Business Accounting for Managers - The Financial Condition of Frasers Fabrics Ltd - Assignment Example

Section A Ratio analysis and commentary Ratio analysis is essential to give a complete financial outlook of the company in order to understand financial statements, analyze them thoroughly for the assessment of trends over time and for evaluating the financial position of the company on the whole (Kangari, Farid, and Elgharib, 1992). It is the most critical tool of financial analysis. To assess the financial condition of Fraser’s Fabrics Ltd, various ratios has been analyzed which portrayed the in-depth picture of financial operations of the company. PROFITABILITY RATIO: The relevant ratios measure the profits earned by the company, based on investment, assets and equity or an overall profit of the company (Reilly and Brown, 2011). Profit margin ratio shows the actual profit of the company excluding all its expenses and costs. The company has reported the decrement in gross profit margin ratio from 29% in 2011 to 25.2% in 2012. This loss was observed due to huge reduction in sales over the period. Conversely, the decline in net income in the year 2013 is attributed to less or no expansion and promotional activities of business which led to drop the sales to £54,300. Consequently this resulted in decline in operating margin ratio to 5% only. And therefore this led to decrease profit after tax ratio from 7.8% to 3.31%. Company has observed huge drop in profits in the year 2012. From the perspective of construction company, the ratio of return on capital employed serves a purpose to analyze the project’s potential to invest or when to startup a new project. This measure of profitability indicates 7.86% in 2012 which has dropped from 16.55% in 2011 and 7.91% in 2010, which signifies that profitability has decreased in 2012 to a greater extent and thus cannot take measure to start up new projects. The return on Shareholders Funds ratio is the assessment of profits for the time period which will be accessible to the regular shareholders with the stake of common shareholders in a company. The ratio has dropped from 14.79% to 6.62% in the year 2012. The decreasing trend of ROSF of Fraser’s Fabrics Ltd shows that its net income is decreasing with a greater degree than its equity. Overall profitability of the company is identified as very vulnerable with weak financial stability in the year 2012. In this situation, company should focus on advertisement and promotion of brand. This expense can pay back greater returns in the future. In addition, company should also expand its operations by making it a web-based business. The feasibility for consumers like online transactions, online store shopping attracts the customers more. EFFICIENCY RATIO: The ratios relevant to efficiency show the company ability to efficiently use its assets and liabilities. Stock turnover is the measurement of efficiency of company to maintain its merchandise (Chandra, 2011). As of the company’s ratio, the stock turnover ratio indicates 206.60 days in 2012 which is higher than 2011 that is 177.79 days. This higher value points to the better performance of the company. Though, a high value of stock turnover ratio may be fulfilled by failure of target sales owing to inventory scarcity. Trade debtor ratio indicates that how long the customers or clients of the company will take to pay the amount. The ratio suggests that the company’s customers has taken 115.67 days to pay the amount in the year 2012, assuming all sales on credit basis; however, clients took around 107 days to clear the payments in 2011. This ratio is particularly higher for a fabric company as mostly building trade credits are given within 30 days. Trade creditor ratio calculates the average time in which company will pay off its debt to its contractors or suppliers. The ratio is accumulated to 92.42 days for the year 2012 while company took around 83.41 days in 2011 to pay back to suppliers and contractors. This is again a very high ratio for a fabric business. Sales to capital employed ratio of Fraser’s Fabrics Ltd shows that company is able enough to generate sales profit by making use of its assets. However, company has been able to maintain the ratio to around 1.57 for the number of years. Overall, company has used and maintained its assets and liabilities efficiently. LIQUIDITY RATIO: Liquidity ratio represents how liquid assets of the company are. From the Fabric company concern, it analyzes whether company’s assets are enough to pay off its debts (Adrian and Shin, 2010). Higher current ratio reflects that the company possesses surplus current assets to pay off its current liabilities. Fraser’s Fabrics Ltd is accounted for 3.92 of current ratio in 2012 which is relatively lower than its previous years’ ratio. The ratio was recorded as 4.44 and 2.96 in 2011 and 2010 respectively. These ratio shows that current liabilities of the company are not more than its current assets and company has enough assets to pay off its debts. It is better for the company to maintain higher current ratio which ensures that company has enough current assets to settle its current liabilities. However, there is some limit to increase the current ratio as too much higher ratio indicates that company is not using its current assets effectively and many of the resources are set idle within the company. The ratio has dropped in 2012 particularly because of the higher rate of decline in current assets than the rate of decline in its current liabilities. It can be concluded that liabilities have dropped