Accounting for Business

ACCOUNTING FOR BUSINESS

Question - 1

1(a) Income Statement for the Year Ended 31st December 2023

Particulars	£000s
Revenue (Sales)	1,300
Cost of Sales
- Opening Inventory	110
- Purchases	800
- Closing Inventory	(120)
Total Cost of Sales	790
Gross Profit	510
Operating Expenses
- Selling & Distribution Expenses	75
- Administration Expenses (adjusted)	150
- Directors' Remuneration	37
- Audit Fee (adjusted)	12
Total Operating Expenses	274
Operating Profit	236
Other Expenses
- Debenture Interest	13
- Depreciation on Machinery	32
Total Other Expenses	45
Profit Before Tax	191
- Taxation	40
Profit After Tax	151

The income statement or the profit and loss statement is a financial statement that provides information about a firm’s revenues, expenses, profits or losses accrued within a certain period of time usually a quarter or a fiscal year. It is utilized to evaluate the operational performance of a business by showing its capacity to make profits out of its central operations. These elements include sales, cost of sales, gross margin, operating expenses and net income.

1(b) Statement of Financial Position as at 31st December 2023

Particulars	£000s
Non-Current Assets
- Land & Buildings (at cost)	624
- Machinery (at cost)	250
- Less: Accumulated Depreciation	(122)
Total Non-Current Assets	752
Current Assets
- Inventory	120
- Receivables	100
- Cash	4
- Bank	12
- Prepaid Administration Expenses	10
Total Current Assets	246
Total Assets	998
Equity
- Share Capital	450
- Retained Profits	111
Total Equity	561
Non-Current Liabilities
- 7% Debentures	200
Total Non-Current Liabilities	200
Current Liabilities
- Payables	70
- Accrued Audit Fee	2
- Proposed Final Dividend	40
- Taxation	40
Total Current Liabilities	152
Total Equity and Liabilities	998

Statement of Financial Position: The balance sheet on the other hand is a special financial report that aims at showing the firm’s financial position at a particular period. It lists a company's assets, liabilities, and equity, following the formula:It lists a company's assets, liabilities, and equity, following the formula:

Assets = Liabilities + Equity

The statement exhibits the company’s assets and the liabilities it owes as well as the residual interest of the shareholders, which is useful in providing useful information about the company’s financial health to its stakeholders.

1(c) Accruals (or Matching) Concept

The Accruals Concept which can also be referred to as the Matching Concept is one of the major concepts used in accounting that dictates that revenues and expenses should be recorded in the period in which they are earned and incurred respectively regardless of when actual cash transactions were made. This makes the financial statements give a better and fair presentation of a company’s financial performance in a certain period.

For example, in the case of AC Ltd, three instances illustrate the application of the accruals concept:

1. Prepaid Administration Expenses: AC Ltd incurred an `administration expenses £ 10,000 which can be allocated to the future periods. The above stated costs are not expensed from the current period instead; they are capitalized and will be expatriated from the periods they are incurred to benefit.

2. Accrued Audit Fee: In spite of the fact that the audit fee of £2,000 has not been paid out yet, this is included in current period’s expenditure. This is important to record the expense in the period when the service was received, in case of payment is done the following period (Alhadab, 2018, p. 397).

3. Depreciation of Machinery: The costs related to machinery are amortised over the useful life because the machinery is depreciated every year. AC Ltd has debited machinery– £32000 depreciation for the current year to bring the depreciation of machinery to Revenue generation year.

Thus, applying the concept of accruals in the preparation of the financial statements of AC Ltd make the organizational financial performance more comprehensible and accurate by matching the income and expenses properly.

Questions – 2

2(a) Calculation of Ratios for Profitability, Liquidity, and Efficiency

1. Profitability Ratios:

These ratios compare the amount of profit that a business makes to the revenue, assets, equity or any other figure in its balance sheet. They include Net Profit Margin, Return on Asset (ROA), and Return on Equity (ROE) that enables investors and analysts to evaluate the efficiency of the company in transforming available resources into profits.

