The Business Plc.: Financial Statements

Worksheet

The following is the work sheet of The Business Plc. for at the end of Year 5. This work sheet includes the trial balance, statement of comprehensive income, statement of financial position, and statement of changes in equity. The work sheet also accompanies journal entries, which have been made for making adjustments as per the given information.

Y/E 5	Trial Balance		Adjustments		Final Trial Balance		Statement of Comprehensive Income (SoCI)
REVENUE	Dr	Cr	Dr	Cr	Dr	Cr	Dr	Cr
Sales		3,904,800				3,904,800	0	3,904,800
Gain on Disposal of Non-Current Assets		11,392				11,392	0	11,392
COST OF GOODS SOLD							0	0
Cost of Sales	2,711,424		1,264	480	2,712,208		2,712,208	0
OTHER INCOME							0	0
Other Income		73,888				73,888	0	73,888
EXPENSES							0	0
Administrative Expenses	550,080		80	13,004	537,156		537,156	0
Selling and Distribution Expenses	241,024		160		241,184		241,184	0
Loss on Disposal Non-Current Assets	0				0		0	0
Interest Expenses	13,408				13,408		13,408	0
Taxation	125,152				125,152		125,152	0
Dividends	0				0		0	0	Statement of Financial Position (SoFP)
Retained Earnings							0	360,972
NON-CURRENT ASSETS									Dr	Cr
Tangible Non-Current Assets	2,425,808		3,168	880	2,428,096				2,428,096	0
Intangible Non-Current Assets	0		10,032		10,032				10,032	0
CURRENT ASSETS									0	0
Inventory	254,592		480		255,072				255,072	0
Account Receivables	138,704				138,704				138,704	0
									0	0	Statement of Changes in Equity (SoCIE)
Prepayments			3,456		3,456				3,456	0
Bank deposit account	136,160				136,160				136,160	0
EQUITY & RESERVES									0	0	Dr	Cr
Ordinary share capital		100,000	99,000			1,000			0	1,000		1,000
Share premium		128,000	32,000			96,000			0	96,000		96,000
Revaluation reserve		192,000	800			191,200			0	191,200		191,200
Retained earnings	284,704			131,000	153,704					207,268	153,704	360,972
CURRENT LIABILITIES									0	0	153,704	649,172
Trade payables		587,792				587,792			0	587,792
Accruals				2,208		2,208			0	2,208
Tax liability		125,152				125,152			0	125,152
Short-term Borrowings		318,032				318,032			0	318,032
Finance Lease				264		264			0	264
NON-CURRENT LIABILITIES									0	0
Long-term Borrowings		1,440,000				1,440,000			0	1,440,000
Finance Lease				2,604		2,604			0	2,604
	6,881,056	6,881,056	150,440	150,440	6,754,332	6,754,332			2,971,520	2,971,520

Journal Entries

Inventory Adjustments		Dr.	Cr.
Cost of sales		1,760
	Inventory		1,760
Inventory		2,000
	Cost of Sales		2,000
Inventory		240
	Cost of Sales		240
		4,000	4,000
Other Sundry Adjustments		Dr.	Cr.
Prepayments		3,456
	Administrative Expenses – Insurance		656
	Administrative Expenses – Rates		240
	Administrative Expenses – Rent		2,560
Cost of Sales		1,264
Administrative Expenses		784
Wages		160
	Accruals		2,208
		5,664	5,664
Share Capital and Dividends		Dr.	Cr.
Shares		99,000
Share Premium		32,000
	Retained Losses (Brought Forward)		131,000
		131,000	131,000
Property, Plant and Equipment & Revaluation		Dr.	Cr.
Depreciation – Non-Current Assets		800
	Cost – Non-Current Assets		1,600
Revaluation Reserve		800
Administrative Expenses		80
	Depreciation Expense for the Year		80
		1,680	1,680
Finance / Operating Lease		Dr.	Cr.
Addition at Costs – Non-Current Assets		300
	Administrative Expenses		300
	Finance Costs
Additions at Cost – Non-Current Assets		2,868
	Finance Lease – Current Portion		264
	Finance Lease – Non-Current Liabilities		2,604
		3,168	3,168
Intangible Non-Current Assets		Dr.	Cr.
Intangible Non-Current Assets		10,032
	Administrative Expenses		10,032
		10,032	10,032
Non-Current Assets		Before Adjustment	After Adjustment
Cost brought forward		230,026	230,026
Additions at Cost		15,513	16,305
Fair Value Adjustments			(1,600)
Cost of Disposals		(9,487)	(9,487)
		236,052	235,244
Depreciation brought forward		82,285	82,285
Depreciation Expense for the Year		5,041	5,061
Fair Value Adjustments			(800)
Depreciation on Disposals		(2,887)	(2,887)
		84,439	83,659

