Business Finance Report: Financial Analysis of Fashion Locker

This report provides a comprehensive financial analysis of a business, Fashion Locker, owned by Lisa and John. It begins with the preparation of an income statement and balance sheet, offering insights into the company's financial performance. The report calculates and interprets key financial ratios, including current ratio, acid-test ratio, operating profit ratio, return on assets, debt-equity ratio, inventory turnover ratio, and interest coverage ratio. These ratios are used to assess the company's liquidity, profitability, and solvency. The report then offers advice to Lisa and John based on the financial analysis, comparing profit and cash flow, highlighting the timing differences and accounting conventions that impact financial statements. Overall, the report offers a detailed overview of the business's financial standing and provides recommendations for improvement.

Business finance

Table of Contents
INTRODUCTION...........................................................................................................................1
TASK...............................................................................................................................................1
1. Income statement and balance sheet.......................................................................................1
2. Calculation of appropriate ratios.............................................................................................2
3. Report to Lisa and John...........................................................................................................3
4. Explanation of the difference between Profit and cash...........................................................5
5. Accounting conventions and their impact on statements........................................................6
CONCLUSION................................................................................................................................8
REFERENCES ...............................................................................................................................9

INTRODUCTION
In the business there are various financial matters which are required to be taken into
consideration and for that financial statements shall be prepared (Ayyagari, Demirgüç-Kunt and
Maksimovic, 2010). All of the things in relation to it will be included in the business finance. In
this report also Lisa and John have started a new business and in that there are various issues
which are faced by them so information will be provided to them in relation to it. Also income
statement and balance sheet will be made for them by which they will be able to take the
important decisions in the business.
TASK
1. Income statement and balance sheet.
Income statement is the representation of the incomes and expenses which have been
made by the business in any particular year and by that the net profit which has been earned by
them will be calculated (Ballwieser and et. al., 2012). Below is presented the same in respect of
Fashion locker which is run by Lisa and John.
Income statement for year ending 30th April 2015
Particulars Amount
Incomes:
Sales : cash 77826
Credit 31247 109073
Total incomes 109073
Expenses:
Cost of goods sold (0+66638-15175) 51463
Interest on loan 1500
O/s electricity expense 133
Depreciation on van 1700
Shop rent (2000*12) 24000
Insurance expense 4132
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Other expenses 2463
Rates bill 3000
Electricity expense (255+390+410+385) 1440
Bad debts 850
Total expenses 90681
Net profit 18392
Balance sheet is the statement in which the assets and the liabilities of the business are
represented in the tabular manner. In this the assets will be equal to the liabilities and by this the
position of the business will be determined. The same is provided below:
Balance sheet as on 30th April 2015
Particulars Amount
Assets
Van (17000-1700) 15300
Debtors (7459-850) 6609
Inventory 15175
Petty cash 854
Total assets 37938
Liabilities and equity
Bank loan 7500
Bank overdraft 4668
Creditors 8245
O/s expenses 133
Owner's capital:
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Capital 25000
Add: Net profit 18392
Less: Drawings 26000 17392
Total equities and liabilities 37938
2. Calculation of appropriate ratios.
In the business there are various ratios which are calculated by the help of which various
interpretations can be drawn (Berger and Black, 2011). They will help the owner to know about
the position of the business and then on the basis of that they will be able to make the best
decisions by which the effectiveness and efficiency of it will be improved. Some of the
commonly used ratios are calculated below:
1. Current ratio = Current Assets / Current liabilities
= 22638 / 13046
= 1.74
2. Acid test Ratio = Quick asset / current liabilities
= 7463 / 13046
= 0.57
3. Operating profit ratio = profit / sales *100
= 18392 / 109073 * 100
= 16.86 %
4. Return on assets = net Income / Average total assets
= 18392 / (37938/2)
= 18392 / 18969
= 96.96 %
5. Debt equity ratio = Debt / equity
= 7500 / 17392
= 0.43
6. Inventory turnover ratio = Cost of goods sold / Average inventory
= 51463 / (15175/2)
= 51463 / 7887.5
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= 6.52
7. Asset turnover ratio = Sales / Average total assets
= 109073 / 18969
= 5.75
8. Interest coverage ratio = EBIT / Interest expense
= (18392 + 1500) / 1500
= 19892 / 1500
= 13.26
3. Report to Lisa and John.
From the above made calculations, there are many findings which can be reported and on
the basis of them Lisa and John can evaluate the performance of the business (Britten‐Jones,
Neuberger and Nolte, 2011). All of the ratios are telling about some or the other aspect of the
business.