Gross Profit Margin

Gross Profit Margin = ×100

Gross Profit (2023) = Sales – Cost of Sales

830.4 – 646.2 = 184.2

Gross Profit Margin = ×100 = 22.2%

Gross Profit (2022):

Gross Profit = Sales ? Cost of Sales =

746.5 ?577.8 = 168.7

Gross Profit Margin = ×100 = 22.6%

Net Profit Margin

Net Profit Margin = ×100

Net Profit Margin (2023) = ×100 = 10.0%

Net Profit Margin (2022) = ×100 = 11.7%

2. Liquidity Ratios:

These ratios evaluate how well a company is in a position to pay its near obligations by employing its current assets. The two most used liquidity ratios include the Current Ratio and the Quick Ratio. They give information on the financial position of a company as it reveals if a company has adequate cash to meet its commitments.

Current Ratio

Current Ration =

Current Ratio (2023) = = 1.21

Current Ratio (2022) = = 1.25

3. Efficiency Ratios:

Efficiency ratios depict the capability of utilized assets and liabilities to generate sales or to maximize profitability. Its key examples include Asset Turnover Ratio and Inventory Turnover Ratio. These ratios assist in determining how efficiently the company is operating its operating assets.

Inventory Turnover Ratio

Inventory Turnover =

Average Inventory (2023) = = 94.85

Inventory Turnover (2023) = = 6.81 times

Average Inventory (2022) = = 83.5

Inventory Turnover (2022) = = 6.92 times

Receivables Collection Period

Receivables Collection Period = × 365

Receivables Collection Period (2023) = × 365 = 18.98 days

Receivables Collection Period (2022) = × 365 = 23.68 days

2(b) Analysis of Financial Performance

This paper undertakes an analysis of the financial position of CR plc for the financial years 2022 and 2023 in a bid to assess its profitability, liquidity and efficiency. This paper aims to evaluate CR plc on the basis of changes it has undergone by comparing different financial ratios, which would enable the company to provide good insights with reference to CR’s practices; into how efficiently this company can organize its resources and operation.

Profitability:

According to the two ratios, known as the gross profit margin and net profit margin, the company’s profitability slightly decreased between 2022 and 2023. From the analysis above it can be seen that the gross profit margin reduced from 22.6% in 2022 to 22.2% in 2023 respectively. This means that, for every pound of sales, CR plc was holding slightly less in 2023 to cater for other expenses apart from the cost of sales. The gross profit margin has decreased, which may be attributed to a rise in the cost of sales meaning that; the costs of acquiring raw materials has gone up or there are inefficiencies in operations (Diana and Maria, 2020, p. 219). However, since the decline of gross profitability is not so steep, the company should pay attention to the further erosion of its costs as a management factor.

It also lowered the net profit margin decrease from 11.7 % in 2022 to 10.0% in 2023. This decline is greater than that in the gross margin, which indicates that during 2023 operating expenses or interest and taxes were higher. The net profit margin paints the picture of the bottom-line profitability where CR plc is keeping lesser amount with it after deducting all allowable expenses including taxes and interest. A decrease in the level of the net profit margin also points out that the company’s cost structure limits the generation of profits. CR plc must review its operating costs such as marketing, administration and interest expenses for it to establish where it can trim cost and regain healthy profit margins.

Liquidity:

The current ratio, as another measure of liquidity, also fell at CR plc between 2022 and 2023. The current ratio has declined to 1.25 in 2022 to 1.21 in 2023 which infers for every pound of current liabilities it had £1.21 in current assets to meet those obligations. A current ratio greater than 1 is commonly observed to mean a healthy liquidity position but the value decreases to mean that CR plc is becoming less liquid or has fewer near-term resources available to pay for its immediate obligations (Rashid, 2018, p. 110). If this trend persists, it may signify that Cash flow problems may arise in the future if short-term liabilities go up and not accompanied by an equal increase in current assets. The recommendation for CR plc is to avoid any deterioration in the current ratio, which can be achieved by a proper management of current liabilities and enhancing the cash flows from operating activities.