in the year 2012 but with the slower rate, whereas current assets have dropped with the faster rate which caused to decline the current ratio. Acid test ratio is another ratio is known as liquidity ratio, and it demonstrates that how quickly a company can convert its assets into cash to pay its debts without selling its inventory. The acid test ratio of the company is greater than 1 that is 1.86, which means the company is able enough to pay its debts. However, it expressed 2.53 in the year 2011 which was even better. Relative to previous years, ratio has dropped, and the company has lost some power to pay its debts by decreasing its current assets. The liquidity position of the company is acceptable and good which means company has enough current assets to cover its current liabilities. Company is financially secure in the short term. With faster conversion of receivable into cash inventory turnovers, company is expected to have higher growth in the future. GEARING RATIO: These are the ratios that determine the financial structure of the firm and their key elements for internal management and external suppliers. Gearing ratio compares the sort of owner’s capital or equity to borrowed funds. Gearing is the determination of financial leverage, illustrating the extent to which activities of company are financed by funds of owners as compared to creditors. With the higher gearing ratio, the company is considered as riskier. Higher leveraging (gearing) ratio of the company is known to be as more vulnerable to dips and depressions in the business operations as the company must carry on to service its debts apart from of how terrible sales are. An increased proportion of the equity gives a cushion and is considered as a evaluation of financial strength. Company reflects that the gearing ratio is increasing by the years as the company recorded 21.53% of gearing ratio in 2012 and 20.32% and 18.30% in the year 2011 and 2010 respectively. The increasing gearing ratio shows that the business is being operated by borrowed funds rather than owners’ equity. In this case, company will have to pay more interest as compared to other companies, concerning the similar sector. Increased ratios are riskier for the company and even lead to bankruptcy when company fails to reimburse its debts. The interest cover ratio identifies the company’s capacity to pay interest expense on debts with its operating income. Fraser’s Fabrics Ltd has shown a fall in the ratio, from 19.15 to 8.49 in the year 2012 and 2011 respectively. This ratio signifies that the company is burdened by debt expense. However, the decline in the ratio was caused due to a reduction in EBIT in 2012 to that of interest expense during the period 2011-2012. Overall, the gearing position of the company is not ideal. Company is burdened with debts and most often it is using creditors’ funds instead of owners’ equity. In this case, Fraser’s Fabrics Ltd can lower its financial gearing ratios by reimbursing some part of interest bearing debts either by utilizing cash reserves or selling off assets that are not utilized yet. Another possible way is to issue its new shares that can be used to reimburse its bank loans as well. INVESTMENT RATIO: These ratios measure the demand for shares and relate the earned financial returns (McNair, Olds, and Milam, 2013). Earnings per share demonstrate the profit that a firm has earned over the previous years by number of share available in the market. For the Fraser’s Fabrics Ltd, earning per share has reported decrement from 23.640 pence to 8.707 pence which is lower than 11.17 pence recorded in 2010. This illustrates that the company is less profitable and it has less profits to allocate to its shareholders. P/E ratio simply states the accounted number of years to buy a share out of earnings. Since the Fraser’s Fabrics Ltd is reflecting increasing P/E ratio, this means the company is gaining some amount of money per share of its stock. This is because investors are paying more for today’s earnings in expectation of future growth in earnings. The Fraser’s Fabrics Ltd’s P/E ratio has witnessed the drop in ratio from 13.45 to 25.50 in the year 2012. This suggests that company is willing to spend more. Dividend yield is measured by calculating annual cash dividend per share of the company divided by the existing value of stock. The ratio suggests that Fraser’s Fabrics Ltd is accounted for 1%, 2.10% and 1.03% dividend yield in the year 2012, 2011 and 2010 respectively. This ratio means that the company is paying this much portion of income as dividends. The remaining income is retained by the company. Dividend payout ratio indicates the extent to which the profit is paid out as dividends. This defines the percentage of net income (earnings) based on every common share owed to paying cash dividends to shareholders. This ratio signifies how sound earnings foster the dividend payment. Considering the data of the company, dividend payout has decreased to 22.97% in 2012 relatively to 27.03% in 2011, which indicates that small portion of the company’s profit goes out as dividends. Dividend cover ratio depicts the number of times the company is able to pay dividends to its shareholders from the profits gained in the particular accounting period. It explains the ability of company to pay dividends and mostly companies try to in line their ability or level to pay with the market expectations. The lower dividend cover ratio suggests that company will not be able to sustain the current level of dividends if the profits change to adverse situation in the