Pink Limiteds Financial Statements Analysis - Case Study Example

Running header: Accounting Student’s name: Instructor’s name Subject code: Date of submission: Table of Contents Table of Contents 2 Introduction 2 Pink Limited’s financial statements analysis 2 Statement of financial position 4 Cash flow statement 6 Non-financial information from the board minute 6 Financial ratios 6 General observation on the company’s performance 7 Usefulness of accounting as a decision making tool 7 Lease or buy decision 8 Leasing option 8 The buying decision 9 The right decision 10 Financing 10 References: 10 Accounting for decision making Introduction This paper looks at the performance of Pink limited in the year 2013 as compared to 2012. The company has generally registered an improved performance in 2013 owing to a number of measures that the company’s management has put in place. These include the introduction of the online store, the hotel contract and the employment of a new marketing director who has put in place aggressive marketing efforts. Pink Limited’s financial statements analysis i) Income statement analysis Pink limited recorded an improved performance both in terms of revenue and profitability in 2013 compared to 2012. The improvement in performance resulted from a number of reasons as will be explained below. a) Revenue The company attained revenue of $6,000,000 in 2013. This was a $2,300,000 improvement compared to the $3,700,000 figure attained in 2013. The improvement in the level of revenue is attributed to a number of reasons including the development of the infrastructure for the on-line store during the start of 2013 (Benjamin, 2011). This platform has served to realize revenues amounting to $1,096,000. The company also secured a contract with Bagnolo Hotels which enabled pink company to manufacture products for the hotel carrying the hotel chain name and logo. This has had an impact of increasing revenues with the contract resulting to sales amounting to $900,000. Furthermore, the company employed a new marketing director. This coupled with all the marketing efforts explained in the company’s minutes explain the rise in the company’s revenue. b) Cost of sales The cost of sales has significantly increased in 2013 to $4,083,000 from the 2012 figure of $2,590,000. The increase is attributed to the increase in the level of sales that resulted from the introduction of new sales segments as discussed above. Furthermore, increased marketing efforts led to an increase in sales thus leading to more cost of sales. c) Gross profit There was a significant increase in the company’s gross profit from the 2012 figure of $1,110to the 2013 figure of $1,917,000. The increase in gross profit is attributed to a number of factors including the introduction of two new segments and the increased marketing activities. d) Overheads The administration costs increased significantly from $413,000 to $670, 000 in 2013. The increase in administration costs includes costs of hiring additional employees and the administrator. Furthermore, the company has hired a new marketing director hence increasing the level of director’s remuneration from $90,000 in 2012 to $130,000 in 2013 (Gupet, 2007). Rental payments have increased owing to the new machinery rental. Furthermore, the introduction of the new segments has meant an increase in administration costs. Similarly, the administration costs significantly increased from $356,000 in 2012 to $664,000 in 2013. e) Operating profits The operating profits significantly increased from $341,000 in 2012 to $583,000 in 2013. The increase resulted from increased revenues and the changes explained above including introduction of two new departments and increased marketing efforts. f) Finance costs The cost also increased from $34,000 in 2012 to $43,000 in 2013. The resulted from increased borrowings in 2013 bearing in mind that the company secured an unsecured loan which hence attracted a higher interest rate. g) Profit/(Loss) before tax Owing to increased revenue generating activities by the company as explained above, the company’s profit before tax significantly increased from $307,000 in 2012 to $540,000 in 2013. h) Income tax expense Owing to increased profit before tax as explained above, the company’s income tax expense increased from $80,000 in 2012 to $135,000 in 2013. i) Profit for the period The company’s overall profit increased from $227,000 in 2012 to $405,000 in 2013 owing to increased revenue generating activities as explained above. Statement of financial position Assets a) Non-current assets The non-current assets slightly declined from $410, 000 in 2012 to $400,000 in 2013. The decline is mainly attributed to depreciation of assets as well as the sale of an asset at $30,000 in 2013. b) Inventories The amount of inventories increased from $980 in 2012 to $1,050 in 2013. The increased inventory is explained by increased production due to anticipated increase in sales. c) Trade and other receivables These increased from $310,000 in 2012 to $455,000 in 2013. The increase is attributed to increased sales activities arising from increased marketing activities as well the additional segments. d) Cash and cash equivalents