Financial Ratio Analysis & Accounting Principles - BTEC HND Report

This report provides a detailed financial ratio analysis of a company, applying accounting principles. It includes an introduction to accounting principles, a sample letter to a client, and an overview of financial statements, including the profit and loss account and balance sheet. The report then calculates and interprets various financial ratios, such as the current ratio, quick ratio, inventory to working capital ratio, and debt to equity ratio, to assess the company's liquidity, solvency, profitability, and efficiency. The report concludes with recommendations for improving the company's financial performance. Desklib provides access to similar reports and solved assignments for students.

Learner Name ID
Programme Name Pearson BTEC Higher National Diploma in Business Management
Unit Number and
Title Unit 5 – Accounting Principles
Credit Value 15 Unit Level 4
Academic Year 2021-2022 Cohort Jan 22
Assessor
Project Title Part 2 Financial Ratio Analysis
Issue Date
Submission
Deadline
IV Name
IV Date
Statement of
Authenticity:
I certify that the
work submitted
for this unit is my
own and the
research sources
are fully
1

Table of Content
Assessment Part 2
Section B:
Introduction 3
Detailed letter to client 3
Financial Statements 4
i] Profit & Loss Account 5
ii] Balance Sheet 6
Ratio Analysis 7
Conclusion 11
Recommendations 11
References 12
2

Part 2
Introduction
Accounting principles mean those rules and regulations that are
followed by the companies and other reporting entities while preparing
financial statements. They should be based on the real assumptions and
understand by the third parties. They should provide the accurate
information to their clients. They use a separate set of accounting
principles, which are known as Generally Accepted Accounting
Principles. The Financial Accounting Standard Board are issued these
principles. The objective of these principles is to determine that financial
statements are accurate and consistency. There are various accounting
principles that are followed to preparation of statements, but most
important principles include the matching principle, revenue recognition
principle and going concern principle. GAAP is a combination of
authoritative standards and the commonly accepted ways of recording
and reporting accounting financial information.These are known as
international Financial Reporting Standards (Alanzi and Alfraih, 2018). In
this report, preparation of financial statements of the company to analyse
the financial position of the company. Further this report, includes to
calculate the finacial ratios and give recommendation to improve the
financial performance of the company.
Detailed letter to client
It is a document that are written by company to their clients. Most
of the sales and marketing business professionals provide letter to
consumers for many reasons such as launching new service in their
product and promoting product. These letter is send by email and
traditional mail (Bruno and Lapsley, 2018). While writing letter to clients,
3

there are many rules and regulations that should be followed by the
professional. They are as follow:
1. It should be write in well manner and formatting should be clean
and easy to understandable.
2. If the letter is working as a representation of the company,
including the company logo and branding elements in the
professional letterhead (Ghio, McGuigan and Powell, 2022).
3. Other formatting rules are also include such as single line
spacing, font size 12 and font in Times new roman.
Financial Statements
As per the Companies Act at the general meeting of the company
and the Board of Directors of the company should disclose the financial
statements. These includes:
 Balance sheet at the year ended
 Profit and loss account, if the company carrying the activity for non
profit then prepare the income and expenditure account.
 Cash flow statement
 statement of changes in equity
If the company is carrying the business as one person company,
dormant company and small company then there is no need to prepare
the cash flow statement. Financial statements are those techniques that
are prepared by the companies and other business enterprises to
determine the financial position of the business. These statements give a
snapshot of the company situation's and cash flow. These statements
are used by both internal and external users. It helps in decision making
process of the investors (Holtzman, 2022). It should be understandable
4

and reliable. Assets, liabilities, incomes and expenses are directly
interrelated with financial position of the business. These statements are
used by the different persons for different objectives:
1. Owners need financial statements to make business decision. It is
used annual report to the stakeholders (Keuning, 2021).
2. Employees are used these statements to making the CBA or
discussing with compensation and promotion.
3. Shareholders are used these statements for making investment
decision.
i] Profit & Loss Account
It is a part of the financial statement. It includes the incomes, costs
and expenses incurred during the accounting period. The components of
the profit and loss account are as follow:
Revenue- It is the money that are earned by business from selling of
products and services. It is also known as revenue or sales revenue.
Cost of good sold- It is a direct costs that are incurred at the time of
production. It is also known as cost of sales (Khlif, Ahmed and Alam,
2020).
Gross profit- It is the difference between sales and cost of goods sold.
Operating expenses- these costs are incurred to managing the
business. It is a direct costs but are not considered in Cost of sales. It
includes rent and salaries and wages.
Operating profit- It is company income after minus all operating
expenses from the GP.
5

