Table of Contents

Analyse budgets and make appropriate decisions based on given information above ....... 1 Calculate of unit costs and make pricing decisions using the above information given in the scenario ......................................................................................................................... 3 Assess the viability of a project using investment appraisal techniques .......................... 10 Explain the purpose of the main financial statements ...................................................... 13 Describe the differences between the formats of financial statements for different types of business ............................................................................................................................. 16 Analyse the financial statements and comment on the results of your analysis and make a recommendation as to whether or not the loan should be approved ................................. 22 References ......................................................................................................................... 25

Analyse budgets and make appropriate decisions based on given information above
Solution: The companys policy is to pay suppliers for materials three months after receipt. Cost of material is illustrated in the table

Material Payment

May 000 35 20

Jun 000 30 30

Jul 000 25 25

Aug 000 25 35

The companys overhead included 2,000 per month which represents depreciation on two cars and one delivery van. Besides that, the company has a one-month delay in paying the overhead expenses.
May 000 14 2 12 14 Jun 000 18 2 16 12 Jul 000 16 2 14 16 Aug 000 14 2 12 14

Overhead Depreciation Payment

On total sales, there are 10% of sales for cash and 90% selling on credit for monthly. Cost of cash is 10% x 70.000 = 7.000 and cost of credit is 90% x 70.000 = 63.000 in June. Credit customers are expected to pay two months after delivery. Therefore, cash budget is 7.000 + 54.000 = 61.000 in June.
May 000 50 5 45 36 41 Jun 000 70 7 63 54 61 Jul 000 60 6 54 45 51 Aug 000 50 5 45 63 68

Sales Cash Credit Receipt

A commission of 5% is paid to agents on all the sales on credit but this is not paid until the month following the sales to which it relates. The commission is 5% x 45.000 = 2.250 in June.

Commission Payment

May 000 2.25 2.7

Jun 000 3.15 2.25

Jul 000 2.7 3.15

Aug 000 2.25 2.7

Delivery is expected in July of a new machine costing 45,000 of which 15,000 will be paid on delivery and 15,000 in each of the following two months. The cash budget can now be constructed CASH BUDGET FOR 3 MONTHS JUNE, JULY, AUGUST 2012
May 000 Payments Wage Material Overhead Commission Repay New Machine 9 20 14 2.7 Jun 000 12 30 12 2.25 25 81.25 61 (20.25) 17.30 (2.95) Jul 000 10 25 16 3.15 15 69.15 51 (18.15) (2.95) (21.10) Aug 000 9 35 14 2.7 15 75.7 68 (7.70) (21.10) (28.80)

45.7 Receipts Sales 41 Surplus (4.70) Opening balance 22 Closing balance 17.30

Calculate of unit costs and make pricing decisions using the above information given in the scenario
MANE COMPANY
Conparative Balance Sheet May-11 This year Asset Current assets: Cash Marketable securities Accounts receivable, net Inventory Prepaid expenses Total current assets Plant and equipment, net Total assets Liabilities and Stockholder's Equity Liabilities: Current Liabilities Bond payable, 12% Total Liabilities Stockholder' equity: Preferred stock, $25 par, 8% Common stock, $10 par Retained earnings Total Stockholder's equity Total Liabilities and Equity Last year Increase(Decrease) Amount %

70,000 0 480,000 950,000 20,000 1,520,000 1,480,000 3,000,000

150,000 18,000 300,000 600,000 22,000 1,090,000 1,370,000 2,460,000

(80000) (18000) 180,000 350,000 (2,000) 430,000 110,000 540,000

-53% -100% 60.00% 58.33% -9.09% 39.45% 8.03% 21.95%

800,000 600,000 1,400,000 250,000 500,000 850,000 1,600,000 3,000,000

430,000 600,000 1,030,000 250,000 500,000 680,000 1,430,000 2,460,000

370,000 0 370,000 0 0 170,000 170,000 540,000

86.05% 0.00% 35.92% 0.00% 0.00% 25.00% 11.89% 21.95%

As can be seen, cash decreased 53% comparison with last year. It is only $70,000. That mean the company may not enough cash to use on running business. Besides that, the company went down marketable securities to $0. However, accounts receivable increased 60%. It brings more risk to the company. A/R can be bad debt that the company cannot get back the revenue. Moreover, there are increasing about inventory. It is 58.33%. The company should create good sales forecast that evaluate consumption of customer

