Financial Statement Elements and Analysis: Accounting Principles

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Financial Statement Elements and
Financial Statement Analysis
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Table of Contents
Introduction.................................................................................................................................................3
Part A..........................................................................................................................................................4
a...............................................................................................................................................................4
b...............................................................................................................................................................5
Part B...........................................................................................................................................................6
Part C...........................................................................................................................................................7
a...............................................................................................................................................................7
b...............................................................................................................................................................7
c...............................................................................................................................................................7
Conclusion...................................................................................................................................................8
References...................................................................................................................................................9
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Introduction
A financial statement involves various financial components and variables and establishes
meaningful relationship between those components to make financial statements more
presentable and relevant. Understanding and analysis of these variables enables the management
and other users to make informed decisions and take strategic decisions which would affect them
in long term.
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Part A
a.
Data given in the question:
Particulars 2019 ($) 2018 ($)
Net Sales 630 000 490 000
Cost of Goods Sold 290 000 250 000
Current Assets 218000 222000
Quick Assets 200000 210000
Current Liabilities 105 000 81 000
Average Accounts Receivables 65000 69000
Average Inventory 140000 140000
Credit Period Policy 30 30
Industry Inventory Turnover
Ratio 101 101
Calculation of Ratios:
Particulars 2019 2018
Current Ratio 2.07 2.74
Quick Ratio 1.9 2.59
Accounts Receivable Turnover
Ratio 9.69 7.1
Inventory Turnover Ratio
(Times) 2.07 1.78
Inventory Turnover Ratio
(Days) 176.32 205
Collection Period (Days) 37.67 51.4
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b.
The solvency of the business can be determined by calculation and analysis of solvency ratios
such as current ratio and quick ratio. These suggest the liquidity position of the company and its
ability to pay off short term debts as and when required. Quick ratio calculates immediate
responsiveness on the part of the company to pay off its debts. From the given data current ratio
comes out to be 2.74 in 2018 and 2.07 in 2019, signifying that that liquidity position has fallen
down. Quick ratio has fallen down from 2.59 (2018) to 1.9 (2019), which can be considered as a
significant fall and hence suggesting marginal decrease in the short term solvency position of the
company (Accountingtools, 2019).
Efficiency of a company can be analyzed by calculating Accounts Receivable and Inventory
Turnover ratio. Inventory Turnover ratio helps in calculating the period in which the inventory of
the company is sold out, which comes out to be 205 in 2018 and 176 in 2019. Although it has
decreased over the year, industry operates at 101 days which is lower than both the years,
suggesting that the company have been unable to meet industry benchmarks and hence less
efficient in comparison to its competitors. Collections period has decreased from 51 to 38,
suggesting that the company is collecting its debt more often. But still as per company polices it
should be or below 30 days, suggesting that the company is not able meet its set benchmarks and
low efficiency.
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Part B
In accounting terms, an income of a company is an amount received by it on a regular basis as a
result of its operations and or in the form of returns or interests from the investments or loan
provided. In the given question, all the provided amounts will amount as income except the
amount received in the form of cash in exchange of shares being $500 000 and the waiver of
liability of $2000 treated as discount. Amounts received from the sale of software ($25 000 000)
and the receipts from the update downloads ($3 000 000) are earned as a part of the operations
and are earned on a regular basis and hence falls under the purview of the income of the
company. Interest income from short term money market ($50 000) is a miscellaneous income
and is earned on a periodic basis, and thus classifiable as an income in the books of accounts of
the company. Hence, total income earned by the company being $28 050 000 for the period.
Income can further be classified as ‘Income from Revenue and Operations’ and ‘Other Income’
in the Income Statement of the company. One condition for receipt being a revenue income is
that it should be regular in nature and should be earned as a result of the operations. Receipts
from the sale of software and update downloads will only be considered as revenue income as
the same have been earned through operations and are incurred on a regular basis. Hence,
revenue income for the company for the period is $28 000 000 (Corporatefinanceinstitute, 2019).
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Part C
a.
A bank would provide loan to a company after analyzing its solvency and liquidity position, as it
need to makes sure that the company will be able to pay off its debts on a timely basis along with
the interest charged on the same. For ascertaining the liquidity position of the company, bank
may calculate the current ratio of both the companies. Current ratio for the company being:
Current
ratio:
Particulars
ABC
Company
XYZ
Company
Current Ratio 0.14 2.17
It can be seen that the Company XYZ Ltd is significantly more liquid than ABC and hence a
safer bet for the bank (Myaccountingcourse, 2019).
b.
For making business acquisition decisions, its necessary fort the business person to calculate the
fair value of the business being acquired and ascertain the most appropriate amount for the
purchase of the business. The value of the business may be calculated as the value of net assets,
which is directly available in the data, being $8 400 for ABC Company and $34 200 for XYZ
Company. From the data, it is apparent that the business person will be willing to pay more for
the XYZ Company, as it has more value in the market (Corporatefinanceinstitute, 2019).
** It has been assumed that the net assets value is calculated at fair value.
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c.
In case where the owner agrees for taking over all the liabilities, the value of the net assets will
change such that new value would be, $61 200 for ABC Company and $46 200 for XYZ
Company. In this case the business person will be willing to pay more for ABC Company.
Conclusion
The assignment involves understanding the financial data and makes the data more presentable
and more presentable for taking decisions. Users such as management, banks and acquirer of the
business requires thorough analysis of the financial data provided and make decisions on the
basis of those calculations and analysis which will impact them for the long run.
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References
 Accountingtools. 2019. Financial statement analysis. [Online] Accountingtools Available at:
https://www.accountingtools.com/articles/2017/5/14/financial-statement-analysis [Accessed
on: 27th May 2019]
 Corporatefinanceinstitute. 2019. What is Revenue vs Income? [Online]
Corporatefinanceinstitute Available at
https://corporatefinanceinstitute.com/resources/knowledge/accounting/revenue-vs-income/
[Accessed on: 27th May 2019]
 Corporatefinanceinstitute. 2019. What is the Quick Ratio? [Online] Corporatefinanceinstitute
Available at: https://corporatefinanceinstitute.com/resources/knowledge/finance/quick-ratio-
definition/ [Accessed on: 27th May 2019]
 Myaccountingcourse. 2019. Inventory Turnover Ratio. [Online] Myaccountingcourse.
Available at: https://www.myaccountingcourse.com/financial-ratios/inventory-turnover-ratio
[Accessed on: 27th May 2019]
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