Finance for Leisure, Tourism, and Hospitality - Essay Example

Finance for Leisure, Tourism, and Hospitality PART A 2. Explanations of accounting concepts: The Going Concern Going concern concept assumes that thebusiness of the entity will continue to run so long predetermined objectives are achieved. Further going concern concept takes into consideration a fact that there are contracts and commitments implied in the financial statements. Theses contracts and commitments are required to be fulfilled. Only because going concern concept assumes a continuation of business, the assets and liabilities are values on historical basis. They are not valued at market value or at replacement costs. The Accrual Concept “Otherwise known as the matching principle, the purpose of this concept is to make sure that all revenues and costs are recorded in the appropriate statement at appropriate time.” (Duncan Williamson, 17th Jan., 2002)1 As per accrual concept of accountancy, revenues and expenditures are recognized as those are earned or incurred and not when they are received is paid for. An accrued cost is in fact is a sort of estimate of cost that has been incurred and is owed, but that has not yet been recorded in the books of accounts. Similarly, accrued income is an estimate of income that has become due to occurrence of a business transaction but has not yet been recorded in accounting system. There as per accrual concept any amount that is owed by the business in current accounting period need to be recorded in books of accounts so that it is added to expenses in profit and loss account. Similarly any income that is earned during the current accounting year but not received must be credited to profit and loss account for the year. Accrual arises on the basis of matching principle where under expenditures and revenues of an accounting period are accounted for whether those have been paid/ received or not during that particular accounting period. It may also happen that some expenditures relating to future accounting period are paid for in current accounting period or some income for future period are received in the current period. Those advance payments of expenditure and advance receipts of income will not be shown into the profit and loss account of current period but will be treated as current assets and current liabilities in the balance sheet. The Consistency Concept “Accountancy is not an exact science. There are certain procedures and principles that are recognized as good practice, but when these limits, there are often various acceptable methods of accountancy for similar items. To make things comparable, the consistency concept just means that you treat similar items in similar way and that the same treatment should be applied from one period to another.” (The Happy Accountant)3 The basic idea behind consistency concept is that transactions that are similar in nature should be treated similarly in accountancy. This adds a comparable quality into such transactions for the purpose of making an analysis. Change of method whenever necessitated should be done with proper disclosure in the financial statements. The Prudence Concept “Otherwise known as conservatism. It is this concept more than any other that has given rise to the idea that accountants are pessimistic boring people!!.” (Duncan Williamson)2 This concept states that caution should be exercised while dealing with uncertainties in the accountancy. But at the same time care should be taken that financial statements do not loose the character of neutralism. As per this concept profit have no place in accountancy until those are realized. Similarly provision for expenses and losses should be made even when exact amount of such expenditure or losses is not known. 3. Report on ratio analysis of Sports Wear Company Profitability Profitability of a company can be judged through its Gross profit ratio, net Profit ratio, and Return on capital employed. Gross Profit ratio ‘measures the percentage of each dollar remaining after the firm has paid for its goods’ (Lawrence J. Gitman, 2006)4 That means higher the gross profit margin the better it is for the company. Net Profit margin shows the earnings left for shareholders as a percentage of net sales. It measures the overall efficiency of production, administration, financing, price fixation, and tax management. Again the higher it is, the better it will be for the entity. Return on Capital Employed is the post tax version of earning power. It considers the effect of taxation but not the capital structure. Looking at these ratios of Sports Wear Company it is observed that Gross profit ratio of the company has come down from 35% in 2006 to 30% in 2007. Net profit ratio has followed suit, and it has come down from 23% in 2006 to 20% in 2007. Similarly ROCE has dropped from 18% in 2006 to 15% in 2007. The entire profitability ratios have shown a downward trend, and this trend shows that Sportswear Company has not been able to maintain 2006 ratios in 2007. This may be due to a variety of reasons, like fall in turnover, inefficiency creeping into the working of the company, price of inputs might have risen more as compare to sales prices and like that. The analysis is that company has dwindled upon its performance of 2006 and this may be due to a number of reasons. Liquidity working capital management Liquidity refers to the ability of the entity to meet its obligations in the short run, usually one year. Liquidity ratios are in fact a relationship between current assets and current liabilities. Current ratio measures the ability to meet current liabilities. The general norm for current ratio is 2:1, but it differs from industry to industry. Acid test ratio takes into account those current assets those are quickly convertible into cash. So inventory is not considered in its calculations. Acid test ratio (also known as quick ratio) of 1:1 is considered the optimum. In the case of Sport Wear Company liquidity ratios have improved a lot. Current ratio has jumped from 1.6 in 2006 to 2.2 in 2007. This is a great achievement and it describes that working capital of the company is being managed efficiently. Definitely, the company is able to meet its current obligations as those become due. That is why the acid test ratio has also shown a remarkable