BFA526 Accounting For Managers and Cash Flow Budget
2. Apart from shareholders, who else might be interested in the contents of financial accounting reports?
3. For each of the following items, classify them as either; asset, liability or equity.
Bank loan
Provision for annual leave
Brand names and intellectual property
Accounts receivable
Prepaid insurance premiums
Deposit paid by a customer for work yet to be done
Retained profit
Answer:
They gain ownership in the form of equity shares and the % of shares hold by them represents their ownership in the company.
- Shareholders are the owner of the company and remain interested in each and every act of the company. Apart from shareholders the following persons are also be interested in the contents of financial accounting reports:
- Lenders
- Bankers
- Investors
- Government agencies
- Customers and Vendors / Suppliers
- General Public
- Classification for the following:
- Paid up capital - Equity
- Bank loan - Liability
- Provision for annual leave - Liability
- Brand names and intellectual property - Asset
- Accounts receivable - Asset
- Prepaid insurance premiums - Asset
- Deposit paid by a customer for work yet to be done - Liability
- Retained profit - Equity
Whereas cash flow statement reflects the cash flows from various activities for a given period. It is prepared for the period which has already been passed, so it’s prepared on actual data. It helps in showing the management the cash flow generation or uses in various activities.
Depreciation refers to degradation/ reduction in the value of assets over a period of time in lieu of general wear and tear or technology obso
lesces. For instance, today a machine has been purchased for an amount of USD 10,000 which will have a salvage value of USD 2000 after 4 years. It means that the value of machinery will go down from 10,000 USD to 2,000 USD in 4 years. So, to make the books reflect true and fair view, we need to make adjustment in the value of machinery and this adjustment is knows as depreciation. So, for the first year the depreciation will be USD 2000 [(10,000-2,000)/4] and the value of machine at the end of first year will be USD 8000.
The pair which is larger from another and its reasons are as follows:
|
Particulars |
Larger one |
Reasons |
|
EBIT and net profit |
EBIT |
EBIT means earnings before interest and tax and net profit is after reduction of interest and tax. So, EBIT is larger since interest and tax have not been reduced from it. |
|
Paid up capital and owner’s equity |
Owner’s Equity |
Owner’s equity means the total amount that belongs to shareholders and paid up capital is a part of owner’s equity. Hence, owner’s equity amount is greater than paid up capital |
|
Dividends per share and earnings per share |
Earnings per share |
An earning per share is the total earnings attributable to a shareholder whereas dividend per share is a part from earnings which is given to shareholders. Hence, EPS is greater than DPS. |
|
Current assets and current liabilities |
Current assets |
Generally current asset is greater than current liabilities. Because excess of current assets over current liabilities represents working capital of the company. And a negative working capital is dangerous for the company. |
|
Net profit and gross profit |
Gross Profit |
Gross Profit is before indirect incomes and expenses whereas net profit is after all the incomes and expenses. |
Net Profit earned or Net loss incurred will also increase / decrease the owners’ equity
Dividend distribution to shareholders will decrease the owners’ equity
Leaving profits in the business would help the business to meet its working capital requirements and thus helps in expanding the business of the company. This expansion will in turn generate more profit and will increase the owner’s equity. Whereas withdrawing the profit for personal use is just an expense which will have no future growth. Examples of not withdrawing the profits are non-declaration of dividends, no drawings etc.
