Financial Decision Making: Accounting Functions & Ratio Analysis

This report critically evaluates the role of accounting and financial functions in financial decision-making, using Alpha Limited as a case study. It begins by defining financial decision-making and highlighting its importance in organizational finance. The report then assesses accounting functions, including tracking, recording, and reporting financial transactions, and finance functions, such as financing, investment, and dividend decisions. It uses examples from Alpha Ltd to illustrate these functions' impact on operational efficiency. The report calculates and analyzes key financial ratios for Alpha Limited for the years 2017 and 2018, including Return on Capital Employed, Net Profit Margin Ratio, Current Ratio, Average Receivable Days, and Average Payable Days. Based on these ratios, it comments on the company's performance from an investor's perspective, noting areas of concern and potential risks. The report concludes by emphasizing the inseparable and essential nature of accounting and finance activities in ensuring organizational resilience and competitive advantage.

FINANCIAL DECISION
MAKING

Table of Contents
INTRODUCTION...........................................................................................................................3
TASK 1- ..........................................................................................................................................3
ACCOUNTING AND FINANCIAL FUNCTIONS-..................................................................3
TASK 2-...........................................................................................................................................6
(A) CALCULATION OF RATIOS- ...........................................................................................6
(B) COMMENTS ON THE PERFORMANCE OF ALPHA LIMITED- ..................................8
CONCLUSION..............................................................................................................................11
REFERENCES..............................................................................................................................11

INTRODUCTION
Financial decision-making is a crucial act by the financial manager relating to the
financing-mix of an organization. It is concerned with the borrowing and allocation of funds
required for the investment decisions. A firm has to decide the method of funding by assessing
its financial situation and the characteristics of the source of finance, this set of activities are
known as financial decision-making (Chen, 2018.) In this report the role of accounting and
financial functions will be critically evaluated and will also be substantiated with relevant
examples. Then the financial rations will be calculated and analysed in reference to the asked
entity and will be critically analysed from the perspective of a potential investor. The report will
broadly discuss how the accounting and financial functions are significant in financial decision-
making and how it can drive the operational efficiency of a corporate institution.
TASK 1-
Accounting and Financial functions-
Accounting and finance functions are key parts of the management. It won't be
exaggeration citing these functions as the backbone of all activities. The Accounting functions
call attention to the process of tracking, storing, recording, analysing, summarizing and reporting
of a company's financial transactions. On the other hand financial functions stand for a part of
financial management in which deals with planning procurement, investment, credit and
collection, loans and advances, tax and insurance etc. further it can also be classified in three
main segments financing decision, investment decision and dividend decision. The success of an
organisation hugely depends on the accounting and finance practices of it. Operational efficiency
of the business is directly linked with it. The efficiency of an entity is nowadays depends on the
data availability, which is why to possessing great data base is now a necessity not a luxury for
the institutions (Sedevich-Fons, 2019.)
Role of Accounting functions — As it is defined a bunch of activities which ensures better
recording and providing data for better management and control of the business. There is a set of
activities under it. In modern business environment the data of the business plays vital role like
in planning, controlling, forecasting, decision-making etc. It is a testimony of various financial
activities of the business. It provides data of their business transactions, fund status, liquidity

