Accounting and Finance: Loan Application Financial Analysis Report

This report presents a comprehensive financial analysis of a business, likely for a loan application. It begins with an analysis of financial ratios provided by the applicant, including current ratio, quick ratio, asset turnover, and profit margins, highlighting strengths and weaknesses in liquidity and profitability. The report then identifies the need for additional ratios, such as debt service and interest coverage ratios, to provide a more complete picture. Trend analysis is performed, comparing sales and profit figures over several years to assess business growth. The report also includes a discussion of profitability and financial stability ratios, such as operating profit, return on assets, and debt ratios. Finally, the report includes a cash flow analysis, budget preparation (sales, purchase, and cash budgets), and variance analysis, demonstrating the business's ability to manage its finances and meet its obligations. The report concludes by emphasizing the importance of cash flow from operations in investment decisions.

Running head: ACCOUNTING AND FINANCE
Accounting and Finance
Name of the Student:
Name of the University:
Author’s Note:

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Table of Contents
Answer to Question 1......................................................................................................................2
Requirement 1.1...........................................................................................................................2
Requirement 1.2...........................................................................................................................4
Requirement 1.3...........................................................................................................................5
Answer to Question 2......................................................................................................................6
Requirement 2.1...........................................................................................................................6
Requirement 2.2...........................................................................................................................8
Reference.......................................................................................................................................10

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Answer to Question 1
Requirement 1.1
Part a
As per the case study Mary Norton who has applied for a loan for a period of 8 years has
provided financial ratios as a proof of the businesses worthiness to acquire such a loan. The
financial ratios which are shown by Mary Norton some of which are considered to be financial
indicators of the businesses performance. The current ratio of the business is shown to be 2.1
which has reduced from the previous year. There has been a fall in the current assets of the
business even though the ratio is still ideal. The quick ratio of the business has improved from
the previous year which shows that the firms liquidity position has further improved and the
same is depicted as 1.4. The asset turnover ratio of the business has fallen from the previous year
which is not a favorable sign for the business. The cash debt ratio has improved slightly which
shows improvement in debt servicing of the company. The profit of the business has decreased
from previous year by 8% which is a significant fall as compared to 2016 which shows that the
profit has increased by 32%. As the profit of the business has decreased therefore the earning per
share of the business has also fallen which is shown as 2.5 per share in 2017.
The ratios which are provided by Mary Norton shows mixed results. In terms of liquidity
condition, the business is very much favorable as it has a perfect current ratio and a near perfect
liquid ratio. The current ratio and quick ratio which is considered to be ideal is 2:1 and 1.5: 1
respectively. The current ratio of the business shows the company’s ability to meet the current
obligations of the business effectively. In addition to this, the acid test ratio of the business
shows the current obligations of the business which is similar to current assets of the business.

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The only difference which lies between current ratio and acid test ratio is that inventory is not
included in acid test ratio of the company. This suggest that the business will be reliable if they
are granted the debt amount. However, the asset turnover ratio has fallen and the profit which is
generated by the business during the year has also fallen which suggest that the current
performance of the business is not good. The asset turnover ratio of the business represents how
much profit the business can earn employing the assets of the company and the return which is
earned on the assets are financial indicators of the strength of the company. Therefore, the
analysis of profitability does not paint the business as favorable. The ratios which are provided
by Mary Norton are somewhat important for decision making but some other ratios like interest
coverage ratio, debt service ratio, debt equity ratio are also important and provides a great deal of
information which will be required before the loan amount can be granted to Mary Norton.
Part b
The three other ratios which needs to be calculated for Borrowers ltd are Debt servicing
ratio, interest coverage ratio and debt equity ratio. The debt service ratio reveals the ability of the
company to manage and maintain the debt capital which the business has taken. The ratio reveals
a great deal about the company’s capability to meet the obligations which are related to debt
capital of the business (Rasoolpur 2014). The interest coverage ratio of the business reflects the
company’s ability to pay the interest charges which are associated with the borrowings of the
business. The interest coverage ratio is used often by financial institution to judge whether the
business is able to meet the interest payments for existing loans (Baños-Caballero, García-Teruel
& Martínez-Solano, 2014). Debt equity ratio is considered to be one of the financial indicators of
the business’s performance. It also reveals the capital structure of the business and also the
nature of the capital which the business uses that is it can tell whether a business is leveraged

