FNSACC50 Provide Financial and Business Performance Information

Nicola  Wang  has  decided  to  start  up  a  small  business,  a  second  clothing  store  located  in Westminster. Nicola is unsure of the steps that she will need to take to set up the business. Nicola has come to you (the group) for advice in setting up a business as she understands that you (the group)  are financial  advisers  who  can  provide  her  with  the  necessary  advice  and  knowledge for the business.  
 
Required: 
You are required to prepare a Report for Nicola Wang that includes: 
1.  A covering letter to her that outlines the purpose of the report and ensure that the letter is addressed to Nicola Wang and has the usual structure of a letter including address, title of person addressed to, content and signature block 
2.  Table of contents including page numbers  
3.  Report must contain the following and relate to the type of business that the client intends to set up: 
a.  The type of business structure that is recommended and clearly stating the reasons why it’s preferred over other structures
b.  Taxation requirements of the business structure that has been selected (e.g. GST, income tax, payroll tax if applicable, PAYG etc, registration)  
c.  The major sources of funding (finance) that are available for the client to set up her new business Remember to justify your reasons for selecting the type of funding (finance).  
d.  The kind of business risk that Nicola may encounter in setting up her new business and the ways she can reduce (mitigate) such risk
e.  In the report make any assumptions as necessary, for example you may assume that Nicola has a partner  
f. Conclusions as to a summary of the advice provided to Nicola  Wang.

 

If Nicola Wang had appointed an accounting firm to provide advice and assistance the firm would be required to issue an engagement letter.  
 
Required:  
What information would be included within the engagement letter.
Ensure you include applicable details around the client’s rights and responsibilities. 

Tony Nelson, acting on behalf of a small group of investors, has presented your team of financial analysts  with  the  financial  statements  of  an  Australian  listed  public  company  for  the  last  two reported financial  years.  Tony  asks  that  you  analyse  the  company  on  his  behalf  and  provide  him with feedback regarding liquidity, profitability, leverage, activity and the overall financial performance and financial position of the company.  
 
Tony Nelson would appreciate the following: 
1.  In-depth analysis using financial ratios 
2.  Interpretation of the ratios  
3.  General discussion about the overall viability and performance of the company  
 
Tony would also like to be presented with a written summary report of your analysis for distribution The company selected must be an entity that is listed on the Australian Stock Exchange and you should  seek  to  compare  two  (2)  years  of  that  company,  for  example  compare  2014  with  2013. Alternatively  the  group  can  compare  one  company  to  another  company  that  operates  within  the same industry and is of the same size, e.g. compare ANZ Bank with Westpac.  
 
Below is just a sample of some of the company’s that may be analysed: 
Communications: Telstra, Optus  
BHP Billiton 
Airlines: Virgin Australia or Qantas  
Retail: Wesfarmers, Coles, David Jones, Harvey Norman    
Banks: NAB, Westpac, ANZ or Commonwealth Bank  
 
Required: 
You are required to prepare a Report with the following: 
1.  Covering letter addressed to Tony Nelson with the usual structure of a letter  
2.  Table of contents of the report including page numbers 
3.  Main body of the report:  
a.  Analyse the company on his behalf and provide feedback regarding liquidity, profitability, activity and leverage of the company. 
b.  Using ratios analysis and the financial statements for two (2) years, interpret what the ratios mean for the company and explain the overall performance and viability for the business. At least 2 ratios must be used for each category. 
c.  Clearly state any assumptions that are made in the report  
4.  Conclusions: as to whether Tony’s investors should invest (buy shares) in your chosen or selected company and explain your reasons why.

There are different types of business structures such as sole proprietor, partnership, limited liability partnership, and corporation[1]. Under sole proprietor structure, the business is controlled by one person. This type of business structure is preferred when the business is to operate at small scale. The proprietor is the whole and sole of business in a proprietorship firm. When the business grows, it would require more capital and more people to control and manage it. In that case, the business structure may take form of partnership. Under the partnership business structure, two or more persons join hands together to share the risk and returns of business in the agreed ratio. The partnership firm is usually formed to carry out business of the medium size which does not require public funds.