In 2013, the company has no balances of cash and cash equivalents though it had $42,000 in 2012. The decline is attributed to the increased spending by the company which used up the available cash. Liabilities a) Non-current liabilities – the non-current liabilities which included long-term borrowings slightly increased from $404,000 in 2012 to $2412, 000 in 2013. The increase is attributed to the unsecured loan that the bank secured in 2013. b) Trade payables – The Company’s trade payables slightly declined to $363,000 in 2013 from $378,000 in 2012. The decline is attributed to better terms of trade between the company and the suppliers. c) Bank overdraft- though the bank did not have a bank overdraft in 2012, it secured a $68,000 facility in 2013 in a bid to finance its operations. Equity Contributed capital remained the same in 2013 as it was in 2012. However, the company’s retained earnings grew from $410,000 to $512,000 in 2013. This is attributed to the improved performance in 2013. As such, the owner’s equity improved from $960,000 in 2012 to $1,062,000. Cash flow statement The company’s cashflows from operating activitiessignificantly declined from $124,000 to (488,000). The decline is attributed to increased spending in operating activities such as the significant increase in the amount of dividend paid from $150,000 in 2012 to $303,000 in 2013. The company’s cashflows from financing activities increased greatly from a deficit of $73,000 in 2012 to $8,000. The increase is attributed to declining loan repayments as well as the loan secured in 2013. Non-financial information from the board minute From the minutes, it is clear that the company has put in place a strategy to ensure improved performance. In 2013, the company developed an online store. The company was also able to secure a contract with the hotel as explained above. Financial ratios The company’s financial ratios for the year 2013 show an improved performance when compared to those of 2012. These are explained below; a) Profitability – the company registered an overall improvement in profitability in 2013. The company’s return on capital employed ratio was up in 2013 at 37.81% compared to 25% in 2012. The company’s gross margin also improved from 30% in 2012 to 31.95% in 2013. b) Liquidity –generally, there was an improvement in thecompany’s liquidity in 2013 in comparison to 2012. The company’s current ratio was slightly lower in 2013 at 3.49 in comparison to 3.52 in 2012. The company’s quick ratio however significantly improved to 1.06 in 2013 compared to 0.93 in 2012. c) Solvency – there was an improvement in the company’s solvency during the two years. For instance, the company’s gearing increased from 29.6% in 2012 to 31.13% in 2013 owing to the loan and the bank overdraft. The interest cover improved from 10.03 times in 2012 to 13.56 times in 2013 owing to improved profitability. General observation on the company’s performance Arising from the above analysis of the various aspects of the company’s performance, it has been observed that the company’s performance is sound and can be expected to improve further due to the various measures that the management have put in place in a bid to improve the company’s profitability. Usefulness of accounting as a decision making tool Accounting is a very useful decision making tool both for the business owners, managers, creditors and investors. The general functions of accounting include providing financial information in a form that is useful to decision makers. In this regard, accounting provides to these decision makers information regarding to how the business is performing including whether or not the business is operating at a profit. Measuring the business performance is an important function in business decision making process. For instance, based on accounting information, investors are able to know the stock price of the company as well as its profitability and hence are able to make good investment decisions based on the forecasts they make out of the accounting information. Accounting also provides useful information to business owners hence enabling them make vital decisions regarding whether the or not the company has performed well. In this regard, they can be able to put the management to task in case the accounting information indicates that their funds are not being prudently invested. In the above scenario, the banks were able to extend loans to Pink limited despite lack of security owing to its good performance as presented by accounting information (Jared, 2010). In essence, accounting enables lenders, suppliers and creditors make sound decisions regarding lending to the organization. Even the government has to base the decision about how much to tax a certain organization on accounting information. In essence, Accounting provides information that is useful to different users in their decision making processes. The usefulness of accounting in decision making is solely based on its quantitative nature and hence its ability to be measured. However, financial as well as managerial decisions cannot be entirely based on quantitative data that accounting presents. This is the main weakness of accounting as a