Calculation of Ratios
- Net Profit Margin = Net income / net sales
= (Sales - cost of sales - other expenses)/ net sales
|
Particulars |
|
30 June 2015 |
30 June 2016 |
|
Sales |
= |
60,000 |
90,000 |
|
Cost of sales |
= |
39,000 |
63,000 |
|
All other expenses |
= |
12,000 |
21,000 |
|
Net income |
= |
9,000 |
6,000 |
|
Net profit margin |
= |
15.00% |
6.67% |
- Rate of return on owners’ equity = Net income / shareholder's Equity
|
Particulars |
|
30 June 2015 |
30 June 2016 |
|
Sales |
= |
60,000 |
90,000 |
|
Cost of sales |
= |
39,000 |
63,000 |
|
All other expenses |
= |
12,000 |
21,000 |
|
Net income |
= |
9,000 |
6,000 |
|
Helena Beauty, Capital |
= |
60,000 |
72,000 |
|
Total shareholder's equity |
= |
60,000 |
72,000 |
|
Rate of return on owners’ equity |
= |
15.00% |
8.33% |
- Current ratio = Current Assets / Current Liabilities
|
Particulars |
|
30 June 2015 |
30 June 2016 |
|
Cash at bank |
= |
12,000 |
(18,000) |
|
Inventory |
= |
18,000 |
33,000 |
|
Accounts Receivable (net) |
= |
12,000 |
30,000 |
|
Current assets |
= |
42,000 |
45,000 |
|
Accounts Payable |
= |
6,000 |
9,000 |
|
Current Liabilities |
= |
6,000 |
9,000 |
|
Current Ratio |
= |
7.00 |
5.00 |
- Acid Test Ratio = Current Assets / Current Liabilities
|
Particulars |
|
30 June 2015 |
30 June 2016 |
|
Cash at bank |
= |
12,000 |
(18,000) |
|
Accounts Receivable (net) |
= |
12,000 |
30,000 |
|
Current assets |
= |
24,000 |
12,000 |
|
Accounts Payable |
= |
6,000 |
9,000 |
|
Current Liabilities |
= |
6,000 |
9,000 |
|
Acid Test Ratio |
= |
4.00 |
1.33 |
- Gearing Ratio = Non-current Liabilities / shareholder's equity
|
Particulars |
|
30 June 2015 |
30 June 2016 |
|
Non-current liabilities |
= |
- |
12,000 |
|
Non-current liabilities |
= |
- |
12,000 |
|
Helena Beauty, Capital |
= |
60,000 |
72,000 |
|
Total shareholder's equity |
= |
60,000 |
72,000 |
|
Gearing Ratio |
= |
0.00% |
16.67% |
Inventory turnover period = 365 / Inventory turnover ratio
|
Particulars |
|
30 June 2015 |
30 June 2016 |
|
Cost of goods sold |
= |
39,000 |
63,000 |
|
Cost of goods sold |
= |
39,000 |
63,000 |
|
Opening inventory |
= |
15,000 |
18,000 |
|
Closing inventory |
= |
18,000 |
33,000 |
|
Average inventory |
= |
16,500 |
25,500 |
|
Inventory turnover ratio |
= |
2.36 |
2.47 |
|
Inventory turnover (in days) |
= |
154.42 |
147.74 |
Profitability
Profitability ratios are a class of financial metrics that are used to assess a business's ability to generate earnings compared to its expenses and other relevant costs incurred during a specific period of time (Staff, 2017)1. It is calculated by dividing the net profit with the sales. Higher the net profit, higher the profitability ratio and the better it is. Similarly, there is also a gross profit margin ratio which reflects the gross profit ratio in comparison of sales. In current situation, the company’s gross profit ratio has reduced drastically from 15% to 6.67% inspite of the fact that the sales have been increased from $60,000 to $90,000. This is not a good indicator for the health of the company and it reflects that the company’s cost of sales is very high.
Short term Liquidity
Liquidity ratios measure a company's ability to pay debt obligations and its margin of safety through the calculation of metrics including the current ratio, quick ratio and operating cash flow ratio (Staff, 2017)2. It shows the capacity or ability of the company to generate cash from its current assets or how quickly a company can settle its current liabilities. Again, the higher the liquidity ratio, the better it is.
These ratios include
- Current Ratio = It compares current assets and current liabilities to determine the company’s ability to pay off its current liabilities from its current assets.
- Quick ratio or acid test ratio = It compares the quick current assets means current assets excluding inventory and prepayments with current liabilities to determine the company’s ability to pay off its current obligations from its quick assets.
The company’s current ratio have reduced from 7 times to 5 times and this is due to increase in current liabilities whereas acid test ratio have decreased from 4 times to 1.33 times.
Long term solvency
Long term solvency is measured through gearing ratio. Gearing ratio is a measure of financial leverage of the company. It compares company’s debt with the equity or outsiders debt obligations with the internal funding and by comparing both of them, tries to find out the financial risk to which the company might be exposed off.
In given situation, the company’s is having no debt in 2015 hence the gearing ratio was zero whereas in 2016 the gearing ratio was 16.67% as the company has taken long term loans.
- Calculation of variable costs per pot for Fancy Terracotta pots
|
Particulars |
Units |
Price |
Total cost pu |
|
Plastic raw material |
1.50 |
1.00 |
1.50 |
|
Machine operator labour |
1.00 |
1.00 |
1.00 |
|
Electricity |
1.00 |
0.10 |
0.10 |
|
Transport and distribution |
1.00 |
0.40 |
0.40 |
|
Total Variable cost per pot |
|
|
3.00 |
- Calculation of contribution margin per pot for Fancy Terracotta pots
|
Particulars |
Amount |
|
Sales price per pot |
4.80 |
|
Total Variable cost per pot |
3.00 |
|
Contribution margin per pot |
1.80 |
Calculation of the break-even output per month if only Plain Black pots are made
Breakeven = Fixed costs / contribution margin pu
= 3500/0.85
= 4,117.65
Hence, 4118 plain black pots should be sold to achieve break even.
