Accounting Assignment Help online:: Letter to the MD for change in Senior level management
To,
The Managing Director, 16thAugust, 2011 Smith Ltd.
Dear Sir,
As an accountant it is my imperative on my part to explain to you all about financial sheets .The very basis of these statements and the information it carries for all the stakeholders involved.
In order to understand financial statements we should first understand the reasons for which businesses produce financial statements .Starting up with a very minor reason to reporting financial health of the corporation to raising capital in the market, the financial statements serve a variety of uses. Thus, the very objective of financial statements is to furnish accurate information about the financial position and financial performance of the organisation, this is turn helps to take a wide range of economic decisions. ()
Thus, financial statements provide decision making information to a plethora of users. The most important of these are:
Managers: The prudence of business decisions taking by managers are based upon the numbers of the financial statements.
Shareholders: Investors use Balance Sheets and Cash Flow Statements to understand the risk return profile of their investments
Prospective Investors: To take decisions that would enable them to decide the financial viability of the company to invest in. The risk associated with the financial health of the company can be easily found out by looking at the fluctuating profits, the steadiness of the cash flow and the expenses incurred in the income statement. The financial prudence of the managers can also be found out by looking at the financial statements, thus giving clear indications about the style of management and their future plans with regard to the organisation
Suppliers: The suppliers look at the credit worthiness of the business from the financial statements. Important rations like leverage ration, Debt Service Ratio, Debtor Days and Creditor Days are looked into to understand whether credit should be extended to the organisation and if extended what should be the number of days for which credit should be extended
Government Agencies: Agencies are mostly concerned with the tax declarations by the corporations .They monitor the items in the Balance Sheet to monitor whether organisations have been correct in declaring their taxes. The performance of various industries belonging to the different sectors of the economy is also found out from Balance Sheets.
Customers: The perspective of customers is important mainly from a business to business transaction where the customer is involved with the organisation from the supply of a key component. By looking at the source side of the Balance Sheets the customer can understand whether the organisation is line to secure its future supplies.
Employees: The employees of the organisation look at the financial statements to understand the stability of their jobs and the increment if any that the organisation will declare.
Financial Institution: Banks and other financial institutions look at the financial statements to understand the asset base of the organisation. This thus helps them decided whether to extend an extra line of credit and if extended to negotiate the terms of the credit. The debt service ratio and the leverage ratio is what the banks are generally interested at.
Competitors and General Public: These entities look at the financial statements to understand the performance of the sector involved and have information about the strategies undertaken.
Financial statements thus provided information which is important to majority of the stakeholders involved with the organisation. The decisions taken by these stakeholders in inherently linked with the financial statements and the quality of information they provide. Good and apt financial statements are the ones that provided adequate information but makes sure not to reveal the underlying strategy of the organisation. Thus, in order to satisfy the requirements of the different stakeholders involved an organisation must produce financial statements. Financial statements also provide a set of disciplinary rules for the entire organisation. By setting a date to the publication of financial statement in accordance with rules as set makes sure that transactions happening across the organisation are duly recorded and made accountable for. Thus, all in all a system of financial prudence sets in ((Elliot, Barry & Elliot, Jamie: Financial accounting and reporting).
The users of financial statements can be duly divided into two distinct categories external users comprising customers, investors, suppliers, government agencies like tax and regulatory authorities. The interests of the stakeholders have been discussed in the memo above. It is to be noted that out of all the external users the financial statements are of prime importance to the tax and regulatory authorities, as it is through financial statements they could judge whether the organisation is meeting the compliances as set forth for it
The internal users comprises management, employees and of course the owners of the organisation. Financial statements are of prime importance for management and owners to understand whether the business is line with the goals and strategy set forth by the organisation. Business managers should be careful look at both Balance Sheet as well as cash flow statements to better gauge the well being of the organisation.
There are basically four types of financial statements that are:
I) Balance Sheet
Ii) Income Statement
Iii) Cash Flow Statement
IV) Statement on the changes of equity
I) Balance sheet represents the statement of financial position of an organisation at any given date… A Statement of Financial Position has three main components:
- Assets: Something a business owns or controls.
