Accountancy, Profitability, Liquidity and Efficiency - Assignment Example

Running head: Accountancy Name: University: Course: Tutor: Date of Submission: Q1. Balance Sheet of Systems Integrated plc as at 31 December 2010 £ 000 £000 DR CR ASSETS CURRENT ASSETS Sales……………………………………………………………………………………………………………….11,178 Purchases……………………………………………………….7,625 Opening Inventory at 1st Jan 2010…………………………………………………………………….850 Closing Inventory at 31st Dec 2010…………………935,000 Bad Debts Allowance……………………………………….25,000 Prepaid Insurance Policy expense………………………………………………………………………90,000 Trade Receivable ………………………………………………………………………………………………….960 Total Current Assets……………………………………………………………………………………………………………………1,070,613 FIXED ASSETS Property at cost……………………………………………………1,900 Less Depreciation at 1st Jan 2010………………………………250 Property as at 1st Jan 2010………………………………………1650 Less accumulated depreciation(2% on reducing basis)….33 Property Net Book Value……………………………………………………………………………………..1617 Machinery at cost 1500 Less dep at 1st Jan 2010…………………………………………….450 Machinery as at 1st Jan 2010………………………………………1050 Less accumulated dep(10% on reducing basis) ……………..105 Machinery Net Book Value………………………………………………………………………………..945 Motor Vehicle at cost………………………………………………………………..480 Less dep at 1st Jan 2010……………………………………………………………...80 Motor Vehicle cost as at 1st Jan 2010………………………………………….400 Less accumulated dep( 20% on reducing basis)…………………………80 Motor Vehicle Net Book Value………………………………………………………………………………320 Total Fixed Assets………………………………………………………………………………………………………………………..2882 Other Assets Retained earnings at 1 Jan 2010………………………………………………………………………….680 10% Debentures 2010……………………………………………………………………………………………700 Total other Assets…………………………………………………………………………………………………………………………1380 TOTAL ASSETS……………………………………………………………………………………………………………………..1,074,875 LIABILITIES AND CAPITAL DR CR CURRENT LIABILITIES Bank overdraft……………………………………………………………………………….430 Trade Payables……………………………………………………………………………….345 Expense Payable (Electricity)…………………………………………………………3,000 TOTAL CURRENT LIABILITIES………………………………………………………………………………………………………….3775 LONG TERM LIABILITIES Tax liability………………………………………………………………………………………………………500,0000 TOTAL LONG TERM LIABILITIES……………………………………………………………………………………………………..500,000 TOTAL LIABILITIES…………………………………………………………………………………………………………….503,775 CAPITAL (Total assets-liabilities)+ ordinary shares= 1,074,875-503775+ 1200=572,300 ordinary shares……………………………………………………………………………………………………1200 Total Capital…………………………………………………………………………………………………….572,300 TOTAL LIABILITIES AND CAPITAL……………………………………………………………………………………………£572,300 SYSTEMS INTERGATED PLC INCOME STATEMENT AS AT 31ST DECEMBER 2010 REVENUES £000 Sales ..……………………………………………………………………………………. £ 11,178 COST OF GOODS Beginning Inventory…………………………………………£850 Purchases……………………………………………………….£7625 8,475,000 Ending Inventory………………………………………935,000 Cost of Good sold………………………………………………………………………………….7540 Gross Profit…………………………………………………………………………………………..3638 EXPENSES Administrative salaries ……………………………………..620 Van drivers’ wages………………………………………400 Rent, rates and Insurance………………………………...219 Telephone expenses……………………………………...210 Advertising ………………………………………………175 Debenture interest paid……………………………………35 Heat and Light……………………………………………213 Bank overdraft interest…………………………….. ……..35 Audit fees…………………………………………………..91 TOTAL EXPENSES………………………………………………………………………1998 NET OPERATING INCOME …………………………………………………………….1640 Other Income ………………………………………………………………………………….. Net income………………………………………………………………………… £ 1640 Q.2 Comments on the company’s performance in terms of Profitability, liquidity and efficiency In order to analyze the financial performance of Systems Integrated Plc in relation to the industry it will be necessary to analyze the gien financial ratios of the year 2009 and 2010.In accounting financial ratios are usually perceived as useful indicators of a firm’s performance as well as its financial situation. To gauge the performance of Systems Integrated Plc in terms of profitability, liquidity and efficiency three financial ratios will be used thus profitability ratio, liquidity and efficiency ratios (Bull,2007,pp.67-70). Profitability Profitability ratios show the success of firm in generating profits. Profitability ratios offer several different measures of the success of the firm at generating profits. Profitability ratios therefore measures how well a company is performing through the analysis of the profits earned relative to the sales, total assets and net worth(Tamari, 2007,pp.89-95). From the financial ratios given it indicates that the operating profit sales margin for the company decreased from 19% in the year 2009 to 16% in the year 2010. The decrease between the years 2009 to 2010 by 3% indicates that the company’s sales profits for the year 2010 have reduced drastically a clear indication that the company is not in a good financial position compared to the previous year as well as not making adequate sales revenues on its product sales. The drastic reduction could be associated with increase in the number of competitors in the industry as well as other factors such as inflation, price reduction among others. According to the company’s gross profit percentage it shows instability in the company’s profits (Tamari, 2007,pp.89-95). The profit margin in the year 2009 was 42% and 40% in the