What Accounting Ratios Mean in Terms of Evidence - Assignment Example

Name of the student Name of the Institution Name of the Tutor Calculate as many accounting ratios as possible for the month of August and explain what these ratios mean in terms of evidence Debtors Ratio Debt to equity ratio = Total Liability/ shareholders equity = 25975/28663 0.906 This is the quantification of financial leverages. It indicates the proportion f the equity and debt used by the company finance. The lower the figure the better, the analysis, it gives 90.6% indicating poor leverage ability of the company hence need to improve it in the following months. Sales to working capital This ratio measures a company ability to finance current operations. Working capital = current assets – current liabilities. It is another measure of liquidity and the ability to cover short term obligations (Deegan, & Ward 2013). This ratio relates the ability of the company to generate sales using its working capital to determine how efficient working capital is being used. In summary, a lower number is preferred because it indicates a company has satisfactory level of working capital. However, an exceptional low number may indicate inadequate sales levels are being generated. From the above company; Sales to working Capital = Sales/ (current Assets – current Liabilities) Sales = $ 20,259 Current Assets = $ 26,334 Current liabilities = $ 25,975 = 20,259 / (26334 – 2 5975) = 20259/ 359 = 56.43 The sale to capital ratio for this company is 56.43 which are high showing that the company level of working capital is strong. The company may want to make an effort to generate additional sales using available working capital. Current ratio The current ratio = current assets/ current liabilities = 26334/25975 = 1.01 The ratio indicates that the current assets can pay the current liabilities once. The ratio is not very good for a big company Account Receivable Turnover Sales / Trade account receivable This ratio normally measures the number of times receivable turn in a year and normally reveals how successful a company is in collecting its outstanding its debts (Deegan, & Ward 2013). A higher number is preferred because it indicates a shorter time between sales and cash collection Account Receivable Turnover = Sales / Trade account receivable = $ 20,259 / 10380 = 1.95 The accounts receivable turnover is 1.95, compared to the previous year. The ratio may not be on the target with company objectives. Day’s sales receivable Trade account receivable / (sales / days) This ratio measures the average number of days a company’s receivables are outstanding. A lower number of days are desired (Gassen 2014). An increase in the number of days receivables are outstanding indicates an increased possibility of late payment by customers. Companies should attempt to reduce the number of the day’s sales in receivable in order to increase cash flow. The general rule used is that the time allowed for payment by selling terms should always exceed by more than 10 to 15 days. = 10380 / ($ 20,259/ 30) = 10380 /675.3 = 15.37 days Question two: Analyze the History of the previous six months trading and identify exactly what has gone wrong and when. Graphs and tables will be useful in pinpointing this evidence. For the past six months from January to June, there have been various activities that take place within the company. Sales for instance, has been so low for the initial six months with the highest sales recorded in March and lowest in June for that particular trading period. In terms of the cost, in the month of July, the highest cost was recoded while the sales were on the lower end. From the graph above, it should be noted that the first six months the company made more losses as the cost were more than sales. The second half of the year, the company started making profit though the profit did not last for long and losses stared to occur again. Debtors and creditors The graph below shows the company creditors and debtor’s management throughout the years From the graph above, it indicates increase in the company debtors something which should be avoided by all means. It further shows that from June to December creditors has not been well managed though were high in the initial years; it reduces towards the end of the year. Question three: Formulate clear recommendations into an action plan for improving the situation From the analysis, the company liquidity ratio is very low hence wanted for the company to get better sales by more advertising and more sales of its product. The company should reduce days in debtors to improve current assets by evaluating accounts receivable on a more frequent basis and take a more confident stance in the procedure used in compilation of debts and delinquent account (Deegan, & Ward 2013). The company manager should prepare thorough cash forecast and assess the company’s ability to meet goals on regular basis. The company managers should consider paying off short term obligations if cash position of the company is positive and lastly the company should believe converting short term debt to long term debt. Activity two Question 1: Calculate as many accounting ratios as possible for the month of December and compare and contrast them with those calculated for August Debt to equity ratio = Total Liability/ shareholders equity = 143/1246 = 0.11 In August it was 0.906 while in December it was 0.11, it shows that in December the company performance in managing liability more than August. Sales to working Capital = Sales/ (current Assets – current Liabilities) = 7500/ (10800-143) = 7500/ 10657 = 0.70 In August the percentage was 56% while in December it is 70% indicating better performance in December than in August. Profit margin ratio December = 1653/7500 = 0.2204 August = - 357/20250 = - 0.017 This indicates a better performance in December compared in August £1,556. With this the net profit to sales = sales/ net profit = 7200 / 1556 = 4.63 Giving high rate of performance The company had 8 sales enquiries, leading to orders for 25 units to a value of £12,500, which will be satisfied next month. Indicating proper trading in the month of August since all stock was sold out. In September the company purchased 1625 components at a cost of £8,125 and produced 25 products. At the end of the month you held 0 products and 0 components in stock. Orders in the previous month generated sales in this month to a total value of £12,500. Variable costs were £9,295 and fixed costs were £1,203, giving total costs of £10,498 and a net profit of £2,002. Net profit margin gives = 12,500 / 2002 = 6.24 This ratio give a good performance compared to the initial months hence showing improvement in sales from the company. The company had 9 sales enquiries, leading to orders for 25 units to a value of £12,500, which will be satisfied next month Question two: Analyze the History of your four months trading, from August to December. Graphs and tables will be useful in pinpointing this evidence. The sales has declines from august moving towards September posting the lowest sales while in October and November sales are more stable only to decline in