Financial Management and Control - The Performance of Prospect Plc - Assignment Example

Financial Analysis Questions al Affiliation Due REPORT ON THE PERFOMANCE OF PROSPECT PLC FOR THE FINANCIAL YEARS 2012 AND 2013. PROFITABILITY OF THE COMPANY The Gross profit increased by a paltry £ 20,000 in 2013 compared to 2012 despite the sales increasing by a whole £1,650,000. This was due to an increase in manufacturing costs from £5,200,000 to £6,880,000 an increase of £ 1,880,000. Some of the relevant ratios can be computed as below; Gross Profit Margin-Cost of sales in a company or the cost of goods sold is made up of labor expenses and overhead in manufacturing process. This are expenses that are deducted the revenue of the company that result in the company’s gross profit. The gross profit margin is used to analyze how the company has been efficient in utilizing its raw materials, labor and manufacturing fixed assets that generate profit. A percentage in margin that is high is favorable indicator for profit. 2012. =5,850 11,000 =0.53 2013 =5,870 12,650 =0.46 The Gross profit margin in 2013 decreased as compared to 2012 due to an increase in manufacturing costs in relation to the profits derived from the sales made. Operating Profit Margin- is derived from subtracting operating expenses from the gross profit figures. Operating expenses are within the company’s management control than what would be with cost of sales outlay. Investors are also required to scrutinize the operating profit margin in the most rigorous manner. Positive and negative changes in the operating costs are mostly down to the management decision. In most companies operating income calculations are used as the metric of investment analysis. 2012 =3,350 11,000 =0.30 2013 =2,170 12,650 =0.17 When the operating profit ratio is high it means that the company is performing well therefore in our company here a drop in the ratio from 0.30 to 0.17 is a deep in profitability of the company and this can be attributed to the increased cost of manufacturing. Pre-tax Profit Margin-Many investors will prefer the use of a pretax income amounts for reasons that are similar to those that were mentioned in the operating income. In the case of the company XYZ they have access to a variety of tax management techniques that allow them to manipulate the magnitude of its taxable income. 2012 = 3,000 11,000 =0.27 2013 = 1,670 12,650 =0.13 The pre tax ratio is dependent on interest payable and in the year 2013 the payable interest increased by £ 100 further decreasing the pre-tax profit ratio. Net profit Margin- is mostly referred to as company’s profit margin. Investors can rely on complete profit margin analysis to show them the several income and expenses operating elements in the income statement that can determine net profit margin. Investors should take a keen and responsive look at a company’s profit margins on a systematic basis. 2012 = 1,850 11,000 =0.17 2013 = 1,000 12,650 =0.08 LIQUIDITY RATIOS FOR THE COMPANY Liquidity can be defined as the ability of a company to achieve its short term financial needs as and when they are due for payments. This includes the ease of conversion of non cash current assets in order to meet the obligations. CURRENT RATIO Current ratio is attained by determining the proportion in the current assets that is available to cover the current liabilities. This ratio is to ascertain whether a company’s short term assets that the company has are enough to meet short term liability Martin, (2011). The short term assets include cash and cash equivalents, short term marketable securities, inventories and receivables. Short term liabilities includes notes payable, current portion of long term debt, accrued expenses and taxes. Theoretically the higher the current ratio means that the company is better placed. 2012 = 3,050 2,400 =1.8 2013 = 4,850 3,000 =1.6 ACID TEST RATIO It’s also referred to as quick ratio. It measures the ability of a company to utilize its quick cash or near cash in the payment of its current or short term liabilities Martin, (2011). Quick asset is made up of current assets that are presumed to be quick to convert into cash at the closing value. Quick ratio of less than one means that the company cannot fully back its current liability. Acid test ratio= (Current assets-inventory)/Current liabilities 2012 =3050-250 2400 =1.2 2013 =4,850-350 3,000 =1.5 In the year 2013, the company is better placed to offset its current liabilities with a ratio of 1.5 compared to 2012’s 1.2. GEARING The most common use of the term gearing is to describe the level of a companys net debt (net of cash or cash equivalents) compared with its equity capital, and usually it is expressed as a percentage. DEBT RATIO It gives us the quick measure of the amount of debts that the company has accrued in its balance sheet as compared to its assets. The more the debts that are signaled by the debt ratio the more the leverage for the company and the more risky it is for the investors. Large and better placed companies can be able to push their debts to higher levels without getting into trouble. This is because they can be able to handle the debts when they fall due (Kelly, 2012). However we can note that debt ratio is not a pure measure of a company’s debt since it is also made up of operational liabilities which include accounts payable and taxes due. 2012 =5,200 8,850 =0.6 2013 =6,500 11,850 =0.5 In the year 2013, the ratio went down from 0.6 to 0.5 meaning the company had fewer liabilities in relation to its assets. This can be attributed to the increase in Property, Plant and Equipment from £ 5,800,000 to £ 7,000,000 with very little movement in the liabilities area. DEBT-EQUITY RATIO This is the ratio that compares a company’s total liabilities to the amount of shareholders capital. Is the amount that the biggest lenders such as supplier and creditors have committed to the company in comparison to the shareholders commitment to the company. To a large extend, the debt equity ratio is an important point in the company’s leverage position. Comparing total liability to the owner’s equity as opposed to total assets is quite important. A lower percentage means that the company is utilizing lower leverage and has stronger equity standing. 