year 2010.The tremendous drop in profits between the years 2009 and 2010 by 2%indicates that the company is not generating much and heavy profits as compared to the previous year. The reduction in gross profit percentage is a clear indication that the company’s resources are reducing hence it has limited resources compared to the previous year (Tamari, 2007,pp.89-95). Despite the mere fact that the company experienced a drop in its gross profit percentage by 2% the gross profit percentage for the company is still high a clear indication that the company has enough financial resources to pay for research, product development, and other costs associated with running and growing business. Efficiency In order to analyze and comment on the performance of Systems Integrated Plc in terms of efficiency it will be necessary to analyze the stated company’s efficiency ratios. Efficiency ratios are usually used to analyze how well a company uses its assets internally, how well it manages its liabilities, how effectively the firm is paying suppliers and whether the business is overtrading or under trading on its equity(Bull,2007,pp.67-70). In most cases therefore efficiency ratios are usually used to calculate the turnover of receivables, the repayment of liabilities, the quantity and usage of equity and the general use of inventory and machinery.  From the financial ratios of Systems Integrated Plc, the Return on capital employed dropped from 35% to 32% in the year 2010.Return on capital employed is ratio used to measure the returns that a company is realizing from its capital. The resulting ratio usually represents the efficiency with which capital is being utilized in revenues (Bull, 2007, pp.67-70). This ratio in most cases usually indicates the efficiency and profitability of a company's capital investments. Though, there was a reduction in the company’s ROCE, it is still higher than the rate at which the company borrows clear indication that that any increases in borrowing cannot reduce shareholder’s earnings (Bull, 2007, pp.67-70). Though, the company recorded a reduction between the two years by 3%, the ratio indicates that management has high ability to generate earnings from the company’s total pool of capital. The reduction gives a clear picture that investors leverage actions have a significant impact on the profitability of the company. The inventory holding period of the company increased from 35 days to 38 days. This is a clear indication that the company having issues selling its products to customers showing inefficiency in terms of inventory levels compared to the previous year. On other hand it implies that the company is overstocking as well as overbuilding its inventory(Gibson, 2008,pp.12-30). The increases in inventory holding period shows that the industry is more volatile compared to the previous year causing low demand for the products. Collection Period ratio is very important in analyzing the overall company’s collectability of accounts receivable as well as how fast a business can increase its cash supply. From the financial ratio’s the supplier collection period reduced from 35 days in the year 2009 to 32 days in 2010.This is a clear indication, that the company is doing well hence suppliers are being paid more rapidly compared to the period on which the company is being paid by their customers(Gibson, 2008,pp.12-30). The financial ratios shows that the customer’s collection period increased from 28 days in 2009 to 30 days in 2010.The increase in Average collection period is an indication that the company has loosened its credit policies with customers primarily as way of competing adequately with the competitors. The interest rate coverage is an indication that the company is able to make the interest payments on its debts with its earnings before interest and taxes also known as EBIT. The increase in interest cover ratio in indicates the adequacy of a company's profits relative to interest payments on its debt. This shows that the Systems Integrated Plc is doing economically hence easily generating the cash necessary to pay its interest obligations. Non current asset usage as well as current asset usage indicates efficiency in asset management and utilization. This illustrates how well management is employing the company's total assets to make a profit. Liquidity Liquidity ratios are normally used to provide information about a firm’s ability to meet its short-term financial obligations. In most cases two ratios are used thus quick ratio and current ratio. Liquidity ratio therefore shows the number of times short –term liabilities are covered by cash (Tamari, 2007,pp.89-95). This ratio is used to measure how easily a company can be liquidated hence in most cases it usually helps financial institutions to gauge the credit worthiness of a company. It usually an indicator which determines whether a firm has enough short-term assets to cover its immediate liabilities without selling inventory. The current ratio of Systems Integrated PLC Company in the year 2010 was 2.1 while in 2009 it was 2.5.1.When the current ratio’s for the two years is analyzed there is concrete evidence that company’s asset position has reduced compared to the previous years. The reduction indicates that the asset position of the company has reduced substantially a clear indication