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ACC00724 Accounting for Managers

Published : 14-Sep,2021  |  Views : 10

Question:

Current assets

Cash and cash equivalents $1,645 $2,110

Accounts receivables (all trades)   4,100   3,675

Inventories   7,000  6,930

Total current assets 12,745 12,715

Non-current assets

Property, plant and equipment 17,190 15,330

Total non-current assets 17,190 15,330

Total assets $29,935 $28,045

Current liabilities

Payables $5,780 $5,990

Total current liabilities 5,780 5,990

Non-current liabilities

Interest-bearing liabilities 9,940 9,450

Total non-current liabilities 9,940 9,450

Total liabilities $15,720 $15,440

Equity

Share capital $7,700 $7,700

Retained earnings   6,515   4,905

Total equity $14,215 $12,605

Nimbin P/L

Income Statement

As at 30 June 2014

($000)

Revenues (net sales) $55,000

Less: cost of sales   35,100

Gross profit   19,900

Less: Expenses

Selling and distribution expenses    7,100

Administrative expenses    4,970

Finance costs    1,560

Total expenses  13,630

Profit before income tax   6,270

Income tax expense   1,908

Profit $4,362

Nimbin P/L

Statement of changes in Equity

For the year ended 30 June 2014

($000)

Share capital

Ordinary (7,200.000 shares)

Balance at start of period $7,200

Balance at end of period 7,200

Preference (250,000 shares)

Balance at start of period 500

Balance at end of period 500

Total share capital $7,700

Retained Earnings

Balance at start of period $4,905

Total income for the period   4,362

Dividends paid – ordinary  (2,702)

Dividends paid – preference       (50)

Balance at end of period $6,515

Additional information:

Payables include $5,620 (2014) and $5,730 (2013) trade accounts payable; the remainder is accrued expenses. Market prices of issued shares at year-end (2014): Ordinary $12; Preference $6.70.

Required:

  1. Calculate the following ratios for 2014. The industry average for similar businesses is shown. 

Industry average

  1. Rate of return on total assets 22%
  2. Rate of return on ordinary equity 20%
  3. Profit margin 4%
  4. Earnings per share 45c
  5. Price-earnings ratio 0
  6. Dividend yield 5%
  7. Dividend payout 70%
  8. Current ratio 5:1
  9. Quick ratio (acid ratio) 3:1
  10. Receivables turnover 13
  11. Inventory turnover 6
  12. Debt ratio 40%
  13. Times interest earned 6
  14. Assets turnover 8
  15. Given the above industry averages, comment on the company’s profitability, liquidity and use of financial gearing.
  16. A local restaurant is noted for its fine food, as evidenced by the large number of customers.  A customer was heard to remark that the secret of the restaurant’s success was its fine chef.  Would you regard the chef as an asset of the business  If so, would you include the chef on the balance sheet of the business and at what value 
  17. b) Indicate the effect of each of the following transactions on any or all of the three financial statements of a business: 
  1. Statement of financial position
  2. Statement of financial performance
  3. Statement of cash flows

Apart from indicating the financial statements (s) involved, use appropriate phrases such as ‘increase total asset’, ‘decrease equity’, ‘increase income’, ‘decrease cash flow’ to describe the transaction concerned.

  1. Purchase equipment for cash.
  2. Provide services to a client, with payment to be received within 40 days.
  3. Pay a liability.
  4. Invest additional cash into the business by the owner.
  5. Collect an account receivable in cash.
  6. Pay wages to employees.
  7. Receive the electricity bill in the mail, to be paid within 30 days.
  8. Sell a piece of equipment for cash.
  9. Withdraw cash by the owner for private use.
  10. Borrow money on a long-term basis from a bank.

Answer:

ROA: Net Income/ Average total assets

$4,362 / $28,990 = 15%

Average total assets = Opening Assets + Closing Assets                       2

($29935+$28045)/2 = $28,990

Industry Average = 22%

  • Return on Equity

ROE:  Net income for equity shareholders/ Shareholder’s equity

($4362-$50) / ($7200+$6515) = 31%

Net income available to equity shareholders = Net income – Preference share dividend

Shareholder’s equity= equity share capital + retained earnings

Industry Average = 20%

Profit Margin = Net income/ Net sales

$4,362 / $55,000 = 8%

Industry Average= 4%

  • Earnings per Share

EPS = Profit for equity shareholders/ No. of Equity Shareholders

$4,312 / $7,200 = 0.60

Industry Average= 45 cents

Price Earning: MPS / EPS

$12 / $0.60 = 20

Industry Average= 12

Dividend Yield Ratio: Cash dividend per share/Market price per share

$0.375 / $12 = 3%

Cash dividend per equity share =   Equity dividend / No. of Equity Shareholders

$2702 / $7200 = $0.375

Industry Average= 5%

Dividend pay-out = Total Dividend / Net income

$2752 / $4362 = 63%

Total Dividends = Equity dividend + Preference dividend

$2702+$50 = $2752

Industry Average= 70%

Current Ratio: Current Assets/ Current Liabilities

$12,745 / $5,780 = 2.21:1

Industry Average= 2.5: 

