The Business Plc.: Financial Statements

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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.

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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
0 0
0 0
0 0
0 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
0 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
0 0
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
REVENUE $ ‘000’
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
Non-Current ASSETS $ ‘000’
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-CurrentLiabilities 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

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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:
    Gross Profit Margin
  • 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:
    Operating Profit Margin
  • 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 Capital Employed
  • 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 Ordinary Shareholders' Funds
  • 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:
    Return on Assets
  • 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:
    Current Ratio
  • 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:
    Acid Test Ratio
  • 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 Inventory Turnover Period
  • 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 Receivables
  • 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:
    Average Settlement Period for Trade Payable
  • 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:
    Gearing Ratio

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.

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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.

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