Accounting and Finance in the Business - Assignment Example

? Modern Furniture a) Purpose of Profit and Loss Account: Profit and loss account is one of key area of the financial statements. It covers the transaction relating to the two fundamentals of accounting; that is the revenue, and expenses (Day and Krakhmal). All the expenses are subtracted from the revenue and the resultant is the profit or loss for the year. Most of the investors are only concerned with the profit figure as it facilitates them to decide whether to invest in the business or not. The ultimate results also help the management to plan the future desired results and take corrective actions for improvements where necessary. However, profit and loss account does not provide information about future. (1.b) Profit and Loss Account Review: When looking at the profit and loss account of the Modern Furniture of both years, there are some items that are worth considering for decision making. The gross profit has declined by 10.75% from 2011. The major reason is the increase in the inventory cost. The other important thing to notice is that, there is a sharp decline of 5.8% in the net profit from last year which clearly indicates that there are no effective controls over the cost. Specially, salaries, maintenance and cleaning costs have increased to a significant amount. In addition to the facts mentioned above the Modern Furniture has also paid a bank interest of ?5200 due to the bank overdraft facility availed by the business in 2012; whereas, there was no such facility in the previous year. Marketing cost has also increased to ?51,500 from ?45,000 which is normal in a growing business like Modern Furniture. (2.a) Purpose of Balance Sheet: As the profit and loss account shows the results of revenue and expenses for the whole year, the balance sheet reflects the financial position of the entity on a particular point of time including the details of total assets, liabilities and owner’s equity. Balance sheet is the engine that drives earning power, risk and capital requirements. It summarizes the results of millions of transactions. Balance Sheet in connection with the profit and loss account is used by investors as a tool to assess the risk in the investment or to ascertain the future profitability of the business. It is a picture that shows the strength and weaknesses of the business. (2.b) Balance Sheet Review: There are many observations in the balance sheet. The liquidity position has deteriorated since last year. There is no cash balance available at the end of year 2012. Investment in the non-liquid assets such as inventory and prepayments has increased together with the investment in receivables since last year. In addition to this Modern Furniture has also availed the bank overdraft facility so, there are major problems regarding liquidity. The business is holding more inventory than the previous year due to the growth in the business. Higher inventory levels will counter the threat of stock out at the price of higher inventory cost. The business has also made heavy investment of ?70,550 in fixed assets keeping in view the future expected demand. The overall position of the business is reasonable except the liquidity issue which requires prompt action from the owner. To overcome the current situation the business should make investment in the liquid assets such as cash and securities otherwise it will be difficult to pay the liabilities in due time. (3 a) Purpose of Cash Flow Statement: Cash flow is also one of the most important parts of the financial statements which reflect all the receipts and payments made by the company during the financial year. The purpose of preparing the cash flow statement is to ascertain whether there are sufficient cash flows available to finance the operations. Cash act as a blood to run any organization. If the business is unable to produce sufficient cash, there will be going concern threat due to severe liquidity problems. The most important of all three activities in the cash flow statement is the operating activity which shows the cash generated by business from its normal operations. (3.b) Cash Flow Review: There are no major changes in the cash flow statement since last year except the worsening liquidity position. The business is not able to generate the sufficient cash from its operation to cover all outflows and due to this reason Modern Furniture was forced to obtain over draft facility. The business is depending heavily on debt finance which is risky in current prevailing situation. Only the interest payment of the long term debt is the 59% of the total operating profit. Further, the business has to repay the principle amount of the long term debt and interest due on the over draft. The cash balance of ?21,750 in 2011 ended up in over draft of ?96,002 at the end of 2012. There is a heavy investment in the fixed assets which is good as the business is expecting growth but, the liquidity issue should be given priority if the business has to survive in the long term. (4) Recommendations: Cost Control: There are problems with cost control due to which profitability has affected to a major extent. Cost controlling strategies should be adopted for example, inventory cost can be controlled by entering into a long term agreement with a supplier to fixing the price of the major raw material for a certain period of time. Efforts should be made to increase the sales level this will help covering the fixed cost and would result in better profitability. Proper budgeting system should be introduced and the actual results should be compared with those of budgeted data. Further, any major variances should be critically evaluated to take reasonable corrective actions. Liquidity: Efforts are required to improve the current liquidity position of the business. One of the option available in this regard is that the reasonable investment should be made in liquid assets so the liabilities could be paid easily in due time. The other option to consider is to make less reliance on the debt finance to facilitate the operation. It will result in less interest cost and high profits and there will be remote chances of going concern issue in case if the over draft facility is lifted by the bank. Works Cited Day, Judy and Vira Krakhmal. An Inroduction to Accounting and Finance in the Business. Milton Keynes, UK: Charlesworth Group, 2006. [Print]. Read More