Components of Financial Analysis - Math Problem Example

1. Part A a. Net profit won’t be the same amount as the increase in cash at bank because some of the customer might have paid in cash. This might have resulted in some profits accruing to cash. b. The value of the asset has not been revised as the company is following a conservatism principle and recording assets on historical prices. (Conservatism Principle, 2010) This also prevents the business from the fluctuation in the prices of assets and helps to ensure the value of the assets are not over estimated. c. Depreciation is “the reduction in the value of assets due to wear and tear”. (Kennon, 2010) A separate account is created so that the organisation use funds from this account when the assets need to be replaced thereby not affecting the normal business cycle. (Kennon, 2010) The amount hasn’t been credited to the asset account as it would reduce the value of the asset on the balance sheet and disclosing the original amount helps to understand the true value of the asset on the purchase date. d. The payment of insurance has not been recorded as it is a personal payment and business is a distinct entity from the individual. The payment will be recorded as drawings in the business financials. e. Gross profit is the profit after charging direct expense for the production of goods where as net profit is the final figure after all expenses has been charged. Both the figures have high relevance but net profit has a higher relevance as it discloses the actual profit the business earns. Part B a. Direct cost are “cost which are directly attributable to the product and can be identified to be incurred while manufacturing a goods”. (Fixed Cost, 2010) Indirect cost are those “which cannot be attributed directly to a product”. (Fixed Cost, 2010) Manufacturing overhead is considered as a direct cost as the cost should be attributed to the manufacturing process and the products itself. b. Work in progress is that inventory which hasn’t being fully processed to be sold in the market but is in the process of being completed. Work is progress is treated as current assets and falls under the assets side. c. The predetermined rate of direct labour hour for the manufacturing overhead is calculated by dividing the total cost by the labour hours used. This helps in allocation of the manufacturing overheads on this basis which helps to calculate per unit cost of a product. d. The debit balance of manufacturing overhead shows that $56,000 was used to produce finished products from raw materials. The ending balance of the manufacturing overhead account is charged to profit and loss statement as it is an expense which the business has incurred to produce the good. e. Fixed costs are “cost that remains fixed irrespective of the number of goods produced”. (Cram, 2010) Variable costs are “cost those changes as quantity changes increases if more goods are produced”. (Cram, 2010) Fixed and variable cost can be direct and indirect and is a further breakdown of cost. 2. A. Schedule of Cost of Goods manufactured for the year ended 30th June 2008   Amount Amount Direct material consumed     Opening stock of raw material 22000   Add: Purchases made during the year 48000     70000   Less: Closing stock of raw material -20000   Raw material Consumed   50000 Direct Labor   35000 Freight Charges   5000 Manufacturing Overhead     Indirect Labor 15000   Indirect Material 10000   Factory Insurance 20000   Depreciation of Factory 25000   Depreciation on Plant & Machinery 15000   Maintenance of Plant & machinery 50000   Factory Electricity 55000   Factory property rates 20000   Administrative cost (60% 0f total administrative cost) 60000   Total manufacturing Overhead   270000 Total Manufacturing cost   360000 Add: Beginning Work in Progress   67000     427000 Less: Closing Work in Progress   -60000 Cost of Goods Manufactured   367000 B. Units produced = 2000 Inventorial Unit cost per shower = 367000 / 2000 = $183.5 C. Selling Price = $ 350 Selling and distribution cost for Alex Industries   Amount Advertisement Cost 49000 Sales Commission 55000 Rental of retail shop 151000 Administrative cost (40% of administrative cost) 40000 Salesman Salary 59000 Total 355000 So, total cost = 355000 + 367000 = 722000 Revenue from sales = 3500 * 2000 = 700000 Loss = 700000 – 722000 = 22000 So selling the showers at $305 will result in Alex industries suffering a loss of $ 22000. D. Alex industries have been allocating the cost on the basis of direct labour cost. This is a good method which helps to ascertain cost for each product. The company can also use a method where costs are allocated on the basis of units produced. This will help to ascertain the cost per unit better. This will be beneficial in case where fixed overheads are apportioned and the cost attributable to each product can be better identified. 3. A. The Bank Reconciliation statement for R Gordon for 31st January 2008     Amount Debit Bank Balance as per cash book   19882 Add:     Cheque not presented for payment     Chq no 1520 1940   Chq no 1522 493   Chq no 1525 4534 6967 Amount wrongly deposited into bank account   525 EFT collection during the month     Customer deposit 1250   Collection of Bills receivable which includes interest 2000 3250     30624 Less:     EFT on 15th January   680 Bank charges   50 Money deposited into bank account but not credited in the bank account   4076 Cheque being dishonored by bank   882 An amount of $8525 wrongly debited by bank instead of $8252   273 Bank Balance as per bank book   24663 The schedule for necessary adjustments is as follows   Amount   Balance as per bank statement on 31st January 24663 Item 1 Adjustments:     Cheques not presented for payment -6967 Item 4 Cheque deposited but credited in bank account 4076 Item 5 Amount wrongly credited to bank account -525 Item 7   21247     Amount   Balance as per cash book on 31st January 19882 Item 10 