future. Dividend cover ratio of Fraser’s Fabrics Ltd reflects the ratio of 4.35 in 2012 which is greater than one recorded in 2011 that is 3.70. This increase in ratio suggest that Fraser’s Fabrics Ltd is retaining greater portion of its earnings in order to meet its financial requirements which will help to offer greater dividend payouts in the future. Section B To support operations of company, management have several choices in budgeting methods. Every budgeting method is helpful for an organization to attain the best possible outcomes concerning the fiscal management of the company. Murray & Sons Ltd has incorporated incremental budgeting for long time. The reason behind its success in managing incremental budget for numbers of years is that they have stable budget that varies little by little. INCREMENTAL BUDGETING: This is a type of budget in which the budget that was used in the previous fiscal year becomes the base for the current year for the incremental distribution. In this type, company uses the same budget with few minor changes for the current period. The entire company and all its departments and heads will keep on operating its business with the similar budget used the last year. This type of budgeting is best for the companies in which managers do not conduct an in-depth analysis of budget and research annually (Garrison, Noreen and Brewer, 2003). The basic benefit of incremental budgeting is the easiness in using this process. This type of budgeting is effective when the finance resources are reliable and the company has assurance that their funds will carry on in the future. Moreover, it demands very little adjustments in the provision of funds. Incremental budgeting creates possible ways for the company to understand the ability of the budget and deal with reduction of interdepartmental contradictions concerning allocation of funds. Most interestingly, this type of budgeting is easy to understand and the computations needed are comparatively easy and uncomplicated (Schick, 1983). This method has the benefit of preparing budgets that are moderately steady and constant, with continuing changes from one year to another. Considering all these characteristics, these are the major reasons that compel Murray & Sons Ltd to use incremental budgeting process. On the other hand, there are numerous other ways to carry out the budgeting process, based on type of organization and its business operations. The report has further explained various alternatives of incremental budgeting that will be more appropriate for Murray & Sons Ltd. ALTERNATIVES OF INCREMENTAL BUDGETING: There are number of alternatives that are more useful than incremental budgeting method. Budgeting methods are classified on the basis of company’s alignment with strategic priorities, preparation of budgets under serious uncertainties and alteration of budgets regarding the fluctuations in operations. The report has proposed some alternatives of incremental budgeting process that will be more productive for Murray & Sons Ltd. They are: Fixed Budgets: These are the budgets that are prepared concerning the given level of activity that can be expressed with respect to sales or expenditures. This is a kind of budget which does not vary or change when sales or any other operations increase or decrease. This type of budget is also referred to as static budget. This is the standard type of budgeting in which a business develops a model of its anticipated outcomes and financial situation for the coming year, and then attempt to compel the real outcomes during the course of period to align with the budget process as strongly as possible. This budget format is typically based on a single expected outcome, which can be really complicated to accomplish. It is likely to set up a great degree of inflexibility into a company, instead of allowing it to respond rapidly to continuing modifications in its surroundings (Ekholm and Wallin, 2011). Flexible Budgets: This type of budget indicates such variables costs or semi variable costs and identifies that cost behave in varying manners. Some of the costs are fixed and few vary accordingly. These can be prepared on absorption or marginal costs basis. This model of budgeting is useful in service based, manufacturing as well as public firms. A flexible budget model allocates to enter different sales levels in the model, which will then regulate intended and planned expenditure levels to compare and match the levels of sales that have been recorded (Ekholm and Wallin, 2011). This procedure of budgeting is practical when levels of sales are complex to evaluate and a major amount of expenses fluctuates with sales. This kind of model is trickier to develop than a static budget model, but be inclined to give up a budget that is rationally equivalent to definite outcomes. Rolling Budgets: In this type of budget, additional periods are added or updated constantly like a quarter or a month and eliminate the initial periods. Similarly monthly rolling process would entail the preparation of budget every month. The first month of the process would be designed in excessive detail leaving rest of the months with lesser detail which reflects uncertainty from future perspectives of the company. However, it provides more realistic budgets with the least uncertainties. Also planning and strategies will be adjusted and maintained according to updated information over the time period. Zero Based Budgeting: A zero-based budget entails the identification of outcomes that management of company needs, and preparing a package of