Accounting for Managers - Essay Example

ACCOUNTING AND FINANCE FOR MANAGERS by Student’s Name Code + Course Name Professor University City/State Date Table of Contents Table of Contents 2 Part A 3 Topic: Primary Financial Accounting Statements & Ratio Analysis 3 Topic: Marginal Costing and Break Even Analysis 3 Topic: Budgeting & Cash Flow Forecasting 4 Topic: Investment Appraisal 4 Part B: Ratio Analysis 6 Background of Stratasys Ltd 6 Ratio Analysis 6 Liquidity 8 Solvency 9 Profitability 9 Efficiency 10 Advantages and Limitations of Ratio Analysis 10 References 12 Part A Topic: Primary Financial Accounting Statements & Ratio Analysis This topic has been very useful to me. I did not know that ratio analysis is crucial in evaluating the relationships among items in financial accounting statement. The main financial statements in accompany are income statement, balance sheet and the cash flow statement. The income statement shows the financial performance of the company for the period under review, which is usually a year. It shows the revenue and expenses of the company for the period. The balance sheet is the statement of financial position of the company. It shows the assets, equity, and liabilities of the company. The assets of the company must be equal to the total equity and liabilities of the company. The assets is what the company owns, the liabilities is what the company owes others whereas equity is what the owners of the company have contributed. Ratio analysis can be used to determine whether the company is using its assets efficient to produce the maximum returns. It can also be used to the implication of the capital structure of the company. For instance, a low debt ratio shows that has a low debt level and hence it is not taking advantage of the tax benefit associated with using debt to finance the operations of the company. Topic: Marginal Costing and Break Even Analysis This topic has been very helpful to me because I was wondering how a manager would know the number of units of a product that must be sold to ensure that the company has not made a loss. It was important to learn that costs can be classified into fixed and variable costs. The fixed costs are not relevant in determining how more units a company should produce without causing a significant change in total costs. However, this is only within a certain range above which the fixed cost will change. The variable cost is therefore, important to determine how much more it will cost the company to produce an additional unit. The concept of break-even analysis can be used to determine the level production at which the company makes neither a loss nor profit. Above this level, the company will operate within the margin of safety hence ensuring that it is maximizing the profit without triggering a shift in the fixed costs. Topic: Budgeting & Cash Flow Forecasting After studying this topic, I have appreciated the importance of budgeting in a company. Before then I thought an individual just incurs a cost as long as it is justifiable; however, I have learnt that justifiable costs must be incurred within the budget. It is from this budget that the company will have a better cash flow forecasting. A good budget will help the manager to monitor the costs and control them in order to achieve a certain target. Both the favourable and unfavourable variances must be controlled since a favourable variance in a particular cost may be the cause of unfavourable variance in revenue. A sales and marketing manager should not be contented that he has incurred the minimum cost in advertising and promotion because this might explain why the company did not meet its budgeted sales revenue. Lack of good cash flow forecasting will cause the company to fall into liquidity problems, which may lead to the downfall of the company. Topic: Investment Appraisal I am now a better-informed person after learning this topic. Initially I thought that management invests in a certain project as long as it has the necessary funds to venture into that project. Before investing in a given project, the management must ensure that the benefits arrived from investing in the project outweigh the costs of investment. This is the only way that the management will ensure maximization of shareholders wealth. Capital funds are a scarce resource in the company despite the opportunities to invest in several viable projects. This requires the company to rank the projects using an investment appraisal technique in order to ensure that it invests in those projects that produce higher returns to the company. It is not enough to say that a certain project is preferable because it produces high cash flows. The timing of those cash flows matters a lot because of the time value of money. Therefore, techniques that discount the cash flows are preferable compared to non-discounting techniques. Part B: Ratio Analysis Background of Stratasys Ltd Stratasys is a publicly traded company that was established in 1989 and its headquarter is in Eden Prairie, Minnesota. Stratasys is a publicly traded company. The company is in computer peripherals industry and in the technology sector providing additive manufacturing solutions for the creation of useful parts in the product’s designing and manufacturing processes and for the direct manufacture of end-use parts. The