Comparative Financial Statements - Assignment Example

Short essay on finance problems Answer Financial analysis can be explained as the interpretation of the financial statements. The financial analysis tools and technique are developed for determining the financial position of the business or the company. There are various financial tools, techniques and methods for analyzing the financial statement of the company or the business. The different techniques of the financial analysis have been developed to ascertain the financial performance and efficiency of the business. The specialized financial analysis tool measures the profitability of the business, determines the growth of the business, and assesses the financial strength as well as solvency of the company. The five specialized financial analysis tools include comparative financial statements, trend analysis, ratio analysis, fund flow analysis and cash flow analysis. The five specialized financial analysis tool can be explained as follows. Comparative financial statements The comparative financial statement can be explained as the tool or method for comparing the current financial statement of the business in comparison with the financial statement of the previous year and this tool helps in identifying the weakness and taking or adopting corrective measure. The comparative financial statement mainly includes the income statement and the balance sheet. The income statement as well as the income statement is prepared in the statement form for the purpose of comparison of the financial statement for the two financial years. Trend Analysis The trend analysis can be explained as a tool or the technique that is developed for analyzing and interpreting the financial statement of the company or the business over a series of period or years. The trend analysis is conducted by calculating and estimating the figure of each item by considering the base year as 100. The trend analysis assists the company or the business in evaluating and analyzing the figure that whether it is moving upward or downward. Ratio Analysis Ratio analysis is considered as the most important and the vital tool for the preparation of the financial statement of the company or the business. Ratio analysis is applied for evaluating the various aspects of the operating and financial performance of the company or the business and it determines or identifies the liquidity, profitability, solvency and efficiency position of the business or the company. The ratio analysis is conducted for comparing the performance and efficiency of other companies in the same industry. The ratio analysis is generally considered or regarded as the cornerstone of the fundamental analysis. Cash Flow Analysis Cash flow analysis is also considered another important and specialized financial tool. It is generally prepared by the business or the company for determining the outflow and inflow of the business or the company over a specific period of time. The cash flow analysis not only deals with the inflow and outflow but it also deals with the time required for the flow of the cash and therefore it is also known as the cash flow budget. Fund flow analysis Fund flow statement is one of the important financial statements of a company and it indicates the main reasons for major changes in a company’s capital structure or financial position between two balance sheets of two consecutive financial years. Fund flow statement analysis helps an investor by evaluating the net outflow and inflow of funds, major sources of inflow and major purposes of outflow. Indentifying the changes in working capital is one of the key objectives of preparing fund flow statement. Fund statement analysis provides detail overview about two categories of fund inflows such as funds raised by issuance of debentures and shares and funds generated from continuous business operation. Answer 2 The assets of the purchasing company are related to the liabilities of the company and it deals with the ability of the business in converting it into cash. The liabilities of the business or the company are arranged in accordance with the time required for its payment. Liability is considered as an obligation for the company (Bull, 2007). The items that are explicitly not recognized or included in the liability side of the balance sheet includes are cash advance, lawsuit payable, warranty liability, bonds payable and unearned revenue. The cash advance is not recognized in the liability side of the balance sheet because it is expected to have the obligation in returning the cash that is taken in advance. Warranty liability is also not recognized or included in the balance sheet since the warranty agreement creates an obligation for the payment received for providing warranty services in future. This item is not recognized in the liability side of the balance sheet because the obligations will be fulfilled within the period of warranty and therefore it is not included and the main reason for not recognizing it in the balance sheet is that it fulfills criteria that has been mentioned in the accounting recognition. The law suit payable is an obligation of the firm or the business is not recognized in the liability side of the balance sheet. The item is included in the adjustment entry. The firm or the business does not consider the obligation arising out of the lawsuit and the company cannot estimate the amount that is due. The unearned revenue is not recognized in the liability items of the balance sheet because the ascertainment of the revenue is subjected to uncertainty in the measurement of the amount and the timing that is required for the generation of revenue as the amount is not recognized under the accounting standard IFRS and GAAP and this amount will decrease in