2012 =5,200 3,650 =1.4 2013 =6,500 5,350 =1.2 ASSET UTILIZATION Asset utilization ratio measures the total revenue earned for every amount of assets that the company owns. Shows how profitable the company is in relation to its total assets. The ROA is a ratio that illustrates how best the management is employing the total assets of the company to make profit. The management can be said to be having a greater ability to utilize the assets base when the returns are high (Kelly, 2012). 2012 Average total assets=8,850+11,850 2 =1,850 10,350 =0.18 2013 =1,000 10,350 =0.097 Inventory ratios are useful, especially when a buildup in inventory exists. Inventory ties up cash. Holding large amounts of inventory can result in lost opportunities for profit as well as increased storage costs. Before extending credit or lending money, one should examine the firms inventory turnover and average age of inventory. INVENTORY TURNOVER Inventory turnover=Cost of goods Sold/Average inventory 2012 =5150/225 =225 2013 =6780/300 =22.60 Advantages and Limitations of Ratio Analysis Financial ratio analysis is useful tool for those who use financial statements to analyze a company. Advantages It makes financial statements easy to understand. Helps in comparing companies with different sizes to each other It highlights important information in simple form quickly enabling one to make judgment by just looking at few numbers instead of going through financial records. Helps in analyzing a company’s trend over a period Limitations Companies operate indifferent fields with different conditions to each other such as market structures, regulatory conditions etc. If companies in different fields are compared in the manner using these ratios, one can be misled. The use of different financial policies impairs comparability and therefore, ratio analysis is less useful in such situations. Ratio analysis deals with past information and therefore may not be useful to a user who is more interested in future or current information. The limitations accompanied with financial ratios There are several limitations to the financial ratios that we as analysts should be conscious of; 1. Established companies operate different division that exists in different industries, therefore for such companies it’s difficult for them to create meaningful sets of industry average ratio. 2. Inflation may badly distort a company’s balance sheet. In such case the profits too will be highly distorted. Ratio analysis of a company or an industry over time must therefore consider different ages and interpret them with judgment. 3. Seasonal factors have the ability to distort ratios. It’s is important to understand different seasonal factors in order to understand the ratio analysis. Retailer inventory can be high in the summer when it’s the back to school season meaning that the company accounts payable will be high and ROA will be low. 4. Different accounting practices are capable of distorting comparisons even in the same company. 5. It is hard to determine the general effectiveness of a ratio. Historically high cash ratio has been classified as growth and as a good sign David, (2012). But is can also be said that the company has reached the last growth point. Ratio analysis utilization Ratio analysis is a systematic way used to analyze most financial statements through ratio calculations. It is applicable in the below instances:- It assists in intra firm comparison which will then mean that the company will base the performance of various departments of the firm so as come up with the best judgment on the best department that is within the company. It helps firms have a comparison that then implies the company is able to compare its performance with that of its competitors. It helps in the forecasting and planning for the future and control by comparing the current performance with the forecasted performance and look for the reasons towards that. It helps bankers, suppliers and creditors to analyze financial statements and other interested parties. It helps to simplify various accounting figures hence make them easily understandable to the laymen as the ratios than in the plain figures scenario. NORFOLK COMPANY CALCULATIONS PART B Break-even point = Fixed costs Contribution 2012 Contribution = Sales – Variable costs = (400) – (200+30+30+50+10) 400 – 30 = 80 B.E.P = (1500000 + 1700000 + 800000)/80 =50000 Units. 2013 Fixed costs = 2440000+4000000 =6440000 S.P = 15 * 400 + 400 100 = 460 = 6440000 460 – 320 = 46000 Units. Safety Margin 2012 = 275000 – 50000 = 225000 Units. 2013 = 27500 – 46000 = 229000 Units. The safety margin in 2013 increased from 225000 units to 229000 units an increase by 4000 units due to the increase in price by 15% but was checked by the concurrent increase in fixed costs by £ 2440000. The company was justified to increase the price due to the increase in fixed costs during the year, had the company not increased the price, then the contribution per unit would have been;- 400 – 320 = 80 While the fixed costs would have increased to £ 6440000 The B.E.P would thus have been; 6440000/80 = 80500 This would have reduced the safety margin to; 275000 – 80500 = 194300 Units. PART C According to the ratios calculated above, the various factors like the payback period i.e. in years, net present value and the internal rate of return, Nere would rather choose the second project (project B) due to the following: PAYBACK PERIOD This is basically the time at which the cash investment to an investment is expected to bring forth the cash inflow produced by the investment Clement, (2013). In this case the project will take a longer time to recover the cash outflow than project A by a year that is six and five years respectively. NET PRESENT VALUE This is used to determine the difference standing in between the present value of cash inflows and outflows and can additionally be used in analyzing