Referral/Deferral Assignment
The following is the summarised financial information of Fastenings Ltd for 2010
Profit & Loss Information for the year ended 31 December
Actual Budget
£000 £000 £000 £000
Sales 11,500 14,835
Cost of sales
Opening inventories 985 1,160
Purchases 6,350 8,980
Closing inventories (1,160) (6,175) (1,445) (8,695)
Gross profit 5,325 6,140
Expenses (2,020) (3,285)
Operating profit 3,305 2,855
Balance Sheet Information as at 31 December
Actual Budget
£000 £000
Fixed Assets
Property, plant and equipment 5,200 7,775
Current assets
Inventories 1,160 1,445
Trade receivables 750 1,485
Bank 230 20
2,140 2,950
Current liabilities 640 969
Non-Current liabilities 2,409 4,190
Additional Information:
Trade receivables as at 31st December 2009 were £340,000
All sales are on credit
Required:
Assume that you are a writing a report for the Chief Executive of Fastenings Ltd. It is January 2011 and your report must comment on the performance of the business during 2010. The figures shown in the ‘Budget’ column were produced by the company accountant in December 2009. Budget preparation is a task the company accountant performs alone and once produced the figures are not referred to again until after the end of the financial year. In your analysis you should use variance analysis and ratios and any other accounting techniques that you consider appropriate.
Your report should address the following issues:
- Introduction – A brief introduction to the report including reasons for using both variance and ratio analysis (5 marks)
- Description and justification – of the ratios you decided to use (10 marks)
- Calculation – of the ratios (20 marks)
- Calculation – of variances between actual and budgeted performance. (including differences between budgeted and actual ratios) (20 Marks)
- Findings – of your analysis (15 marks)
- Limitations – of your analysis with regards to the information you have been provided. (10 marks)
- Conclusion – including recommendations for action Fastenings Ltd needs to undertake in the future and how performance could be monitored. (20 marks)
Word Limit: 1600 words excluding any tables, calculations and references
The report is to be written individually. The areas mentioned above must be covered in your report. The calculations required for the report will account for 40% of your coursework mark. There is also an emphasis on analysis and evaluation. The chief executive will soon be making a presentation to the board of Fastenings Ltd The board will be looking to hear practical steps the company can take to improve performance. Where appropriate your reasoning must be supported through adequate and rigorous referencing (do not use the essential textbook as your only source) and the report must follow the Harvard style of referencing. The Academic Skills Unit (ASU) has developed materials explaining his form of referencing. This is available in the ASU area of Studynet.
Please ensure while writing the report you clearly state all your assumptions and the reasoning behind them. Some of the required parts of the report do not have a correct answer and the mark awarded will depend on the application of the knowledge and understanding that you will display in your arguments.
You will be assessed on:
- Coverage and application of relevant theory
- Critical analysis of data
- Critical evaluation of results
- Evidence of reading and research (including sourcing and referencing using the Harvard referencing system throughout, accompanied by a bibliography)
- Overall structure and presentation of report (including requirements listed below)
Your answer should be written in Microsoft Word in report format. Please use 1.5 or double line spacing and font size no less than 12. You should submit one Microsoft Word file via StudyNet. State your name and ID number on the front page of the report and present your calculations in the form of an APPENDIX in the end of the report.
Submission date: 10pm Monday 18June 2012
SOLUTION
Introduction:
The report uses both ratio analysis and variance analysis. Through ratio analysis the performance of Fastenings ltd has been analyzed in absolute terms. Through variance analysis the performance has been analyzed against the predetermined targets or expectations set in the budget.
Ratio analysis is the most popular method of analyzing financial statements. Liquidity ratios, profitability ratios, leverage ratios and turnover ratios have been used for analyzing the performance of the company (Kieso, D. E, Weygandt, J. J, & Warfield, T. D,2007).
Both revenue and cost variance have been used for analyzing the performance of Fastenings ltd against budgeted targets and estimates (Ehrhardt, M., Brigham, E ,2008).