Non operating items- it is indirect expenses that are not related with the
main business activity (Menicucci, 2020).
Net profit and loss account- it is company profit after deduct all non
operating expenses from the operating profit.
ii] Balance Sheet
Balance sheet is a very important component of financial
statements. It determines the financial position of the company. It reports
the company assets, liabilities and shareholder funds. To used of
financial statements the fundamental analysts calculate the financial
ratios. It should be compared with the previous year balance sheet. It
works to the following equation that is assets equal to the liabilities plus
share holder funds. It determines the company has a ability to pay its
liabilities. The components of balance sheet are as follow:
1. Assets- it includes non current assets and current assets. Non
current assets mean those assets which are retain in the business
to obtain the future economic benefit. It includes machinery, land
and building and motor vehicles (Partalidou, 2020).Current assets
6

means those assets that are easily converted into the cash such
as cash and bank balances, trade receivables and inventories.
2. Liabilities- It consists of non current and current. Non current
liabilities mean those liabilities which are settlement after the 12
months. It includes debentures and long term bank loan. Current
liabilities mean those liabilities that are payable within 12 months.
It includes trade payables and short term bank loan (Puri and
Singh, 2021).
3. Shareholder funds- It means those money that are attributable to
the business owner. It includes equity share capital, preference
share capital and retained earnings (Saleh and et.al, 2021)
Balance sheet of Alpha Ltd
at the year ended on 31st December 2020
Liabilities Amount Assets Amount
Capital - 180000
Drawings (12000)
Net profit 172000
340000 Non current assets:
Current assets: Premises 160000
Trade payables 46000 Equipment 150000
Provision for doubtful
debts
5000 Current assets
Outstanding energy bill 3000 Debtors- 50000
bad debts (8000)
42000
Closing stock 28000
Cash and bank balances 14000
Total 394000 total 394000
7

Ratio Analyses
It is a quantitative technique which provides a clear insight about
any business which gives detail information about company’s liquidity
position, efficiency of operation and measurement of profitability. Ratio
analysis is done with the help of financial statements which includes
income statement and statement of position. It compares the business
enterprise line item data from final statement and the ratio study reveals
that how organisation performing over the year or how efficient they are
when compare to another business in the same sector. The usefulness
of ratio analysis occurs when money investor evaluates the feasibility of
any company by analysis their last and recent performance. By ratio
analysis, analysts understand the variable which are driven to
company’s stock prices, their future, forward and options prices. There
are six different kinds of financial ratios available which are as follows:
Liquidity ratios – This ratio simply determine the company’s capability to
pay its debt whether it is long term or short term through the help of
organisation assets. Some of the examples of liquidity ratio is current
ratio, working capital and quick ratio (Tohirovich, 2021).
Solvency ratios – It is also term as financial leverage ratios. It generally
uses in ability to cover debt level with the help of equity and earning.
This ratio is used only by lenders and money providers to understand the
financial position of borrower company. Solvency ratio includes interest
coverage ratio, debt equity ratio and debt service coverage ratio.
Profitability ratio – In this ratio, it signifies how a company able to create
opportunities for profit earning from their operation. It is derived from an
evaluation of sales to distinction groupings of costs in the earnings
statement. Examples of profitability ratios are the contribution margin
ratio, gross income ratio and net income ratio.
Efficiency ratio – This ration is also known as activity ratio. It identifies
how a company utilise their assets to create revenue and enhance their
level of profitability. Some of the examples of efficiency ratio is turnover,
stock turnover and average sales receivable ratio.
Computation of following financial ratio of ABC Ltd are as follows:
Current ratio – It is used to measure whether an enterprise possesses
enough current assets to pay off its current liabilities. The ideal ratio
8

should be 2:1 which implies that company would have twice the current
assets than current liabilities to exhibit its short term solvency position
(Wei, 2021).
Formula of current ratio = Current assets / current liabilities
= £ 350,000 / £ 150,000
= 2.33
Interpretation
Current ratio act as a useful tool for enterprises and money
makers because it gives early signal that a business not using its
working capital effectively. In context to ABC ltd, the current ratio
is coming out to 2.33 which is quite higher than ideal ratio. This
signifies that ABC company is not efficiently utilising its current
assets and investing assets.
Quick ratio - This ratio measures a company’s potential to pay its current
liabilities with no need to promote its stock or acquire extra financing.
The short ratio is taken into consideration a greater conservative degree
than the ratio, which incorporates all present day property as insurance
for present day liabilities. The short ratio is calculated via way of means
of dividing a company's maximum liquid property like cash, cash
equivalents, marketable securities and bills receivables via way of
means of general current liabilities. The ratio possesses ideal ratio which
is 1:1.
Formula for quick ratio = Quick assets / current liabilities
= £ 150,000 / £ 150,000
= 1
Interpretation
As the result of quick ratio for ABC ltd. is comes out to 1. It is
considering as normal ratio which signifies that assets are
sufficiently liquidated to pay off their current liabilities. In other
words, if quick ratio is stand for 1 which is most acceptable
situation in respect of creditors and money providers.
Inventory to working capital – In this case, it implies how quickly
company’s stock used to convert into cash and cash equivalent. In
working capital, it signifies that how enterprise current assets is used to
pay its current liabilities and short term debts.
9

