Corporate Financial Reporting and Taxation - Essay Example

Introduction IP group, founded in in 2001, is a British-based company that deals in the intellectual properties by providing investment opportunities to technology companies. Ip group has its headquarters in London (U.K). The company’s key target marget is the universities in the U.K. The companies aims are as follows: to identify compelling intellectual property-base opportunities in their key target sectors; to develop the identified opportunities into a diversified portfolio of robust businesses; to grow the assets on behalf of the third ;arty; and to provide shareholders with quoted access to potentially high growth technology companies. The year 2012 has been marked the company’s growth in the value of net assets. This, therefore, essay covers analysis of the company’s financial statements for the year 2012, risk of a possible corporate failure and the importance of the objectivity and integrity in the preparation of the financial statements (Financial Statement: the IP group, pp. 1-9). The financial analysis Investment ratio Return on capital employed (ROCE) – capital employed is total assets – current liabilities. Therefore, return on capital employed ratio indicates the return generated by every pound invested as capital employed. Concerning the IP group, the ROCE for the year was 15.5%. The interpretation of the ratio goes that in 2012, 15.5% of the company’s net profit was generated by the company’s capital employed. This ratio can also be used by investors to determine the required rate of return on investments. Generally, a lower return on capital employed than the cost of capital is not preferable to investors (Duncan Hughes, Asset management in theory and practice, pp. 42-44). Profitability ratios Net profit margin – the ratio indicates a company’s financial health after meeting the cost of sales and the operating expenses. It also indicates the company’s ability to pay for future operating costs. Concerning the IP group, the ratio for 2012 was 77.5%. This means that in the year 2012, 77.5% % of the total revenue were net profit, whereas, the remaining 22.5% of sales were consumed by the company’s operating costs. From this analysis, it can be concluded that the level of operational efficiency for IP group was high due to the effective cost management strategy. (Sarngadharan M. & Kumar R. S. Financial analysis for management decisions, pp. 121-135). Net profit margin before tax – this ratio shows how well a company manages its operating expenses. The higher the ratio, the lower the operating expenses of a company. The opposite is true. Concerning the IP group, the net profit margin before tax for 2012 was 77.5%. The interpretation of the ratio shows that in 2012, 77.5% of Tesco’s revenue were net profit before tax, whereas, the remaining 22.5% were consumed by operating expenses. From the interpretation, the level of the operating expense of IP group was low. The company’s level of operating expenses shows the implementation of more stringent cost control methods starting with the cost of sales. The level of gross profit determines the profit level. Gross profit levels should be high to ensure a high net profit, assuming a low level of operating costs (Sarngadharan & Kumar, Financial analysis for management decisions, pp. 121-135). Liquidity ratios Current ratio – this ratio measures the ability of a business to meet its current obligations using the current assets. Generally, it is advisable for the ratio of current assets to current liability to be 2: 1. Concerning the IP group, the company’s current ratio for 2012 is 122 times. The ratio clearly shows that the company is excessively liquid enough to sufficiently settle its short-term obligations using the current assets. To rectify the excess liquidity, the company could invest in long-term securities. Acid test – the ratio is with immediate liquidity therefore ignores the inventory. It measures the ability of a company to meet the short-term obligations using highly liquid assets. A highly liquid asset is that which is easily converted into cash. A company is considered well off if this ratio is above 1. Concerning the IP group, the quick ratio of 2012 is similar to the current ratio for the reason that the company had no inventory during the financial period in consideration. Based on the ratio, the company’s liquidity was excessively high. (Khan M. Y & Jain P. K. Financial management, 6-40). Gearing ratios Debt ratio – this ratio indicates the proportion of a company’s total assets that has been financed by the total liabilities (long and short-term liabilities). It also shows the value of assets that creditors would claim in case of liquidation. Concerning the IP group Company, ratio for 2012 is 0.15% %. The ratio shows an insignificant level of dependency on the total debt to finance the company’s assets. The ratio interpretation indicates that in 2012, 0.15 % of the total assets were financed by the company’s total debts. Secondly, debt/equity ratio indicates the proportion of fixed charge capital in the capital structure of a firm. Concerning the IP group, the company’s capital structure is 100% equity, according