            However, when the business grows further and it is considered necessary to raise funds at a large scale from public, the required business structure is the corporation. The corporations are the legal business structures which are allowed to raise capital from public by listing the shares on stock exchange.   

In the case of Nicola Wang who is considering setting up a clothing store it is preferable to opt for proprietorship business structure. The clothing store would operate at small scale requiring low capital and less number of people to control and manage therefore the proprietorship business structure is suitable. Further, the income tax implications also differ depending upon the type of business structure. In the case of proprietorship business, the income tax is levied on individual (proprietor) based on slab rates which is advantageous as compared to the flat rate applied to the partnership and corporation structures[2]. Further, the legal formalities in regards to registrations and licenses are also less in case of proprietorship business structure as compared to partnership and corporations.                    

Taxation Requirements

            Nicola Wang would carry out trading business through clothing store in Westminster, London, United Kingdom in the form of proprietorship firm. Nicola Wang would be required to get the clothing store registered under VAT rules of the United Kingdom. As per the rules, every business is required to register under VAT if the value of total supplies exceeds £300,000[3] in the past preceding 12 months. Initially it would not be mandatory for Nicola Wang to register under VAT; however, registration may be taken voluntarily. Further, Nicola Wang would be required to remit the amount of VAT collected on sales (after taking set off of vat paid on purchases) to the government on periodical basis.

            The income tax liability arises as soon as the business starts earning profits, therefore, Nicola Wang would be required to take registration income tax office. The tax would be levied at the slab rates and thresholds allowed to the individuals. Further, Nicola Wang would be required to submit tax return by 31^st January after the end of tax year[4]. Along with filling the return, Nicola Wang would also be required to pay the income tax to the credit of government.

            Further, every employer is required to register for Pay as You Earn (PYAG) tax deduction before he pays to emoluments to the employees. Thus, Nicola Wang would be required to get registered with HM revenue and customs (HMRC) for PYAG and remit the tax deducted from employee salary to the credit of government[5].              

Major Sources of Funding (Finance)

            There are various sources from which funds can be raised for business, for example, issue of shares to public, issue of bond/debenture, term loan from bank, overdraft or cash credit facility etc[6]. The proprietorship firm is not allowed to raise funds from the public by issuing shares or debt securities. The corporation is the only form of business that is allowed to raise funds from public by issuing equity and debt securities. Therefore, the options left for the proprietorship firm are loan from banks and financial institutions, personal funds, loan from family members and relatives.

            The loan from bank can be taken on security of inventory or other tangible assets like land and building. Further, term loans can be taken from banks for purchasing an item of plant and equipment. In addition to this, banks also provide overdraft facilities to business concerns which can be used for day to day operations. Moreover, there are angel investors and government grants which can also be used as a source of finance. The angel investors provide funds to the startup business to finance the operations. The governments of the states also frame various policies to provide financial assistance to the startup businesses.                 

Business Risk and Mitigation Plan

            Nicola Wang is considering starting up a new business in the form of clothing store for sale of clothes and wearing apparels. The entrepreneur must consider the fact that there are various risks which he will have to encounter while setting up a new business. The most crucial is the market risk. Market risk refers to the risk of not achieving the estimated demand. Nicola Wang will have to make estimations in regards to demand of goods to be sold at the clothing store. There exists a risk that due to increased competition or any other reasons, the demand in market may fall short leading to loss of revenues[7].

            Further, there is financial risk in setting up a new business. The finical risk relates to the risk of funds falling short. Nicola Wang would be required to make projections in regards to capital and funds needed to run the daily operations. It is possible that the projected funds fall short of the requirements. Further, there is the risk of hiring the people to manage the business operations. It is possible that the firm may not be able to hire sufficient number of people to operate the business smoothly. However, Nicola Wang has a small clothing store therefore the risk of hiring people is not so material.