The first ratio which has been calculated is current ratio which tells about the position of
the current assets and liabilities of the business (Cole, 2013). By this it will be determined that
whether the organisation will be able to meet its current liabilities on time or not. The standard in
respect of it has been set at 2:1. it is said that the ratio will be good if it is at higher level. In the
given case it has been calculated at 1.74 which means that it is not upto the margin and can be
improved further. The company is having good amount to payoff its liabilities as a new venture
and will be able to make its position even better.
The next ratio is the quick ratio by which the liquid asset available with the business will
be identified. In this inventory is not included as it takes time to be converted into cash. It is
calculated to be 0.57 which shows that company is not in the position to pay its all the liabilities
with the available resources and needs to take some action in this aspect.
Then comes the operating profit ratio by which the amount of profit made on the sales id
determined and is at 16.86 %. as a beginner it is a good amount and the business is earning well.
Return on asset is the ratio by which the earnings made with the available assets is
identified and this will tell that whether the business is making proper use of the assets present
(Columba, Gambacorta and Mistrulli, 2010). It is 96.96 % which is a very good margin and
shows that most of the assets are utilised in effective manner.
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Further debt equity is found which will be representing the amount of the debts business
is having in comparison to the equity funds. By this it will be known that the debts shall be at
optimum level. The business is having it as 0.43 which is good as the debts are lower which
means that there is less risk involved that will have to be faced.
The level of the inventory maintained in respect the cost of goods sold will be shown by
the inventory turnover ratio. This is 6.52 which shows that the business is having this times of
inventory and it is a good as by this it is known that company is having proper control.
By interest coverage ratio it will be determined that how efficient will be the business in
the payment of the interest and it can be seen that it is 13.26 which says that Lisa and John will
be able to meet the interest expense even if it will be increased (Cuthbertson, Nitzsche and
O'Sullivan, 2010).
The acid test ratio and operating profit of the business can be improved by Lisa and John
by increasing the balance of the liquid assets and for that cash balance will have to be increased.
In order to improve the operating profit ratio they can raise the level of the sales and also the
control will have to be established on the expenses which are made by them in the maintenance
of the operations at the lowest cost possible.
4. Explanation of the difference between Profit and cash.
In any business cash will be the main need as all the operations which will be conducted
would be requiring the funds (Ghosh and Moon, 2010). All of the aspects will be needing it and
it will not be possible to carry on the business without it. Whereas profit is the amount which is
earned and is the major objective or can say motive for which the business is established but in
this it cannot be said that operation cannot be carried out without it. In order to achieve the
growth profit will be required and in case that the business is not making any profits for long
then the business will have to suffer the consequences of it as all the investments which have
been made will dwindle. The profits will be calculated after deducting the expenses which have
been incurred from the amount of sales made in any particular period of time. The cash balance
at the end of the year will be determined by the deduction of all the outflows which have been
made from the amount of the inflows.
In the given case it can be seen that there is the income which is made by Lisa and John
but their cash balance is in overdraft and there can be various reasons of it (Gitman and Zutter,
2012). There are mainly two reasons due to which difference exist among both of them and the
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main among them is timing difference which exist when the operation is carried out but the
payment or the receipt in relation to it has not occurred in the given period. Also sometimes there
is different manner which is used to record the fixed assets and then it will be affecting the
amount of the cash and also the profits.
In the given case there are various expenses which are made and have been paid from the
cash so due to them the balance of the cash is affected but as they are not included in income
statements so there will be no impact of it on the amount of the profits made. Such as the
business is new and is not having much of the cash balance and had taken loan for it. It can be
seen that the amount of the loan which has been taken from the bank is 15000 out of which 7500
had been repaid in the current year so the cash balance has been reduced (Hillier, Grinblatt and
Titman, 2011). Also the van has been purchased costing to 17000 which is high amount and is
leading to the shortage of the funds.
Company has made insurance and the premium is paid in relation to it in the current
period by which the cash balance is affected and this is not the expense of the current year or it
can be said that although the amount is paid but there is no advantage which has been received in
relation to it. The purchase of the asset although has led to the decrease in the mount of the cash
but there has been no effect of it on the profit as it is not included in the calculation of it (Karlan
and Valdivia, 2011). The repayment made of the bank loan is also not considered in the profit
and loss account whereas they will be treated in the calculation of the closing balance of the cash
so that will be declined. These are the major aspects because of which the situation has arisen.