that the company is not in a good position of the assets. The Acid test ratio of the company remained the same between the two years. Since Acid ratio is not less than 1 it implies that the company is in a good financial position hence it can adequately meet its short-term debts and liabilities. The ratio indicates the safety that the company possesses to cover its short-term debts (Gibson, 2008,pp.12-30). Q.3.Reliability of Accounting Numbers Reliability in accounting refers to the valuation of assets which analyses the role of what it intends to represent. In relation to this, relevance refers to the statistical infinite relation that is between the value of the investors firm and the accounting number. In this case, a benchmark plays some role in which it poses as a surrogate to the fundamental in that the accounting number is compared directly to the benchmark for the valuation of its reliability(Patrick, 2004,pp.78-89).. Therefore, this implies that reliability is the best measure that is used to ascertain the effectiveness of attaining relevance. The accounting number in the setting of valuation is chosen to represent the asset value. Valuation of the asset with an accounting number specifies a benchmark in this case and therefore describes the valuation methods that are acceptable to use to obtain an estimate of the benchmark. Reliability is therefore used in the fair measurements. Accounting numbers can be termed as reliable at all they can assist in differentiating decisions by helping users to come up with predictions on the outcomes of the past, the present and even then future in which they ought to confirm the prior expectations. Reliability thus depends on the strength of the description of the accounting measurement that deems to be faithful, neutral and thus verifiable in any case. This asserts that any information can therefore be regarded as representational faithful on condition that the related measures and descriptions are verifiable and neutral (Thomas,2009,pp.193-200). Accounting numbers in this context are thus seen to be values of assets and liabilities. Reliability is important in the accounting numbers for it ensures that errors are omitted thus being in position to defend the information gotten from the auditors. Reliability too makes the information from the auditors strong and beyond any doubt thus strengthening the market. Thomas, (2009,pp.193-200),also asserts that the reliability in the historical cost reporting is more valuable to most of the users of the information than benefits of the value reporting in the cases where the cost of estimation outdoes the benefits of the auditor independence that is in danger particularly in private firms (Thomas,2009,pp.193-200). In the fair value measurements, they do provide more transparency than those of the historical cost based measurements. Therefore, if companies had taken the initiative measured all financial instruments at a fair value, the regulators, the shareholders, and the investors could have achieved greater regulatory and market discipline and thereby avoided some of the losses that investors and taxpayers have had to incur during previous downturns in the market economy. Accountants are said to presently use a wide array of accrual and deferral methods in preparing financial statements (Patrick, 2004,pp.78-89).. Those methods are essentially mathematical calculation even to a minute cent to get the precision. According to (Patrick, 2004,pp.78-89),Sterling, accountants who continue to look more precise are to be admired and encouraged. Reliability in this case is as important as relevance because relevant information that is not reliable is useless to an investor Therefore historical numbers cannot qualify to be termed as a reasonable benchmark if at all the evidence do not show its significance, if there are no good estimates available for the fair value, the historical cost can then be considered just estimates of the fair value and not as a benchmark. The current economy has required greater use of fair value measurements in the financial statements because it is perceived that the information is as more relevant to investors than historical cost information (Carroll & Thomas,2003,pp.1-23). As a summary, only one model should exist for measuring financial instruments. That model refers to fair value. Measuring financial instruments at fair value does not necessarily mean abandoning historical cost information. Fair value measurements should be reliable and worked out in a manner that is faithful to the causal economics of the transaction References Bull, R (2007).Financial Ratios: how to use financial ratios to maximise value and success for your business. Publisher : Elsevier,pp.67-70 Carroll T & Thomas,L (2003). The Reliability of Accounting values and Fair Value. Journal of Accounting, Auditing and Finance. New York: Mc-Graw Hill,pp.1-23 Gibson, C., H (2008). Financial Reporting and Analysis (Book Only).11th ed.Publisher: Cengage Learning,pp.12-30 Patrick, M (2004). Accounting Principles.Chicago:Wiley and Sons,pp.78-89 Tamari, M (2007).Financial ratios: analysis and prediction.London: P. Elek Press, pp.89-95 Thomas, M (2009). Related Qualities of Useful Accounting Information. Journal of Accounting and Business research.Chicago: Univesity of Chicago,pp.193-200 Read More