- Liabilities: Something a business owes to someone
- Equity: What the business owes to its owners. This represents the amount of capital that is left in the business after its assets are used to pay off its outstanding liabilities.
This leads us to the Accounting Equation:
Assets = Liabilities + Equity
The Equation may be re-arranged as follows:
Equity = Assets – Liabilities
Liabilities = Assets – Equity
ii) Income statement also knows as the Profit and Loss statement is about the income and expenses for any given financial year of an organisation. The income statement thus helps to understand whether the set of strategies employed for the given year have generated or have generated loses. Important items like depreciation and amortisation are also covered in the income statement. This helps the organisation about key operating parameters like EBIDTA (Earning before Interest Depreciation Taxation and Amortisation), Pre-Tax Revenues and Post-Tax Revenues. Thus Profit and Loss statement helps us to analyse the decisions taken in the current year.
iii) Cash Flow Statement: Some of the items in the balance sheet like depreciation and amortisation are non-cash expenses as a result of which the profits generated may not actually accrue into cash flows. Thus, to get a clear understanding of the cash flows involved a cash flow statement is prepared. The cash flow statement is divided into three parts Operating Activities, Investing Activities and Financing Activities. Operating activities contains headings like cash flow from operations: trade payables, trade receivables and working capital requirements. Investing activities looks into receipts and payables on purchase and proceeds of sales on current and non-current assets. Financing Activities consists of proceeds from receipt and payment of loads.
iv) Statement in the changes of equity report if any dilution in equity has taken place and also about any changes that may have occurred due to dilution of stakes of the owners involved. This report captures important events like buyback of shares ,splitting of shares and the position of the organisation after any major corporate take over
Financial Statements in spite of their importance have their share of limitation as well. Some of the important limitations that one can think of are:
I)The data reported in the financial statements required astute financial acumen to be interpreted. Without intelligent interpretation they would be just numbers without any conclusive evidence to justify action if any
ii)The financial statements are historic in nature. They do not capture any information regarding the social, economic and political scenario of the future. Thus it may so happen that a firm placed to gain positively by the turn of social and political events may be poorly placed to in terms of financial statements.
iii)Many items in the financial statements are placed to the judgement of the accountant like Depreciation Rules, Cost of Good Valuation ,Bad Debts etc.Thus, objectivity of financial statements may be lost
iv)The value of the fixed assets mentioned as less of depreciation may not be the same as that they would actually fetch in the market
v)The valuation and devaluation of the currency involved is also not captured by the Balance Sheets
vi)Only quantitative information is captured in the financial statements ,qualitative information like such as reputation and prestige of the business with the public, the efficiency and loyalty of its employees, integrity of management etc. do not appear in the financial statement.
v) Different companies follow different principles with regard to depreciation ,amortisation and other non-cash items. Thus comparison across companies becomes difficult.
vi) Changes in senior management level of the organisation, competitive environment ,loss of major customers are not reported by the financial statements.
Regards,
William Dockings,
Accountant.
Question 2
For each scenario below you must indentify:
- The type of business entity used and whether it has limited or unlimited liability.
- The most appropriate source(s) of finance
- Whether the chosen source(s) of finance are internal or external sources of finance
- Explain why you have chosen these sources of finance – try to match the appropriate form of finance against the organisation type.
Scenario 1
Mark Jennings is a plumber who has been working from home for the last 2 years. He would like to buy a property with plenty storage and office space
An) Type of Business Entity Used: Sole Trader
Type of Liability: Unlimited Liability
Sources of finance: Financial Lease
Internal or External: External
Reasons for Leasing: Jennings may not have enough cash to pay for the asset, and may have difficulty obtaining a bank loan to buy it: Leasing may be cheaper than a bank loan
Scenario 2
Hinton Ltd specialises in producing designer t-shirts and has decided to upgrade the current computer network within her offices in Manchester. She estimates that the cost of a new computer network will be £30 000 and would like to upgrade this system every 3 years.
