Short-term obligations - Essay Example

? ASSIGNMENT 29 February ASSIGNMENT Table of contents 0 Introduction……………………………………………………………………………….3 2.0 Financing the short term obligations of businesses……………………………………….3 3.0 Task 2……………………………………………………………………………………..4 3.1 meeting short term obligations……………………………………………………4 3.2 liquidity and efficiency ratios of the companies………………………………….5 3.3 comparing liquidity position of the companies……………………………………6 3.4 comparing efficiency ratios……………………………………………………….7 4.0 Conclusion……………………………………………………….………………………..7 5.0 Recommendation……………………………………………….…………………………8 6.0 Reference list……………………………………………………………………………...9 Introduction ‘Short-term’ obligations are liabilities owed by an institution to outsiders and are due within a period of less than one year. They can be understood as part of an organization’s assets that have been contributed by external sources. The obligations include creditors, accrued expenses, and ‘short-term’ loans. This paper seeks to discuss the financing of ‘short-term’ obligation of PepsiCo and MacDonald’s company. The paper will explore how the two companies that fall within the manufacturing industry financed their ‘short-term’ obligations. This will be achieved through analysis of the financial reports of the companies for the year 2009. 1. Financing the short term obligations of business Businesses apply a variety of ways to finance their short term obligations. The obligations are outstanding payments that are to be made but outweigh organization’s current assets. As a result, external sources are the only available options for offsetting the liabilities. One off the approaches to financing ‘short-term’ obligation is the use of trade creditors. Creditors are entities that are owed money by the organization for goods delivered or services offered to the company. They occur when benefits are received but no consideration is transferred. The effect of trade creditors is that they allow for retention of cash and cash equivalence within the organization. The cash that would have been paid to the creditors can then be used as a source of finance to ‘short-term’ obligation (Guerard, Guerard and Schwartz, 2007, 108). ‘Short term’ obligations can also be financed through ‘short term’ loans. Banks and other financial institutions offer financial services that an organization can use for financing its current liabilities. There exists a wide variety of ‘short term’ loans. Unsecured loans as well as loans that are offered upon guarantee are examples of available options from the financial institutions. “Revolving line of credit” is another possible option for financing the ‘short term’ obligations. The arrangement in which a bank agrees to offer specified amount of money to an enterprise on a renewable term provides availability of funds as may be needed by an organization. This is because once an arrangement is made for the revolving fund; the company is assured of obtaining it in case of need (Worldacademy, n.d., 1; Pride, Hunges and Kapoor, 2011, 577). Factoring is another suitable approach to financing ‘short term’ obligations. This is defined as the transfer of rights over debtors to a third party for finances. The arrangement involves a form of sale of debtors’ accounts to another entity that will then offer money based on the accounts receivables balances and the risks involved in the accounts. The transaction also offers money for offsetting ‘short term’ obligations. Other possible methods of financing ‘short term’ obligations include “accounts receivable loans, inventory loan, and term loan” (Seidman, 2005, 96- 100). Reclassification of ‘short term’ obligation as ‘long term’ liabilities and making financing contracts are other possible methods of financing current liabilities (Norton, Diamond and Pagach, 2006, 550). Task 2 a. Meeting short term obligations McDonalds Company, as witnessed from its financial statements, has a variety of sources of finance that can be used to finance ‘short term’ obligations. From the company’s cash flow statement, a number of sources of finances can be identified. There was for instance an increase in accounts receivables by 50.1 million dollars. This means that the company had the potential factor method by selling rights over the accounts to a party in exchange for finances. The company also employed ‘short term’ borrowings of about three million dollars that could be associated with financing ‘short term’ objectives. The presence of accounts payable in the company’s balance sheet indicates that the company used the intended cash for purchase to finance other ‘short term’ objectives. Additional paid in capital and retained earnings are other sources that contributed to the company’s available sources for financing short term obligations (McDonalds, 2010, 26- 28, 39). Similarly, PepsiCo had a variety sources to its pool for financing ‘short term’ objectives. These included