Case Study On Accounting For Business Of Sales Outstanding

Small Business Analysis 1

Describe the Case Study for Accounting for Business of Sales Outstanding.

a) The earning ability of an organization would be better understood with the help of ratios. The profitability of an organization can be better understood with the help of four following ratios;

Return on assets

Return on Equity

Gross Profit margin

Net Profit margin

a	2015
	$
	Teda
RETURN ON ASSETS		17.83%
PAT	75000
ASSETS	420675
RETURN ON EQUITY		32.20%
NET INCOME	75000
EQUITY	232935
GROSS PROFIT MARGIN		255%
GP	155000
SALES	60868.4
NET PROFIT MARGIN		123%
PAT	75000
SALES	60868.4

b) The asset to equity ratio is important assessment if it is compared with previous year’s figure to assess the source of funds to buy the assets. Here, in 2014 the asset to equity ratio was higher than 2015 figure; this reflects that despite asset size increase the ratio has declined. This means Teda has either transferred profit to the reserve or issues fresh share in 2015 to finance the assets[1].

c) DSO figure is however not attractive for the company. The company has debtor’s collection day’s figure of 111.86. This reflects that that the company has not been good at managing receivables².

d) The company is managing higher current assets and working capital position. The better working capital potion can help the company to run very smoothly and to manage the affairs of the company in a far better way.

b	2015	2014
	$	$
	Teda	Teda
ASSET TO EQUITY		1.80597592		2.03412073
ASSET	420675		387500
EQUITY	232935		190500
c	2015
	$
	Teda
DAYS SALES OUTSTANDING-DSO		111.867568
AVERAGE ACCOUNTS RECEIVABLE *365	51738750
TOTAL CREDIT SALES	462500
D	2015
	$
	Teda
CURRENT RATIO		1.82459677
CA	285075
CL	156240
E	2015
	$
	Teda
INVENTORY TURNOVER		2.44047619
COGS	307500
AVERAGE INVENTORY	126000

A few of the Ratio Analysis of TUST Pty.Ltd. Is enclosed herewith which are explained in detail below for better understanding of the outcome of the results stated herewith–

Ratios	Formula	2012	2013	Ideal Level
Current Ratio	Current Assets Current Liabilities	2.1:1	2.6:1	2:1
Acid test or quick ratio	Current assets – inventory Current liabilities	1.8:1	2.2:1	1:1
Days inventory in hand	Average Inventory    X 365 days Cost of Sales	122	127	Lower the better.
Days debtors outstanding	Receivable       X 365 days      Sales	30	46	30
Net Profit Margin	Profit before interest & tax(PBIT) Turnover	10%	12.2%	Higher the margin, the better.

The ratios indicate either an increase or decrease from the previous year.

Liquidity: Liquidity ratios are used to determine and measure the company’s strength and ability to be able to cover all its expenses. They are Current ratio and Quick ratio. The current ratio measures short term solvency and liquidity. The ideal current ratio is nearer to 2:1 but this varies from business to business[2].

The quick or acid test ratio which measures the urgent solvency of any business as the inventory part is left out of the current assets which is not ready cash but to be sold and realised only hence there may be great variation on liquidity as the valuation of stock will depend on market conditions at any given point of time. The normal quick ratio is 1:1 but it is also depends on business format. Both ratio formulas are shown in the table above.

Asset efficiency: Asset efficiency ratio is the method to determine the main power of assets in running the business more effectively. The assets are the main performance generating element of any business. Every business needs different types of Assets like fixed and current assets in general. A fixed asset comprises of Plant & Machinery, Land & Buildings, Furniture and Fixtures, Tools and Equipments, Office Equipments, etc and Current Assets comprises of Bank, Cash, Debtors, Inventory, etc. These assets are all used in different manner in a business to generate profit which again is ploughed in the business to generate more assets so that business can grow and handle competition from the other players from the industry[3].

Ratios	Formula	Ideal Level
Asset turnover	Turnover Total Assets or capital employed	6.74
Percent Rate of Return on Assets	Earnings before Taxes  X 100 Total Assets	4.53%

Small Business Analysis 2: Ratio analysis of TUST Pty. Ltd

Asset Turnover– this is a type of ratio used to measure the production of sales in comparison to asset base. If the measurement is higher it is better.

Percent Rate of Return on Assets—this ratio is used to find out the generation of profit is against the company’s assets and it is very important one for business process evaluation. But care must be taken to avoid heavy depreciation which may be affect calculation³.    