            In order to achieve the business objectives, it is necessary for Nicola Wang to formulate a proper risk mitigation plan[8]. There must be marketing and advertisement arrangements to counter the risk of increased competition. Further, Nicola Wang should keep a buffer of funds to mitigate the risk of funds falling short and there must also be adequate budgetary system. In order to reduce the risk of hiring, Nicola Wang should have contract with the placement consultancy firms to provide labor support when needed.                

            From the overall discussion, it is summarized that Nicola Wang should opt for proprietorship firm. It would be better from the income tax view point and legal formalities would also be less. The sources of finance that Nicola Wang could adopt are personal savings, private loans from family members and friends and loan from banks. Further, Nicola Wang should have adequate risk management plan to mitigate the market risk, finance risk, and management risk.   

Disclaimer Statement  

            The work produced in the report given above is out own and the information has been extracted from the reliable and credible sources and the same have been cited in the report. 

            The engagement letter is the mechanism through which the business entity and accounting firm gets into a binding agreement for services. The engagement letter sets out the terms of engagement which may include the items such as nature of services to be provided, fees for service, payment terms, duties of service provider, duties of service receiver, the right of service provider and receiver, and the period of services. Agreeing the terms of engagement through the engagement letter would be helpful in clearing any kind of ambiguities[9]. Nicola Wang is considering appointing an accounting firm to provide advisory services for the clothing business

The engagement letter for this purpose should include all the terms that relate to the services to be provided by the accounting firm. As part of the duties of accounting firm, there must be included the reporting responsibility, confidentially of information, and compliance with the professional standards of service. Further, the engagement letter should also include the duties of Nicola Wang to provide access to the records and all the necessary information. Further, Nicola Wang should be duty bound to provide all necessary assistance and corporation in performance of services by the accounting firm.   

Company Profile

            BHP Billiton Limited, listed on the Australian Stock Exchange, is one of the world’s largest resource companies. The company engages in the business extraction and production of natural resources and it also undertakes marketing and distribution of the natural resources. The company was founded in the year 1851 and since then it has grown superbly over the years to own total assets of $124,580 million in 2015[10]. The company operates through four major segments namely Petroleum, copper, iron ore, and coal. In the year 2015, the company has been observed to be generating revenues of $44,636 million with net profits of $2,878 million. Further, the market cap of the company is $91.86 billion[11] which depicts that the company is conducting its business at a large scale. The stock of the company has grown significantly in last one year from $26.42 to $34.52.       

Analysis of Profitability

            The analysis of profitability is the first step towards analysis of the financial performance and position of the business. In order to analyze the profitability of BHP Billiton Limited, three crucial ratios such as net margin, operating margin, and return on equity have been computed[12]. The net margin shows profits as a percentage figure of total revenues. The net margin is the primary indicator of profitability. In the case of BHP Billiton Limited, the net margin has been found to be 6.45% in 2015 and 26.82% in 2014 (Appendix). It could be seen that the net margin of the company has gone down in the current year as compared to the previous year. The main reason for downfall in the net margin in 2015 has been observed to be the decrease in sales by a significant amount. It was found out that the total sales of the company went down from $56,762 million in 2014 to $44,636 million in 2015 (Appendix).

            Further, the operating profit margin showing the operating profits as a percentage figure of total revenues was found to be 19.42% and 39.90% in 2015 and 2014 respectively (Appendix). It could be observed that the decrease in sales also affected the operating profits adversely. Further, the return on equity was also analyzed to evaluate the profitability of the company. The return on equity shows profits attributable to the equity holders as a percentage figure of total shareholder’s equity. It is the return that business gives to the investor on their investment. In the case of BHP Billiton, the return on equity has been found to be 4.08% and 19.24% for the year 2015 and 2014 respectively (Appendix).

            The return on equity could be seen to be down in 2015 as compared to 2014. This is due to the decrease in sales which reduced the net profits and consequently the return on equity fell down.                