Type of Business Entity Used: Incorporated. Private Limited Company
Type of Liability: Limited Liability
Sources of finance: Hire Purchase
Internal or External: External
Reasons: It can obtain assets now and pay for them over a period of time. This avoids putting a strain on the business cash flows
Scenario 3
Mike Randall has just been made redundant from a major high retailer. He has received a redundancy payment of £50 000 and would like to set up an organic fruit and vegetable shop in Dewsbury.
Type of Business Entity Used: Sole Trader
Type of Liability: Unlimited Liability
Sources of finance: Bank Loans + Own Savings
Internal or External: Internal and External
Reasons: The working capital can be raised through his own savings while the bank loan can be used to finance the shop
Scenario 4
Deplanes Ltd, who specialises in producing bird boxes, would like to upgrade her current machinery in order to be more productive. She has used all available retained profits and would like to spread the cost of £100 000 over a longer period of time.
Type of Business Entity Used: Incorporated. Private Limited Company
Type of Liability: Limited Liability
Sources of finance: Leasing
Internal or External: External
Reasons: It can obtain assets now and pay for them over a period of time. This avoids putting a strain on the business cash flows
Scenario 5
Ken Gilkes wants to set up a mobile car valeting service and needs to buy equipment such as a power jet, cleaning materials and a small white van with which to visit clients. Ken estimates that he will need at least £15 000 to buy all the necessary equipment.
Type of Business Entity Used: Sole Trader
Type of Liability: Unlimited Liability
Sources of finance: Own Savings
Internal or External: Internal
Reasons: The working capital can be raised through his own savings
Scenario 6
Kotecha Ltd is a family run business selling authentic Indian food. The company has been very successful in the UK and is looking to expand its operations in Europe. They are planning to open a new factory as well as 100 outlets across Europe. This is estimated to cost £5 million. Type of Business Entity Used: Incorporated. Private Limited Company
Type of Liability: Limited Liability
Sources of finance: Franchising
Internal or External: External
Reasons: Instead of establishing branches under its own name it licenses franchisees to use its name, corporate identity and so on. Thus it need not spend money on branches, employee costs and working capital requirements
Scenario 7
Jonathan Whelan is a partner in a solicitors firm and would like to purchase 10 company cars for use by the 10 partners. They will be covering a wide geographical area and therefore each car will be subject to high mileage.
Type of Business Entity Used: Incorporated. Private Limited Company
Type of Liability: Limited Liability
Sources of finance: Hire Purchase
Internal or External: External
Reasons: It can obtain assets now and pay for them over a period of time. This avoids putting a strain on the business cashflows.They will also pay less as compared to leasing
Scenario 8
Swifty Ltd has just designed an innovative teabag with milk and has been turned down by the local bank and is in need of a substantial investment. She also needs support and help in launching this risky but innovative product.
Type of Business Entity Used: Sole Trader
Type of Liability: Unlimited Liability
Sources of finance: Grants
Internal or External: External
Reasons: The grants provided by various business development corporations will help to set up the business. They will also provided advice and direction to the new business initiative
Scenario 9
Charlotte King runs a high class boutique and needs to replenish her stock levels. She is currently experiencing cash flow problems due to the seasonal nature of her business and needs to think of ways of getting new stock.
Type of Business Entity Used: Sole Trader
Type of Liability: Unlimited Liability
Sources of finance: Bank Overdraft
Internal or External: External
Reasons: The amount required is for day to day managing of business and can be easily carried out through bank overdraft.
Scenario 10
Sophie Leader runs a small hairdressing salon in Prestwich and has had a final demand from her telephone provider. She is currently having cash flow problems and needs to pay the bill before she is cut off!
Type of Business Entity Used: Sole Trader
Type of Liability: Unlimited Liability
Sources of finance: Friends and family
Internal or External: External
Reasons: The amount required is meagre and can be easily borrowed from family and friends without the need to pay interests
NB20
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