the future date. The bonds payable is not recognized in the liability side of the balance sheet since the bonds are subjected to fluctuation. The above liabilities that are not recognized in the liability side of the balance sheet are considered or known as the contingent liability and they are the potential liability of the company or business be3cause these items are affected by the future event that may or may not occur as they are not disclosed in the balance sheet they are separately recognized in the notes. Assessing the value of these items is very difficult and complex and therefore the valuation of these items are to be interpreted carefully. Answer 3 The red flag items that an astute analyst is required to consider apart from increasing its account receivable without the growth in sales can be explained in reference or support of the following points The companies or the firms are expected to meet its target within a stipulated period of time that will increase the growth rate. The companies generally expect to satisfy the earnings and generating smooth earning path. Therefore it is expected by the firm to determine the earning per share of the firm or the business that will lead towards its growth and development. The companies or the business firms generally adopt the conservative depreciation approach that will assist the investors in determining the most appropriate depreciation rate of the industry. The depreciation charged will result in the increase in the earning of the firm in the short run and it is not associated with the replacement cost of the firm or the company. Monitoring or evaluating the revenue and the expenses of the company or business is considered as an important and critical step for determining the profit or the revenue of the company or the business. Determining and maintaining of inventory in which the companies or the business is required to contribute in the distribution channel. Determination of inventory is very critical and therefore the need of inventory is required to be scrutinized and monitored carefully. The inventory is considered as an important item of the red flag activity. The maintenance of inventory can create problem in shipping and distribution process. Therefore the inventory is required to be maintained in such a way that it increases the earnings and revenue of the company or the business. Earnings before interest tax, depreciation and amortization measure the performance of the business or the firms. This is also considered as an important item of the red flag activity since it determines the earning of the company before paying of its interest and tax (Kieso, Weygandt, and Warfield, 2007). Answer 4 Inventory turnover ratio is used to determine the time that is required to sell the inventory and it is replaced at a specific period of time. The account receivable turnover ratio can be explained as the ratio that determines the efficiency position of the firm or the business. It determines the time taken by the business to convert its receivable into cash. Part 4a ABC Company the manufacturer of the computer has experienced a lower inventory turnover as compared to the inventory turnover in the previous year. The effect of the decrease in inventory on the financial position of the company can be analyzed by the fact that inventory affects the profitability of the business. The lower inventory can affects negatively on the cost and profitability of the company. The negative or the adverse affect on experiencing lower inventory can be explained as lower inventory level can be a threat for the company as it will increase the shipping and logistic cost of the company as the company will have to pay high cost for fast and quick delivery of its premium products. Since ABC is a computer manufacturing company therefore it is subjected to depreciation therefore maintain lower level inventory is not favorable since it will result in the probability of damage or spoilage of the computer and lower inventory will increase the holding cost of the inventory. Maintaining lower level inventory is not favorable for the company since it limits the space needed for the storage of the inventory which minimizes the cost of maintains the inventory and it affects the liquidity position of the company. Part 4b The effect of lower account receivable experienced by the company in the current year as compared to the previous years and its impact on the financial position of the company can be emphasized with the help of the following points Experiencing lower account receivable will strengthen the company in increasing the collection period of the company and improving the cash cycle of the company. Lower account receivable also improves the net sales of the company and it will increase the efficiency of the company in using all of its assets. On the contrary the adverse impact on lowering the account receivable of the company can be observed by the fact that it will lead to the decline in economic situation of the company and will lead to the increase in bad debt. Therefore from the above analysis on the basis of lower inventory turnover level by the company in the recent year as compared to the previous year signifies that the financial condition of the company has degraded in the recent year. But lower account receivable turnover is favorable for the company (Parker, 2007). Answer 5 Assuming the role of the investment analyst of Edward Jones company in advising investment to my client by analyzing the financial ratios of both the companies Graph Tech inc and Core Software Company it can be observed that on the basis of the ratios and it can be emphasized that the inventory turnover in case of core software is less as compared to the graph tech which indicates that the liquidity