Profitability: The ROCE or Return on Capital Employed is used to determine the business profitability and this determinant is helped by Capital employed which is equity and debt figures. Debt fund are other than current liabilities and equity is the fund employed by shareholders. Total capitals employed are calculated by considering the long term debt, shareholders fund taken together. ROCE comprises of two parts operating profit margin and asset turnover. The lower the ROCE it is higher the capital employed or low margin of profit and vice versa. Assets, liabilities, and share capital are to be considered very carefully to calculate ROCE[4].

Introduction

Any business can run in its own way whatever be the size but they all have a common feature which may differ from business to business and from country to country but the basics do not differ. All these businesses need fund or capital to run business and all these also need to have a control on that fund for better profit generation. For this various financial reports are prepared by each and every business to find how they doing.

Small and medium businesses manage the funds in easier manner than bigger ones. Bigger businesses need to have greater organizational structure and systems to make them successful as huge capital is involved and shareholders and other stakeholders are involved with such businesses. Hence to have greater control on the entire financials of the business very strict format of accounting and auditing are followed. To understand the financial health by the management, shareholders, debtors, creditors, bankers, suppliers, government, local bodies, general public, different financial reports and statements are published.  

General reports like Trading Account, Profit and Loss Account and Balance Sheet are the published accounts of any business which are made public. But there certain group of the business like Board of Directors and the Top Management including the Managing Director who needs some more information in detail about the daily , weekly, fortnight, monthly, quarterly, half-yearly, and yearly financial status.

Research on the Financial Ratio

A set of special reports are prepared for them exclusively. These special reports are called Financial or Management Accounting Ratios and this is used to derive various types of financial and non financial information which helps the management to take different types of decisions to save the business from collapse and saving the business from making huge losses.

The different types of Ratios are used by management are summarised here below—

Common Size Ratios–

Common size ratios from the Balance Sheet.

Common size ratios from the income Statement.

Liquidity ratios—

Quick Ratio.

Current Ratio.

Operating ratios—

Cash Cycle.

Return on Assets Ratio.

Accounts Payable Days.

Accounts Receivable Days on Hand.

Accounts Receivable Turnover ratio.

Inventory Turnover ratios.

Inventory days on hand.

Solvency Ratios—

Z-Score.

Working Capital.

Net sales to Working Capital.

Debt to worth ratio.

Business Ratios.

The Current Ratio of TUST Pty Ltd is shown as 2.1:1 in 2012 that means there is presence of 2.1 current assets share against 1 share of current liabilities. In 2013 the ratio became 2.6:1 which means that 2.6 share of current assets are present in the business against 1 share of current liabilities. Enekwe Chinedu Innocent, Okwo Ifeoma Mary and Ordu Monday Matthew stated in their research paper “Financial Ratio Analysis as a Determinant of Profitability in Nigerian Pharmaceutical Industry” pointed out ideal ratios in an industry. The ideal level is fixed in the industry in general is 2:1 that means 2 share of assets against 1 share of current liabilities is ideal. In this case it is evident that for 2012 and 2013 both years the ideal level were achieved and situation was healthy. The level thus achieved must be further maintained and keep forward and increased far more to make the business more healthy financially. Management and auditors must take all necessary steps for the same. This ratio is derived by division of current assets by current liabilities[5].

The acid test ratio or quick test ratio of TUST Pty Ltd is shown as 1.8:1 for 2012 which means that there are 1.8 shares of current assets against 1 share of current liabilities and this figure in 2013 shows as 2.2:1 which means that there is a share of 2.2 current assets against 1 share of current liabilities. The ideal level or desired level is fixed in the industry in general as 1:1. This means that 1 share of current assets is to be present for 1 share of current liabilities. In this case for both the years 2012 and 2013 the ideal level condition was not only achieved but it was much higher than that thus showing the liquidity condition to be very healthy. The management and the auditors must keep on maintaining the same ratio for coming years or try to increase the share of current assets against the current liabilities. This ratio is derived by putting out the inventory part from current assets and subtracting current liabilities.

In another research paper “A financial Ratio Analysis of Commercial Bank Performance in South Africa” by Mabwe Kumbirai and Robert Webb stated the importance of the ratio analysis and banks. TUST Pty Ltd the days inventory in hand is shown as 122 in 2012 and 127 in 2013. In both years it seems that the inventory holding period of almost 4 months is too high. Ideal level is lower the days better the movement of goods. Too high period means trading is slower or sales have dropped extensively or some parts of products are not in demand. It may be that some parts of the goods have become obsolete or out market due to which the demand have fallen or may be the goods were sent to such places from where sales return were too high and it subsequently got affected in the years 2012 and 2013[6].