improvement from 1.1 in 2006 to 1.5 in 2007. Liquidtywise, Sport Wear Company is comfortable and solvent. Stock or inventory turnover ratio “commonly measures the activity, or liquidity, of a firm’s inventory.” (Lawrence J. Gitman)5 . it reflects the efficiency of inventory management. The higher the ratio the more efficient is the management of inventories. For Sports Wear Company, this ratio has risen from 20 days in 2006 to 30 days in 2007. That means the inventory management has improved rapidly in 2007. The debtors’ collection period may be compared with creditors’ payment period in order to judge the efficiency of credit management. The debtors’ collection period has risen from 30 days in 2006 to 45 days in 2007; and this may be a sign of inefficiency creeping into the system of credit management of the company. But the point to consider is creditors’ payment period has also risen from 35 days in 2006 to 50 days in 2007. This rise of credit payment period when compared with rise in debtors’ collection period would give an impression that the company has managed well its credit affairs as rise in debtors’ period is lower than creditors’ payment period. Overall liquidity wise the company is solvent and it is also managing its credit affairs in an efficient way. Gearing of the company Capital gearing refers to use of debt finance. This is also called financial leverage. Leverage ratio helps in assessing risk arising from use of debt capital. Capital gearing ratio is in fact debt equity ratio that shows the relative contributions of creditors and its owners. When this ratio is higher the company is called highly geared and assets of the company are said to be financed more through debt capital. But high geared companies give an advantage to equity holders, as after meeting fixed liabilities of debt interest and preferred capital dividend, equity holders enjoy the entire profits of the company. Accordingly high capital gearing works both ways. It may provide an opportunity to equity holders to earn more, and at the same time when earning are not good not only company suffers the burden of fixed liabilities and also the equity holders suffer from lower or no returns. Sports Wear Company has become high geared in 2007 when compared to 2006, and this suggests that in 2007 more debts were used in assets financing as compared to 2006. But still the company is low geared in both the years as assets are only 25% financed through debts and rest 75% has come from owners’ equity. 4. Forecast Cash Budget of Fitness Training Centre 5. Recommendation to prepare detailed cash flow forecasts Cash Flow Forecast is fundamental requirement of any business. It envisages cash inflow and cash outflow of the business over a predetermined period of time. The business plans its strategies on basis of such cash inflows and outflows. In fact without making a monthly cash flow forecast, it is not possible to approach markets for raising capital funds or even loan from capital market. Even the financial institutions like would ask for such for cash forecast before granting any financial assistance. Cash flow forecast analyses whether there would be positive cash flow or shortage of cash flow during the future period of envisaging. An opportunity is provided by such analyses to plan out damage control measure when negative cash flow is forecasted. The gaps between cash inflow and cash outflow are revealed, and an entity can accordingly work out its strategies to meet such eventuality. Cash flow forecast should be treated as an integral past of the business planning. It brings out or translated the planning of business into a practical shape by providing the resultant cash flows out of business transactions. It provides guidance to achieve maximum profitability within the given framework of resources. It is not mere statement of liquidity flowing in and flowing out, but shows the basic strength and weaknesses that needed to be exploited or taken care of in order to achieve the objectivities of the business. PART B 1) The company selected for this analysis is KYONI, and as per its balance sheet the company has used following funds to finance its assets: 2007 2006 Amt./$ % Amt./$ % Equity funds 635604 32.2 600807 33.5 Non-Current liabilities 125158 6.3 103284 5.8 Current Liabilities 1215734 61.5 1089635 60.7 100.0 100.0 Total debt liability both under current as well non- current liabilities comes to $1268841 for 2007 and $1131886 for 2006 and rests are provisions and deferred tax liabilities. Taking these figures into account the debt equity ratio is calculated as under for both 2006 and 2007 Debt equity ratio reveals that company is highly geared in both years. In 2007 debt financing is almost 200% of equity funds as compared 186.22% in 2006. As debt equity ratio mostly interests lenders/ creditors and investors, high geared capital structure of the company may dissuade most of them to finance the company unless the company operational profits (EBIT) are extremely well to cover fixed interest and tax liabilities. KYONI is very delicately poised in this regard and its EBIT for both the years is only 3% and profits available for shareholders after meting interest and tax expenditures are 2.9% in both the years. The company should improve its capital structure by lowering its current liabilities that are the significant portion of total debts. The most appropriate way is raise capital from market and use some of that raised equity funds to pay off current debts so that its debt equity ratio may come down to a comfortable level; and thereby creating an interest of creditors into the company. References: 1Duncan Williamson, Accounting WEB Co.Uk, 17 Jan., 2001, http://www.accountingweb.co.uk/cgi-bin/item.cgi?id=69109 2Duncan Williamson, Prudence Concept, Accounting Concepts and Conventions, viewed on July 14, 2008, http://www.duncanwil.co.uk/concepts.htm 3 The Happy Accountant, The consistency Concept, viewed on July 14, 2008, http://happyaccountant.wordpress.com/2007/04/13/the-consistency-concept/ 4 Lawrence J. Gitman, Principal of Managerial Finance, Eleventh edition, 2006, Gross Profit Margin, chapter 2, page 67 5 ibid, Inventory turnover, Chapter 2, page 60 6 KUONI Financial Report 2007, http://ir2.flife.de/data/kuoni/igb/index.php?bericht_id=1000014&lang=ENG Read More