company offers various systems for rapid prototyping, desktop three-dimensional printers for idea and design development, and production systems for direct-digital –manufacturing under the Mojo, Dimension, Solidscape, Object and uPrint brands (Yahoo! Finance 2014). The company’s solutions are used in architecture, business machines, education institutions, apparel, automotive, aerospace, dental, defence, jewelry, medical, heavy equipment and toys industries. At a global scale, the company serves customers by selling its products through a resellers and independent sales agents’ network. Currently, the company is an employer of 1,100 full time employees. The company is the industry leader in terms of market capitalization with its market capitalization standing at 5.349 billion. Ratio Analysis Fridson and Alvarez (2011) define ratio analysis as a technique of evaluating the relationships among items in the financial statements of a business. They are used in the identification of trends and comparison between more than one businesses or comparison of financial results of the same business for different financial years. The data used in conducting ratio analysis are sourced from the financial statements of Stratasys Ltd. The analysis has covered three years: 2011, 2012, and 2013. For the purposes of evaluation of financial accounting statements of Stratasys Ltd, the ratio analysis has been broken down into six main ratios: fixed asset turnover, ROCE, return on sales, gross profit margin, current and gearing ratios. The main source of data for ratio analysis is the financial accounting statements for the company. Financial statements are contained in the annual reports of the reporting entity. Ratio analysis is mainly concerned with the income statement and the balance sheet of the company. The primary objective of ratio analysis is to provide useful information for decision makers. Users of accounting information do not have similar needs and interests; therefore, since these financial statements serve a variety of users, the needs of some of the users receive more emphasis than the need of others. Some of the users of financial statements include; investors, managers, potential suppliers, government regulators, employee unions, customers and creditors among others. The ultimate measure of the performance of the firm is not the firm’s earnings but how investors value the earnings. A low return on investment will discourage existing investors and scare potential investors (Greuning 2005). If a decision maintains or increases the firm’s overall value, it is acceptable from a financial viewpoint. The income statement reveals the performance of the business during a particular period. It measures the revenue generated from sales and the expenditure incurred by the business in the generation of that revenue. The balance sheet shows the financial position of the company as at a particular date. In other words, it states the company’s assets at a particular date and how those assets are financed. The balance sheet identity is given since assets are identically equal to liabilities plus shareholders’ equity (Needles, Powers, & Crosson 2010). The balance sheet shows the resources (assets) of a company and how they have been funded through liabilities and equity. The resources of the company are reflected in its current and non-current assets. The mixture of current and long-term liabilities and the owners’ equity shows the means of financing these resources. Ratio analysis groups ratios into four major categories each of which has several ratios. This is explained in the context of ratio analysis of Stratasys Ltd. The table below shows some of the key ratios that were determined from the financial statement analysis for years 2011, 2012, and 2013. Ratio Category Key ratio year 2013 Year 2012 Year 2011 Liquidity Current ratio 6.19 3.50 3.20 Solvency Gearing ratio 5.5% 4.1% 4.8% Profitability Gross profit margin 46.7% 51.1% 52.9% Return on sales -6.1 8.6% 20.1% ROCE -1.1% 1.1% 16.3% Efficiency Fixed asset turnover 25.10% 15.28% 121.27% Liquidity Liquidity deals with issues related to financial obligations in the short term. Liquidity ratios determine whether Stratasys Ltd is well placed to honour its financial obligations in the short term. The liquidity position of the company, as evaluated using current ratio, is good and has been increasing over the years. However, the current ratio is above the required range of between 1.4 and 2:1. Even if the ratio is high, it is an indication that there is inefficient management of debtors and stock. The company has so much debtors which than the creditors which is not health for the business. In addition, the high ratio is caused by a high level of inventory, which means that there is too much cash tied up in inventory. The company stands to incur opportunity costs because of slow moving inventory. Solvency Hilton (2004) explains that solvency ratios are very useful in determining the financial stability of the company in the long term. Stratasys Ltd is financed through both equity and debt financing. Equity financing is obtained through issuance of shares to the public. Debt financing is obtained through borrowings or loans from finance institutions or other credit facilities. The objective of ratio analysis is to use solvency ratios to