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firm or not. Moreover, the debt equity ratio also shows the dependency of the business on the
equity and debt capital for financing the activities of the business. The debt capital in the
business represents the leverage of the business. However, too much leverage would increase the
financial leverage of the business which is not a favorable sign and therefore the leverage
conditions and business stability is reflected by debt equity ratio which is to be considered before
loan can be granted to Mary Norton.
Part c
The limitations which ratio analysis faces in case of credit or investment decisions are given
below in point form:
 The calculations of ratios does not considers the effect of inflations in the computation
process than bring out unrealistic results.
 The data which is presented in the Profit and loss account are at current cost where as the
items which appear in the balance sheet is reported at historical costs which some time
produces unusual results (Smith & Smith 2014).
 The ratios are based on formulas which are set but it is seen for calculating ratio
sometimes two separate formulas are available which might give approximately same or
different results so there arises a confusion which formula is genuine (Vogel 2014).
Requirement 1.2
Part a

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Items 2017 2016 2015 2014 2013 2017 2016 2015 2014 2013
Net Sales 4555.2 4350.9 3222.2 2943.7 3080.3 148% 141% 105% 96% 100%
Profit after Tax 966.2 1166.2 919.9 799.3 462.9 209% 252% 199% 173% 100%
Year Trend
The above table shows the trend of net profit and sales of the business. The trend and the
changes in sales figure of the business is shown in the diagram above. The maximum net sales
which is achieved by the business is in the year of 2017 itself and the maximum amount of profit
which is generated by the business is in the year 1166.2 in the year 2016.
Part b
The question has taken the 2013 as the base year on the basis of which trend is to be
analyzed for each period. If the base is taken 2013, the trend shows that in 2014 there has been a
fall in the sales of the business but the profit of the business has significantly increased which
signifies that the company has effectively managed the cost of the business. In 2015 and 2016
both the figures of sales and profits have significantly increased which suggest that the business
is developing and growing. The net sales of the business has increase from previous year and is
shown as 4555.2, however the profit of the business has reduced which can be attributed to cost
of the product or even other factors are also possible.

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Requirement 1.3
Formula
Profitability Ratios 2017 2016
Operating Profit EBIT/Net Sales 3.48% 0.64%
Return on Assets EBIT/Average Total Assets 0.28% 0.03%
Net Profit Margin
Net Profit/Average Total
Assets 0.84% 0.71%
Return on Equity
Net Profit/Average Owner's
equity 7.21% 11.52%
Financial Stability
Debt Ratio Liabilities/Total Assets 0.29 0.94
Debt to Equity Liabilities/Equity 0.41 14.67
Interest Cover EBIT/Interest Expense 5.17 0.50
Assets Utilization
Assets Turnover Ratio
Net Sales/Average Total
Assets 0.08 0.05
Calculations
The profitability ratio of the business consists of operating profit ratio, return on assets,
return on equity and net profit margin of the business (Parsian & Shams Koloukhi 2013). The
operating profit ratio of the company shows that the ratio has significantly improved from 2016
estimates. The returns on assets of the business also shows a similar result which suggest that the
utilization if assets by the business has improved considerably. The net profit margin of the
business has also increased from previous year which suggest that the business has improved
their operations and generated more profit (Agha 2014). The return on equity of the business has
reduced from previous year which suggest that the business needs to focus on the needs of the
shareholders of the business.
The financial stability ratio is made up of debt ratio, debt equity and interest cover ratio.
The debt ratio has reduced which means that the business has reduced the debt capital which was
used by the business (Baum, Checherita-Westphal & Rother 2013). The debt to equity ratio
reflects the capital structure of the business which has reduced significantly as shown in the table

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above. The asset turnover ratio of the business has increased which is a positive sign for the
business (Delen, Kuzey & Uyar 2013).
Part b
As per the question, Peter is of the opinion that the operating cash flows is one of the
important decision which helps in the decision-making process. The argument of Peter is correct
as the cash from operation reveals the operational efficiency of the business and also reveals the
ability of the business to reduce the costs which are related to operations and such is considered
to be a financial indicator of the business performance (Biddle, Ma and Song 2013). Therefore, it
helps investors in making investment decisions as almost all investors consider such a ratio.
Answer to Question 2
Requirement 2.1
Part a
Schedule of Expected Cash Receipts from Debtors:
Particulars January February TOTAL
Expected Sales $60,000 $55,000 $1,15,000
Less: Cash Sales@ 30% $18,000 $16,500 $34,500
Credit Sales $42,000 $38,500 $80,500
40% receipt in the month of sale $16,800 $15,400 $32,200
60% receipt in the next month of sale $25,200 $25,200
Total Receipts from Debtors $16,800 $40,600 $57,400
Part b