The option to issue right shares for the purpose of raising $10 million has been exercised, which after making relevant adjustments shows that the company will be in a position to pay some dividends to its shareholders. This would in turn motivate investors and shareholders to invest in the company’s stocks (Clendon, 2009; Needles & Powers, 2010).

Financial Statements

Based on the financial information available of the company and worksheet derived as above, the following financial statements of The Business Plc. are prepared, which include Statement of Consolidated Income, Statement of Financial Position, and Statement of Changes in Equity.

Statement of Consolidated Income

The statement of consolidated income for The Business Plc. at the end of Year 5 is provided below:

The Business plc, Statement of Comprehensive Income (SoCI) for the year ended 5
Particulars	Amount, $ ‘000’
REVENUE
Sales	3,904,800
Gain on Disposal of Non-Current Assets	11,392
COST OF GOODS SOLD
Cost of Sales	2,712,208
Other income
Other Income	73,888
EXPENSES
Administrative Expenses	537,156
Selling and Distribution Expenses	241,184
Loss on Disposal Non-Current Assets	–
Interest Expenses	13,408
Taxation	125,152
Dividends	–
Net Income / Retained Earnings	360,972

Statement of Financial Position

The statement of financial position for The Business Plc. at the end of Year 5 is provided below:

The Business plc, Statement of Comprehensive Income (SoCI) for the year ended 5
Particulars	Amount, $ ‘000’
Non-Current ASSETS
Tangible Non-Current Assets	2,428,096
Intangible Non-Current Assets	10,032
Total Non-CurrentAssets	2,438,128
CURRENT ASSETS
Inventory	255,072
Account Receivables	138,704
Prepayments	3,456
Bank deposit account	136,160
Total Current Assets	533,392
Total Assets	2,971,520
EQUITY & RESERVES
Ordinary share capital	1,000
Share premium	96,000
Revaluation reserve	191,200
Retained earnings	207,268
Total Shareholders’ Equity	495,468
CURRENT LIABILITIES
Trade payables	587,792
Accruals	2,208
Tax liability	125,152
Short term Borrowings	318,032
Finance Lease	264
Total Current Liabilities	1,033,448
Non-Current LIABILITIES
Long term Borrowings	1,440,000
Finance Lease	2,604
Total Non-Current Liabilities	1,442,604
Total Liabilities	2,476,052
Total Shareholders’ Equity and Liabilities	2,971,520

Statement of Changes in Equity

The statement of changes in equity for The Business Plc. for the year 5 is given below:

EQUITY & RESERVES
Ordinary share capital	Share premium	Revaluation reserve	Retained earnings
$ ‘000’	$ ‘000’	$ ‘000’	$ ‘000’
			(284,704)
100,000	128,000	192,000
(99,000)	(32,000)	(800)
			131,000
			(153,704)
			207,268
			153,704
1,000	96,000	191,200	360,972

Analysis of Financial Performance – Ratio Analysis

Based on the financial information available of the company – The Business Plc. for the last two financial years, the analysis of its financial performance has been carried out in the following, which is based on values of several useful ratios derived for the respective years (Warren et al., 2011; Needles & Powers, 2010).

Profitability Ratios

In order to determine the financial performance in respect of the company’s profitability during the past two years, the following ratios are determined for The Business Plc.:

• Gross Profit Margin
  

  Ratio	Year 4	Year 5
  Gross Profit Margin	30.62 %	30.54 %
  Gross Profit Margin = Gross Income / Sales

  Source: (Horngren & Harrison, 2009; Clendon, 2009; Needles & Powers, 2010).