through market analysis. The company can reduce inventory and save a lot of capital for keeping products on warehouse. On the other hand, current liabilities increased 86.05%. There can be trouble financial on the company when debt is large. The company should have plans to pay some debt. Otherwise, retained earnings go up 25%. This is signal that the company is good on business. Above all, the companys financial is better than last year based on the increasing trend of total assets. Its 21.95%.

MANE COMPANY
Conparative Income Stament and Reconcilliation May-11 Increase(Decrease) This year Last year Amount % Sales 5,000,000 4,350,000 650,000 14.94% Cost of goods sold 3,875,000 3,450,000 425,000 12.32% Gross margin 1,125,000 900,000 225,000 25.00% Saling and Administrative expenses 653,000 548,000 105,000 19.16% Net operating income 472,000 352,000 120,000 34.09% Interest expenses 72,000 72,000 0 0.00% Net income before taxes 400,000 280,000 120,000 42.86% Income taxes (30%) 120,000 84,000 36,000 42.86% Net income 280,000 196,000 84,000 42.86% Dividents paid: Preferred dividents 20,000 20,000 0 0.00% Common dividents 90,000 75,000 15,000 20.00% Total dividents paid 110,000 95,000 15,000 15.79% Net incomes paid 170,000 101,000 69,000 68.32% Retained earning, beginning of year 680,000 579,000 101,000 17.44% Retained earning, end of year 850,000 680,000 170,000 25.00%

In this year, Mane Companys revenue increased 14.94%. This rate is higher than rate of cost of goods sold. That mean the production is good. The company should keep stable on increasing rate between revenue and cost of goods sold. Otherwise, selling and administrative expenses go up too high. It reaches 19.16%. On the other hand, there is strength increasing on net income. Its 42.86%. This rate shows that the company is running business very well. For shareholder, common dividends increase 20%. The company will make shareholder satisfy with this rates. Through that, the company can be easy to obtain capital from the shareholder to expand business.

MANE COMPANY Conparative Income Stament and Reconcilliation May-11 Increase(Decrease) This year Last year This year Last year Sales 5,000,000 4,350,000 100.00% 100.00% Cost of goods sold 3,875,000 3,450,000 77.50% 79.31% Gross margin 1,125,000 900,000 22.50% 20.69% Saling and Administrative expenses 653,000 548,000 13.06% 12.60% Net operating income 472,000 352,000 9.44% 8.09% Interest expenses 72,000 72,000 1.44% 1.66% Net income before taxes 400,000 280,000 8.00% 6.44% Income taxes (30%) 120,000 84,000 2.40% 1.93% Net income 280,000 196,000 5.60% 4.51% Dividents paid: Preferred dividents 20,000 20,000 0.40% 0.46% Common dividents 90,000 75,000 1.80% 1.72% Total dividents paid 110,000 95,000 2.20% 2.18% Net incomes paid 170,000 101,000 3.40% 2.32% Retained earning, beginning of year 680,000 579,000 13.60% 13.31% Retained earning, end of year 850,000 680,000 17.00% 15.63%

As can be seen, in this year, cost of goods sold occupies 77.5% of revenue. Mane Company reduces near 2% than that of the previous year (79.31%). That mean the company has good production system that it can help the company reduces wastage on production. Thus gross margin increasing 2%. Otherwise, there is no significant decreased on interest expense and others. The different between this year and the previous year is retained earnings. It increases near 1.5%. In short, Manes financial is better than the previous. The main evident is that increasing retained earnings and net income. This is signal that the company is running business well.