Analysis of Liquidity

            After analyzing the profitability of the business, it is crucial to evaluate the position as regards liquidity. Analysis of liquidity refers to analysis of the company’s ability to meet out the short term debt obligations. In order to analyze the liquidity of BHP Billiton, the two primary ratios such as current ratio and quick ratio have been analyzed. The current ratio indicates current assets relative to current liabilities of the business[13]. The current ratio of BHP Billiton has been found to be 1.27 times and 1.23 times for the year 2015 and 2014 respectively (Appendix). It could be observed that the current ratio has increased in 2015 as compared to previous year. The increase in the current ratio is an indication of the improvement in the liquidity position of the company.

            Further, the quick ratio shows readily realizable current assets relative to the current liabilities. This ratio takes a more rigid view of liquidity because here inventories are not considered as current assets. In the case of BHP Billiton, the quick has been found to be 0.94 times and 0.90 times for 2015 and 2014 respectively (Appendix). The quick ratio is also showing increase which implies improvement in the liquidity of the company.              

Analysis of Activity/ Efficiency

            The analysis of activity or efficiency is concerned with the use of company’s resources by the management. This analysis indicates that whether the management has made efficient and effective utilization of the company’s resources in a responsible manner or not. For this purpose, three primary ratios such as inventory holding days, accounts receivable days, and assets turnover have been computed and interpreted. The inventory holding days entails the number of days for which the company is not able to sale the goods. The lower the number of days more favorable it will be for the company. In the case of BHP Billiton, the inventory day ratio has been found to be 35 days and 39 days for 2015 and 2014 respectively (Appendix). It could be observed that inventory days have decreased in 2015 which indicates a favorable position of the company.

            In the same way accounts receivable days show the number of days for which the amount of sales remains uncollected. The higher the number of days lower will be the efficiency of management. The accounts receivable days for BHP Billiton have been found to be 35 days and 45 days for 2015 and 2014 (Appendix). The receivables days have decreased in 2015 which indicates improvement in the management’s efficiency as regards receivables. Further, assets turnover ratio is also an essential indicator of management’s efficiency. It measures the dollar revenues generated by the dollar investment in assets. In the case of BHP Billiton, the assets turnover ratio has been found to be 0.36 times and 0.37 times for 2015 and 2014 (Appendix). It could be observed that the assets turnover ratio has decreased slightly in 2015 which indicates that the management has not been able to utilize the resources optimally.                    

Analysis of Leverage/ Solvency

            The analysis of leverage or solvency relates to the evaluation of the company’s ability to meet out the long term debt commitments. The company should have enough owned funds to satisfy the outsider’s debts[14]. In order to analyze solvency, three primary ratios such as debt equity, capital gearing, and interest times have been computed. The debt equity ratio of BHP Billiton has been found to be 0.77 times and 0.91 times for 2015 and 2014 respectively (Appendix). It could be observed that the ratio has decreased in 2015 which indicates that the debt has reduced relative to equity. The decrease in debt indicates reduction in risk of solvency.

            Further, the capital gearing ratio of the company has been found to be 0.41 times and 0.51 times for 2015 and 2014 respectively (Appendix). The capital gearing shows use of debt funds in total capital. The reduction in capital gearing ratio indicates that the use of debt funds has reduced in the year 2015 as compared to the year 2014. The reduction in debt funds reduces the solvency risk but it also reduces the advantages of leverage due to which profit goes down. Further, the Interest Times ratio has been found to be 12.35 times and 22.76 times for 2015 and 2014 respectively (Appendix). The Interest Times ratio is decreasing in 2015 which shows reduction in company’s ability to pay off debt obligations on time.           

Conclusion

            The decision to invest in shares of a company depends upon various considerations which includes evaluation of past performance, current performance, and future prospects. Further, the analysis from both technical as well fundamental viewpoints is essential for such decision. However, this report carries out only fundamental analysis in respect of BHP Billiton Ltd. Based on the results of fundamental analysis, it could be articulated that the company’s financial performance has not been so good in the recent years. The sales and profits of the company are down. The utilization of assets has not been effective as indicated from decreased assets turnover ratio. Therefore, it is recommended to the potential investors that they should not invest in shares of the company.     

