Annotation of the Ratios and What They Imply - Assignment Example

FINAL PROJECT Ratio Analysis Ratio analysis is a tool of financial analysis commonly used in the comparison of the relationship between risk and returns of companies of different sizes (Kimmel et al. 2008). Ratio analysis is a systematic use of ratios to analyze and interpret the company’s financial statements so as to determine its weaknesses and strengths, financial health as well as its current performance and historical performance (Kieso et al. 2011). The relationships between financial statement accounts helps both internal and external stakeholders of the company in understanding how well and efficiently the firm is performing together with the areas that should be improved (Khan & Jain, 2007). Liquidity ratios Working Capital Working capital =current assets-current liabilities =$48050-9400= $38650 Current Ratio Current ratio = current assets/current liabilities =48050/9400= 5.11 Cash Ratio Cash ratio = cash/current liabilities =20400/9400= 2.17 Acid test ratio Acid test ratio= (current assets-inventories)/current liabilities =48050-6500)9400= 4.42 Peyton Approved has more current assets than current liabilities. It is therefore able to meet its current obligations with lots of ease. It has relatively high financial strength (Kimmel et al. 2008). Profitability ratios Gross profit percentage Gross margin = gross profit/revenue =45000/75000=60% Profit Margin ratio Profit Margin ratio = net profit/revenue =12350/75000= 16.47% Return on total assets ROA= net income/total assets ROA= 12350/146850= 8.41% Peyton approved is very profitable. It has a higher overall performance as well as efficiency. It generates a relatively higher return after meeting its operating expenses (Kieso et al. 2011). Efficiency ratios Accounts receivable Turnover Ratio Accounts receivable Turnover Ratio = revenue/accounts receivable =75,000/6000= 12.5 times Inventory turnover ratio Inventory Turnover = (Cost of Sales) / (Average Inventory) =30000/6500= 4.62 times The company has a higher efficiency in managing its liabilities. In addition, it effectively utilizes its assets in generating revenues. In summation, Peyton Approve is very efficient in its operations (Khan & Jain, 2007). Debt ratios Debt Ratio Debt ratio= total liabilities/.total assets =39400/146850=26.83% Debt to Equity Ratio Debt-to-equity ratio= total liabilities/ shareholders’ equity =39400/107450= 36.67% The company is lowly leveraged as it is using few debts. It therefore, has low business risks. In addition, it has a higher long-term solvency, it is very solvent (Kieso et al. 2011). Annotation of the ratios and what they imply Current ratio shows the ability of the company to meet its near-term liabilities using its current assets. Peyton Approved is more able to meet its short term liabilities using current assets (Kimmel et al. 2008). Cash ratio shows the ability of the company to meet its near-term liabilities using its cash and cash equivalent. Peyton Approved is more able to meet its short term liabilities using its cash and cash equivalents (Khan & Jain, 2007). Acid test ratio shows the ability of the company to meet its near-term liabilities using its most liquid assets. Peyton Approved is more able to meet its short term liabilities using its most liquid assets (Kapil, 2011). Working capital shows the liquidity of the company. Peyton approved has higher working capital hence more liquid (Kimmel et al. 2008). Gross profit margin indicates how much profit is earned on the company’s products without considering indirect costs. Peyton approved has higher gross profit margin hence it is efficient and effective in producing products for their customers (Kieso et al. 2011). ROA measures the amount of profit that is earned relative to the firm’s investment level in total assets. It has higher percentage implying that the company is using its total assets efficiently to generate sales (Khan & Jain, 2007). Net profit margin indicates percentage of revenue that remains after all expenses have been deducted from total revenue (Dyson, 2007). Peyton approved has higher net profit margin hence it is good at managing its expenses relative to its net sales (Kapil, 2011). Accounts receivable Turnover Ratio shows how efficient the company is at collecting its credit sales from its customers. Peyton approved is very efficient at collecting its credit sales (Kimmel et al. 2008). Inventory turnover ratio shows how well a firm is managing its inventory levels. Peyton approved is efficient at managing its inventory levels hence it is not overbuilding or overstocking its inventory (Kieso et al. 2011). Debt Ratio shows proportion of the company’s assets financed by debts. The company uses few debts hence lowly leveraged (Khan & Jain, 2007). Debt to Equity Ratio shows the percentage of company financing coming from investors