Efficiency

The inventory turnover ratio in the case of CR plc was slightly low in the last financial year and was recorded at 6.92 times in 2022 to 6.81 times in 2023. This means the company is cycling its inventory slightly less in 2023 and this could be due to some inefficiency with inventory or lower sales. A slow inventory turnover means that the company is holding a larger inventory which may result in increased costs such as deterioration of goods, wastage, or idle inventory (Kolawole et al., 2019, p. 4). Conservative working capital management on the other hand may create a problem whereby CR plc may delay on accurate inventory management to avoid holding on excess stock hence it may need to review its inventory control practice to avoid keeping stocks that are not selling out fast hence taking a lot of space and hence a lot of capital which is better used elsewhere.

However, as a positive note, CR plc achieved a reduction in the receivables collection period to 23.68 days in 2022 to 18.98 days in 2023. This improvement means that the company is obtaining payments from customers faster, which is always favourable in terms of cash flow and credit risk. Effective management of receivables is pivotal to the issue of cash flow, and this enhancement would imply that the company has sound practices of credit controls in place or that customers are paying earlier than expected (Okpala et al., 2019, p. 11). Receivables management facilitates more effective cash spending and the capacity to reinvest the proceeds into operations or repay debt, which leads to the overall financial strengthening of the company.

In summary, from the analysis of financial ratios, potential and current problems with reference to its financial statements, it can be concluded that, despite some negative factors, for example, reduced profitability and liquidity, CR plc has many advantages and best practice in efficient management of receivables. To resolve the issues of profitability and operating cash flow, the company should focus on reducing its costs and improving the efficiency of its operations, especially in terms of inventory management and cost of sales (Soboleva et al., 2018, p. 203). When managed successfully, these problems present a window of opportunity through which CR plc can rebuild its financial health and long-term prosperity.

Reference

Alhadab, M. (2018) ‘Abnormal audit fees and accrual and real earnings management: evidence from UK.’ Journal of Financial Reporting and Accounting, 16(3), pp.395-416. Available at: https://www.emerald.com/insight/content/doi/10.1108/JFRA-07-2017-0050/full/html

Diana, H.I. and Maria, M.M. (2020) ‘The importance Of profitability indicators In assessing The financial performance Of economic entities.’ The Annals of the University of Oradea, 29(2020), p.219. Available at: https://dea.lib.unideb.hu/server/api/core/bitstreams/5a2122e5-a91a-4d47-a84a-e1d84a17d420/content#page=213

Kolawole, A.D., Akomolafe, A.B. and Olusipe, B.J. (2019) ‘Inventory management: An impetus for increased profitability in manufacturing firms.’ International Journal of Accounting, Finance and Risk Management, 4(4), pp.1-6. Available at: http://eprints.abuad.edu.ng/569/

Okpala, K.E., Osanebi, C. and Irinyemi, A. (2019) ‘The impact of credit management strategies on liquidity and profitability.’ Journal of behavioural studies, 1(1), pp.1-14. Available at: https://www.researchgate.net/profile/Chimsunum-Osanebi/publication/333867498_The_Impact_of_Credit_Management_Strategies_on_Liquidity_and_Profitability/links/6294de4ec660ab61f852a118/The-Impact-of-Credit-Management-Strategies-on-Liquidity-and-Profitability.pdf

Rashid, C.A. (2018) ‘Efficiency of financial ratios analysis for evaluating companies’ liquidity.’ International Journal of Social Sciences & Educational Studies, 4(4), p.110. Available at: https://www.researchgate.net/profile/Chnar-Rashid/publication/325870971_Efficiency_of_Financial_Ratios_Analysis_for_Evaluating_Companies'_Liquidity/links/5b2a20f30f7e9b1d009bcd54/Efficiency-of-Financial-Ratios-Analysis-for-Evaluating-Companies-Liquidity.pdf

Soboleva, Y.P., Matveev, V.V., Ilminskaya, S.A., Efimenko, I.S., Rezvyakova, I.V. and Mazur, L.V. (2018) ‘Monitoring of businesses operations with cash flow analysis.’International Journal of Civil Engineering and Technology, 9(11), p.2034. Available at: http://www.fa.ru/fil/orel/science/nir/Documents/Matveev+%20Scopus.pdf