finances from mergers, “sale of property, short term investments proceeds from issuance of long term debts” and accounts receivables (PepsiCo, 2009, 72- 74). b. Liquidity and efficiency ratios for the companies Liquidity ratios measure an organization’s ability to meet its ‘short term’ obligations. The ratios include current ratio and acid test. The rations for McDonalds are as follows, Liquidity ratios Current ratio= current assets/ current liabilities =4368.5/2924.7 = 1.494 Acid test ratio= current assets less stock and prepayments/current liabilities =3566.7/2924.7 =1.219 Efficiency ratios Debtor days= (average debtors/credit sales)*365 The company’s financial report has no record of credit sales. It is therefore not possible to calculate its debtor days. Creditors days= average creditors /credit purchase. There are also no records of credit purchase hence the ratio cannot be computed. Stock turn over days = (average stock/ cost of sales)*365 (108.05/16601.5)*365 =2.38 days For PepsiCo Liquidity ratios Current ratio= current assets/ current liabilities =17569/ 15892 =1.11 Acid test ratio= current assets less inventory and prepayments =12692/15892 =0.799 Efficiency ratios Debtor days= (average debtors/ credit sales)*365 The ratio cannot be calculated because there are no records of credit sales. Similarly, creditors’ days cannot be calculated because of lack of records for credit purchases. Stock turn over days = (average stock/ cost of sales)*365 =(2995/26575)*365 =41.13 days c. Comparing liquidity positions of the companies Ratio McDonalds PepsiCo Liquidity ratio 1.494 1.11 Acid test ratio 1.219 0.799 McDonalds poses better liquidity ratios than PepsiCo. This is because the higher the ratio, the better the liquidity status of a company. The low liquidity ratios for PepsiCo company with acid test ratio of less that 1 means that the company is overwhelmed by its ‘short term’ obligations. d. Comparing efficiency ratios Ratio McDonalds PepsiCo Stock turnover days 2.38 41.13 From the stock turn over days, McDonalds operates more efficiently as compared to PepsiCo. This is because PepsiCo takes longer days, on the average, before selling its inventory. The large difference in stock turnover between the two companies is attributable both cost of obtaining their revenues and their average stock. The management of McDonalds is therefore more efficient that the management of PepsiCo. Conclusion ‘Short term’ obligations are liabilities that are expected to fall due within a short duration of time and yet cannot be offset by an enterprise within the accounting period. Organizations apply a variety of approaches to financing ‘short term’ objectives. These sources includes bank loans, factoring, accounts payables, accounts receivables and other possible incomes and injections of capital as were used by McDonalds and PepsiCo companies in their 2009 operation periods. This paper explores the financial statements McDonalds Company and PepsiCo Company, two companies in the food industry, to understand their liquidity and efficiency status. McDonalds has stronger liquidity ratios as well as efficiency ratios as compared to PepsiCo Company. Recommendation The paper recommends that the management of PepsiCo formulate policies towards improving its efficiency and liquidity ratios. This is because the company is well beaten by McDonalds that is its competitor in the industry. Based on the challenge faced in computing efficiency ratios such as creditors’ period and debtors’ periods, the paper recommends that values for credit sales and credit purchase be included in the financial reports. Even if their disclosure is not a necessity, the items should be incorporated as notes in the statements. The paper therefore recommends change in presentation of financial reports to include all items that are applicable to analysis of financial statements. Reference list Guerard, John, Guerard, John and Schwartz, Eli. (2007). Quantitative Corporate Finance. Philadelphia, PA: Springer McDonalds. (2010). ‘2010Annual report’. McDonalds. Available from: http://www.aboutmcdonalds.com/content/dam/AboutMcDonalds/Investors/C-%5Cfakepath%5Cinvestors-2010-annual-report.pdf. [Accessed on 29 February 2012] Norton, Curtis, Diamond, Michael and Pagach, Donald. (2006). Intermediate accounting: financial reporting and analysis. Boston, MA: Cengage Learning PepsiCo. (2009). ‘Performance with purpose’. PepsiCo. Available from: http://www.pepsico.com/Download/PepsiCo_Annual_Report_2010_Full_Annual_Report.pdf. [Accessed on 29 February 2012] Pride, William, Hunges, Robert, and Kapoor, Jack. (2011). Business. Mason, OH: Cengage Learning. Print Seidman, Karl. (2005). Economic development finance. California, CA: SAGE. Print Worldacademy. (n.d.). ‘Short term financing’. World Academy. Available from: http://worldacademyonline.com/article/24/350/short-term_financing.html. [Accessed on 29 February 2012] Read More