Ratio Analysis of the Profit & Loss statement and Balance Sheet of the company for 2010
All figures in GBP’ 000
Profitability ratios
Gross profit margin:
| Gross profit |
5325 |
| Sales |
11500 |
| Gross profit margin |
0.463043 |
The gross profit margin of Fastenings Ltd in 2010 is 46.30 per cent. This ratio measures the margin left after meeting the cost of sales or manufacturing costs.
Budgeted Gross profit margin:
| Budgeted sales |
14835 |
| Budgeted gross profit |
6140 |
| budgeted gross profit margin |
0.413886 |
The budgeted gross profit margin is less than the actual profit margin.
Operating profit margin:
| Operating profit |
3305 |
| sales |
11500 |
| operating profit margin |
0.287391 |
The operating profit margin of Fastenings Ltd in 2010 stood at 28.739 per cent. The operating profit margin measures the margin left after meeting the operating expenses.
Budgeted operating profit margin
| budgeted operating profit |
2855 |
| budgeted sales |
14835 |
| budgeted operating profit margin |
0.19245 |
|
Return on capital employed
Operating profit |
3305 |
| Tax rate |
25% |
| NOPAT |
2478.75 |
| Average total assets |
7340 |
| Return on capital employed |
0.337704 |
The return on capital employed (ROCE) of Fastenings ltd in 2010 stood at 33.77 per cent. ROCE measures the return on total capital invested in the business.
Budgeted Return on capital employed :
| budgeted operating profit |
2855 |
| tax rate |
25% |
| Budgeted NOPAT |
2141.25 |
| Budgeted total assets |
10725 |
| Budgeted Return on capital employed |
0.19965 |
Liquidity Ratios:
Current Ratio
| Current Assets |
1160 |
| Current liabilities |
640 |
| Current ratio |
1.8125 |
The current ratio of Fastenings ltd on December 31st, 2010 stood at 1.8125. The current ratio measures the capacity of the firm to fulfill its current liabilities. A current ratio of 2 is generally considered to be safe and current ratio of Fastenings Ltd is less than that.
Budgeted current ratio:
| Budgeted current assets |
2950 |
| budgeted current liabilities |
969 |
| budgeted current ratio |
3.044376 |
Acid-Test Ratio
| Quick assets |
980 |
| current liabilities |
640 |
| Acid-test ratio |
1.53125 |
|
|
The acid test ratio is a better measure of liquidity than current ratio. It excludes inventory from its calculations. Quick assets are calculated by deducting inventory from current assets.
Leverage Ratios:
Debt-to-equity ratio
| Total Assets |
7340 |
| total liabilities |
3049 |
| Shareholder’s equity or net worth |
4291 |
| Debt-to-equity ratio |
0.415395 |
The debt-to-equity ratio of Fastenings Ltd on 31st December 2010 stood at 41.53 %. Fastenings Ltd is therefore not a highly leveraged company and is less vulnerable to risk of bankruptcy.
Budgeted debt-to-equity ratio
| Budgeted total assets |
10725 |
| Budgeted total liabilities |
3049 |
| budgeted shareholder’s equity |
7676 |
| Debt-to-equity ratio |
0.397212 |
Turnover Ratios:
| Cost of goods sold |
6175 |
| Average inventory |
1160 |
| Inventory turnover ratio |
5.323276 |
The inventory turnover ratio measures the efficiency of inventory management. The higher the inventory turnover ratio, the more efficient is the inventory management of the company. However a high inventory turnover ratio may also be due to low levels of inventories, which may cause frequent stockouts and loss of sales (Ehrhardt, M., Brigham, E ,2008).
Inventory turnover ratio of Fastenings Ltd in 2010 stood at 5.323.
Debtors Turnover Ratio
| Net credit sales |
11500000 |
| Trade receivables on December 31st, 2009 |
340000 |
| Trade receivables on December 31st, 2010 |
750000 |
| Average sundry debtors |
545000 |
| Debtors Turnover Ratio |
21.10092 |
The debtors turnover ratio measures the efficiency of credit management. The higher the debtors’ turnover ratio, the more efficient is the credit management. The debtors’ turnover ratio of Fastenings Ltd in 2010 stood at 21.10, which is very good.