Quick Ratio: Quick assets/Current liabilities

$5,745 / $5,780 = 0.99:1

Quick Assets = Total Current Assets- Inventory

$12,745-$7,000 = $5745

Industry Average= 1.3:1

Receivables turnover: Net credit sales/Average Debtors

$55,000 / $3887.5 = 14.15%

Average Debtors = Opening Receivables + Closing Receivable / 2

($3,675+$4,100) / 2 = $3887.5

Industry Average= 13

Inventory turnover: COGS/Average inventory or stock

$35,100 / $6,965 = 5.04

Average Inventory= Opening Inventory + Closing Inventory / 2

($6,930+$7,000) / 2 = $6965

Industry Average= 6

Debt Ratio = Total Liabilities/Total Assets

$15,720 / $29,935 = 53%

Industry Average= 40%

  • Times Interest Earned

Times Interest Earned: EBIT/Interest expense

$7,830 / $1,560 = 5.02

Industry Average= 9

Asset Turnover Ratio: Total Revenue/ Average total assets

$55000 / $28990 = 1.90

Average Total Assets= Opening Total Assets+ Closing Total Asset / 2

Industry Average= 1.8

Analysis of company’s profitability

Profitability can be determined by analysing ratios like profit margin, ROA and ROE. These ratios indicate the capability of company to make profits.

Looking at the profit margin maintained by the company which is 8% as compare to industry average which is 4%, it can be said that the company is a capable of making more profits than the expected ones. It is operating profitably.

The ratio of return on asset tells about the efficiency of a company in generating its revenue with the use of its total assets. Return on asset ratio is 15% which is less than the industry ratio of 22%.  This means that the company is not able to produce more revenue from its assets as it is inefficient in managing its assets (Jenter and Lewellen, 2015). As far as, return on ordinary equity ratio is concerned, it is 31% which is more than the industry benchmark of 20%. ROE indicates the potential of a company to generate return from the investments. Maintaining a high ROE shows that company has a sound profitability position as it can produce high returns from its investment. Investor can find it profitable to invest in (Penman, Reggiani, Richardson and Tuna, 2017).

 Analysis of company’s Liquidity

These ratios are used to show the liquidity position of a company. They are current ratio and quick ratio. The current ratio is 2.21:1, which is lower than the industry benchmark of 2.5:1. It shows that company is not efficient enough to meet the expectations of its creditors and investors and to deal with its liquidity problems. Moreover, the quick ratio 0.99:1 is also considerably lower than the industry’s ratio of 1.3:1, which indicates that the company cannot meet its short term liabilities using its liquid assets, which can easily and quickly be converted into cash, whenever required. Hence, the company does not maintain a good liquidity position (Saleem and Rehman, 2011).

Analysis of financial gearing

Financial gearing means the proportion of debt and equity used by the company in its operations. It determines the capital structure of the company. Debt ratio means the amount of assets of the company which are provided through debt. It is 53% which is quite higher than the industry average of 40%. It indicates that the company has high financial risk because of its excessive use of debt in conducting its operations (Levi and Segal, 2015).

A chef is a human resource and is considered as an asset to the business because he contributes in the success of the business. However, accounting practices does not include any measurement or recognition method for human resource assets. Therefore, the valuation of this asset is not possible as it cannot be measured in terms of money. So as a result it cannot be recorded in the financial statements.

  1. Purchase equipment for cash.

Statement of financial position: Increase in assets and decrease in cash.

Statement of Cash flow: Decreased cash (financing activities).

  1. Provide services to a client, with payment to be received within 40 days.

Statement of financial position: increase in asset and increase in equity.

Statement of financial performance: increase in income.

  1. Pay a liability

Statement of financial position: Decrease in cash and decrease in liabilities.

Statement of cash flow: Decrease in Cash (operating activities).

  1. Invest additional cash into the business by the owner.

Statement of financial position: increase in equity and increase in cash

Statement of cash flow: increased cash (financing activities).

  1. Collect an account receivable in cash

Statement of financial position: increase in assets (cash) and decrease in assets (debtors).

Statement of cash flow: increased cash (operating activities).

  1. Pay wages to employees.

Statement of financial position: Decrease in asset (cash) and decrease in equity.

Statement of financial performance: Decrease in expenses (wages).

Statement of cash flows: decreased cash (operating activities).

  1. Receive the electricity bill in the mail, to be paid within 30 days.

    Statement of financial position: increase in liability and decrease in equity.

    Statement of financial performance: increase in expense.

  1. Sell a piece of equipment for cash.

Statement of financial position: Increase in cash and decrease in asset.

Statement of Cash flows: increased cash flow

  1. Withdraw cash by the owner for private use.

Statement of financial position: Decrease in capital account and decrease in cash (current asset).

Statement of Cash flows: Decreased cash.

  1. Borrow money on a long-term basis from a bank.

Statement of financial position: increase in asset (cash) and increase in liability (loan)

Statement of Cash flows: increased cash flow.

References:

Jenter, D. and Lewellen, K., 2015. CEO preferences and acquisitions. The Journal of Finance, 70(6), pp.2813-2852.

Levi, S. and Segal, B., 2015. The Impact of Debt-Equity Reporting Classifications on the Firm's Decision to Issue Hybrid Securities. European Accounting Review, 24(4), pp.801-822.

Penman, S.H., Reggiani, F., Richardson, S.A. and Tuna, A., 2017. A Framework for Identifying Accounting Characteristics for Asset Pricing Models, with an Evaluation of Book-To-Price.

Saleem, Q. and Rehman, R.U., 2011. Impacts of liquidity ratios on profitability. Interdisciplinary Journal of Research in Business, 1(7), pp.95-98.

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