Accounting
A Sample of Financial Analysis

Introduction

In this assignment, financial analysis for Central Pool and Taff View Pool will be performed. There are five parts in this writing, each designed to address a specific areas important to financial management and analysis of the newly acquired swimming pools by Fairvalue.

Part I: Profit and Loss Account & Balance Sheet for Taff View Pool

In this section, the profit and loss statement as well as the balance sheet for Taff View Pool will be constructed based on the limited information acquired from the previous management. The profit and loss account for Taff View Pool will be presented in Table 1, while the balance sheet will be presented in Table 2.

 

Table 1: Profit and Loss Account for the Taff View Pool (31st December 2010)

1

 

Table 2: Balance Sheet for Taff View Pool (31st December 2010)

 2

 Remark:               * After considering a depreciation rate of 10%

                                ** Original reserve of 20,500 + earnings carried forwards from previous year of 30,000

                                *** Plug-in figure to ensure balance of account

 

Part II: Financial Comparisons between various Pools

In this section, several financial ratios for Central Pool and Taff View Pool will be compared to one of their competitors, namely Field Park Pool. Before the financial ratios are calculated, the various financial variables for Central Pool and Taff View Pool are listed in Table 3 below.

 

Table 3: Financial Variables for Central Pool and Taff View Pool

3

Remark:           * Calculation of operating assets = Total assets – Debtors

** In calculation of Gearing Ratio, only long term debt will be considered.

 

After the values of the various financial variables are presented, financial ratios can be computed. The computations of the various financial ratios are shown in Table 4 below.

 

Table 4: Financial Ratios

4

Remark: calculated from Excel Spreadsheet

 

Analysis of Operating Profits/ Operating Assets. This ratio investigates the efficiencies of which the business able to churn out operating profits from the operating assets. The higher the operating profit, or the lower the operating assets required/ used; the better. Obviously, Central Pool is scoring worst. Although Taff View Pool is scoring satisfactory results, the ratios still lose to the achievement of Field Park Pool. Overall, Central Pool is not utilizing the operating assets well or efficiently. Management must reduce inefficient operations or wastages occurred in operations.

Analysis of Operating Profit/ Sales. This ratio measures the operating profit margin. The higher the margin; the better. Taff View Pool has the highest operating margin. Again, it is found that Central Pool scores the worst in terms of this ratio. It indicates that the expenses incurred in managing the pool are too high.

Analysis of Sales/ Operating Assets. This is a ratio of operating assets turnover. The higher the ratio; the better. Field Park Pool score the best in this dimensions. In contrast, the performance of Central Pool and Taff View Pool is not satisfactory. For these pools, the business only able to generate slightly more than one dollar of sales from 1 dollar of operating assets. It indicates that operating assets are not used effectively to generate revenues.

Analysis of Expenses/ Sales. This ratio measures the percentage of expenses incurred in managing the business relative to the revenue figure. The lower the ratio, the better. It is found that Taff View Pool is scoring the best in this dimension. However, the performance of Central Pool is miserable, whereby 98.6% of the revenues are incurred as expenses in managing the business. Overall, this indicates that the business management should take greater focus on cutting the unnecessary expenses incurred in managing Central Pool.

Analysis of Sales/ Fixed Assets. The fixed assets turnover ratio for Field Park Pool is the best among the many pools; triple that figure or achievement of Central Pool and Taff View Pool. Overall, such an observation indicates that the management of both Central Pool and Taff View Pool is not utilizing the fixed assets effectively to generate revenue.

Analysis of Sales/ Current Assets. Overall, the current asset turnovers for all of the pool are relatively comparable.

Analysis of Sales/ Stock. This ratio indicate the stock/ inventory management of the pool. It is found that Field Park Pool is the best performer in this ratio among the many pools. On the other hand, it can be seen that the performance of Central Pool is miserable, whereby management should take more care in handling or managing the inventory level in the business. Keeping too many inventories may not be a wise choice.

Analysis of Sales/ Debtors. In this ratio, the revenue is measured relative to debtors amount. This is the ratio whereby both Central Pool and Taff View Pool perform better than Field Park Pool, as lower debtors amount relative to revenue indicates tighter account receivable management (i.e., a more conservative financial management practices).

Analysis of Current Ratio. The current ratio for Field Park Pool is the best, indicating the cash management of the pool is most conservative. As the current ratio is higher than the other businesses, the liquidity risks faced by the pool are also lower than of the other pools. The current ratio of Central Pool is moderate, but the current ratio for Taff View Pool is worrying. This is because the current liabilities are much higher than of the current assets, indicating potential solvency risks for the pool.

Analysis of Gearing Ratio. The usage of debt in capital structure for all of the pools are low to moderate, as even Field Park Pool only employ a total of 25% debt in its capital structure. The usages of debt in Central Pool as well as Taff View Pool are also conservative. Overall, all of the pools will be able to raise more debt for expansion purposes, because the debt burden on the business is still largely manageable. From this ratio, it can be seen that most of the pools are financially conservatively managed.

Part II: Relative Profitability of Canteen and Pool

In order to find out the relative profitability of the canteen and the pool, the income statement of the different division will be presented in Tale 5 and Table 6 below.

 

Table 5: Profit and Loss Statement for the Pool

 5

 

Table 6: Profit and Loss Statement for the Canteen

6

 

In order to investigate the relative profitability of the two different business division, the various profitability ratios (calculated as a percentage of revenue for the respective division can be performed) are shown in Table 7 below. Such an analysis method is called common ratios analysis.