Budgeted Debtors’ Turnover ratio
| Budgeted sales |
14835000 |
| Budgeted trade receivables |
340000 |
| Trade receivables on December 31st,2009 |
750000 |
| Average debtors |
545000 |
| Budgeted debtors’ turnover ratio |
27.22018 |
Average collection period
| Debtors turnover ratio |
21.10092 |
| Average collection period |
17.29783 |
The average collection period of Fastenings Ltd in 2011 stood at 17.29 days.
Fixed assets turnover ratio
| Net sales |
11500 |
| Average net fixed assets |
5200 |
| Fixed assets turnover ratio |
2.211538 |
The fixed assets turnover ratio of Fastenings Ltd in 2010 stood at 2.211. This ratio measures the efficiency in utilization of fixed assets of the company – the higher the ratio, the more efficient is the utilization of fixed assets.
Total Assets turnover ratio
| Net sales |
11500 |
| Average total assets |
8249 |
| Total assets turnover ratio |
1.394108 |
The total assets turnover ratio of Fastenings Ltd in 2010 stood at 1.394. This ratio measures the efficiency of the utilization of total assets of the company. The higher the ratio, the more efficient is utilization of assets.
Variance Analysis:
Gross Profit Margin Variance:
| Actual Gross profit margin |
0.463 |
| Budgeted gross profit margin |
0.4138 |
| Gross profit margin variance |
0.0492 |
The gross profit margin of Fastenings ltd is favorable.
Operating profit margin variance:
| Actual operating profit margin |
0.28739 |
| budgeted operating profit margin |
0.19245 |
| Variance |
0.09494 |
The operating profit margin variance is favorable.
Current ratio Variance:
| Current ratio |
1.8125 |
| Budgeted current ratio |
3.044 |
| Variance |
-1.2315 |
The current ratio variance is unfavorable.
Debt-to-equity ratio variance
| Actual debt-to-equity ratio |
0.41539 |
| Budgeted debt-to-equity ratio |
0.3972 |
| Debt-to-equity ratio variance |
0.01819 |
Sales variance:
| Budgeted sales |
14835 |
| Actual sales |
11500 |
| Sales variance |
3335 |
| Sales variance as a percentage of estimates |
22.48062 |
The sales variance was unfavorable in 2010 i.e. actual sales were less than budgetary estimates. Sales variance as a percent of budgetary estimates stood at 22.48062 per cent.
Cost of sales variance:
| Budgeted cost of sales |
8695 |
| Actual cost of sales |
6175 |
| Cost variance |
2520 |
| Cost variance as a percent of budgetary estimates |
28.98217 |
The cost of sales variance was favorable i.e. actual costs were less than budgeted costs. However the main reason for this is that the actual sales were much less than budgeted sales, therefore cost of sales is also less than budgeted estimates.
Purchases variance:
| Budgeted purchase estimate |
8980 |
| Actual purchase |
6350 |
| Purchase variance |
2630 |
| Purchase variance as a percentage of budgetary estimates |
29.28731 |
The purchases variance in 2010 was favorable, mainly because of lower actual sales than budgetary estimates. The favorable purchase estimates, as a percentage of budgetary estimates, stood at 29.28 per cent during 2010.
Gross profit variance
| Budgeted gross profits |
6140 |
| Actual gross profit |
5325 |
| Gross profit variance |
815 |
| gross profit variance as a percentage of budgetary estimates |
13.27362 |
The gross profit variance is unfavorable i.e. actual gross profit is less than budgetary estimates. The gross profit variance in 2010 stood at 13.27 per cent.
| Budgeted operating expenses |
3285 |
| Actual operating expenses |
2020 |
| Expenses variance |
1265 |
| Expenses variance as a percent of budgetary estimates |
38.50837 |
The operating expenses variance was favorable i.e. actual expenses were less than budgeted one.
