HC1010 Financial Statements Elements and Financial Statement Analysis Assessment Answer
HC1010 Accounting For Business
PART A Financial Ratios and Financial Statement analysis
1. Ratios Calculation: The given information and calculations can be presented as follows:
|30 June Year 2019||Year 2018||Year 2017|
|Net credit sales||$ 6,30,000||$ 4,90,000|
|Cost of goods sold||$ 2,90,000||$ 2,50,000|
|Cash||$ 18,000||$ 12,000|
|Accounts receivable||$ 70,000||$ 60,000||$ 78,000|
|Inventory||$ 1,30,000||$ 1,50,000||$ 1,30,000|
|Current liabilities||$ 1,05,000||$ 81,000|
|Period to Pay||30 days|
|Industry Average Inventory Turnover||101 days|
The calculation of ratios and formulae are:
|Ratio||30 June Year 2019||Year 2018||Formula|
|Quick Ratio||0.17||0.15||Quick Assets/CL|
|Accounts Receivable Turnover (times)||9.69||7.10||Net Credit Sales/Average Receivables|
|Accounts Receivable Turnover (days)||37.7||51.4||365/Accounts Receivables Turnover|
|Inventory Turnover (times)||2.07||1.79||COGS/Average Inventory|
|Inventory Turnover (days)||176.2||204.4||365/Inventory Turnover|
2. Ratio Analysis:
- Regarding short term solvency, the focus should be on current ratio and quick ratio. The company’s current ratio reduced from 2.74 to 2.08 in year 2019. A current ratio of 2.0 indicates ideal level where the current assets provide 200% buffer for the current liabilities. The company has a level above 2.0 which indicates sufficient coverage.
- However, quick ratio, also known as acid test ratio further reduces current assets by excluding non-liquid current assets such as, inventory and accounts receivable. This is because in a situation where company needs to discharge its current liabilities immediately, these types of non-liquid current assets may not be useful as they may not be convertible to cash immediately. The company’s level of quick ratio is quite low at 0.15 in 2018 and 0.17 in 2019, indicating that it may be unable to discharge its current liabilities immediately, if the need arises. However, the slowly rising level of quick ratio y-o-y basis indicates that company may be making an effort to improve the level.
- The turnover ratios are also known as efficiency ratios as they indicate how efficiently a company is utilizing its assets. The accounts receivable turnover ratio has improved considerably y-o-y basis from 51.4 days in 2018 (7.10 times) to 37.7 days in 2019 (9.69 times). This indicates that on an average, payment from debtors is received within 37.7 days. However, the average period to pay in the industry is 30 days and company still has scope to reduce this ratio to match the industry average period. The company’s inventory turnover ratio has also improved considerably y-o-y basis from 204.4 days in 2018 (1.79 times) to 176.2 days in 2019 (2.07 times). This indicates that on an average, the inventory is turned around in 176.2 days. However, this is very high as compared to industry average of 101 days. This is a big risk as the inventory entails a huge cost of maintenance, warehousing etc. Further, high period of inventory may also cause obsolescence risk. It may be prudent to review inventory levels and reduce the production of items that are not selling or put up a clearance sale to get rid of inventory at hand currently.
PART B Income & Revenue
The required can be presented as follows:
|Software Sales||$ 25,00,000||Revenue|
|Updates Download||$ 30,00,000||Revenue|
|Interest on short-term investment||$ 50,000||Income|
|Discount on early liab settlement||$ 2,000||Cash Discount or Income|
|Share Issue||$ 5,00,000||Income|
The last column indicates classification for each line item. For any company, revenue refers to the amount received from customers for the company products and services.
Whereas, income is a much larger term that indicates net profit of the company after including all items. In other words, the revenue and total income from various sources is included and then all expenses are deducted to arrive at income.
In above case, company is a software company selling anti-virus software. Hence, revenue will be the line items that show software sales and software updates download as these are related to product of the company.
All the other line items, such as interest earned on short-term marketing securities (investment income), cash discount (operating income) and share issues (financing income) can be classified as income.
PART C Balance Sheet Comparison
The required can be presented as follows:
|ABC Company||XYZ Company|
|Balance sheet||Balance sheet|
|As at 30 June 2020||As at 30 June 2020|
|Cash at bank||2,400||2,000|
|Total current assets||7,200||26,000|
|Total non-current assets||54,000||20,200|
|Loan payable due 30 September 2020||31,200||7,200|
|Total current liabilities||52,800||12,000|
|P. Cable Capital||8,400||34,200|
|Total owners’ equity||8,400||34,200|
|Short term Loan to Equity||3.71||0.21|
From above, the three key ratios can be seen. XYZ has a much higher current ratio of 2.17 indicating higher level of liquidity as compared to ABC. Further, XYZ has a much higher quick ratio of 0.17 indicating higher level of immediately available liquidity as compared to ABC. If the debt to equity ratio is seen, XYZ scores better with a lower ratio of 0.21.
- Hence, a bank should definitely select XYZ as compared to ABC for approving a short term loan seeing the liquidity and debt levels.
- Even an investor should go for XYZ as level of liabilities is lower and liquidity is much better. Additionally, net assets level is much higher.
- The impact will be negligible seeing the difference between ABC and XYZ. Hence, decision will remain the same.