expenditures that will hold up every outcome. By bringing together numerous packages of outcome-expenditure, a budget is formulated that should provide a particular set of outcomes for the whole organization in the end (Hilton, 1994). This method is extremely helpful for the organizations or for service-level entities, for example governments, where supreme and dominant services are available. Though, it also consumes significant amount of time to prepare and execute, in relation to the static budget. Contingency Budgeting: This type of budgeting is mostly used for those businesses that are operating at initial stage and are new to the market. In such cases, detailed budgeting cannot be developed that base upon past experience. The use of this type of budgeting helps in making certain best strategies and practices since it demands companies to appraise alternative circumstances and create contingency plans to make sure that project implementation risk is reduced. Activity Based Budgeting: Activity based budgeting is a method of the budgeting process that deals with identification of costs of activities that exist in every part or department of organization or business and finding out the ways in which activities are related to each other. The available data related to these activities and their relation with each other is used to develop objectives and aims that assist the company to progress (Shane, 2005). The clear understanding to every possible relationship between the entire activities of company, it becomes even more promising to develop realistic budgets for every department that are reasonable and fair and sets in the welfare of the company from the long-term perspective. The concept behind activity based budgeting is entirely diverse from the method referred as cost-based budgeting. The cost-based method most often deals with evaluating the actual expenses relating them with an earlier budgetary period and merely altering those amounts while comparing the current inflation rate or reporting these changes in the amount of profits earned. In comparison to this, activity based budgeting method is more focused on the activities and internal operations of the business, the relation between various activities and their alignment with the strategies and different business goals (Shane, 2005). Then it also focuses on allocation of funds to every single activity, based on the complete cost that will incur to accomplish those activities effectively and efficiently. Performance Based Budgeting: According to literature of budgeting processes and methods, performance based budgeting often focuses on performance information with the management and distribution of resources. Also the argument has been faced that performance based budgeting method is a continuum that incorporates the accessibility and utilization of performance based information at every single stage of the process of budget (Kordbache, 2007). The process includes reparation of budgets, endorsement and agreement, implementation, audit and assessment. This method helps to improve responsibility and accountability because reports related to budget are based upon estimated outcomes with inputs of process. This process also result in improved decision making, as decisions regarding spending will be associated to company-wide goals and objectives. In addition, this can also result in improved service delivery given that the budget sets up performance standards which assist the managers to meet the targets in the short as well as long run. Participatory Budgeting: This is one of the budgetary tools that is used by government bodies which helps to create strong affiliation of local communities with decision making procedures about the budget. However, this method is appropriate when dealing with local communities and allocating their services and activities as community-led business (Wampler, 2000). Resource Restricted Budgeting: This is the type of budget in which businesses are restricted to spend some particular amount of money. A company will execute the restricted budget when it is going through net loss. However, restricted budgeting method is not effective as it restrained the services provided by company owing to lack of funds. These are the most common available budgeting methods that companies use. The company like Murray & Sons Ltd is operating for the last 150 years in timber products manufacturing industry while using incremental budgeting method. It is important to upgrade the budgeting process and adjust the changes as per requirement. The incremental budgeting method restrains the company from innovation. Murray & Sons Ltd cannot innovate as new budgets have not been allotted to company to execute some sort of changes in the system. Management can become familiarized to expenses as company is continually spending same sum of money annually with an intention to justify the fund allocation. Even if there would be no need of funds in particular area, management may use those funds in order to avoid risk for the next year. Also this assumes the suitable funding levels for each department regardless of high or low requirements of the company. Considering the following drawbacks, now Murray & Sons Ltd should execute rolling budgeting method, in which budgets are prepared every month and updated constantly to justify every single change and innovation. This budget provides realistic budget by eliminating all uncertainties regarding planning and strategies. Another appropriate budgeting method for Murray & Sons Ltd is activity based budgeting method which