Executive summary
The financial statements are vital documents that are prepared to communicate the results of operations of a company for a specific trading period. It enables the stakeholders to compare the financial performance of an entity with those of other companies that operate in the same industry. The statements also facilitate monitoring the trend of the financial performance over time. In the paper, the financial statements that are prepared to report the findings of the company are a statement of financial position, cash flow statement, cash flow budget, and income statement. The first year of operation for any business is always quite challenging. In the case of the Fashion Clothing Company, the company was able to grow its revenue, profit and the assets during the first six of operation. However, it faced numerous challenges that were associated with management of cash.
Introduction
One of the main goals of forming a business is to generate profits from the key activities of the business. Financial statements are prepared to give information on the performance of the entity after a period of trading. The first statement that will be prepared is the statement of financial position. It will give information on the assets, liabilities and capital of Fashion Clothing. Secondly, the income statement will also be prepared. It will provide information on revenues, expenses, and the profit at the end of the trading period. The third statement is the cash flow statement. It will summarize the movement of cash in and out of the business. It will also reveal whether the company has adequate cash that can facilitate smooth running of the business activities. The final statement is the monthly cash flow forecast. The statement will give information on the collections and disbursement that are made by the company every month. The report will focus on the preparation and discussion of these statements.
Main financial findings
Summary of the first 6 months business operations
During the first six months of operation, Fashion Clothing has engaged in buying and selling of inventory, payment of materials purchases, collection of receipts from sales, payment of labor and other expenses. Besides, it can be noted that tangible non-current assets were purchased and tax bill were also paid in the month of December. There were no other major financial activities. The expected revenues and expenditure for the first six months of operation was provided. This information will be used to prepare the various financial statements and to evaluate the financial performance of the entity (Atrill & McLaney 2013). At the end of the six months, the company will be able to grow its capital base from £200,000 to £315,000. Also, the net income amounted to £115,000 at the end of the trading period. This shows that the company had favorable results. However, Fashion Clothing experienced a cash deficit (Omoye & Eraghe 2014). This can be attributed to excessive expenditure that exceeded the amount of cash collected. Thus, the cash and cash equivalent balance that is reported in the cash flow was (£95,000). This was much lower than the cash reported at the beginning of the period.
Financial accounting statements
The three major financial accounting statements are prepared to summarize the financial operations of the company for the first six months of operation. The statements are presented in ANNEX I, II, III, and IV.
Analysis
Initial analysis in context of the three financial statements
Statement of financial positions
The statements of financial position are presented in the ANNEX 1. The book value of the tangible assets grew by £30,000 due to the acquisition that was made in December. The value of accumulated depreciation was £15,000. Therefore, the net book value of the non-current assets grew by £15,000. The accounts receivables and inventory that were acquired during the year led to an increase in current assets. The value of accounts receivable was £175,000. The cash balance dropped from £50,000 at the beginning of the period to an overdraft position of £95,000 at the end. Apart from the overdraft, the company also had accounts payable at the end of December. The accounts payable amounted to £60,000. Total capital grew by the amount of net profit. Thus, the value of net assets and capital invested at the end of December £315,000 (Horngren et al. 2012)
Income statement
In the income statement, it can be noted that the total amount of sales that were made during the six month period was £1,350,000. The cost of goods available for sale was £390,000 while the gross profit amounted to $960,000. Further, the operating profit amounted to £135,000. Fashion Clothing generated profit amounting to £115,000.
Cash flow statement
The indirect method was used to prepare the cash flow statement. The company had a negative value of cash flow generated from operating activities. This implies that the cash flow that is generated from operating activities cannot support the day to day operations (Abdullah & Ismail 2008). The cash flow that was generated from investing activities amounted to £30,000. There were no financing activities during the period. The total decrease in cash amounted to £145,000. The company had a negative cash balance amounting to £95,000.