• Graphical Illustration of Trends in the Past Years
  In order to obtain an overview of the trends in this ratio, the following graph has been made:
  
• Operating Profit Margin
  

  Ratio	Year 4	Year 5
  Operating Profit Margin	7.09 %	8.94 %
  Operating Profit Margin = Net Income / Sales

  Source: (Horngren & Harrison, 2009; Clendon, 2009; Needles & Powers, 2010)

• Graphical Illustration of Trends in the Past Years
  In order to obtain an overview of the trend in this ratio, the following graph has been made:
  
• Return on Capital Employed
  

  Ratio	Year 4	Year 5
  Return on Capital Employed	15.76 %	18.01 %
  Return on Capital Employed = Net Income / Total Capital Employed

  Source: (Horngren & Harrison, 2009; Clendon, 2009; Needles & Powers, 2010)

• Graphical Illustration of Trends in the Past Years
  In order to obtain an overview of the trend and patterns in this ratio, the following graph has been made:
  
• Return on Ordinary Shareholders’ Funds
  

  Ratio	Year 4	Year 5
  Return on Ordinary Shareholders’ Funds	59.10 %	121.1 %
  Return on Ordinary Shareholders’ Funds = Net Income / Ordinary Shareholders’ Funds

  Source: (Horngren & Harrison, 2009; Clendon, 2009; Needles & Powers, 2010)

• Graphical Illustration of Trends in the Past Years
  In order to obtain an overview of the trend in this ratio, following graph has been made:
  
• Return on Assets
  

  Ratio	Year 4	Year 5
  Return on Assets	8.91 %	11.74 %
  Return on Assets = Net Income / Total Assets

  Source: (Horngren & Harrison, 2009; Clendon, 2009; Needles & Powers, 2010)

• Graphical Illustration of Trends in the Past Years
  In order to obtain an overview of the trend in this ratio, the following graph has been made:
  
• Liquidity Ratios
  For the purpose of analyzing the liquidity position of the company, the following ratios have been determined:
• Current Ratio
  

  Ratio	Year 4	Year 5
  Current Ratio	0.35	0.53
  Current Ratio = Current Assets / Current Liabilities

  Source: (Horngren & Harrison, 2009; Clendon, 2009; Needles & Powers, 2010)

• Graphical Illustration of Trends in the Past Years
  In order to obtain an overview of the trend in this ratio, the following graph has been made:
  
• Acid Test Ratio
  

  Ratio	Year 4	Year 5
  Acid Test Ratio	0.16	0.28
  Acid Test ratio = Current Assets – Inventory / Current Liabilities

  Source: (Horngren & Harrison, 2009; Clendon, 2009; Needles & Powers, 2010)

• Graphical Illustration of Trends in the Past Years
  In order to obtain an overview of the trend in this ratio, the following graph has been made:
  
• Management Efficiency Ratios
  In order to determine the efficiency of the management of The Business plc for carrying out the company’s business operations and undertaking important decisions in past two years, the following efficiency ratios have been determined:
• Average Inventory Turnover Period
  

  Ratio	Year 4	Year 5
  Average Inventory Turnover Period	10.77 days	10.63 days
  Average Inventory Turnover Period = 365 / Days Inventory Outstanding

  (Horngren & Harrison, 2009; Clendon, 2009; Needles & Powers, 2010)

• Graphical Illustration of Trends in the Past Years
  In order to obtain an overview of the trends in this ratio, the following graph has been made:
  
• Average Settlement Period for Trade Receivables
  

  Ratio	Year 4	Year 5
  Average Settlement Period for Trade Receivables	8.98 days	12.97 days
  Average Settlement Period for Trade Receivables = Trade Receivables x 365 / Sales

  (Horngren & Harrison, 2009; Clendon, 2009; Needles & Powers, 2010)

• Graphical Illustration of Trends in the Past Years
  In order to obtain an overview of the trend in this ratio, the following graph has been made:
  
• Average Settlement Period for Trade Payable
  

  Ratio	Year 4	Year 5
  Average Settlement Period for Trade Payable	107.77 days	79.10 days
  Average Settlement Period for Trade Payable = Trade Payables x 365 / Cost of Sales

  Source: (Horngren & Harrison, 2009; Clendon, 2009; Needles & Powers, 2010)

• Graphical Illustration of Trends in the Past Years
  In order to obtain an overview of the trend in this ratio, the following graph has been made:
  
• Gearing Ratios
  

  Ratio	Year 4	Year 5
  Gearing Ratio	10.64	2.91
  Gearing Ratio = Long Term Debt / Total Equity