to the financial statement of 2012. From the analysis, the company’s leverage level is zero. The company, therefore, faces no risk of default on debt obligations (Bowhill, B. Business planning and control: integrating accounting, strategy, and people, pp. 265-284). The risk of Corporate failure Corporate governance encloses factors such as managing the sources of finance, maintaining a reasonable level of working capital, the methods a company uses to finance the working capital, the current liability management strategy and value creation strategy. The capital structure of a company is key to determining the future position of a company in terms of leverage level. A highly leveraged company faces the risk of default. That is, interest and the principal amount of debt must be paid, when due, regardless of a company’s financial position. Failure to meet the debt obligations could send a company into receivership. Concerning the IP group, debt should be sought for financing purpose. The company’s capital structure is 100% equity (. The company faces the risk of low growth rate since the profits made are shared to the shareholders. On the other hand, using debt increases the company’s growth potential by reducing the cost of capital and profit retention. Second, considering the company’s liquidity level, there is excess liquidity. The company faces the risk of low cash inflow for the reason that working capital does not earn interest. Secondly, the company’s net assets, risk being under-utilized for the reason that a big portion of the net working capital is idle Therefore, a low level of working capital indicates a poor current asset management strategy. A successful implementation of the concept of corporate governance is dependent on maintaining a favorable level of working capital (neither too high nor too low). Therefore, for the mentioned two reasons, the IP group risks experiencing a failure in corporate governance (Damodaran, A., Applied corporate finance, pp. 9-17). The importance of objectivity and integrity in the preparation of the financial statements The preparation of financial statement is an obligation to every organization, both for profit and not for profit. The International Financial Reporting Standards (IFRS) has set rules and regulations to converge and govern the approach used in the preparation of the financial statements. Users of the financial statement are as follows: investors, lenders, employees, customers, government and their agencies and suppliers. The following are the importance of objectivity and integrity in the preparation of financial statement: first, it provides useful information for the current and potential investors, creditors and other users of the named above. The preparation of the financial statements based on the objectivity and integrity ensures the provision of clear and useful information that help the users in decision-making. Second, the financial statements provide potential investors with reliable information to help them assess the amount, time and risks of the prospective return on investment. The ability of an enterprise to generate enough cash to meet its obligation may be affected by investor’s and creditor’s the perception of a company. This may eventually influence market prices and enterprise security (Lee, T. A., Financial reporting and corporate governance, pp. 113-139). Accounting estimate and its impact Obtaining some information for accounting purposes is partly dependent on estimates. This is important in a case where a particular issue cannot be determined with absolute certainty. The company has relied on estimates to determine the rate of depreciation on the fixed assets. In order to determine the rate of depreciation, an asset’s useful life and salvage value is estimated prior. An incorrect estimation of these variables results in an incorrect determination of depreciation expense. Accounting information such as depreciation expense is useful in stating the correct net value of fixed assets in the balance sheet. Consequently, an incorrect estimation of depreciation expense results in a false information on the value of a company’s fixed assets thus, the financial position. Secondly, the false information would also appear in the cash flow statement under investing activities, thus, cause reporting of inaccurate net cash used in investing activities. The ultimate negative influence of providing such inaccurate information is felt by the users of financial statement (Lee, Financial reporting and corporate governance, pp. 113-139). Reference List Bowhill, B., Business planning and control: integrating accounting, strategy, and people ( Chichester, England: Wiley, 2008) Damodaran, A., Applied corporate finance (Hoboken, NJ: John Wiley & Sons, 2011) Duncan Hughes, Asset management in theory and practice ([S.l.], New Age International Pvt, 2009) Financial Statement: the IP group. (WEB). . Khan, M. Y., & Jain, P. K., Financial management (New Delhi: Tata McGraw-Hill, 2007) Lee, T. A., Financial reporting and corporate governance (Chichester [u.a.]: John Wiley & Sons, 2006) Sarngadharan, M., & Kumar, R. S., Financial analysis for management decisions (NY: Wiley, 2011) Read More