Cash flow forecast
The projected cash flow forecast shows the difference between the total inflows and total outflow for each month. In the months of July, August and September, the value of total outflow exceeded the total inflow. The net cash flows during the remaining months were positive. Further, it can be noted that the company had a negative closing cash balance during the entire period. It indicates that the cash inflow generated cannot cover the cash payment. Therefore, the company may need to take a credit facility at the bank. An example is the overdraft facility. The value of this facility can be set at the total amount of net cash flow during the first three months, that is, £265,000. However, the company will incur interest expense for the unpaid amount of the loan. On the other hand, the company can gain by investing the amount borrowed. It will earn interest income (Petty et al. 2012).
Investigations to increase efficiency
Inefficiency is observed in lack of adequate cash to enable the business run smoothly. This can be attributed to the fact that the company relies on cash in the bank to make payments. There are no other sources of cash such as financial instruments. Efficiency can be improved by taking a credit facility which can be invested in interest earning instruments. This will generate interest income for the company. The amount of the credit facility should exceed the current balance of bank overdraft. For instance, if the company takes a credit facility amounting to £265,000, then it will cover the bank overdraft amounting to £95,000 and a balance of £170,000 will be invested in other securities. The company can also negotiate for favorable credit terms with both the customers and suppliers. This will help in improving the working capital and cash flow (Abraham et al. 2010).
Conclusion
A review of the financial statement of Fashion Clothing shows that the company performed well during the first six months of operation. The company was able to generate net income and grow the balance sheet. However, the company faced a problem in cash management. This can be improved by exploring options such as taking loans that can be used to boast the liquidity position.
References
Abdullah, A & Ismail, K 2008, ‘Disclosure of voluntary accounting ratios by Malaysian listed companies’, Journal of Financial Reporting and Accounting, vol. 6, no. 1, pp. 1 – 20.
Abraham, A, Glynn, J, Murphy, M & Wilkinson, B 2010, Accounting for managers, South-Western Cengage Learning, USA.
Atrill, P & McLaney, E 2013, Accounting and finance for non-specialists, Pearson Publishing Company, UK.
Horngren, C, Harrison, W, Oliver, S, Best, P, Fraser, D, Tan, R & Willett, R 2012, Accounting, Pearson Publishing Company, Australia.
Omoye, A & Eraghe, E 2014, ‘Accounting ratios and false financial statement detection: evidence from Nigeria quoted companies’, International Journal of Business and Social Sciences, vol. 5, no. 7, pp. 206 – 215.
Petty, J, Titman, S, Keown, A, Martin, J, Martin, P, Burrow, M & Nguyen, H 2012, Financial management: principles and applications, Pearson Publishing Company, Australia.
Appendices
APPENDIX I: Statement of financial position Fashion Clothing – 01.07.20X5 and 31.12.20X5
Fashion Clothing. Statement of Financial position. As at 01.07.20X5.
Fashion Clothing. Statement of Financial position. As at 31.12.20X5.
APPENDIX II: Income statement Fashion Clothing – 6 months to 31.12.20X5
Fashion Clothing. Income statement. For the period ended 31.12.20X5
APPENDIX III: Statement of cash flow Fashion Clothing – 6 months to 31.12.20X5
Fashion Clothing. Cash flow statement. For the period ended 31.12.20X5.
APPENDIX IV: Projected cash flow forecast for the first 6 months of trading
Fashion Clothing. Cash flow forecast. For the period ended 31.12.20X5.
Others – Ratios
From the income statement, the resulting value of gross profit margin, operating margin, and net profit margin were 71.11%, 10%, 8.52%, and 24.47% respectively. In terms of efficiency, the receivables turnover, payable turnover and inventory turnover were 7.71 times, 6.5 times and 3 times respectively. Finally, the quick and current ratios (measures of liquidity) were, 1.97:1 and 1.13:1 respectively.
Workings
Accounts receivable = (£1,350,000 (sales) – £1,175,000 (cash collected) = £175,000
Accounts payable = purchases – payments £520,000 – £460,000 = £60,000.