situation etc. The role of accounting are control of financial policy, formation of planning,
preparation of the budget, cost control, evaluation of employees' performance, prevention of
errors and frauds, exhibiting financial affairs, communicating financial information etc.
Over the years there are other branches of accounting also introduced which aims specific
purpose for instance- Management accounting aims to assist management in managerial
decision-making. In management accounting there are multiple works are performed for helping
the managers of various stages. In it generally we perform ratio analysis, cash flow statement,
fund flow statement, common size statements, comparative statements etc. For better
fortification, lots of institutions are following MIS( Management Information System). Whose
role is to draw the road map for a strong management information system so that various relevant
information can be processed further and then being reported to the managers for whom it is
relevant. Whereas cost accounting helps cost managers in controlling the cost of the products. In
cost accounting the entire aim is to aid the cost management and make them more competent
with this regard. It performs the role of helping in pricing, formulate cost efficiency policies and
complying with the legitimacy as well. The role of accounting can be perceived by the given
instance (Kozlowski, 2018).
For example- In ALPHA Ltd it is seen that the Net Profit Margin Ratio of the firm has
been declined in the year 2018, from 12.5 to 8.75%. It was due to higher cost of production. This
accounting information is generated by management accounting and will be helping management
. Taking it into focus it can be concluded that in ALPHA Ltd the operational activities are
underperforming, specifically the cost management is no efficiently working. Net credit purchase
of the company is also reported higher in the books of account but it did not hike the revenues
which is also a discussable issue. In the absence of accounting managers and other key position
holders would be helpless in decision-making.
But there is a dark side of accounting as well. It may mislead the conclusions to certain
degree. There are so many accounting standards and practices in the business fraternity. But
every and each business is a separate in nature and also faces different situations as well.
Applying same set of regimes may take down the usefulness of the accounting reports. There
may be some other qualitative elements as well which are explicitly avoided in modern

accounting practices. And sometime we just consider mathematical expressions for being driven
to conclusion which is not too much reliable. For instance in this case where ALPHA Ltd is not
performing good in the year 2018 compares to 2017. It is also possible that it is a half picture.
This company is there from 1954 and serving the customers from more than 70 years. The
performance of two consecutive years is not sufficient to decide the way forward. There may be
some short term factors which had caused this jeopardy to the entity but it is possible that the
waste size of the company may help it in getting its position back. There are many more fuzzy
functions of accounting like manual mistakes, individualism, manipulation, only monetary
expressions etc. Yet it can't be eliminated due to the wide range of well-bing it brings to the
business (Doktoralina, 2018)
Role of Finance functions- Finance functions can be broadly bifurcated in three parts-
Financing, Investing, Dividend distribution. Finance is also called the blood of a business and
any mismanagement with it may outperform the entire operations. In finance functions there are
multiple tasks to be performed. Such as in financing it is decided that how to arrange funds on
right time, in required amount and from such sources which can minimize the risks and also
reduce the burden of cost of capital. Further more at one the finance is arranged then it is decided
that how and in what it should be invested so that can maximize the capacity of the fund to pop
out returns for the organisation then at last it is decided that how much share of the profit or net
revenue should be redeployed and how much should be announced as dividend. (Hassan,
2020.)So altogether it is a cluster of multiple activities whose final pursuit is to create a strong
finance environment within a business. It decides the well performance of various finance
activities and insure their better role in surging revenues for the business. The role of finance
functions can be experienced by the given instances
For example- The ALPHA Ltd. Was having debt of 7,50,000 euros in 2017 but in 2018 it
was 15,00,000 which is a failure of their finance activity. Since it is a general phenomenon that
if you are not generating enough profits then it is better to go with owner's fund where there is no
fixed rate of return has to be given. In 2017 the finance cost was just 75,000 euros but in 2018 it
was 1,50,000 euros, which significantly impacted their EBIT.

In finance functions investment policy is also framed which decided the future of finance in an
organisation. In the case of ALPHA Ltd. It has no investment externally. About dividend policy
so the company has retained good reserves, it was 5,62,500 euros in 2017 and in 2018 it was
8,25,000 euros, which defines that the entity wants to utilize the revenue funds for their
expansions or for strengthening their operations. These both examples are articulating the role of
finance functions in an organisation.
Along with these pros there are a few cons as well. It is arguably said that the financial
functions introduce couple of perils as well as like- if such policies are rigid in nature then will
restrict the entity to take advantage of prevailing opportunities. Future is not certain and the core
function of planning is to plan for future which makes this task complicated and a minute
mistake may hurt the financial predictions. Generally it is seen organisations pay more attention
to fund-raising and less to fund utilization, in such cases they end up being profitless (Zhang,
Zhang and Pei, 2019.)
Despite having these lacunas of finance functions it can be concluded that both
accounting and finance activities are inseparable and essential functions of any organisation,
which make them more resilient and prolific in the competitive business environment and give
upper-hand in financial decision-making (Zhou, 2018. )
TASK 2-
(a) Calculation of ratios-
(1) Return on capital employed-
Return on capital employed= EBIT/ Capital employed
Capital employed= Total assets- Current liabilities
2017 2018
Total Assets 2,235 4,035
Current liabilities 322.50 1,110