Operating profit variance
| budgeted operating profit |
2855 |
| actual operating profit |
3305 |
| Operating profit variance |
450 |
| Operating profit variance as a percentage of budgetary estimates |
15.76182 |
The operating profit variance in 2010 of Fastenings Ltd was favorable. This was mainly because of operational efficiency of Fastenings Ltd which ensured that in spite of lower than estimated revenues; the company was able to exceed budgetary estimates of operating profit.
Fixed Assets variance:
| Budgeted fixed assets |
7775 |
| actual fixed assets |
5200 |
| fixed assets variance |
2575 |
| fixed assets variance as a percentage of budgetary estimates |
33.11897 |
The actual fixed assets are less than budgeted fixed assets. This might be because Fastenings Ltd’s actual capital expenditure was much less than was originally envisioned.
Current Assets variance:
| Budgeted current assets |
1445 |
| Actual current assets |
1160 |
| Current assets variance |
285 |
| current assets variance as a percentage of budgetary estimates |
19.72318 |
The actual current assets on 31st December 2010 were less than budgeted estimate. This was mainly due to trade receivables which were actually much less than budget expectations. Inventories too, at GBP 1160000, were less than budget estimate of GBP 1445000.
Current liabilities variance
| Budgeted current liabilities |
969 |
| Actual current liabilities |
640 |
| Current liabilities variance |
329 |
| current liabilities variance as a percent of budgeted estimates |
33.95253 |
The actual current liabilities were much less than budget estimates. The current liabilities as a percentage of budgeted estimates stood at 33.95 per cent.
Non-current liabilities variance
| Budgeted non-current liabilities |
4190 |
| Actual non-current liabillities |
2409 |
| Non-Current liabilities variance |
1781 |
| Non- Current liabilities variance as a percent of budget estimates |
42.50597 |
There is a favorable non-current liabilities variance i.e. actual non-current liabilities were much less than budgeted estimate. Fastenings Ltd has not used leverage or debt as much as was estimated in the budget.
Findings:
Fastenings Ltd managed to generate operating profit margin of 28.73 percent. The return on capital employed stood at 33.77 per cent. The company seems to have succeeded in maintaining a high degree of operating efficiency which is the main reason why it was able to post operating profit, in spite of the fact that actual revenues were less than targeted revenues.
Fastenings Ltd is not a highly leveraged company. Leverage can be increased to increase returns to shareholders. The company’s capital expenditures during the year were much less than expected in the budget, and this may hamper its growth in future.
The turnover ratios of the company are reasonably good with high inventory turnover ratio and debtors turnover ratio..
Limitations:
The limitations of this financial analysis report arise from lack of data on some crucial parameters like net profit. Without the information on net profit for the year, the return on equity couldn’t be calculated. Return on equity is the most important measure of performance as it shows the return given to owners or shareholders of the company (Prasanna Chandra, 2010).
The budget has not been prepared in an appropriate way. It should have information on net profit.
Conclusion
The actual revenues, assets and liabilities of Fastenings Ltd are less than budgeted estimates. However gross profit, operating profit and return on capital employed are greater than budgetary estimates because of efficient cost controlling.
It is recommended that Fastenings Ltd in future should focus more on revenue generation. Currently the company seems to be focusing too much on cost controlling. The revenues in 2010 were much less than budget estimates.
Fastenings Ltd should also use more debt, which is a cheaper source of capital than equity, for amplifying the return generated for shareholders.
Fastenings should also maintain an adequate rate of capital expenditure in order to sustain its future growth.
References:
Kieso, D. E., Weygandt, J. J., & Warfield, T. D.,2007, Intermediate Accounting (12th ed.). Hoboken, NJ: John Wiley & Sons
Ehrhardt, M., Brigham, E ,2008, Corporate Finance: A Focused Approach, Prentice Hall
Prasanna Chandra, 2010, Investment Analysis and Portfolio Management, Prentice Hall
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