Too high level of inventory days means that blockage of working capital, high interest cost in maintaining the inventory and also risk of becoming back dated or obsolete or out of market fashion or demand supply break. The higher the inventory brings the risk of damage also by pilferage, theft, burglary, fire, flood, or by other natural calamities beyond imagination like earthquake, Tsunami, etc. Hence it can be said that TUST Pty Ltd should take care of this area very seriously in the future so that the wastage of working capital, loss by higher interest cost and inventory carrying cost can be avoided and easy movement of inventory can be ensured though proper sales management and a good coordination needs to be implemented between sales, purchase, and inventory departments so that over stocking does not takes place and its needs to reviewed by the management team as well as the auditors. This ratio is calculated by taking inventory for this year with inventory of last year and divided by 2 and then the result is divided further by sales cost and multiplied by 365 days.

TUST Pty.Ltd, days debtors outstanding is shown as 30 in 2012 which is a very ideal level as per industry practice is concerned but for 2013 it has become 46 which means one and a half month debtors outstanding in the market. This is 16 days higher than 30, the market or industry standards. According to VIJAY S PATEL and CHANDRESH B. MEHTA stated in their research “A FINANCIAL RATIO ANALYSIS OF KRISHAK BHARATI COOPERATIVE LIMITED” regarding financial ratios includes various means[7].

The accounts department has not taken necessary steps to make follow-ups with the outstanding debtors and with the sales team responsible for generating such credit sales and also required to inform the higher management and Board regarding the same as this very alarming as per the working capital management is concerned. An extra 16 days of working capital and subsequent interest on this is very costly affair. The management and the auditors must take all such steps like stooping further sales to such parties and also warn the concerned sales team of not passing their sales commission is such outstanding are not collected by certain stipulated date as specified by the higher management for recovering the entire debtors overdue by 16 days otherwise in the long run these may convert into bad debt resulting more expenses and less profit generation. This ratio is derived by division of total receivables by sales and multiplied by 365 days.

In the case of TUST Pty Ltd it is found that the net profit margin is shown as 10% in 2012 and as 12.2% in 2013. The profit before interest and tax or PBIT is the calculation required to be done to determine the net profit margin in the business. The ideal level as per the general industry standards is higher the net profit margin it is the better. In this case it is 10% in 2012 and this increased to 12.2% in 2013. It means that the net profit margin have increased by the usage of higher turnover or sales. The ratio is percentage is derived by dividing the PBIT figure by Turnover or sales by multiplying it with 100(%). The other profit margin ratios are also calculated for better understanding and they are

Gross profit/turnover.

Profit after tax/turnover.

Advertising cost/turnover.

Distribution costs/turnover.

Cost of sales/turnover.

The lower profit margins are very bad for any business and its shows the weakness of the business finances. The various business functions like new market entry may affect this percentage as it is in new condition of market sharing with already existing players but it should improve in the long run.

The most important question thus arises is that what type of ratios is to be constantly studied by the management for making business better and financially healthy and surviving and long-lasting. The business financials are becoming more complex day by day and needs very good management ratios for the derivation of correct results.   The ratio of management accounting thus is only used by management and auditors but not general stakeholders. Should not there be any ratios which may be useful to other stakeholders and they may be included in such financial reports generated on the basis of such ratios which may be of great interest and importance like liquidity ratio, net profit margin after making it simple in terminology, Current ratio, Cash ratio, Inventory days, Debtors outstanding days, are some of the useful ratios may be of some use to them.

The ratios of all types particularly the performance ratios and the operating ratios are the most important to follow to get the most important financial indications to understand if the business is in good health or it needs to be put into ventilator or any other type hospitalization is required for making it more healthy and running in the near future. The ratios like Current ratio, quick or acid test ratio, Inventory Days In hand ratio, debtor’s outstanding ratio and the net profit margin ratios are the most important as shown in the case above for TUST Pty Ltd. These ratios cover almost all important functions of the business without which any business cannot move forward. The elements of Inventory, Current assets, Current Liabilities, Accounts Receivables outstanding days, Sales, Average Inventory, PBIT of profit before interest and tax. If these elements are taken with great care which forms the part of operating and performance ratios then any business will prosper in right manner with great survival rate.

Conclusion

The ratios thus studied above are of different types and usage but the management always are positive and optimistic with these ratio approach that the desired result will be achieved if these ratios answer all their questions. The management accountants have worked great and in very hard manner to achieve this and the business these days are prospering with the help of these ratios to great heights.