how profitable an investment is. Hence in this case Nere should consider project B due to its higher net present value in 5 years (145) in comparison to A project that is (120) therefore meaning that project B is more profitable to invest in than the first one (Brent, 2013). ACCOUNTING RATE OF RETURN Accounting rate of return can be defined as the amount of profit or return that an individual can expect based on an investment made. It divides the average profit by the initial investment in order to get the expected return or ratio thus allowing an investor to easily compare the profit potential for investments or projects. In our case the computed ARR percentages for project A and project B are 15 and 18 respectively this gives us another reason to invest in project B since it has a higher ARR percentage and therefore is more profitable (Brent, 2013). INTERNAL RATE OF RETURN This is best defines as the rate of discount through which the present value of each future cash flow is equivalent to the initial investment. Project B breaks even at a lower rate (14%) than project A that is at 16% hence another reason to invest in project B rather than A. PART D Committed Costs Committed costs basically refer to the various costs tied around the establishment and maintenance of a business. The expenditures related to the purchase of a patent right, plant and equipment can lead to long term obligation falling in the committed cost category. In the case of depreciation, the fixed costs expire and hence become expenses. Committed fixed costs can form the basis for planning and control of the day-by-day, month by month and year by year business activities (Brett, 2012). Committed fixed costs are relevant in the optimal mix of products to maximize a company’s profit as they determine the variable costs/incremental/avoidable costs that the company has to consider when carrying out its business activities. The fixed costs can be spread over a long period of time hence broken down into smaller costs. This cost can be spread to different business units to be absorbed as variable costs when they are incurred or spent. As the cost is mostly known, it forms the basis of other costs that the company has to incur and be prepared to analysis on a continuous basis. Budgets These are plans that are financial in nature showing the expected revenues and incurred costs of a business. It helps in financial control of an organization by making sure the expenditures are as per the budget plan. This enhances accountability and transparency. Budgets for the various expenditures are put in place before the start and then used for comparison and as guideline during the implementation stage (Brett, 2012). Uses of budgets They assist to control the income and the various expenditures of an organization through projection and forecasting of financial indicators. These include the inflation factor, market forces and prices and the various interest rates. They help to assign tasks to project managers’ and supervisory team to ensure the implementation goes according to the plan They offer viable direction so as to meet objectives and help in turning the goals into a reality through the daily, weekly, monthly and yearly reports on the project. Assists to check and come up with priorities and change strategies in accordance to the prevailing market factors and make necessary changes. Assists ensure proper communication down the management line of the various changes in the implementation stage and ensure they go as per the plan. Motivate staff through better development programs like training, conducive working environment it also provides them with targets to achieve during their work hours. Improve efficiency through ensuring that each business unit is adequately provided for with required resources to carry out its mandate on time and accuracy Monitor performance by comparing the organization’s actual performance against the budgeted performance and also analyzing the variance between the two. Planning or business activities. This involves making forecasts about the organizations environment both internal and external, such as government regulations, interest rates, actions of competitors among others for the external environment and expansion or downsizing, out-sourcing of some departments for the internal environment etc. these factors are either controllable or uncontrollable and regulated through planning for them in the budget (Antony, 2012). We have established that there are many uses of budgets yet there are set of guiding principles for budget control in business. Usually an effective budget system; The responsibility of the management is clearly defined-in particular the responsibility to adhere to the budget (Mitch, 2011). Every budget lays a plan of action that should be observed Performance must be monitored in relation to the set budget If the results differ from the budget corrective action must be taken to align the result to the budget Departures by the budgeters in preparation of the budget is only permitted by the senior management and that is the only basis for variability Accounted for variances are investigated according to the rules set by the management during the agreements that are created with the board and shareholders References Antony, B.(2012). Financial Accounting, New York NY: McGraw-Hill 1 Brett, J.(2012). The Principles of Accounting, Vol 2, 2nd ed. New York NY: McGraw-Hill Brent, E. (2013). Business management, Oxford: Oxford University Press Business Planning & Financial Statements Template Gallery, http://www.score.org/resources/business-plans-financial-statements-template-gallery Clement, W.(2013). Financial Analysis, New York NY: McGraw-Hill David, B.(2012). A Comparative Ratios, New York NY: McGraw-Hill Duncan, J.(2010). An introduction to financial accounting, New York NY: McGraw-Hill Kelly, M.(2012). Financial Statements and Significance, Journal Business Daily Martin, D.(2011). Financial Accounting, New Jersey NJ: Prentice Hall Mitch, E.(2011). Principles of Accounting, Kampala, Makerere Press Read More