and creditors. The company has a lower debt to equity ratio implying less creditor financing (Kieso et al. 2011). Usefulness of ratio information Ratio information helps a company to locate weaknesses in its operations even though it may have a good general performance (Kieso et al. 2011). Secondly, ratio information helps in simplifying and analyzing financial statements of a company thus helping the company to understand its financial position or situation for the purposes of decision making as it converts the raw information in the financial statements of a company into useful information that is helpful for decision making (Kimmel et al. 2008). Thirdly, ratio information is helpful in financial forecasting and planning decisions. They help in establishing company’s future trends used in formulating future plans. The company has favourable ratios hence the business is worth pursuing. The company has a potential for future growth. Peyton Approved is more liquid, more profitable and more efficient in its operations. It uses few debts and has low business risk (Khan & Jain, 2007). Decisions Firstly, I will make financial forecasting and planning decisions by establishing company’s future trends used in formulating future plans I will make investment decisions v. The company is viable and is worth investing in because it is capable of expanding and producing more returns. Finally I will make financing decisions (Kimmel et al. 2008). Due to the viability of the business, it is necessary to expand it. The expansion of the business requires external financing, for instance, obtaining loans from banks. Therefore, I will obtain loans financing to grow the company (Kieso et al. 2011). MEMORANDUM To: Bank Manager From: (Your name) Subject: Results of operations of Peyton Approved Date: 28th June, 2015 Peyton Approved has opened and commenced its operations during the month of January 2015. The company has recorded its 6-month end financial statements. The following is the company’s operations and activities in details. Overview of the Peyton’s accounting system Accounting is defined as a precise enumeration or list of financial transactions for a given period of time (Kimmel et al. 2008). It is a list of financial transaction in a small business which is used in tracking the money that comes into the business or the money that goes out of the business (Khan & Jain, 2007). It is helpful in showing if the business is making profit. It also reveals sources of income as well as expenses thereby helping the business owner to make decisions based on such information (Steger & Wolfgang, 2008). Being a small startup business, Peyton Approved uses a correctly developed manual accounting system. Manual accounting systems are paper based systems used in recording transactions. They deliver efficient accounting information system for small businesses (Dyson, 2007). In book keeping the company uses double entry book keeping method. The transactions are usually hand-written in a ledger which is then balanced off, then taken to a trail balance. The information in the trial balance is then used in preparing financial statements such as balance sheet and income statement for the company which is then communicated to the stakeholders (Khan & Jain, 2007). The basis of the accounting used by the company is the accrual method. The company counts income when the sale is made while the expenses are counted when they are actually paid (Kieso et al. 2011). It is used by the company because it results in a more accurate and more faithful financial statements that better represents the actual circumstances (Dyson, 2007). It records expenses and revenues together in same time periods on the basis of causal relationships thus producing very precise gauges of the performance of the company (Kimmel et al. 2008). Strategies ensuring responsible accounting practices First, there is strict compliance and adherence to accounting principles. Secondly, there is centralized accounting system so that different departments can collaborate and coordinate. Thirdly, the company uses electronic document management so that same reporting tools can be used in addressing compliance requirement. Finally, the company uses strict privacy measures and a breach to any of them is severely punished (Steger & Wolfgang, 2008). The overall accounting process and the internal controls for cash First the transactions are identified and classified using written documents. The information is then recorded in the company’s manual accounting ledgers. The company records income when the sale is made while the expenses are recorded when they are actually paid on a daily basis. At the end of the day, financial reports and statements are prepared (Dyson, 2007). They are then reconciled at reviewed weekly, monthly, semi annually and annually in order to get weekly, monthly, semi annually and