  Source: (Horngren & Harrison, 2009; Clendon, 2009; Needles & Powers, 2010)

• Graphical Illustration of Trends in the Past Years
  In order to obtain an overview of the trend in this ratio, the following graph has been made:
  

Summary of Findings

Based on ratios determined above, and the resulting patterns and trends shown in the respective graphs for each of the ratios, it can be stated that The Business Plc. has been able to improve its financial position as far as the profitability of the business is concerned. Apart from the decline in its gross profit margin, which resulted due to an increase in the cost of sales of the company, there have been favorable changes noted in values of other ratios including an increase in net profit margin, return on shareholders’ funds, and assets and capital employed (Horngren & Harrison, 2009; Clendon, 2009; Needles & Powers, 2010).

Opposing to the profitability of the company, its liquidity position has remained low at the end of year 5 similar to the position at the end of year 4. Although there have been improvements that are noted in the current and acid test ratios of the company in year 5 as compared to year 4, these improvements are not significant enough to bring the overall liquidity position of the company to a favorable position. The reasons which appear to be the primary factors of the low liquidity of the company include a significantly high level of short-term borrowing and outstanding trade payables of the company (Horngren & Harrison, 2009; Clendon, 2009; Needles & Powers, 2010).

Apart from this, the efficiency of management in conducting the company’s business operations has also been analyzed. In this regard, three ratios have been determined including average inventory turnover period, average settlement period for trade receivables, and average settlement period for trade payables. The results indicate that the performance of the company’s management is deteriorating as shown by the unfavorable changes in the selected three ratios’ values (Horngren & Harrison, 2009; Clendon, 2009; Needles & Powers, 2010).

Lastly, the gearing ratio has also been determined, which shows a significant reliance of the company on external debt for obtaining finance. Considering the total long-term debt of the company, it can be noted that it has remained the same in years 4 and 5. However, a decrease in the equity of the company has resulted in a higher gearing ratio value in year 5, which shows the dependency of the company on the long-term borrowing for obtaining finance (Horngren & Harrison, 2009; Clendon, 2009; Needles & Powers, 2010).

Recommendations

From the analysis presented above, it has been concluded that the company is in a favorable position as far as the profitability of the business is concerned. However, liquidity, management efficiency, and gearing are concerned areas, which require attention from the management and those who are responsible for the governance of the entity.

Recommendations for “The Business plc”

Based on the findings and conclusions reached from the financial analysis of the company, the following recommendations are set out for the company:

• The company shall consider managing its cost of sales more efficiently as there has been a significant rise in the same noted in year 5, which has resulted in a decline in the gross profit margin (Clendon, 2009; Needles & Powers, 2010).
• For improving the liquidity position of the company, it is recommended that the company shall improve its current assets and decrease current liabilities in order to reach a favorable liquidity position. In the current liabilities portion of the company, it has been noted that there is a significant amount of short-term borrowings of the company, which has resulted in an unfavorable liquidity position of the company. By lowering its reliance on short-term borrowing, the company can improve its liquidity position (Clendon, 2009; Needles & Powers, 2010).
• The company shall consider reducing the time it takes to recover receivables from its debtors. This would enable the company to improve the availability of cash (Clendon, 2009; Needles & Powers, 2010).
• In addition to this, the management of the company shall delay its payment to creditors and negotiate in a manner that the company’s cash reserves are not drained.
• The company shall also focus on lowering its inventory balances in order to improve the inventory turnover ratio (Clendon, 2009; Needles & Powers, 2010).
• The company shall consider reducing its gearing level by focusing on equity-based financing rather than looking for finance from long-term borrowings. In this way, it will be possible for the company to improve its solvency position (Clendon, 2009; Jiambalvo, 2010).

References

Clendon, T 2009, A student’s guide to Group Accounts, Kaplan Publishing, Wokingham.

Horngren, C T & Harrison, W T 2009, Accounting. Upper Saddle River, Prentice Hall, New Jersey.

Jiambalvo, J 2010, Managerial Accounting, John Wiley & Sons, Inc., Hoboken.

Needles, B E & Powers, M 2010, Financial Accounting, Cengage Learning, Mason.

Warren, C S, Reeve, J M & Duchac, J 2011, Financial and Managerial Accounting, South-Western Cengage Learning, Mason.