determine the financial stability of the company. The analysis has established that financial stability of the company is good. A gearing ratio of 5.5% in 2013 shows that the company is not burdened with debt and hence most of its assets are not committed. That is, it is only 5.5% of the capital that is borrowed. It shows that Stratasys Ltd is not highly geared. However, this proportion is not advisable since it does not allow the company to take full advantage of the tax benefits resulting from the use of debt financing in the company. This low ratio can also be interpreted to mean that lenders are afraid of extending loan facilities to the company because of the perceived risk exposure. Profitability Profitability ratios measure the financial performance of the company and include measuring the company’s ability to generate revenue income. The gross profit margin, the ROCE and the return on sales have been declining over the years. This shows that Stratasys Ltd is worsening in terms of profitability. If such a trend is not corrected in time, it can result to cash flow problems in the company. In addition, most people will disinvest from the company since its poor trend in profitability shows that the financial performance of the company is poor and that investors risk losing their investment. Efficiency Efficiency ratios are crucial indication of whether Stratasys Ltd is utilizing its assets efficiently. Stratasys Ltd is provided with capital resources for which it is required to use in order to generate revenue. If the capacity of the company to produce goods and services is not maximized, then it implies that assets are not used efficiently. The efficiency as measured by fixed asset turnover has shown an increase from 15.28% in year 2012 to 25.10% in year 2013. This shows that Stratasys Ltd improved its efficiency in maximizing the usage of its fixed assets to generate revenue with in year 2013. However, this ratio is still low and the company should exploit its assets maximally to generate maximum sales for the company. The high fixed asset turnover ratio of 121.27% in year 2011 cannot be used to explain the trend because of the low level of fixed assets during that year. Advantages and Limitations of Ratio Analysis Ratio analysis uses the most current financial reports hence it is very useful in the decision making process of the business. For instance, a potential investor warned against making investment in Stratasys Ltd because it has shown a declining trend in its profit to 46.7% as shown by gross profit margin. The data used for ratio analysis is easily available from the annual report of the company. This is because it uses past data unlike future data where an analyst has to forecast the data. Therefore, ratio analysis saves time and other resources. It is easier to calculate and interpret accounting ratios. Therefore, an investor does not have to consult with an expert to analyse the performance of the company. Nevertheless, as much as it is true that ratios are valuable analytical tools and serve as screening devices, ratios alone do not give the whole story. Ratios are not predictive because they merely analyze past performance of the company and not forecast on what the company may perform in future. Ratios do not provide a meaningful measure of the performance of the company; therefore, they must be analyzed against certain standards (White, Sondhi, & Fried 2002). The selection of similar company for comparison with Stratasys Ltd is hard. This is because the two companies cannot be similar in all respects. Even if they had similar sales revenue and profit, they differ in other aspects such as the capital structure. Ratio analysis is made out of financial statements, which include balance sheet and income statements. These statements are periodic hence will hold to be true as at a particular point in time (Spiceland & Sepe 2001). Basing investment decisions purely on the results of ratio analysis can be misleading as it wholly relies on the data reported on the financial reports of the business – mainly the balance sheet and the income statement. These data are quantitative in nature and therefore cannot report on the qualitative nature of the company. Since the data used in financial statement analysis comes from the financial reports it means that any error in the financial reports will be transmitted to the financial ratios. Therefore, by extension, it means that the conclusions drawn from this analysis will be invalid and thereby leading to the making of wrong investment decisions. References Fridson, M.S & Alvarez, F 2011, Financial statement analysis: A practitioner's guide, John Wiley & Sons, New York Greuning, H. V 2005, International financial reporting standards: a practical guide, Routledge, New York Hilton, R. W 2004, Managerial Accounting: Creating Value in a Dynamic Business Environment, McGraw-Hill Publisher, New Delhi Needles, B.E, Powers, M & Crosson, S.V 2010, Financial and managerial accounting, Cengage Learning, New York Spiceland, J. D & Sepe, J.F 2001, Intermediate accounting, McGraw-Hill Publisher, New Delhi White, G.I, Sondhi, A.C & Fried, D 2002, The analysis and use of financial statements (3rd ed.), John Wiley and Sons, New Jersey Yahoo! Finance 2014,. Stratasys (SSYS) [Online] Available at: [Accessed 20 July 2014] Read More