Capital employed 1,912.5 2,925
EBIT
Profit after financial cost 300 262.50
Add; financial cost 75 150
EBIT 375 412.5
Return on Capital employed 375/1,912.5×100 412.5/2,925×100
19.60 14.1025
(2) Net Profit margin ratio-
Net Profit margin ratio= Revenue- cost/ Total Revenue×100
2017 2018
Revenue- cost/ Total Revenue×100 300/675×100 262.50/750×100
Net Profit margin ratio 12.5% 8.75%
(3) Current ratio-
2017 2018
Current assets 757.50 1,035
Current liabilities 322.50 1,110
CR=CA/ CL
Current ratio 2.3488 0.9324
(4) Average Receivable days-
2017 2018
Net credit sales 2,400 3,000

Average receivables 450 600
2,400/365 3,000/365
Average collection per day 6.5753 8.2191
450/6.5753 600/8.2191
Average receivable collection period 68.43 days 73 days
(5) Average Payable days-
2017 2018
Net credit purchase 1,350 2,400
Average payable 285 1,050
1,350/365 2,400/365
Average payment per day 3.6986 6.5753
285/3.6986 1,050/6.575
Average payable days 77.05 days 159.68 days
(b) Comments on the performance of ALPHA limited-
(1) Return on capital employed- Capital employed refers to the excess of Total assets over
current liabilities, simply it defines the amount which is employed to generate revenues for the
organisation. As an investor it is prominent for it to measure the return rate on the capital
employed of an entity and prefer the firm with higher ROCE. For ALPHA Ltd it was 19.60 % in
2017 whereas in 2018 it was 14.10 %. which is indicating their poor performance in the second
year. There may be some causes like- low amount of EBIT. Earlier it was 375 and then 412.5,
which is looking absolutely higher but in relation to invested amount or capital employed it is
low. Since capital employed in 2017 was 1912.5 and in 2018 it was 2925. There may be other
reasons as well. For instance- lower sales, or high cost of production, higher prices of purchase
etc. It may lead to a few circumstances as well like- the lower rate of return on capital may

bother the loan-providers, and they may go for taking their money back, which will ultimately
affect the investors. (Casielles, 2019.) So as an investor it won't be a smart decision to invest in
such entity which is constantly experiencing downfall in term of their returns on capital
employed. Since it shows that the deployed money is not returning revenues in the amount it is
expected. At the same time if this rate is lower than the average rate of the particular industry
then there is no scope of investment. It would be a risky and non-lucrative alternative for the
investor.
(2) Net profit margin ratio- It is the ratio which compares the profit of a company to the total
amount of money it brings in. Here in this case it was 12.5% in 2017 and 8.75% in 2018. which
shows that the retention rate of the total revenue is lower comparatively. Higher the rate is
considered better for the investor's point of view. In the year it is toppled and came to 8.75%
which depicts that if company generate $100 revenue in sales then it is able to keep just $8.75,
as their net profit. It is also indicating poor operational performance of the entity since it was
higher last year. There may be range of causes and effects of this case but these may be
considerable- Occurring higher cost of goods sold, generating lower revenue on sales, low
selling during the period etc. Here in this case by general observation it can be concluded that in
the year the Total revenue were less than 2018 but the cost part was also lower. In 2017 the net
revenue was 300 whereas in 2017 it was 262.50, which is lower. It is not a good symbol. In the
year 2017 the production cost was lower due to the purchase price but in the year 2018 the
purchase price is higher and it must be the biggest cause of this toppling. Here it is prominent for
an investor to analyse the causes of it. If the price is hiked due to general or unavoidable reasons
then such nuances can be avoided and if it was just poor management of the company then it
should not be ignored. And it is a negative indication for a potential investor (Hasanudin and
Awaloedin, 2020.)
(3) Current Ratio- It shows the relationship between the short term assets and liabilities of an
entity. Here in this case for ALPHA Ltd it was 2.34 in the year 2017 and in 2018 it was 0.93.
Which is not a good sign. The ideal current ratio is considered 1.5 to 3. which shows that for
paying one dollar debt the firm is having one and half dollar. In the year 2017 it is satisfactory
but in 2018 there is dubious sign for the potential investor. There may be such causes and effects