Return on Total Assets =

= 12.1%

Return on total assets is 12.1% in Mane Company. That mean for each $100 of total asset, the company will make profit $12.1. This rate is still lower than industry average rate (13%). Therefore, the efficiency on business is not high in Mane Company. The company should have plans to improve their business and increase net income that can be making higher return on total assets.

Return on Common Stockholders Equity = = = 22.03%

Return on Common Stockholders Equity measures how well the company used the owners investment to earn income. In Mane Company, this ratio is 22.03%. Its not low. However, the company should continue going up the ratio that the company can make shareholder satisfy by overcome commitment about return.

Current ratio =

= 1.9

In Mane Company, current ratio is only 1.9. That mean current asset is just near double than current liabilities. Its lower than industry average ratio 2.5. That is not good within the company. A declining ratio is sign of deteriorating financial condition. Therefore, the company should increase current assets and try to go down current liabilities.

Acid-Test Ratio =

= 0.69

Acid-Test Ratio is only 0.69 in Mane Company. Its too lower than industry average ratio 1.3. That mean the company may be had to liquidate inventory to meet obligations. The price of product will be declined a lot. Therefore, the company should have solution to increase this ratio.

Accounts Receivable Turnover = = Average Collection Period = days Average collection period is 28.47 days. That mean the company has to spend 28.47 days to collect an account receivable. It is too late to be compared with average collection period industry 18 days. The company may be had to borrow cash from bank to run the business. Therefore, the company should have some changes in contract with consumers that reduce time to be payment. = 12.82 times

= 28.47

Inventory Turnover = Average Sale Period =

= =
= 73 days

= 5 times

The average sale period is 73 days in Mane Company. Its too long to be compared with the average sale period industry (60 days). The company will spend a lot capital for keep product on warehouse. Therefore, Mane should develop strategies to sell product faster.

Times Interest Earned =

= 6.56 times

Times interest earned ratio measure a company's ability to meet its debt obligations. In Mane Company, its 6.56 times. This ratio indicates a company can cover its interest charges on a pretax basis more than 6 times. However, its still higher than average industry ratio (6.0). A high ratio can indicate that a company has an undesirable lack of debt or is paying down too much debt with earnings that could be used for other projects. The rationale is that a company would yield greater returns by investing its earnings into other projects and borrowing at a lower cost of capital than what it is currently paying to meet its debt obligations.

Debt-To-Equity Ratio =

= 0.875

A measure of a company's financial leverage is calculated by dividing its total liabilities by stockholders' equity. It indicates what proportion of equity and debt the company is using to finance its assets. In Mane Company, its 0.875 that is near average industry ratio (0.9). A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense. Above all, Mane Company is quite good on running business. Therefore, the company should borrow capital from the bank to expand their business. However, the company has to reduce time to collect debt from customers. Besides that, Mane should create good strategies for selling products that can be attracted customers to buy products.

Assess the viability of a project using investment appraisal techniques

Machine X Capital cost Residual value Annual cost savings Depreciation 300,000 50,000 30,000 250,000 Machine Y 350,000 70,000 56,000 280,000

The depreciation per year of machine X: 250,000/5 = 50,000 The depreciation per year of machine Y : 280,000/5 = 56,000 Cash flow of machine X: 30,000 + 50,000 = 80,000 Cash flow of machine Y: 56,000 + 56,000 = 112,000 Payback period Payback period for machine X: 300,000/80,000 = 3.75 years = 3 years 9 months Payback period for machine Y: 350,000/112,000 = 3.125 years = 3 years 1 month 15 days Net present value Machine X Item Annual cost savings Residual value Initial investment Net present value Year 1-5 5 Now Amount of cash flows 80,000 50,000 (300,000) 10% factor 3.791 0.621 1 Present value of cash flows 303,280 31,050 (300,000) 34,330

The NPV is positive, which mean that the project will earn more than 10%. (34,330 would have to be invested now at 10% to earn the future cash flows; since the project will earn these returns at a cost of only 300,000 it must earn a return in excess of 10%.