Disclaimer Statement   

            The work depicted in above report is our own and the information for this work has been collected from the reliable sources which have been appropriately cited and given in the bibliography.   

References

BHP Billiton, ‘Annual Report of BHP Billiton 2015’, http://www.bhpbilliton.com/-/media/bhp/documents/investors/annual-reports/2015/bhpbillitonannualreport2015.pdf?la=en, 2015, (Accessed 16 June 2017).

Tracy, A., Ratio Analysis Fundamentals: How 17 Financial Ratios Can Allow You to Analyse Any Business on the Planet, RatioAnalysis.net, 2012. 

Yahoo finance, ‘BHP Billiton Limited: Summary’, https://in.finance.yahoo.com/quote/BHP?p=BHP, 2017, (Accessed 16 June 2017).

Yahoo finance, ‘Price history’, https://in.finance.yahoo.com/q/hp?s=BHP&a=05&b=25&c=2014&d=06&e=05&f=2015&g=d&z=66&y=198, 2017, (Accessed 16 June 2017).

[1] J., Malinak, Etsy-preneurship: Everything You Need to Know to Turn Your Handmade Hobby into a Thriving Business, John Wiley & Sons, 2012

[2] CCH Tax Editors, U.S. Master Tax Guide 2009: CCH Tax Research Consultant Edition, CCH, 2008.

[3] GOV.Je, When a business must register for GST, ‘https://www.gov.je/TaxesMoney/GST/Businesses/Registration/Pages/ShouldIBe.aspx’, 2017, (Accessed 16 June 2017).

[4]Bytestart, ‘Sole Trader Tax – A guide for start-ups and the newly self employed’,

http://www.bytestart.co.uk/sole-trader-tax-guide.html, 2017, (Accessed 16 June 2017).

[5] Gov.uk, Register as an employer, ‘https://www.gov.uk/register-employer’, 2017, [Accessed 16 June 2017].

[6] Hayre, A., Managing Financial Resources and Decisions, GRIN Verlag, 2015

[7] C.L., Culp, The Risk Management Process: Business Strategy and Tactics, John Wiley & Sons, 2002

[8] K., Sadgrove, The Risk Mitigation Handbook: Practical Steps for Reducing Your Business Risks, Taylor & Francis, 2016.

[9] R., Klein, R., Rosario, and S.M., Holl, CPA's Guide to Effective Engagement Letters: Implementing Successful Loss Prevention Practices, CCH, 2007.

[10] BHP Billiton, ‘Annual Report of BHP Billiton 2015’, http://www.bhpbilliton.com/-/media/bhp/documents/investors/annual-reports/2015/bhpbillitonannualreport2015.pdf?la=en, 2015, (Accessed 16 June 2017).

[11] Yahoo finance, ‘BHP Billiton Limited: Summary’, https://in.finance.yahoo.com/quote/BHP?p=BHP, 2017, (Accessed 16 June 2017).

[12] A., Tracy, Ratio Analysis Fundamentals: How 17 Financial Ratios Can Allow You to Analyse Any Business on the Planet, RatioAnalysis.net, 2012.

[13] A., Tracy, Ratio Analysis Fundamentals: How 17 Financial Ratios Can Allow You to Analyse Any Business on the Planet, RatioAnalysis.net, 2012

[14] A., Tracy, Ratio Analysis Fundamentals: How 17 Financial Ratios Can Allow You to Analyse Any Business on the Planet, RatioAnalysis.net, 2012

[15]BHP Billiton, ‘Annual Report of BHP Billiton 2015’, http://www.bhpbilliton.com/-/media/bhp/documents/investors/annual-reports/2015/bhpbillitonannualreport2015.pdf?la=en, 2015, (Accessed 16 June 2017).

[16]Yahoo finance, ‘Price history’, https://in.finance.yahoo.com/q/hp?s=BHP&a=05&b=25&c=2014&d=06&e=05&f=2015&g=d&z=66&y=198, 2017, (Accessed 16 June 2017).