annually financial reports and statement. This helps in arriving at the financial performance, condition and status of the company (Kimmel et al. 2008). Internal controls for cash that are in place are voucher systems, bank reconciliations and electronic fund transfer. Electronic fund transfer is a service that transfers funds automatically from one account to other thus minimizing individuals that access company’s funds (Kieso et al. 2011). Voucher system is a system that is focused on documenting each aspect of each transaction to make sure that all required payments are only made once. Bank reconciliation is a process of regularly checking cash accounts on a company’s books against bank statements (Khan & Jain, 2007). Analysis of the results of operations Peyton is positioned to provide high financial rewards because the results of the operations indicate that it is more liquid, more profitable and more efficient in its operations. It is easily able to meet its sort term obligations (Kapil, 2011). It has higher profitability hence it is efficient and effective in producing products for their customers. In addition, it is using its total assets efficiently to generate sales. Also, it is good at managing its expenses relative to its net sales. The company uses few debts thus has few business risks (Kimmel et al. 2008). The financial statements as well as ratio analysis indicates that the company has high financial performance hence has good financial position. It has more current assets than current liabilities. It has more assets than liabilities hence very have high net worth (Dyson, 2007). However, the company has higher cash ratio. This implies that the company holds more cash hence limited investment returns opportunities (Steger & Wolfgang, 2008). Changes to be made in operations First, there is a need to establish an inclusive and a winning culture so as to develop a close relationship with its consumers. Secondly, it needs to drive global employee and customer engagement so as to increase the company’s overall performance (Kapil, 2011). This will help in generating long-term sustainable growth by outdoing their competitors. Thirdly, the company needs to use a new, lower cost delivery and operating model so as to decrease unnecessary costs thereby increasing its revenue further (Kieso et al. 2011). The company’s financial strengths and weaknesses The company has a higher profitability implying that it has a higher growth prospective. From its efficiency ratios, it is crystal clear that it is very efficient in using its assets. It is also very efficient in managing its liabilities (Khan & Jain, 2007). The company is likely to attract and retain more customers because it offers custom made dog treats. This is the key reason for its high profitability (Kapil, 2011). The company has higher liquidity and is more able to meet its short-terms obligations. The company also has strong marketing and advertising campaigns through word of mouth referrals that help it gain valuable coverage (Kimmel et al. 2008). On the contrary, the company is not able to predict changes in the market. It cannot easily predict seasonal preferences, demand and popularity. Its revenues are heavily dependent on the dog treats; a decrease in this market share will greatly affect it. Also, it faces stiff competitors from well known and well established firms (Steger & Wolfgang, 2008). The company intends to employ more experienced analysis to help in predicting changes in the market. It also intends to venture in other product offerings to widen the market. Finally, the company should use strong marketing and advertising campaigns so as to attract more customers. Opportunities the company can explore because of its strengths The income that comes from its higher profitability can be reinvested in the company to generate or create value for the shareholders of the company by expanding its size (Kapil, 2011). Secondly, the company can venture in other products offerings to increase their market share. Finally, the company can expand to other regions. All the three opportunities increases the market share which in turn increases it sales revenue (Steger & Wolfgang, 2008). References Dyson, J. R., Dyson, J., Dyson, J., & Dyson, J. (2007). Accounting for non-accounting students. Harlow, Financial Times Prentice Hall. Kapil, S. (2011). Financial management. Noida, India, Pearson. Pg. 120-130  Khan, M. Y., & Jain, P. K. (2007). Financial management. New Delhi, Tata McGraw-Hill. Pg. 6.2-6.27 Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2011). Intermediate Accounting. 13th Ed. New York: Wiley. Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2008). Accounting: tools for business decision making. Chichester, John Wiley. Steger, Ulrich, and Wolfgang Amann. (2008). Corporate Governance: How to Add Value. Chichester: John Wiley & Sons. Read More