position of core software is more favorable as it has less inventory turnover ratio it can quickly dispose of its inventory. The gross profit percentage of core software is also more as compared to graph tech inc which indicates that core software is able to generate more revenue. The return on equity and the time interest earned of core Software Company is more as compare to the graph tech Inc which signifies that the company is able to increase its profitability from the amount invested by the shareholders and the time interest earned indicates that the company is more efficient in generating its earning after paying of its interest and depreciation (Helferty, 2001). The day sales receivables of core software company is less as compared to Graph inc which indicates that the company experiences less collection period for its receivables therefore it implies that the company is efficient in quickly realizing its due account receivables on the contrary the return on asset of Graph tech is more as compared to that of core software company which indicates that Graph tech is more effective in generating revenue through the proper utilization of its assets. Therefore on the basis of the above analysis it is clear that Core software company is more favorable for investment as compared to Graph tech inc since the financial condition of core software company is more sound as compared to Graph tech inc (Peterson and Fabozzi, 2012). Answer 5 The financial condition of can be analyzed with the help of the liquidity and the profitability ratio of the company. The total current asset of the company in 2014 is 2, 10, 000 US $ and the total current liability of the company in 2014 is 2, 989, 000. Therefore the current ratio of the company is (2, 10, 000 / 2,989,000) = 0.07 which signifies that the financial condition of the company is not favorable since the liquidity condition is not favorable as the current ratio is less than 1 and the current liability of the company is more than its current asset and therefore it is advisable that the company should strengthen its total current asset base. The inventory turnover ratio which determines the efficiency of the company can be determined by considering the average inventory and the cost of goods sold of the company which is 5,370,000 and 9,70,500 therefore the inventory turnover ratio is (5,370,000 / 9,70,500 ) = 5.5 which indicates that the company inventory turnover level is favorable . The investment position of the company can be evaluated by assessing the debt ratio of the company by evaluating (6, 498, 000 / 8,113, 000) = 0.8 which indicates that the debt ratio of the company is less therefore the company has less obligation to pay of its liabilities and the profitability position of the company can be analyzed by calculating the operating profit margin ratio of the company by considering the operating income and revenue of the company and it can be calculated as ( 1,192,000 / 8,268,000) = 0.14 which indicates that the profitability condition of the company is not favorable therefore the company should focus on increasing its total revenue to improve its profitability condition (Campbell Soup Company, 2014). The average collection period of the company for the year 2014 can be evaluated or ascertained by taking into consideration the net receivables and the total revenue of the company and dividing the net receivables by total revenue (6, 70, 000 / 8, 268, 000)*365 = 29 days which indicates that the company should focus more on reducing its account receivable period for the prompt collection of its due. The return on investment of the company can be observed by dividing the net profit of the company after tax by the total asset of the company ( 1073000 / 8113000) = 0.132 which indicates that the financial position of the company is not sound as it is not capable of generating sufficient return from its investment and the total operating expenses of the company can be evaluated by dividing the total operating expenses by the total revenue of the company ( 1706000 / 8268000) = 0.20 which indicates that the operating expenses of the company is not more therefore it can utilize its revenue for the generation of earning in the subsequent year. Therefore as a financial analyst I can advise that the company financial position is not very favorable for investment since the liquidity and profitability condition of the company is not sound as it is less than 1 and therefore the company is required to focus on the profitability and liquidity position in order to pay of its short term debt obligations and liabilities. The return on investment of the company is also not favorable which indicates that the company is not efficient in generating return from its investment and the account receivable period should be reduced so that it can collect its receivables within a short stipulated time period which will reduce its burden but the operating expenses is not so higher therefore the company can adjust its revenue for conducting other activities and future investment apart from meeting its operating expenses References Bull, R. (2007). Financial Ratios: How to use financial ratios to maximize value and success for your businesses. Amsterdam: Elsevier. Campbell Soup Company. (2014). Annual report. Retrived from. http://investor.campbellsoupcompany.com/phoenix.zhtml?c=88650&p=irol-reportsannual. Helferty, A. (2001). Financial Analysis: Tools and techniques. New York: McGraw Hill. Kieso, D. E., Weygandt, J. J. and Warfield, T. D. (2007). Intermediate Accounting. New York: John Wiley and Sons. Parker, R. (2007). Understanding company financial statements. London: Penguin Books. Peterson, P. P. and Fabozzi, F. J. (2012). Analysis of financial statements. New Jersey: John Wiley and Sons. Read More