Bfa526 Accounting For Managers And Assessment Answer


They gain ownership in the form of equity shares and the % of shares hold by them represents their ownership in the company.

  • Shareholders are the owner of the company and remain interested in each and every act of the company. Apart from shareholders the following persons are also be interested in the contents of financial accounting reports:
  1. Lenders
  2. Bankers
  3. Investors
  4. Government agencies
  5. Customers and Vendors / Suppliers
  6. General Public
  • Classification for the following:
  • Paid up capital - Equity
  • Bank loan - Liability
  • Provision for annual leave - Liability
  • Brand names and intellectual property - Asset
  • Accounts receivable - Asset
  • Prepaid insurance premiums - Asset
  • Deposit paid by a customer for work yet to be done - Liability
  • Retained profit - Equity
Cash flow budget shows cash inflows and cash outflows from various sources over a period of time. It involves estimations of cash flows and is basically prepared for decision making with respect to liquidity. It is generally prepared for future estimations.

Whereas cash flow statement reflects the cash flows from various activities for a given period. It is prepared for the period which has already been passed, so it’s prepared on actual data. It helps in showing the management the cash flow generation or uses in various activities.

Depreciation refers to degradation/ reduction in the value of assets over a period of time in lieu of general wear and tear or technology obsolesces. For instance, today a machine has been purchased for an amount of USD 10,000 which will have a salvage value of USD 2000 after 4 years. It means that the value of machinery will go down from 10,000 USD to 2,000 USD in 4 years. So, to make the books reflect true and fair view, we need to make adjustment in the value of machinery and this adjustment is knows as depreciation. So, for the first year the depreciation will be USD 2000 [(10,000-2,000)/4] and the value of machine at the end of first year will be USD 8000.

The pair which is larger from another and its reasons are as follows:

Particulars

Larger one

Reasons

EBIT and net profit

EBIT

EBIT means earnings before interest and tax and net profit is after reduction of interest and tax. So, EBIT is larger since interest and tax have not been reduced from it.

Paid up capital and owner’s equity

Owner’s Equity

Owner’s equity means the total amount that belongs to shareholders and paid up capital is a part of owner’s equity. Hence, owner’s equity amount is greater than paid up capital

Dividends per share and earnings per share

Earnings per share

An earning per share is the total earnings attributable to a shareholder whereas dividend per share is a part from earnings which is given to shareholders. Hence, EPS is greater than DPS.

Current assets and current liabilities

Current assets

Generally current asset is greater than current liabilities. Because excess of current assets over current liabilities represents working capital of the company. And a negative working capital is dangerous for the company.

Net profit and gross profit

Gross Profit

Gross Profit is before indirect incomes and expenses whereas net profit is after all the incomes and expenses.

The major changes that would give rise to increase or decrease in owners’ equity during the year are as follows:
Issues of shares will increase the owner’s equity whereas buy back of shares will reduce

Net Profit earned or Net loss incurred will also increase / decrease the owners’ equity

Dividend distribution to shareholders will decrease the owners’ equity
Issuance of treasury stock will also increase the owners’ equity

Leaving profits in the business would help the business to meet its working capital requirements and thus helps in expanding the business of the company. This expansion will in turn generate more profit and will increase the owner’s equity. Whereas withdrawing the profit for personal use is just an expense which will have no future growth. Examples of not withdrawing the profits are non-declaration of dividends, no drawings etc.
Bad debts refer to the amount receivables with no or less probability of receiving the amount back. If the fact that the debt has become bad, is not considered in the financial statements then the financial statements will not reflect the true and fair position of accounts receivable. The financials will show that the company is to receive say an amount of 10,000 USD from its accounts receivable in lieu of goods sold whereas in actual only 8000 USD has to be received back and remaining 2000 USD has become bad as the customer has been declared as bankrupt.
Statement of cash flows shows the inflow and outflow of cash from various activities. If the cash flow from operating activities is negative than it means that the instead of generation of cash the operative activities are using the cash. The reasons for negative cash flow from operating activities are as follows:
Negative working capital
Excess expense in comparison of income resulting in net loss
Decline in sales or profit margin resulting in lower or negative profits
More income from other sources or lower income from operating activities will also lead to negative cash flow from operating activities.

Calculation of Ratios 

  • Net Profit Margin = Net income / net sales

=  (Sales - cost of sales - other expenses)/ net sales

Particulars

 

 30 June 2015

 30 June 2016

Sales

=

                  60,000

                  90,000

Cost of sales

=

                  39,000

                  63,000

All other expenses

=

                  12,000

                  21,000

Net income

=

                  9,000

                  6,000

Net profit margin

=

15.00%

6.67%

  • Rate of return on owners’ equity = Net income / shareholder's Equity

Particulars

 

 30 June 2015

 30 June 2016

Sales

=

                  60,000

                  90,000

Cost of sales

=

                  39,000

                  63,000

All other expenses

=

                  12,000

                  21,000

Net income

=

                  9,000

                  6,000

Helena Beauty, Capital

=

                  60,000

                  72,000

Total shareholder's equity

=

                60,000

                72,000

Rate of return on owners’ equity

=

15.00%

8.33%

  • Current ratio = Current Assets / Current Liabilities

Particulars

 