Introduction:

The financial ratios are calculation and understanding of relative magnitude two selected numerical values collected from the financial report of two enterprises. The comparative financial analysis of two companies includes understanding of relative comparison based on various factors. Financial analysis is an art mostly used by the managers and the financial institutions for assessment of business, projects, performance and profitability. The ratios are expressed in decimal values and it helps to understand back ground and financial health of an organisation.

Financial statement of two companies Qantas Airways Limited and Virgin Australia Holdings Limited are used for calculations of various ratios which can will be interpreted in the following manner to establish the actual reasons for the change.

The careful interpretation of data would result into precise understanding of the business and the business scenarios. These ratios would quantify many aspects of a business. The financial ratios are categorized based on different financial aspects of the company.

The EBIT is nothing but Earnings before Interest and Taxes. The higher earning is reflected by deduction of expenses and costs from sales. The higher EBIT margin represents better management of cost and expenses. Here, Qantas Airways Limited has EBIT margin of 1.85% in 2012 and for Virgin Australia Holdings Limited it is 3.50%. This clearly represents the fact that cost of sales for Qantas Airways Limited is much higher than of Virgin Australia Holdings Limited. This purely reflects the fact that Virgin Australia Holdings Limited has also been managing its costs effectively[8].

ROE stands for Return on Equity. The ratio is calculated by using the formula PAT/Equity x 100. The higher ratio represent better bottom line for the company. Significant increase in equity can also brought down the ROE. Here, Virgin Australia Holdings Limited had ROE of 8.40%, this clearly indicates better bottom line of the company compared to Equity. This can also be interpreted in another way that Virgin Australia Holdings Limited is highly leveraged. But in continuation to EBIT margin, the ROE is better for Virgin Australia Holdings Limited. This indicates better bottom line for the company. On the other hand Qantas Airways Limited had comparatively lower ROE at 3.38%. If it is interpreted in continuation to EBIT margin, this would reflect that higher cost reflected in the bottom line of the company resulted into lower ROE³.

ROA stands for Return on Assets. The higher ROA can only be because of higher bottom line. The ROA increased signifies better utilization of assets for higher sales and cost control. The better utilization of assets to boost bottom line is reflected in this ratio. Here, ROA Virgin Australia Holdings Limited is at 3.29% compared to 2.12% of Qantas Airways Limited. If these two figures of two companies are analyzed based on EBIT margin and ROE. This would clearly indicate that Virgin Australia Holdings Limited has higher net profit in 2012 compared to Qantas Airways Limited. The higher net profit is reflecting in higher ROA⁴.

The debt to equity ratio has increased in 2015 compared to total equity. The long term debt ratio stood at 0.18 in 2014 but increased to 0.20 in 2015. The debt is being used for purchasing fixed assets and to develop property of the company in 2014 but it was repaid in 2015. In terms of total debt and capital, the total debt to outsider stood at AED 0.20 against every AED 1 of capital in 2015. The indication is of low leverage position of the company. This indicates financial strength of the company[9].

In current ratio, Current assets are divided by current liabilities. Higher current ratio or ratio of 2: 1 is considered ideal for much industry. But is not always the case of all companies. Airliner companies usually have lower current assets as these companies usually have lower inventory. Here, Qantas Airways Limited had current ratio of 0.77 compared to 0.65 of Virgin Australia Holdings Limited. Qantas Airways Limited has better ratio than Virgin Australia Holdings Limited. The higher ratio could be caused by lower realization of accounts receivable and holding of too much cash and cash equivalents. The higher amount of creditors and short term loan can bring down current ratio⁵.

The net profit is divided by sales to reflect Net Profit Higher net margins are always better for the companies but the ratio does not indicate whether the sales are coming down or not. As expected Virgin Australia Holdings Limited has better net margin of 2.23% compared to 1.36% of Qantas Airways Limited. If this ratio is analyzed on the basis of previous calculations. This would really indicate that Virgin Australia Holdings Limited has managed its costs in a better way to earn better net margins. Here the important factor is cost and expenses management which is done far better by Virgin Australia Holdings Limited.

Conclusion:

The analysis and the assessment are clearly indicating better performance for Virgin Australia Holdings Limited compared to the other company. Better cot management is the key to better bottom line and better growth. Here, both companies have managed significant gain in the business but better cost management has become the key for Virgin Australia Holdings Limited. This report would really help the managers to understand the key reason for the better performance of Virgin Australia Holdings Limited. The better EBIT ratio is reflected down to the bottom line of Virgin Australia Holdings Limited. This also represents the fact that Virgin Australia Holdings Limited is better managed and the debts are also well managed by this company.

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