflow
1 600 390000 -389400 600
2 700 390000 -389300 700
3 800 390000 -389200 800
4 600 390000 -389400 600
5 100 390000 -389900 100
Year
Cash
flows
of
System
A
Cumulativ
e cash
flows
1 600 600
2 700 1300
3 800 2100
4 600 2700
5 100 2800
Payback
period 2
3

0.9
Payback
period
2 year and
9 months
From the above calculation it can be specified that NS Plc will become able to cover the
initial investment in 2.9 years
b) computing net present value
year
cash
inflows
PV
factor
@
10%
Discounted
cash flows
1 600 0.909 545
2 700 0.826 579
3 800 0.751 601
4 600 0.683 410
5 100 0.621 62
0
Total discounted cash inflow 2197
Initial investment 2000
NPV (Total discounted
cash inflows - initial
investment) 197
On the basis of given information, it can have stated that net present value of the project is
197 which is positive and giving favourable indicator for the project
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c) Justifying the basis of advice
On the basis of calculation via using payback period and net present value technique of
capital appraisal it can be identified that it will offer positive discounted cash flow. In addition to
this, it is good sign of the NPV tool that contribute in gaining appropriate decision. Payback
period is helpful to estimate how effectively the organization is making particular recovery of
initial invested capital. It will recover the investment with 2.9 year that is profitable. On the
basis of these factor it can be justified that specified firm should choose the option as it is
profitable & efficient.
d) stating 5 qualitative factor that should consider in decision making procedure
Following are the financial factors which are considered when making and investment,
Risk :
In an investment there are always risks involved which are considered to be the key
towards the consideration of the areas which help the organization to analyse whether they
should make investments regarding the areas of the financial investments (Gomes, 2020).
Liquidity :
The liquidity of the investment which the organization is making needs to be considered
before making the investment decision. This will help the organization understand how
effectively the business will be able to convert the investment into cash.
Fluctuations at investment market :
The investment market is one of the most fluctuating markets that needs to be considered
very heavily in order to understand the benefits of making an investment into any part of it
(Siziba and Hall, 2021).
Investment planning factors :
This is a factor which explains the opportunities which the investment has in its history
of being an investment which is considered to be the factor which helps in the minimization of
the risks.
Tax Implications :
Different tax implications are applicable on different kinds of investment which are made
by the organization. Studying these implications can help the company save some tax and also
be effective at the same time.
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e) Computing IRR
year cash inflows
0 -2000
1 600
2 700
3 800
4 600
5 100
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IRR 14%
From the evaluation of given table it can identified that internal rate of return from this
investment is 14%. Higher the return on investment greater would be the associated benefits
with the investment. On the basis of this it can be interpreted that project is beneficial.
QUESTION 4
a) Calculating ratio
Gross profit ratio
Particular Formula A ltd B ltd
gross profit ratio gross profit/ sales * 100 35.00 33.33
gross profit 350 200
sales 1000 600
Net profit ratio
Particular Formula A ltd B ltd
net profit ratio net profit/ sales * 100 19.00 19.17
net profit 190 115
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sales 1000 600
Current ratio
Particular Formula A ltd B ltd
current ratio current asset/ current liabilities 1.88 2.64
current asset 375 330
current liabilities 200 125
Quick ratio
Particular Formula A ltd B ltd
quick ratio
(current asset - inventory) / current
liabilities 1.10 1.52
current asset 375 330
inventory 155 140
current
liabilities 200 125
Receivables ratio
Particular Formula A ltd B ltd
account
receivable
average account receivable/ total sales *
365 62 88
account
receivable 170 145
sales 1000 600
Inventory days in ratio
A ltd B ltd
Inventory Inventory/ cost of sales *365 87 128
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days
Inventory 155 140
Cost of sales 650 400
b) Commenting on financial performance on the basis of computed ratios
ratio analysis is one of the significant technique that helps in gaining crucial information about
the factors that are useful in making proper evaluation of financial performance of firm. (Islami,
and Rio, 2019).
Gross profitability ratio is helpful in ascertaining capacity of company to gain
profitability by reducing the cost of goods sold. The ideal gross profit margin that company
should possess is 65%. From the evaluation of given information regarding the ratios it can be
specified that A &B ltd are having gross profitability such as 35 and 33.33% respectively.
Comparing it with the ideal ratios it can be specified that these outcomes are less which are
required to be improved. As compared to B, A Ltd has good gross profits.
Net profitability is related with margin in which company is generating revenue to
incline profits (Maheshwari, Maheshwari and Maheshwari, 2021). There are several
stakeholders who give emphasis on net profitability such as investors, financial institution, etc
who analyses NP to make decision. The net profit margin of the both the mentioned companies
are 19 and 19.17% which is less that ideal ratio that is 20%. On the basis of this it can be
articulated that there is requirement to make changes in A’s performance as ineffective than B.
Current ratio is helpful in assessing how effectively organization is paying off debts with
help of current assets (Kengatharan, 2018). it is used to evaluate pay attention on credibility of
company. The standard benchmarking that has been established is for current ratios lies between
1.32 to 1.5 times. A and B ltd outcome in this respect are current ratios are 1.88 and 2.68 times.
A has 1.88 time more assets than liabilities whereas B possess 2.68 times assets than its short
term debt. On the basis of this it can be articulated that liquidity of B ltd is good as compared to
A.
Quick ratio of two mentioned organizations is 1.0 and 1.52 times which is helpful in
assessing the cash & equivalent assets to pay off short term liabilities. On the basis of this it can
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be identified that B ltd has higher cash & equivalent assets as compared to liabilities. Receivable
ratios of the companies are 62 & 88 days respectively which indicate A is better than B.
Inventory turnover aids in assessing how effectively stock is replaced to make revenue.
From comparing both the mentioned company’s Inventory turnover in days it can be said that
outcomes are 87 and 128. A is replacing inventory effectively as compared to B ltd. from the
above evaluation of given details it can be specified that A is having good performance as
compared to B.
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REFERENCES
Books and Journals
Gomes, P., 2021. Financial and non-financial responses to the Covid-19 pandemic: insights from
Portugal and lessons for future. Public Money & Management. pp.1-3.
Islami, I. N. and Rio, W., 2019. Financial ratio analysis to predict financial distress on property
and real estate company listed in indonesia stock exchange. JAAF (Journal of Applied
Accounting and Finance). 2(2). pp.125-137.
Kengatharan, L., 2018. Capital Budgeting Theory and Practice: A review and agenda for future
research. American Journal of economics and business management, 1(1), pp.20-53.
Maheshwari, S. N., Maheshwari, S. K. and Maheshwari, M. S. K., 2021. Principles of
Management Accounting. Sultan Chand & Sons.
Siziba, S. and Hall, J. H., 2021. The evolution of the application of capital budgeting techniques
in enterprises. Global Finance Journal. 47,. p.100504.
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