decision making tool. Qualitative aspects have to be born in mind when making decisions. For instance, numbers will not say anything about the quality of products offered. As such, it would be prudent to combine non-financial information with accounting information to enable the management make more quality decisions. Lease or buy decision The company has an option of either continuing to lease the machine or buy a new one. The two alternatives are analyzed below; Leasing option If the company decides to continue leasing the machine, then it will have to continue paying $59,000 lease rentals every year. If the decision is analyzed against the expected returns for a five year period, then the net present value of expected cashflows will be $48,069. However, as stated above, such a decision should not be entirely based on numbers. Other factors need to be considered. The main advantages that accrue from continuing to lease the machine include; a) Leasing will give the firm the opportunity to use and control over the machine without having to incur huge capital expenses since it will only require making annual rental payments of $59,000 as stated above. This will avail funds to the company for alternative use. b) Leasing can be said to be a form of faster and cheaper credit since leasing companies are more accommodating than financial institutions and banks as far as terms of financing are concerned (Jerold, 2005). As such, it is cheaper to use leasing in acquiring such an asset as opposed to other forms of financing. c) Leasing will increase the company’s capacity to borrow since more of the firm’s funds are used for working capital purposes as opposed to low yielding fixed assets. Leasing does not affect the firm’s debt equity ratio and hence more room is left for further borrowing if need arises. d) Leasing will protect the firm against obsolescence especially if the asset becomes obsolete at a first rate. On the other hand, leasing may present a number of challenges to the company and hence prove to be disadvantageous. The challenges may include; a) Leasing will deprive the company ownership of the asset. The company will only get the right to use and hence the asset can never be pledged as a security for securing loans from financial institutions. b) The company will be deprived of the asset in case it makes a default in lease rentals payments since in such a case, the lessor is entitled to take over the asset and the company cannot prevent it. The buying decision The buying decision will involve the company making a onetime payment of $250,000 and the company will have the use of the machine for five years with the machine having nil residual value. Various methods have been used to analyze the buying decision. Using the payback period, the company may take 3.5 years to recoup the money invested in buying the machine. The machine’s accounting rate of return will be 24%. On the other hand, the company will realize a net present value of $44,580 after the life of the project. The company should however consider other factors in deciding to buy the new machine such as the cost of maintenance and whether the company will borrow funds as well as the rate of interest the loan will attract. In case the machine is highly likely to be obsolete due to rapid changes in technology, then buying is not the best option. Furthermore, buying would mean investing a lot of initial capital which would otherwise be available for use in other business purposes (John, 2007). However, buying has the advantage of giving the company full control over its asset and it can even be used as collateral to secure loan. When bought in cash, there would be absolutely no threat of it being taken over by anyone as opposed to leasing. The right decision Based on the fact that the company doesn’t have cash at the moment and hence it has to borrow at even higher rates so as to buy the new machine, I would advocate for the company to continue leasing the machine. As stated above, leasing won’t require a lot of cash while the company will be able to use the machine for the entire period without having to incur a lot of expenses. Financing It is clear that the company does not have cash at the moment. As such, funds will have to be sourced from other sources. In this regard, I would advise the company to borrow funds from the bank. This is because banks will willingly fund the project given the company’s good financial outlook. The advantage of this source of funding is that it does not dilute the ownership of the firm since after the loan has been cleared, the firm does not have further obligations to the lender. However, credit has the disadvantage of exposing the company to liquidation risks in case the company is unable to meet its principal and interest obligations. References: Benjamin, B2011, Accounting for decision making, London, Rutledge. Gupet, C2007, Accounting: Business reporting and decision making, Oxford, Oxford University Press. Jared, N2010, Accounting tools for business decision making, New York, John Wiley & Sons. Jerold, K2005, Accounting for decision making and control, Cambridge, Cambridge University Press. John, N2007, Accounting, London, Rutledge. Read More