 

Table 7: Profitability Ratios

7

 

From the calculation above, it can be seen that the operating margin for the pool is much higher than that of the canteen. Thus, the very first measure to be taken is to cut down the expenses incurred in the canteen operation. From another perspective, it could also be the canteen is no getting many customers, thus, lower revenue (but the minimal overhead costs remain high). Thus, management can launch a series or marketing promotional activities to attract more customers to visit the canteen more often. Perhaps by revitalizing the menus of the canteens, the target customers can be expanded to people not using the swimming pool.

Part IV: Possible Sources of Financing

Generally, there are three methods of financing for expansion projects, namely financing from equity market, bond market or from retained earnings. All of these methods have respective advantages or disadvantages as will be discussed in the following paragraphs.

Financing from equity market. Generally speaking, financing from equity market is not a preferred method because such the costs of equity are often the highest among the various means of financing methods (Brigham et. al., 2004). Existing shareholders may be reluctant to invest more money into a business, as the business is already not doing well. Besides, as the costs of equity is generally higher than other means of financing methods, to finance expansion projects using equity generally indicate that the company is already running out of other sources of financing possibility, which can be a really negative signs to investors (Reilly et. al., 2003). Having to say that, there are certain advantages of financing from equity market. For example, when the market sentiment is positive, it is easy to obtain financing from the equity market. Besides, financing from equity market will not cause the business to become financially distressed due to burdens of interest payment should the economy enter into recessionary era or the business expansion projects turns bad.

Financing from debt market. There are many advantages of financing from the debt market. Firstly, the interest payment is tax deductible (Brigham et. al., 2004), which cause the cost of debt is generally lower than the costs of equity. Given the situation that the company is lowly leveraged (i.e., both the pools have low gearing ratios), it is relatively easy for the firm to undertake financing from debt market. Besides, if the expansion projects are viable, the profitability of the firm can be greatly enhanced due to the higher usage of debt in the capital structure (for example, Return on Equity can be improved due to the leverage effects). There are several disadvantages of debt financing worth mentioning. Firstly, interest payments will be required, and should anything unpredictable happens, the firm may suffer from liquidity or solvency risks (Silbiger, 2005). Secondly, when usage of debt is excessive, the cost of debt can increase significantly, putting serious downward pressures to the stock prices. This is due to the fact that it is not hard to observe highly leverage businesses to go burst in hard times (i.e., increase probability of bankruptcy).

Financing from retained earnings. Perhaps the best way is to finance from retained earnings. The costs of financing from retained earnings are lowest. Such methods also require less work or approval or regulatory agencies, or dependent on market sentiment. Financing from retained earnings can also send positive signs to the shareholders as it indicates that the business is profitable and able to generate extra cashes for taking up more new profitable projects in the competitive business environment (Reilly et. al., 2003). However, given the situation whereby the operations of the pools are not truly profitable, it may be hard for them to finance from retained earnings, should the business expansion projects require large sum of capital investment.

Part V: Benefits of Budgetary Planning and Control

There are many benefits that can be reaped from introduction of budgetary planning and control system in the organization. Firstly, a budget system tend to force the management to think in a more serious and comprehensive manner about the future (Warren et. al., 1999). Through the planning process, manager will form a better forward looking or scenario planning for the organization.  The many details can be planned and seriously considered, whereby goals or targets can be set (Anthony et. al., 1999). The organization missions can be refined, researched and the organization performance can be better managed. Besides, a good budgetary planning and control system also enable or encourage people to coordinate as well as to communicate among each other. This will enhance the understandings of people from different department, can management can form better or more complete picture on the organization. Besides, budgetary control system also enables the various jobs, duties and responsibilities of different department or people are defined in a clearer manner (Horngen et. al., 1997). People or workforce can have better understanding on their responsibilities and roles they played in achieving organization goals. As such, the properly planned and relevant budgetary system enables a better performance management or appraisal system in the organization to be carried out. The budget or predefined targets can become the yardstick to manage the performance of people. Control can be better exercised as the differences between planned results to the actual results can be researched, investigated and corrected. Besides, a good budget system will also enable more efficient allocation of resources. Overall, it is not hard to observe that good budget system will enhance the organizational performance and increase the profitability of the firm in the long run.

References & Bibliography

Anthony, R. N., Hawkins, D. F., and Merchant, K. A. (1999). Accounting: Text and Cases, 10th international edition, McGraw-Hill.

Brigham, E. F., & Houston, J. F. (2004). Fundamentals of financial management, 10th edition. International Thomson Publishing.

Horngen, H. and Izan, B. F. (1997). Accounting, 2/e, Prentice Hall.

Meigs, R., Williams, J., Haka, S. and Bettner, M. (1999). Accounting: The Basis For Business Decisions, 11/e, McGraw-Hill

Reilly, F. K. and Brown, K. C. (2003). Investment Analysis and Portfolio Management (7th edition). International Thomson Publishing.

Silbiger, S. (2005). The 10-day MBA: a step-by-step guide to mastering the skills taught in top business schools. Piatkus.

Skousen, K., Albricht, W., Stice, J. Stice, E. and Swain, M. (1998). Accounting: Concepts and Applications, 7/e, International Thomson Publishing

Warren, C. S., Reeve, J. M., and Fess, P. E. (1999). Accounting, 19/e, International Thomas Publishing

Weygandt, J., Kiero, D., and Kimmel, P. (1998). Financial Accounting, 3/e, John Wiley

Wild, J. J. (2000). Financial Accounting-Information for decision, McGraw-Hill

 

 

 

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