Formula of inventory to working capital = inventory / current
assets – current liabilities
= £ 200,000 / £ 350,000 – £ 150,000
= 1
Interpretation
The running capital ratio is a totally simple metric of liquidity. It is
supposed to signify how successful an enterprise is of assembly
its modern monetary responsibilities and is a degree of an
enterprise`s simple monetary solvency. In connection with
monetary statements, it's far the discern that looks on the lowest
line of an enterprise's stability sheet. The good ratio is denoting to
1 which is indicated as company is capable to tackle future issues
of liquidity.
Debt to equity ratio - It is used to analyse a company financial leverage
ratio and it is compute by dividing an enterprise total liabilities by
shareholder equity fund. This ratio denotes how an enterprise capital
structure is entitled towards equity sources or debt financing.
Formula of debt to equity ratio = short term debt + long term debt
+ other payments / shareholder’s equity fund
= 420,000 + 100,000 + 50,000 / 200,000 + 40,000
= £ 570,000 / £ 240,000
= 2.375
Interpretation
A D/E ratio of two shows that the agency derives two-thirds of its capital
financing from debt and one-third from shareholder fairness, so it
borrows two times as plenty investment because it owns (2 debt devices
for each 1 fairness unit). An agency`s control will, therefore, attempt to
purpose for a debt load this is well matched with a positive D/E ratio so
that it will feature without stressful approximately defaulting on its bonds
or loans.
Conclusion
10

This report includes the financial statements of the Alpha Ltd.
Accounting principles mean those rules and guidelines that are followed
by the management to preparation of financial statements. To use of the
balance sheet and profit and loss account the financial analysts to
calculate the different types of ratios such as inventory working capital
ratio, debt equity ratio, quick ratio and current assets ratio. The company
has sufficient current assets to pay its current liabilities. The company
should reduce the trade receivable so that company can easily
converted into the cash. To survive the business in the long term
company should follow going concern assumption.
Recommendations
ABC company to be recommend that after calculating its financial ratios
through the help of statement of financial position is they have more
current assets than required. This signifies that they are not effectively
utilising their investment and current assets. When it comes to quick
ratio, which is equivalent to ideal one that is they are really adaptable for
quickly converted into cash. In the inventory and working capital ratio,
which comes out to 1 that is equal to ideal one. It means that company
able to manage their liquidity position in future. In the debt equity ratio,
when it is higher it signifies a well levered firm preferred for an enterprise
who have stable cash flow generation. And, when ratio is low, a firm is
less levered and it is closer to become fully equity. But debt equity ratio
is vary according to industry and sectors.
11

References
Alanzi, K.A. and Alfraih, M.M., 2018. The effect of students’ performance in introductory accounting
on college duration: Evidence from Kuwait. Journal of Global Responsibility, 9(3). pp.247-260.
Bruno, A. and Lapsley, I., 2018. The emergence of an accounting practice: The fabrication of a
government accrual accounting system. Accounting, Auditing & Accountability Journal.
Ghio, A., McGuigan, N. and Powell, L., 2022. The Queering Accounting Manifesto. Critical
Perspectives on Accounting. p.102395.
Holtzman, M.P., 2022. FASB Streamlines Income Tax Accounting. The CPA Journal, 92(1/2). pp.54-
56.
Keuning, B., 2021. Principles of Accounting I: A Revolution. Michigan Academician, 47(3). pp.13-14.
Khlif, H., Ahmed, K. and Alam, M., 2020. Accounting regulations and IFRS adoption in francophone
North African countries: the experience of Algeria, Morocco, and Tunisia. The International
Journal of Accounting, 55(01). p.2050004.
Menicucci, E., 2020. IAS/IFRSs, Accounting Quality and Earnings Quality. In Earnings Quality (pp.
83-105). Palgrave Pivot, Cham.
Olomskaya, E., Tkhagapso, R. and Khot, F., 2020, May. Accounting Policy as the Key Factor of the
Interaction of Various Types of Accounting in the Context of Digitalization of the Economy.
In International Conference on Integrated Science (pp. 81-92). Springer, Cham.
Partalidou, X., 2020. Financial accounting, auditing and environmental behavior of socially
responsible companies (Doctoral dissertation, Δημοκρίτειο Πανεπιστήμιο Θράκης (ΔΠΘ).
Σχολή Επιστημών Γεωπονίας και Δασολογίας. Τμήμα Αγροτικής Ανάπτυξης. Τομέας
Αγροτικής Οικονομίας και Διοίκησης Αγροτικών Επιχειρήσεων).
Puri, N. and Singh, H., 2021. Current Trends in Finance in the Context of Adoption of Principle-
Based Accounting Standards in Accounting Education. In Financial Intelligence in Human
Resources Management (pp. 151-171). Apple Academic Press.
Saleh and et.al, 2021. Factors of applying creative accounting and its impact on the quality of
financial statements in Jordanian hotels, sustainable practices. Journal of Sustainable Finance
& Investment. pp.1-17.
Tohirovich, Q.N., 2021. International financial accounting standards in Uzbekistan. ACADEMICIA: An
International Multidisciplinary Research Journal, 11(4). pp.328-333.
Wei, Q., 2021, April. Research on the Teaching Reform of Accounting Course under the Background
of Innovation and Entrepreneurship. In 2021 2nd Asia-Pacific Conference on Image
Processing, Electronics and Computers (pp. 132-135).
12