Accounting Decision Analysis - Assignment Example

of Topic: Accounting Decision Analysis (Fin & Ratio Analysis Introduction: This paper aims to use the ratio analysis data provided and fully discuss all aspects of profitability and risk for the company considering each ratio. The paper will answer several questions given. 2. Questions and answers’ (1)What information does this ratio tell you about the company? (Please do not use textbook definitions but explain in your own words what the ratio measures) The ratio tells us the company is profitable, liquid and solvent. Profitability is obvious the more than 10% return of assets and return on the equity for the years 2004 through 2007. Said ratios convinces a good financial performance of the company as it has generated more than adequate returns to compensate the used of assets and investments from stockholders. The company is likewise liquid as reflected in the current ratios of 1.561, 1.248, 1.065, 1.938 and 1.724 for the years 2003 2004, 2005, 2006 and 2007 respectively1. Since liquidity indicates the capacity of the company to meet currently maturing obligations, the company therefore faces less risk from bankruptcy or insolvency. Investors would at the least be assured that company has short term solvency in the short term and creditors may be more than willing to extend working capital requirement should the company plans to apply for one in case of need by the company. 2)How will accounting analysis adjustments (e.g. Adjustments of depreciation expense, provision for doubtful debts, rev/exp, debt&equity financing, effect of IFRS adoption, over/understatements of A/R, A/P) have an effect on important ratios. The accounting analysis adjustments (e.g. Adjustments of depreciation expense, provision for doubtful debts, rev/exp, debt & equity financing, effect of IFRS adoption, over/understatements of A/R, A/P) will have an effect on important ratio by increasing, decreasing the same or maintaining the same ratios. As to how will it increase the ratios require and understanding the formula to get the values affected by the formula in computing the ratios. To illustrate, an adjustment in depreciation will result to increasing expenses and increase in expenses necessarily reduces net profit that will be used in computing net operating margin. The same entry for depreciation will also decrease the total assets of the company and hence this will bring down the total assets for computing the ratio from return on assets. Decreasing total assets will of course reduce the denominator and all other thing being equal, this would increase the return on assets ratio. (3)What is the direction of change in the ratio over the years of analysis? The company is growing in revenues and assets over the years. Sales revenues grew by 39.10%, 22.80%, 12.00% and 18.70% for the years 2004, 2005, 2006 and 2007 respectively. It is obvious from the rates that sales continuously grew although at lesser than what was recorded in 2003. It may be argued that since the average annual increase in revenues in more than 10%, there is basis to say the company is still growing as confirmed also by the annual increase in assets which are recorded at 5.70%, 18.70%, 12.50% and 17.10% for the years 2004, 2005, 2006 and 2007 respectively. The growth in assets may therefore also confirm the profitability of the company from the continuous growth in revenues as reflected in the increasing trend in net profits. This increasing trend also mean an increasing efficiency of the company as measured by improving net operating profit margin reflected at 0.072, 0.01, 0.049, 0.039 and 0.044 from fiscal years 2004 to 2007 although the rate recorded in 2003 was actually even higher at net operating margin of 0.72. (4) Is it the numerator/denominator or both that is affecting the change? The increase in net operating margin reflects both increase in numerator and denominator. The increase in numerator is obvious because mathematically speaking, higher ratios means higher numerators. But since revenues in their absolute values also increase, there is basis to conclude that the increase in net operating margin must have considered also the denominator in computing net operating margin, since the base or denominator in the formula is total revenues. . (5) -How has movement in the ratio over the years changed your opinion of the intrinsic value of the company? As a general rule, the greater the profitability of a company, the greater should be its intrinsic value. In the case at hand, the company reflected Return on Equity (b4 non-recurring) at 0.143, 0.18, 0.149 and 0.187 for the years 2004, 2005 , 2006 and 2007 respectively which means that the company has on the average earned on average more than 10% on equity on the average for the past four years. Since increase in profitability are converted into accumulate earnings , it follows that the net worth or total equity of the firm must have also increase and necessary the company gained more value hence its intrinsic or market value to investors must have also increased as a result. It may be further argued that the greater the increase in total equity in relation of debt, the less risky the company becomes hence investors would most likely be attracted more to buy the company’s stock. Conclusion To conclude, it may be proper to answer whether the company has been using some sort of earnings management strategy. On the basis of the analysis made as to the profitability, liquidity and solvency ratios of the company, this paper could only agree. For a company to have increasing revenues is not an accident in the life of a business. Companies generally go into business to earn profits. This is based on the premise that before the company puts some business, the investors have opportunity cost2 for the money that were invested in the company. The investors could have just invested their money in risk free investment under which they were assured profits. But since an alternative offers greater opportunity for profit, they did make their investment to the company at issue and hence as expected and planned the have earn better than the money generated from the said risk free investment. Works Cited Super Cheap Auto (2007) Company’s financial statement. {www document} URL, http://www.supercheapauto.com.au/corporate/investor-centre.aspx, Accessed October 1o, 2007 Brigham and Houston, Fundamentals of Financial Management, Thompson South Western, UK, 2002 Read More