Calculation of contribution margin per pot
|
Particulars |
Amount |
|
Sales price per pot |
2.80 |
|
Total Variable cost per pot |
1.95 |
|
Contribution margin per pot |
0.85 |
Fixed costs per pot
Rent on premises 1,000.00
Manager's salary 2,500.00
Total fixed costs 3,500.00
Special Order
|
Variable cost per plain black pot |
1.95 |
|
Less: Transportation cost |
0.40 |
|
Net variable cost for special order |
1.55 |
|
Offered price |
1.90 |
|
Net Profit per pot |
0.35 |
Since, the variable cost is $1.55 and offered price is $1.90, resulting in a profit of $0.35, so the offer should be accepted.
- If the special order would have included the transportation and distribution cost of $0.40, then the offer should not be accepted as it would lead to a loss of $0.05 per pot.
|
Variable cost per plain black pot |
1.95 |
|
Offered price |
1.90 |
|
Net Loss per pot |
(0.05) |
|
Particulars |
Fancy Terracotta pots |
Plain Black pots |
Total | ||||
|
Units |
Price pu |
Total |
Units |
Price pu |
Total | ||
|
Sales |
900.00 |
4.80 |
4,320.00 |
1700 |
2.80 |
4,760.00 |
9,080.00 |
|
Less: Variable Costs |
900.00 |
3.00 |
2,700.00 |
1700 |
1.95 |
3,315.00 |
6,015.00 |
|
Contribution Margin |
|
|
1,620.00 |
|
|
1,445.00 |
3,065.00 |
|
Particulars |
Amount |
|
Sales |
9,080.00 |
|
Less: Variable Costs |
6,015.00 |
|
Contribution Margin |
3,065.00 |
|
Less: Fixed Costs |
3,500.00 |
|
Net Loss |
(435.00) |
Calculation of a price quotation for Job No. 43
|
Particulars |
Units |
Price pu |
Amount |
|
Direct labour costs |
630 |
20 |
12,600 |
|
Direct Material |
|
|
14,000 |
|
Manufacturing overheads |
315 |
45 |
14,018 |
|
Administrative overheads |
630 |
26 |
16,301 |
|
Total cost |
|
|
56,919 |
Price quotation for Job No. 43 is $ 56,919.
The requirement of cash depends upon the requirement of working capital by the company. The more working capital requirement indicates more cash needed and vice-versa. The main factors that influence how much cash / working capital a business will hold are as follows:
Nature of business– Requirement of cash depends upon the type of business and person is involved. Manufacturing companies, takes lots of time in converting their raw material into finished goods and thus requires higher working capital whereas trading companies require low amount of working capital as the goods are ready for sale.
Scale of Operations – The scale of operations decides the requirement of working capital. The higher the scale of operation the larger is the requirement of working capital and vice-versa. The more requirement of working capital is the more requirement of cash.
Pros
- Financing through retained profits does not lose the control of owners and maintains the full control of shareholders
- The profits does not ruin in interest payments and entire earnings are available to shareholders
- Taking finance from loans involves lots of costs including upfront fees and all, whereas when the financing is done through retained earnings no such costs are there.
Cons
- Financing through debts is a cheaper source as tax savings can be made on interest payments whereas in cash of financing through retained earnings, the dividend payable to shareholders is not allowed as deduction for tax payments.
- Further, generating finance through retained earnings is a slow process and can take a lot of time for arranging funds.
- Following non-financial information a venture capitalist would be concerned with while making prospective investment opportunities:
- Background / experience of the promotors or founders of the business– To check whether the management of the company is having adequate experience in the business they are running as no experience or inadequate experience may run business into losses.
Bibliography
Staff, I. (2017). Profitability Ratios. [online] Investopedia. Available at: https://www.investopedia.com/terms/p/profitabilityratios.asp [Accessed 14 Aug. 2017].
Staff, I. (2017). Liquidity Ratios. [online] Investopedia. Available at: https://www.investopedia.com/terms/l/liquidityratios.asp [Accessed 14 Aug. 2017].
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