of this fall- company has generated more short-term debts which are to be paid in the future,
there is surge in both current assets and liabilities in the year 2018 but inter-relatively it is lower,
which caused this unfavourable expressions. 0.93 is a horrendous figure which shows that at
present the entity is just having 0.93 dollar against the short term debt of 1 dollar. Which is a
negative sign for them. (Koksal, Sbeta and Yildiz, 2019.) It can adversely impact the operational
efficiency of the firm. It is seen on many occasions that firm with insufficient working capital
got failed in achieving their operational goals. As a potential investor it must be seen that how
the company will set off it in emergency and if it is not manageable then the investment won't be
safe.
(4) Average Receivable collection period- It refers to the length of time a business needs to
collect its accounts receivables. Companies calculate the average collection period to ensure that
they have enough cash on hand to meet their financial obligations. This period indicates the
effectiveness of a company's average receivable management practices. Lower the period is
considered good. If it is less than 30 days then it's a favourable sign. For the ALPHA Ltd it was
68.43 days in 2017 and in 2018 it was 73 days. Both are not good by it got worse in 2018 which
is a negative sign. There may be mismanagement of receivable collection policy of the entity, or
there may be poor responses from the payers. It is not a healthy practice since it will lead to poor
short term liquidity. It will not impact the current ration expressions due to the same nature of
cash and receivables for accounting point of view but for an investor it can't be avoided. They
ought to look into the issues behind it. (Siele and Tibbs, 2019. )If it is low then somehow it will
impact the capacity of the entity to pay back to their payables. For investor scrutinizing the
causes and analysing their implications is a must needed practice. Here it can be concluded that it
is a little poor but there is no such huge variability in two years.
(5) Average payable days- stands for the average time period taken by an organisation for paying
off its dues with respect to purchases of materials that are bought on the credit basis from the
suppliers of the company. Keeping it lower is considered good so that the benefit of cash
discount can be availed. For ALPHA Ltd. It was 77.05 days in 2017 but in 2018 it hiked up to
159.68 days. Which is significantly high. There may be poor payment management by the entity
and other reasons consist less availability of funds or liquidity issues etc. It is not a good

indication, which is citing that the entity is not in the position to pay back to their suppliers. It
may destroy their relationship possibly with suppliers and tarnish their image as well. For an
investor this can't be ignored. It shows poor management and operational performance which
may cause horrendous damages to the entity in the future so investing in such entity is not safe
highlighting this point.
Observing all the ratios it is being pointed out that currently the entity is underperforming in the
all segments of their business in such predicament it won't be a wise decision to invest in such
entity. At the same time their performance in second year is a severe threat for a novice investor
(Zhagyparova,)
CONCLUSION
From the analysis done in the report above it can be concluded that in the report firstly
the accounting and finance functions are elaborately discussed. The character of accounting and
finance activities were evaluated keeping the disadvantageous factors of it in mind. Further the
report also used substantive and logical examples to articulate the role in more clear and
perceivable way. Along with it the report had also calculated financial ratios for the ALPHA Ltd
and then defined the mathematical expressions from the perspective of potential investor that
how the comparative or relatives changes in the ratios for given two years may influence the
decision of investors. And what had been the possible causes and effects of these changes.
Report had concluded various aspects of financial decision-making and logically represented it
with appropriate examples and explanations.

REFERENCES
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Online
Recording Business Transactions in Accounting, 2003-2022. Online. Available
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