 30 June 2015

 30 June 2016

Cash at bank

=

                  12,000

                (18,000)

Inventory

=

                  18,000

                  33,000

Accounts Receivable (net)

=

                  12,000

                  30,000

Current assets

=

                42,000

                45,000

Accounts Payable

=

                    6,000

                    9,000

Current Liabilities

=

                  6,000

                  9,000

Current Ratio

=

7.00

5.00

  • Acid Test Ratio = Current Assets / Current Liabilities

Particulars

 

 30 June 2015

 30 June 2016

Cash at bank

=

                  12,000

                (18,000)

Accounts Receivable (net)

=

                  12,000

                  30,000

Current assets

=

                24,000

                12,000

Accounts Payable

=

                    6,000

                    9,000

Current Liabilities

=

                  6,000

                  9,000

Acid Test Ratio

=

4.00

1.33

  • Gearing Ratio = Non-current Liabilities / shareholder's equity

Particulars

 

 30 June 2015

 30 June 2016

Non-current liabilities

=

                         -   

                  12,000

Non-current liabilities

=

                         -   

                12,000

Helena Beauty, Capital

=

                  60,000

                  72,000

Total shareholder's equity

=

                60,000

                72,000

Gearing Ratio

=

0.00%

16.67%

Inventory turnover ratio = Cost of goods sold / average inventory

Inventory turnover period =  365 / Inventory turnover ratio

Particulars

 

 30 June 2015

 30 June 2016

Cost of goods sold

=

                  39,000

                  63,000

Cost of goods sold

=

                39,000

                63,000

Opening inventory

=

                  15,000

                  18,000

Closing inventory

=

                  18,000

                  33,000

Average inventory

=

                16,500

                25,500

Inventory turnover ratio

=

2.36

2.47

Inventory turnover (in days)

=

154.42

147.74

Profitability

Profitability ratios are a class of financial metrics that are used to assess a business's ability to generate earnings compared to its expenses and other relevant costs incurred during a specific period of time (Staff, 2017)1. It is calculated by dividing the net profit with the sales. Higher the net profit, higher the profitability ratio and the better it is. Similarly, there is also a gross profit margin ratio which reflects the gross profit ratio in comparison of sales. In current situation, the company’s gross profit ratio has reduced drastically from 15% to 6.67% inspite of the fact that the sales have been increased from $60,000 to $90,000. This is not a good indicator for the health of the company and it reflects that the company’s cost of sales is very high.

Short term Liquidity

Liquidity ratios measure a company's ability to pay debt obligations and its margin of safety through the calculation of metrics including the current ratio, quick ratio and operating cash flow ratio (Staff, 2017)2. It shows the capacity or ability of the company to generate cash from its current assets or how quickly a company can settle its current liabilities. Again, the higher the liquidity ratio, the better it is.

These ratios include

  1. Current Ratio = It compares current assets and current liabilities to determine the company’s ability to pay off its current liabilities from its current assets.
  2. Quick ratio or acid test ratio = It compares the quick current assets means current assets excluding inventory and prepayments with current liabilities to determine the company’s ability to pay off its current obligations from its quick assets.

The company’s current ratio have reduced from 7 times to 5 times and this is due to increase in current liabilities whereas acid test ratio have decreased from 4 times to 1.33 times.

Long term solvency

Long term solvency is measured through gearing ratio. Gearing ratio is a measure of financial leverage of the company. It compares company’s debt with the equity or outsiders debt obligations with the internal funding and by comparing both of them, tries to find out the financial risk to which the company might be exposed off.

In given situation, the company’s is having no debt in 2015 hence the gearing ratio was zero whereas in 2016 the gearing ratio was 16.67% as the company has taken long term loans. 

  • Calculation of variable costs per pot for Fancy Terracotta pots 

Particulars

Units

Price

Total cost pu

Plastic raw material

1.50

1.00

1.50

Machine operator labour

1.00

1.00

1.00

Electricity

1.00

0.10

0.10

Transport and distribution

1.00

0.40

0.40

Total Variable cost per pot

 

 

3.00

  • Calculation of contribution margin per pot for Fancy Terracotta pots 

Particulars

Amount

Sales price per pot

4.80

Total Variable cost per pot

3.00

Contribution margin per pot

1.80

 Calculation of the break-even output per month if only Plain Black pots are made 

Breakeven =  Fixed costs / contribution margin pu

= 3500/0.85

  =  4,117.65

Hence, 4118 plain black pots should be sold to achieve break even.