deals with activities and internal operations of the business and departments, the relation between various activities and their alignment with business objectives and strategies. By executing proposed budgeting methods, Murray & Sons Ltd can improve the operations of business and make them more effective for the business. Section C Active Toys Ltd is a manufacturing company of toys which only restrains to three various types of toys used by children. The variety of production includes Scooter, Tricycles and Balance Bikes. The production is carried out in one of its divisions that is based in Aberdeen. Active Toys Ltd basically focuses on selling their product in two ways. One way is to create a package of toys that contains all of three toys and other way is to sell all types of products in isolation. Moreover, these products can only be produced in the Aberdeen Factory. It has been assumed that business is operating at full competencies. CONTRIBUTION MARGIN PER UNIT: Contribution margin is calculated as the revenues minus total variable costs. The amount computed is the contribution margin that will be used to pay the fixed costs. The concept of contribution margin is helpful for identifying the least possible price at which a product will be sold. In other words, it can be said that contribution margin is also used to give an approximate number of units that should be sold in order to achieve a breakeven for the entire business (Garrison, Noreen and Brewer, 2003). As of the calculated contribution margin, the total contribution margin per unit is computed as £13,074,991.10 which is the sum of all three types of products manufactured by company. However the contribution margin per unit for scooter is equal to £5,959,991.80, for tricycle is £4,297,491.40 and for balance bike it is equal to £2,817,489.10. This indicates that £5,959,991.80 amount will be paid to cover the fixed cost of Scooter products and so on. This measures that how efficiently a firm can manufacture products and maintain low levels of variable costs.   Scooter Tricycle Balance Bike Total Total units 80000 45000 35000 160000 Manufacturing overhead         Variable cost per unit 4.2 4.5 6.6   variable cost of manufacturing overhead £ 336,000.00 £ 202,500.00 £ 231,000.00   Selling and administration         Variable cost per unit 4 4.1 4.3   Variable cost of selling and administration £ 320,000.00 £ 184,500.00 £ 150,500.00   Total variable cost £ 656,000.00 £ 387,000.00 £ 381,500.00 £ 1,424,500.00           Revenue         Sales demand in units 80000 45000 35000   Selling price per unit 74.5 95.5 80.5   Total revenues £ 5,960,000.00 £ 4,297,500.00 £ 2,817,500.00 £ 13,075,000.00 Contribution per unit         Revenues £ 5,960,000.00 £ 4,297,500.00 £ 2,817,500.00 £13,075,000.00 Total Variable cost £ 656,000.00 £ 387,000.00 £ 381,500.00 £ 1,424,500.00 Total units 80000 45000 35000 160000 Contribution per unit £ 5,959,991.80 £ 4,297,491.40 £ 2,817,489.10 £13,074,991.10 NUMBER OF UNITS PRODUCED PER MACHINE HOUR: Machine hours comprise of all of the costs acquired by a company, for example electricity and raw materials. It is essential for proprietors to identify and know the number of hours that a machine takes to produce single unit of product (Garrison, Noreen and Brewer, 2003). In case of Active Toys Ltd, company has maximum of 50000 machine hours for the quarter time period. However, the company is expected to produce 80000 units of Scooter, 45000 of tricycles and 35000 of balance bikes in next quarter. As of the calculation for number of units produced per machine hour, 0.63 scooter, 1.11 tricycles and 1.43 balance bikes can be produced by a factory per machine hour. This indicates that Scooter takes more time in production as compared to tricycles and balance bikes. In one machine hour, not a single scooter can be produced, whereas tricycles and balance bike can get ready in that particular time.     Scooter Tricycle Balance Bike Sales demand for next quarter (units)   80000 45000 35000 Maximum machine hours 50000       Number of units produced per machine hour   0.63 1.11 1.43 OPTIMUM PRODUCT MIX FOR PROFIT MAXIMIZATION FOR THE PROFIT: REFERENCES: McNair, F. M., Olds, P. R., & Milam, E. E. (2013). Fundamental financial accounting concepts. McGraw-Hill Irwin. Kangari, R., Farid, F., &Elgharib, H. M. (1992). Financial performance analysis for construction industry. Journal of Construction Engineering and Management, vol. 118, no. 2, pp. pp. 349-361. Reilly, F. K., & Brown, K. C. (2011). Investment analysis and portfolio management. Cengage Learning. Adrian, T., & Shin, H. S. (2010). Liquidity and leverage. Journal of financial intermediation, vol. 19, no. 3, pp. 418-437. Chandra, P. (2011). Financial management. Tata McGraw-Hill Education. Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2003). Managerial accounting. New York: McGraw-Hill/Irwin. Schick, A. (1983). Incremental budgeting in a decremental age. Policy Sciences, vol. 16, no 1. PP. 1-25. Hilton, R. W. (1994). Managerial accounting. New York, NY: McGraw-Hill. Ekholm, B. G., & Wallin, J. (2011). The impact of uncertainty and strategy on the perceived usefulness of fixed and flexible budgets. Journal of Business Finance & Accounting, vol. 38, no 1‐2. PP. 145-164. Kordbache, M. (2007). Performance-based budgeting. The Journal of Planning and Budgeting, vol. 11, no 6. PP. 3-31. Shane, J. M. (2005). Activity-Based Budgeting. FBI Law Enforcement Bulletin, vol. 74, no 6. P. 11. Wampler, B. (2000). A guide to participatory budgeting. In conference on participatory budgeting. p. 3. Read More