Adjustments:     Bank Charges -50 Item 3 Payment of insurance through EFT -680 Item 2 Cheque dishonored due to insufficient fund -882 Item 6 EFT collection made by bank 3250 Item 8 Excess amount charged by bank for payment -273 Item 9   21247   4. A. The internal control weakness demonstrated here is that the business should encourage more cheques instead of cash as the business has to deposit the money in the bank. This will reduce the risk and also reduce the paper work and bring efficiency. It will also help the business to ensure more safety and quicker mechanism of collection. B. Hiring employees on contractual basis and that too new employee increases the burden on the departments as new file has to be prepared all the time. Instead the business should look towards same employees. It also increases the risk that significant policies are disclosed to the public which should not have been done. C. This increases the internal weakness as storing at a single location could lead the file to be destroyed. The other weakness seen is that since employees and staff have access to this files it could lead towards vital information being leaked to other business units thereby hampering the business. D. Since, Joe the head of the department doesn’t looks into the inspection himself and just authorises by signing it could lead to a situation where employees tie among themselves and push out inventory which are in good condition to outside sources at a subsidized price. This could have an ill effect on the future earning potential and make the business suffer. E. The internal weakness seen in the IT department entering the data is that there is duplication of work. This could result in some vital parts to be missed out when the data is entered again. Also since the programmers have access to the programs and they can make changes it could result in vital information being deleted or become obsolete as a change in the program could make the system of entering data loose relevance. 5. A. Calculation of ratios for Mary Consultancy Current Ratio for 2009 = Current Assets / Current Liabilities = 346198 / 154652 = 2.24 Inventory Turnover Ratio for 2009 = Cost of Goods Sold / Average Inventory = 4310 / 2760 = 1.56 Debt to Equity Ratio for 2009 = Debts / Equity = 154652 / 394255 = 0.39 Gross Profit Margin for 2009 = Gross Profit / Sales * 100 = 108569 / 112879 * 100 = 96.18% B. The different ratios help to understand the financial position of the company. Analyzing the statement helps in “planning, budgeting, monitoring, forecasting and improving the financial performance by taking vital decision”. (Micro Strategy, 2010) Proper analysing helps a long way to “understand the financial health”. (Micro Strategy, 2010) It helps to identify trends and compare with competitors and industry to gain advantage. The following is the ratios analysis for Mary Consultancy Current Ratio: “It measures the ability to pay the short term liabilities out of short term assets”. (Financial Modelling Guide, 2010) This ratio helps creditors, suppliers and investor to identify the liquid position. It is calculated as “Current Assets / Current Liabilities”. The current ratio is 2.24. The ratio shows that Mary Consultancy has a sound liquidity position. This might make investors and suppliers stay with the company. Inventory Turnover Ratio: “It is defined as the number of times inventory is rolled over during a year”. (Joseph, 2010) Companies prefer it to be high. It is calculated as “Cost of Goods Sold / Average Inventory”. The ratio for Mary Consultancy is 1.56. The above ratio indicates that Mary Consultancy has revolved its inventory around one and a half times. The company needs to improve it so that it is able to revolve the inventory better. This will ensure less money in inventory and help to ensure that the funds are not blocked. Debt to Equity Ratio: “It determines the proportion of long term debt in relation to the shareholders fund and long term debt”. (Transtutor, 2010) This ratio helps to identify the financial soundness. It is calculated as “Debts / Equity X 100”. The ratio for Mary Consultancy is 0.39. The ratio indicates soundness. It shows that the company has a scope for more investment through debts. This is a good sign and shows the company has a space for future projects. Gross Profit Margin: “It is defined as the profit generated after deducting cost of goods sold and before the indirect expenses are accounted for and considers only the direct expenses”. (Kennon, 2010) Gross profit helps to find out the actual profit that is attributed directly to the product. It is calculated as– “Gross Profit / Sales X 100”. The ratio for Mary Consultancy is 96.18%. Mary Consultancy has a high gross profit indicating soundness in manufacturing process. It also shows that the strategies are well managed. It shows that the company is able to manage its direct cost and ensure growth by saving on cost. References Conservatism Principle, (2010), “The Conservatism Principle”, Accounting Coach Cram, (2010), “Fixed Cost and Variable Cost”, retrieved on September 30, 2010 from www.college-cram.com Financial Modelling Guide, (2010), “Liquidity ratios”, retrieved on September 29, 2010 from http://www.financialmodelingguide.com/financial-ratios/liquidity-ratios/ Fixed Cost, (2010), “Fixed cost and variable cost”, Answers Corporation Micro Strategy, (2010), “Financial Analysis”, retrieved on September 29, 2010 from http://www.microstrategy.com/financial-analysis/ Joseph K, (2010), “Analyzing an income statement: Inventory Turnover”, about.com guide, The New York Times Company Kennon J, (2010), “Analyzing an income statement: Gross Profit”, about.com guide, The New York Times Company Transtutor, (2010), “Capital Structure Ratios”, retrieved on September 29, 2010 from http://www.transtutors.com/finance-homework-help/dividend-decisions-and-tools-of-financial-planning/Capital-Structure-Ratios.aspx Read More