Calculation of contribution margin per pot

Particulars

Amount

Sales price per pot

2.80

Total Variable cost per pot

1.95

Contribution margin per pot

0.85

Fixed costs per pot

Rent on premises   1,000.00

Manager's salary   2,500.00

Total fixed costs   3,500.00

Special Order 

Variable cost per plain black pot

            1.95

Less: Transportation cost

            0.40

Net variable cost for special order

            1.55

Offered price

            1.90

Net Profit per pot

            0.35

Since, the variable cost is $1.55 and offered price is $1.90, resulting in a profit of $0.35, so the offer should be accepted.

  • If the special order would have included the transportation and distribution cost of $0.40, then the offer should not be accepted as it would lead to a loss of $0.05 per pot.

Variable cost per plain black pot

            1.95

Offered price

            1.90

Net Loss per pot

           (0.05)

Calculation of Profit / loss for the month of May

Particulars

 Fancy Terracotta pots

 Plain Black pots

Total

 Units

 Price pu

 Total

 Units

 Price pu

 Total

Sales

        900.00

                   4.80

               4,320.00

1700

           2.80

     4,760.00

     9,080.00

Less: Variable Costs

        900.00

                   3.00

               2,700.00

1700

           1.95

     3,315.00

     6,015.00

Contribution Margin

 

 

               1,620.00

 

 

     1,445.00

     3,065.00

  

Particulars

 Amount

Sales

            9,080.00

Less: Variable Costs

            6,015.00

Contribution Margin

            3,065.00

Less: Fixed Costs

            3,500.00

Net Loss

             (435.00)

Calculation of a price quotation for Job No. 43

Particulars

 Units

 Price pu

Amount

Direct labour costs

       630

               20

12,600

Direct Material

 

 

14,000

Manufacturing overheads

       315

               45

14,018

Administrative overheads

       630

               26

16,301

Total cost

 

 

56,919

Price quotation for Job No. 43 is $ 56,919.

The requirement of cash depends upon the requirement of working capital by the company. The more working capital requirement indicates more cash needed and vice-versa. The main factors that influence how much cash / working capital a business will hold are as follows:

Nature of business– Requirement of cash depends upon the type of business and person is involved. Manufacturing companies, takes lots of time in converting their raw material into finished goods and thus requires higher working capital whereas trading companies require low amount of working capital as the goods are ready for sale.

Scale of Operations – The scale of operations decides the requirement of working capital. The higher the scale of operation the larger is the requirement of working capital and vice-versa. The more requirement of working capital is the more requirement of cash.

Business Cycle– Every business has its own highs and lows. During the boom period, the company’s sales are at higher level and thus more cash is required whereas during low periods, low sales are there and thus low cash is required.
Seasonal Factors– Some products gets impacted during some special occasions or seasons. These types of businesses require higher working capital or cash during these periods.
Operating Efficiency– Cash requirement also depends on the capacity and operating efficiency of the company. If the company is able to convert its raw materials into finished goods quickly than low amount of cash is required whereas if the company takes more time in conversion then higher amount of cash is required.
The business has to face the following costs for holding too low a level of inventory:
Missed Sales– Due to low level of inventory there are higher chances that due to non-availability of material a sales opportunity can be missed out.
Higher shipping costs– Due to urgency of inventory, the company might face circumstances when inventory is bought and transported at a higher shipping cost.
Missing out on discounts– When company buys material at a larger quantity then the company is in a position to negotiate the price and have a chance of taking discounts but when the inventory are purchased quickly but in low quantity, bulk discounts are not given.
Retained profits/earnings are not a free sourceof finance to the business.

Pros

  1. Financing through retained profits does not lose the control of owners and maintains the full control of shareholders
  2. The profits does not ruin in interest payments and entire earnings are available to shareholders
  3. Taking finance from loans involves lots of costs including upfront fees and all, whereas when the financing is done through retained earnings no such costs are there.

Cons

  1. Financing through debts is a cheaper source as tax savings can be made on interest payments whereas in cash of financing through retained earnings, the dividend payable to shareholders is not allowed as deduction for tax payments.
  2. Further, generating finance through retained earnings is a slow process and can take a lot of time for arranging funds.
  • Following non-financial information a venture capitalist would be concerned with while making prospective investment opportunities:
  1. Background / experience of the promotors or founders of the business– To check whether the management of the company is having adequate experience in the business they are running as no experience or inadequate experience may run business into losses.
Feasibility of product– To check whether the product has sufficient demand in the market and have future growth options.
Presence of Competitors– To check whether the company is having competitors in the market or is a monopolistic business.
Government Laws– To check whether the government laws are favourable to the business of the company. If the laws are not favourable then the business is at the risk.
Economic risks– To check whether there are any other risks associated with the business of the company like economic risks, or the operating area risks. For instance, the business associated in an area which is prone to terrorists activities can have low life.

Bibliography 

Staff, I. (2017). Profitability Ratios. [online] Investopedia. Available at: https://www.investopedia.com/terms/p/profitabilityratios.asp [Accessed 14 Aug. 2017].

Staff, I. (2017). Liquidity Ratios. [online] Investopedia. Available at: https://www.investopedia.com/terms/l/liquidityratios.asp [Accessed 14 Aug. 2017].


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