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Machine Y Item Annual cost savings Residual value Initial investment Net present value Year 1-5 5 Now Amount of cash flows 112,000 70,000 (350,000) 10% factor 3.791 0.621 1 Present value of cash flows 424,592 43,470 (350,000) 118,062

The NPV is positive, which mean that the project will earn more than 10%. (118,062 would have to be invested now at 10% to earn the future cash flows; since the project will earn these returns at a cost of only 350,000 it must earn a return in excess of 10%. Above all, the company should choose Machine Y to invest because it returns capital earlier than Machine X.

Machine X Average Investment Value =

= 175,000
Accounting rate of return =

=
Machine Y Average Investment Value =

= 17.14%

= 210,000
Accounting rate of return =

= 26.67%

As can be seen from that, the machine Y has the bigger IRR than machine X (26, 67 > 17, 14) that mean the machine Y will convert into money quickly than machine X.
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Discounted payback Year Present Value (X) Cumulative PV Present Value (Y) 1 2 3 4 5 72,720 66,080 60,080 54,640 49,680 72,720 138,800 198,880 253,520 303,200 101,808 92,512 84,112 76,496 101,808 194,320 278,432 354,928 Cumulative PV

As can be seen, Machine X takes about 4 years 11 months and nearly than 10 days to get back the investment. However the machine Y just needs 3 years 11 months and 10 days to get back. The machine Y is quickly and the company should choose the machine Y. Above all, the company should invest to machine Y which brings more benefit than machine X. However, the company can choose machine X if they do not enough cash to invest machine Y which is higher price than machine X.

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Explain the purpose of the main financial statements

The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions. Financial statements should be understandable, relevant, reliable and comparable. Reported assets, liabilities and equity are directly related to an organization's financial position. Reported income and expenses are directly related to an organization's financial performance. Balance sheet

A balance sheet or statement of financial position is a summary of a person's or organization's balances. The balance sheet's purpose is to show the assets of the company. Balance sheets are based on a fix point called a reporting period such as a day, a month, a quarter, a year. Besides that, the main purpose of a balance sheet is to determine if the accounts are in balance and what types of accounts and balances an organization has. A quick glance at a balance sheet will show you what the company owns and how much it owes. Balance sheets include assets (property, cash, anything owned of value), liabilities (debt owed) and shareholder's equity. The Balance Sheet is an extremely important statement in the accounting and will be found, sometimes several ways, in the company prospectus. It is also provided to various government regulatory agencies. They use them to assure the business is complying with laws, regulations and taxing requirements. Typically, there is an outside audit of this statement along with the Income and Cash Flow statements too. This provides an outside review and an opinion of how well the business is keeping their books. So, the Balance Sheet is an extremely important financial document1. A balance sheet helps Mane's owner quickly get a handle on the financial strength and capabilities of the business. Is the business in a position to expand? Can the business easily handle the normal financial and flows of revenues and expenses? Or should the business take immediate steps to bolster cash reserves?

http://ezinearticles.com/?The-Importance-of-the-Balance-Sheet-as-a-Financial&id=513212

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Profit and loss account (or income statement)

Income statements show the revenue earned during a reporting period. The main purpose of a profit and loss account is to calculate and determine if a company made a profit or not. Included in this report are the expenses and cost of creating the revenue. Once the expenses and costs are removed from the total revenue, the bottom line of the report reveals whether or not the company lost money or made money. This report is sometimes referred to as the profit and loss statement. Another feature of the income statement is the EPS, or earnings per share. This reveals what a shareholder would receive if you were being paid dividends per each share owned2. The income statement is important because it shows the profitability of a company during the time interval specified in its heading. The purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported. So the income statements is necessary for each company, investors and creditors to determine the past financial performance of the enterprise, predict future performance, and assess the capability of generating future cash flows through report of the income and expenses.3 Cash flow statement