December. This is an indication of poor performance in the part of the company as it is explained by gross profit. Monthly sales Months August September October November December Sales 20259 8324 12500 12500 7501 For the past trading period, the gross profit of the company has been fluctuating up and down as shown in the table below The fluctuation shows lack of stability however still shows potentiality of improving its business. In the month of August the purchase was 1040 components at a cost of £5,200 and the company produced 16 products. At the end of the month you held 0 products and 0 components in stock. This shows higher sales compared to other months Orders in the previous month generated sales in this month to a total value of £7,200. Variable costs were £5,200 and fixed costs were £1,018, giving total costs of £6,218 and a net profit. In the month of October the company purchased 1625 components at a cost of £8,125 and you produced 25 products. At the end of the month you held 0 products and 0 components in stock. Orders in the previous month generated sales in this month to a total value of £12,500. Variable costs were £8,755 and fixed costs were £977, giving total costs of £9,732 and a net profit of £2,768. The net profit margin gives = 12,500 / 2768 = 4.52 This indicates decline the net profit margin from the previous month. The company had 5 sales enquiries, leading to orders for 15 units to a value of £7,500, which will be satisfied next month. In terms of your bank account, you received £5,000 and paid out £9,756. The resulting change in your bank balance (or cash flow as it is known) was -£4,756, leaving you with a closing balance of £914. In the month of November the company purchased 975 components at a cost of £4,875 and the company produced 15 products. At the end of the month you held 0 products and 0 components in stock. Orders in the previous month generated sales in this month to a total value of £7,500. Variable costs were £4,875 and fixed costs were £972, giving total costs of £5,847 and a net profit of £1,654. The profit margin is given as; = 7500/ 1654 = 4.53 The margin remains fairly constant in the same month indicating that the company has not change their performance greatly. The company had 4 sales enquiries, leading to orders for 10 units to a value of £5,000, which will be satisfied next month. And in the last month, that is December, the company purchased 1625 components at a cost of £8,125 and you produced 25 products. At the end of the month you held 0 products and 0 components in stock. Orders in the previous month generated sales in this month to a total value of £12,500. Variable costs were £8,755 and fixed costs were £977, giving total costs of £9,732 and a net profit of £2,768. Net profit margin = = 12500 / 2768 = 4.52 The company had 5 sales enquiries, leading to orders for 15 units to a value of £7,500, which will be satisfied next month. In terms of the bank account, you received £13,451 and paid out £5,868. The resulting change in your bank balance (or cash flow as it is known) was £7,584, leaving you with a closing balance of £8,465. Graphically, the net profit margin can be shown as below The graph offer clearer picture on the performance of the organization as net profit margin declines with from August. The performance decline mostly in October up to December, the management should consider and check issues to do with sales and improves the company performance. In the month of September This ratio normally measures the number of times receivable turn in a year and normally reveals how successful a company is in collecting its outstanding its debts. A higher number is preferred because it indicates a shorter time between sales and cash collection Account Receivable Turnover = Sales / Trade account receivable September = 7200 /8130 = 0.89 October = 12500/ 8050 = 1.55 November = 12500/15550 = 0.80 December = 7500 / 10800 = 0.69 From the analysis, October posted the best turnover in terms of the account receivable. The accounts receivable turnover is 1.95 in August while in the following month it is 0.89, 1.55, 0.8 and 0.69 for September, October, November and December respectively. The ratio may not be on the target with company objectives. Sales to working capital It is another measure of liquidity and the ability to cover short term obligations. This ratio relates the ability of the company to generate sales using its working capital to determine how efficient working capital is being used. In summary, a lower number is preferred because it indicates a company has satisfactory level of working capital. However, an exceptional low number may indicate inadequate sales levels are being generated. From the above company; Sales to working Capital = Sales/ (current Assets – current Liabilities) September = 7200 /- 8582 = 0.839 October = 12500/ 7907 = 1.58 November = 12500/15407 = 0.81 December = 7500 / 10657 = 0.70 Since a lower number is preferred because it indicates a company has satisfactory level of working capital. Therefore in December the company performed relatively better as compared to the previous months. From the analysis, the company has not been performing as expected more especially in the following areas; Debtor’s collection Sales Liquidity management The company delays so much before they could collect the account receivables showing lack of commitment to follow the expected financial rules that states that the collection period should be less than 10- 15 days. In the month of August, it was 15.33 days while the preceding months it was higher than that. Sales of the company product is relatively very low resulting to lower gross profit margin which is further translated to net profit margin. The company should lower the overheads while increasing sales. Question three: Function three From the analysis, the company should plan to employ debt collector to help them in collecting their finances since the days taken to collect the funds are long and not within the recommended bracket of 10 to 15 days. The company further need to take action on the sales and marketing department as a result of drop in sales as it is evidence from the historical sales data with a wide variation in sales from one month to another. Another important indicators, which the management needs to work on is the liquidity ratio which is not encouraging. Practical steps should be taken to rectify such mistakes and ensure consistency in the trading throughout the year. Bibliography Beatty, A., & Liao, S. (2014). Financial accounting in the banking industry: A review of the empirical literature. Journal of Accounting and Economics, 58(2), 339-383. Deegan, C., & Ward, A. M. (2013). Financial Accounting and Reporting: An International Approach. Gassen, J. 2014. Causal inference in empirical archival financial accounting research. Accounting, Organizations and Society, 39(7), 535-544. Harrison Jr, W. T., Horngren, C. T., Thomas, C. W., Berberich, G., & Seguin, C. (2013). Financial accounting. Pearson Education Canada. Horngren, C., Harrison, W., Oliver, S., Best, P., Fraser, D., & Tan, R. 2012. Financial Accounting. Pearson Higher Education AU. Read More