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Cash Budget:
Particulars January February TOTAL
Cash Flow Operating Activities:
Cash Sales $18,000 $16,500 $34,500
Receipts from Debtors $16,800 $40,600 $57,400
Payment to Suppliers -$35,000 -$35,000
Offi ce Salaries -$10,000 -$12,500 -$22,500
Net Cash flow from Operating Activities $24,800 $9,600 $34,400
Cash Flow Investing Activities: $0 $0 $0
Cash Flow Financing Activities:
Owner's Contribution $85,000 $85,000
Owner's Withdrawal -$3,000 -$3,000 -$6,000
Net Cash flow from Financing Activities $82,000 -$3,000 $79,000
Net Increase/(Decrease) in Cash Flow $1,06,800 $6,600 $1,13,400
Add: Opening Cash Balance 0 $1,06,800 0
Closing Cash Balance $1,06,800 $1,13,400 $1,13,400
Part c
Hamilton Manufacturer had previously taken a loan for which the installment is due and
therefore the installment needs to be paid in February. The business will be able to pay off their
loan as the closing cash balance of the business is sufficient to meet the obligation which is
related to the loan amount. The amount which is to be paid as installment amounts to $ 80.000.
The cash balance which the business has is shown in the cash flow statement for thee year 2016
is shown to be $ 1,13,000.

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Requirement 2.2
Part a
Sales Budget:
Particulars October November December TOTAL
Budgeted Sales Volume 22000 27000 32000 81000
Selling Price per unit $5.50 $5.50 $5.50 $5.50
Budgeted Sales Revenue $1,21,000 $1,48,500 $1,76,000 $4,45,500
Part b
Purchase Budget:
Particulars October November December TOTAL January
Budgeted Sales Volume 22000 27000 32000 81000 30000
Add: Closing Inventory 8100 9600 9000 9000
30100 36600 41000 90000
Less: Opening Inventory 6600 8100 9600 6600
Budgeted Purchase Volume 23500 28500 31400 83400
Purchase Price per unit $4.00 $4.00 $4.00 $4.00
Budgeted Cost of Purchase $94,000 $1,14,000 $1,25,600 $3,33,600
Part c
Cash Budget:
Particulars October November December TOTAL
Cash Sales $1,08,900 $1,33,650 $1,58,400 $4,00,950
Receipts from Debtors $9,900 $12,100 $14,850 $36,850
Payment to Suppliers -$72,000 -$76,800 -$94,000 -$2,42,800
Net Increase/(Decrease) in Cash Flow $46,800 $68,950 $79,250 $1,95,000

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Add: Opening Cash Balance $17,000 $63,800 $1,32,750 $17,000
Closing Cash Balance $63,800 $1,32,750 $2,12,000 $2,12,000
Part d
Variances refers to the deviation which arises between the standard which is et by the
management and the actual performance of the business (Chen, Weikart & Williams 2014). The
main purpose and use of variances comes in budgets as it helps budgets to monitor activities of
the business. In addition to this, variances are useful to identify the faults in the management and
take corrective actions so that such variances do not occur.
A common limitation which variance analysis faces is that the applicability of such a approach is
not very much wide and therefore it is only applicable.
Reference
Agha, H., 2014. Impact of working capital management on profitability. European Scientific
Journal, ESJ, 10(1).

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Baños-Caballero, S., García-Teruel, P.J. & Martínez-Solano, P., 2014. Working capital
management, corporate performance, and financial constraints. Journal of Business
Research, 67(3), pp.332-338.
Baum, A., Checherita-Westphal, C. & Rother, P., 2013. Debt and growth: New evidence for the
euro area. Journal of International Money and Finance, 32, pp.809-821.
Biddle, G.C., Ma, M.L. & Song, F.M., 2013. The risk management role of accounting
conservatism for operating cash flows.
Chen, G.G., Weikart, L.A. and Williams, D.W., 2014. Budget tools: Financial methods in the
public sector. CQ Press.
Delen, D., Kuzey, C. & Uyar, A., 2013. Measuring firm performance using financial ratios: A
decision tree approach. Expert Systems with Applications, 40(10), pp.3970-3983.
Parsian, H. & Shams Koloukhi, A., 2013. A study on the effect of free cash flow and profitability
current ratio on dividend payout ratio: Evidence from Tehran Stock Exchange.
Rasoolpur, G.S., 2014. Impact of Cash Flow Coverage, Debt Service & Current Ratio on Capital
Structure Decisions: Empirical Evidence from the Indian Corporate Sector. Journal of Research
in Marketing, 3(1), pp.232-238.
Smith, S.R. & Smith, K.R., 2014. The journey from historical cost accounting to fair value
accounting: The case of acquisition costs. Journal of Business and Accounting, 7(1), p.3.
Vogel, H.L., 2014. Entertainment industry economics: A guide for financial analysis. Cambridge
University Press.