The another matter which will be considered in this is that the business is allowing the
credit facility to the customers so the sales will be made but the cash will not be received in this
case. By this the net profit will be increased as the credit sales is also included in the total
revenues but this will not be added in the cash account.
The balance is overdrawn and the another example of it in the present scenario is the
drawings which are made by Lisa and John. By this the profit will not be declining as they are
not deducted as an expense and they are treated in the capital account but since the amount will
be withdrawn so the balance of the funds will be declining and which will be having an adverse
impact as the business is new and in the initial stage only if the drawings will be made then it
will not be left with much funds and will not be able to carry on the activities in the appropriate
manner. So it will have to be ensured that the amount of the cash shall be maintained at correct
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level and for this proper control system will have to be established by which the expenses which
are incurred will be monitored on the regular basis and thereby the expenses which can be
avoided will be identified and measures will be taken to overcome the excessive expenditures.
All of these were some of the reasons due to which the difference has arisen and also the
variation among the cash and profit is made which are two separate aspects and will have to be
managed in the best manner possible.
5. Accounting conventions and their impact on statements.
In the business there are various accounting processes which are undertaken and among
them several statements are made and in relation to them there are many rules and regulation
which have been made (Ryan, Buchholtz and Kolb, 2010). They are known as the accounting
conventions and are required to be followed in the business so that the recording of all the
transactions can be made on the appropriate basis. There are various conventions which are
specified by the authorities and the two among them which have been used by the Lisa and John
are described below:
 Convention of conservatism: In this the main focus is provided on keeping the business
in the safe position. In this the transactions are recorded by keeping in view the concept
that all the expenses and losses which are involved in the business shall be taken into
consideration and the incomes which will be earned in the future and are not made in the
current period will have to be ignored (Abor and Quartey, 2010). By this it will be
provided that al the risk and the uncertainties which are present will be given proper
importance so that the adverse impact of them can be dealt with in the most appropriate
manner. In this the main example which can be considered is the valuation of the stock in
which the rule which is followed specifies that the inventory shall be valued at the
amount which will be lower of the cost value or the price in the market.
The another major part which is dealt in this convention is the bad debts which are the amount of
the debtors about whom the uncertainty is there that whether they will be paying back the
amount or not. The same case is present in the given situation as there is one mail order customer
who purchase the products on credit and she owes 850 and now she is not able to pay the amount
and is requesting that she should be given some extra time to repay the amount. But John has
identified that there are very less chances that the amount will be recovered as it is the image of
that customer in the market. So while making the statements the amount has been involved in the
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income statement as the bad debt and also it has been reduced from the amount of the total
debtors outstanding at the end of the period. So by this it can be said that the convention of the
conservatism has been applied in the business.
 Convention of materiality: Under this it has been specified that all the material aspects
which are there and the transactions shall be included in the preparation of the financial
statements. It shall be noted that the transactions which are of small amount and are not
of much significance shall be not given the emphasis (Anandarajan, Anandarajan and
Srinivasan, 2012). This is done as they will not be of much importance to the
management as there will be no effect which will have to be borne due to them and also
no information will be provided by them which can be used in the decision making
process of the business.
The item will be considered to be material when there will be the significant impact which will
have to be dealt with if it will be omitted to be included in the accounting. Also the decisions will
be affected because of them which will be made by the persons who will be using them. In this
sometimes it happens that the many small matters are accumulated and then on the combined
basis they become relevant so they will be included. Such as in the given case the head is
provided with the name of other expenses in which nothing is specified separately but all of them
are included and the profit is affected by them. The other material aspects which will be involved
in the business will also be incorporated so that the the true picture can be made and all the
decisions which will be taken on the basis of them will be the best and the business will be able
to achieve the advantage of it.
So these are the two conventions which are considered and are to be followed
compulsorily in the business so that the accounting records which are kept by Lisa and John will
be in appropriate format and they will be able to have all the information which will be utilised
in the future period so that the further growth can be achieved by the company. Also as the
venture is new so it will be ensured that its going concern can be maintained and there will be no
r8isk in relation to it which will have to be dealt with by the business.
CONCLUSION
From the above mentioned report it can be concluded that there are various matters which
will have to be given due importance in the business by which the management of business can
be carried out in the most appropriate manner. For this there has been analysation made for
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which the ratios have been calculated that are telling about the position and performance of the
business. Then the interpretation is done and the reasons which are there by which the profits and
cash are different and there is an overdraft in the balance of cash. The conventions which are
complied with are also described with the help of which proper accounting has been undertaken.
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