Cash Flow Statements Cash on hand is important because it supports the daily activities of a business. There must be enough cash on hand to pay expenses and buy assets as needed. The money coming into the business is called cash inflow, and money going out from the business is called cash outflow. Cash flow statements track the inflow and outflow of cash. They reveal whether or not cash was generated by the business. The data for a cash flow statement comes from an income statement and the balance sheet. The cash flow statement reveals net decreases or increases of cash for the reporting period4. The purpose of the cash flow statement or statement of cash flows is to provide information about Manes gross receipts and gross payments for a specified period of time. Besides that, it reconciles the other two financial statements - income statement and balance sheet. For the income statement, it reconciles the accounting assumptions with

2 3

http://www.ehow.com/about_5047231_purpose-financial-statements.html http://en.wikipedia.org/wiki/Income_statement 4 http://www.ehow.com/about_5047231_purpose-financial-statements.html

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the actual cold, hard cash the business earned. For the balance sheet, the cash flow statement shows the differences in the level of assets or liabilities from the previous reporting period. The last purpose of cash flow statement is to understand the effect of investment and financing activities on the operation of the business.

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Describe the differences between the formats of financial statements for different types of business
A sole trader is a type of business entity which is owned and run by one individual and where there is no legal distinction between the owner and the business. All profits and all losses accrue to the owner (subject to taxation). All assets of the business are owned by the proprietor and all debts of the business are their debts and they must pay them from their personal resources. This means that the owner has unlimited liability. Partnership is a company that set up by more than two people, partners contributes their money to run business, so that partners (owners) share with each other the profits or losses of the business. Partnerships are often favored over corporations for taxation purposes, as the partnership structure does not generally incur a tax on profits before it is distributed to the partners. A limited company is a company in which the liability of the members or subscribers of the company is limited to what they have invested or guaranteed to the company. Limited companies may be limited by shares or by guarantee. And the former of these, a limited company limited by shares, may be further divided into public companies and private companies. Who may become a member of a private limited company is restricted by law and by the company's rules. In contrast anyone may buy shares in a public limited company. Sole trader The balance sheet A balance sheet which The shows liabilities assets of Partnership balance sheet Limited company The balance sheets many

and shows the balance of the the capital amount of under owners equity.

comprises

categories like share capital, earnings, retained other

business including the each partner classified owners capital.

revenue and capital reserves. The and profit An income statement The income statement loss which normally shows a schedule on
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The Income statement shows a Statement of

account (Income statements)

consists of profit and how the net profit/loss loss of account and is distributed to the incorporates the trading partners. account for businesses that buys goods. and sells

Changes where

in

Equity in

changes

share capital, profit, revenue and other

capital reserves during the year.

Sample of Financial Statement Balance sheet of sole trader

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Balance sheet of partnership

ABC PARTNERSHIP BALANCE SHEET AT 31 December, 2003 $ $ Fixed assets Plant and machinery 25,000 Office furniture 6,000 31,000 Current assets Stock 9,000 Trade debtors 4,740 Cash at hands 3,327 17,067 Current liability Trade creditors 1,976 15,091 46,091 Long-term liability Loan repayable 2005 5,000 41,091

Balance sheet of limited company

ABC LIMITED COMPANY BALANCE SHEET AT 31 December, 2003 $ $ Fixed assets Plant and machinery 25,000 Office furniture 6,000 31,000 Current assets Stock 9,000 Trade debtors 4,740 Cash at hands 3,327 17,067 Current liability Trade creditors 1,976 15,091 46,091 Long-term liability Loan repayable 2005 5,000 41,091
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The profit and loss account (Income statements) of partnership

ABC PARTNERSHIP PROFIT And LOSS ACCOUNT For the year end 2003 $ $ Sales 66,941 Opening stock 50,000 Purchases 42,000 92,000 Less closing stock 62,000 Cost of sales 30,000 Gross profit 36,941 Less overheads: - Shop expenses - Wages - Rent paid - Telephone expenses - Interest paid - Travel expenses Net profit

6,200 3,350 750 500 4,500 550

15,850 21,091

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The profit and loss account (Income statements) of sole trader

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The profit and loss account (Income statements) of limited company

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Analyse the financial statements and comment on the results of your analysis and make a recommendation as to whether or not the loan should be approved
Total joint cost
Quantity (Units) 10.000 6.000 4.000 Total Joint cost 280.000 168.000 112.000 560.000

Product Evergreen Morning Flower Evening Flower

Joint cost 28 28 28

Product cost
Sales price () Evergreen 40 Morning Flower 100 Evening Flower 150 Product Quantity (Units) 10.000 6.000 4.000 Separable cost per unit 20 40 50 Total separable cost 200.000 240.000 200.000 640.000 Net realizable value 200.000 360.000 400.000 960.000 Share Joint cost 116.667 210.000 233.333 560.000 Joint cost per unit 11,67 35,00 58,33 Total cost per unit 31,67 75,00 108,33

Sale value 400.000 600.000 600.000 1.600.000

Weight 20,83% 37,50% 41,67% 100,00%

Gross margin =

= 25%

Based on the table, the total cost per unit of Morning Flower is 75. If the company reduces the sale price to 60, they will loss 15 for each product. However, it can help the company compete better and the sales volume may increase. Therefore, the company may sell below cost because the other products will shoulder the cost for Morning Flower products.

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Sales price () Evergreen 40 Morning Flower 60 Evening Flower 150 Product

Quantity (Units) 10.000 6.000 4.000

Sale value 400.000 360.000 600.000 1.360.000

Separable cost per unit 20 40 50

Total separable cost 200.000 240.000 200.000 640.000

Net realizable value 200.000 120.000 400.000 720.000

Weight 27,78% 16,67% 55,56% 100,00%

Share Joint cost 155.556 93.333 311.111 560.000

Joint Total cost cost per unit per unit 15,56 35,56 15,56 55,56 77,78 127,78

Gross margin =

= 11,76%

At the present, the company wants to reduce the sale price of Morning Flower to 60 which gross margin is 11,76%. However, the company expects that gross margin is at least 20% on sale. The solution is the company should sale both Morning Flower and Evening Flower as a new product. The reason is that the company should get more than 40 for each Evening Flower which can cover losses for each Morning Flower. In here, the company will reduce a lot profit for this new product. Therefore, the company should have planning to promote selling. High revenue will ensure that gross margin will reach at least 20%.

The company expects Gross margin = 20% with minimum price for Morning Flower
Gross margin = Sale value x Gross margin = Sale value (Total Joint cost + Total separable cost) Sale value Sale value x Gross margin = Total Joint cost + Total separable cost Sale value(1- Gross margin) = Total Joint cost + Total separable cost Sale value =

= 1.500.000

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Sale value of Morning Flower = 1.500.000 (400.000 + 600.000) = 500.000 Sale price =

= 83,33

Therefore, if the company expects that gross margin is 20% on sales, the minimum sale price for Morning Flower is 83.33

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References
2012. Ezine Articles. [Online] Available at : <http://ezinearticles.com/?The-Importance-of-theBalance-Sheet-as-a-Financial&id=513212>[Accessed 19 September 2012] 2012. Ehow. [Online] Available at : <http://www.ehow.com/about_5047231_purpose-financialstatements.html>[Accessed 19 September 2012] 2012. Wikipedia. [Online] Available at : <http://en.wikipedia.org/wiki/Income_statement>[Accessed 19 September 2012]

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