This essay consists of three parts. In the first part of this essay, the financial analysis of the Small Company Ltd. has been made by using the ratio analysis tool. Some of the most important ratios for this company have been calculated by using the financial information for the two years (i.e. 2012 & 2013). Moreover, important areas of the business are also highlighted that requires the greatest attention and the concentration of the management of this company.
Second part of the essay includes some healthy discussions on the stakeholders of the company and also the discussion of how the accounting reports assist these stakeholders have been made in detail.
In the last part of the report, discussions about the legal regulation bodies that are responsible for the publication of the accounting reports have been made. Moreover, it has also been explained in sufficient detail that how these regulation bodies helps to prevent the companies in terms of providing the misappropriated information to the shareholders.
Financial Analysis of Small Company Ltd.
In order to analyze what’s going wrong with the business of Small Company despite of increasing the sales in the recent time (i.e. 2013 year), ratio analysis tool is being used.
Following are the lists of ratios that have been calculated in order to analyze the Small Company Ltd.
- Gross Profit Margin
- Operating Profit Margin
- Return on Capital Employed
- Current Ratio
- Quick Ratio
Above ratios have been calculated for the year 2012 and 2013 on the basis of the provided annual report of the Small Company Ltd. Below is the detailed discussions of the ratio analysis along with the working document of the ratios.
Gross Profit Margin
This ratio is used to judge that whether the Small Company is generating enough gross profits or not. Gross profit means the profits of the business that is derived after deducting the cost of sales only from the revenue/sales (i.e. turnover).
As clear states in the above mentioned detailed graph that the gross profit margin of the Company was 45.55% and 30.67% in year 2012 and 2013 respectively. These figures show that the gross profit margin was reduced by 14.78% (i.e. 45.45-30.67) in year 2013 as from the year 2012. That reduction is just because of increasing the cost of sales of the Company. Despite of the reduction in the gross profit margin, still these percentages are considered to be high for the Small Company Ltd.
Operating Profit Margin
That ratio is used to judge the capability of the Company relating to earning the operating profits. Operating profit is the profit of the business that is derived after deducting the cost of sales and operating expenses (i.e. selling/distribution and administrative expenses) only from the business turnover.
The operating profit margin of the Company was 18.91% and 6.33% in year 2012 and 2013 respectively. It is pretty much obvious that the operating profits percentages are very low despite of achieving the reasonable percentages of the gross profit margin. After calculating this ratio, it has been identified that the operating expenses (i.e. especially the administrative expenses) have been increased significantly in year 2013 as compared to the previous year (i.e. 2012 year). That is a major factor which reduced the profit for the year 2013 despite of making the more sales in year 2013 as compared to year 2012.
For example, the administrative expenses of the Company were 132,000 in year 2012 but it has been increased to 168,000 in year 2013 which is the threatening part of the business.
Return on Capital Employed
Return on capital employed is the typical accounting term which needs to be understood firstly in order to analyze the figures. Capital employed means the shareholder’s funds and the long term liabilities of the business. So return on capital employed ratio is the most widely used ratio to evaluate a company’s efficiency in terms of earning the profits from the capital investments.
As shown in the above graph that the return on capital employed of the Company was 51.38% and 19.54% in year 2012 and 2013 respectively. It again showed that this ratio is decreased significantly (i.e. by 31.84%) in year 2013 as from the year 2012. It means that the Small Company is not generating a sufficient return with the employed capital and the main factor is the reduction of the profits in year 2013 as from the previous year.
This ratio is used to check that whether the Company has sufficient current assets so that they can pay the current obligations smoothly and easily without facing any financial crisis. As a standard figure, ratio 2 is seems to be a healthy sign for the company.
As shown in the above graph that the current ratio of the Company was 4.97 and 3.58 in year 2012 and 2013 respectively. After analyzing these figures, it is evident that the Small Company has more than necessary current assets in order to pay the current liabilities of the Company. It is pointed out that lots of funds of the Company in the form of current assets are tied, and they can be used in the long term capital investments which will help the Company to earn higher profits than the existing profits.
This is same like the current ratio but only difference is that this ratio check that whether the company has sufficient most liquid assets (i.e. those assets which can easily and rapidly be converted into cash) in order to pay the current obligations. As a standard, ratio 1 is seems to be a good sign for the company.
The quick ratio of the Company was 2.73 and 2.66 in year 2012 and 2013 respectively. Again it showed the same result as the current ratio shown that the Small Company Ltd. has far more than the necessary liquid assets in order to pay current liabilities.
On the basis of above ratio analysis, it has been concluded that there are lots of areas that the management of the Small Company Ltd. should have to focus, and it needs greater attention of the management. If these areas are resolved then the Company will surely able to convert its sales revenues into big profits margins. These areas are listed below.
- Control the cost of sales of the business
- Control the operating expenses of the business especially
- Finding capital investments opportunities which generate the higher level of returns
- Utilizing the idle short-term resources in order to get maximum advantages of the funds of the Company
Stakeholders mean those persons who have an interest in the company. Interest is not same for all the stakeholders. So all the stakeholders are not the same. Stakeholders can be classified as the internal stakeholders of the business/company or the external stakeholders of the company.
Following are the lists of some of the stakeholders of the business.
- Owners(i.e. shareholders of the company)
- Employees of the business
- Trade Union
- Financial Institutions
- Government Taxation Departments
All above listed stakeholders can influence or be influenced by the company’s actions and policies and have an interest in the activities of the company. That’s why these are considered to be the stakeholders of the company. Some of them are the internal stakeholders of the company as directors, owners, employees and others are recognized as the external stakeholders of the company as trade union, financial institutions, taxation officers etc.
Accounting reports of the company can assist them in many ways as the information needs of all the stakeholders are different. Following are the major five components of the accounting report/annual report.
- Income Statement
- Balance Sheet
- Statement of Changes in Equity
- Statement of Cash Flows
- Notes to the Accounts
Following is the detailed explanation that how accounting reports can assist each of the above mentioned stakeholders.
Ways that Accounting Reports Can Assist the Stakeholders
Accounting reports helps the directors and owners of the company greatly in terms of judging that whether the business is going well, how many profits a company is earning, how much assets a company has at a specific date, etc.
Accounting reports help the creditors in terms of their decision that whether the company has strong current resources and liquidity condition or not. Because after all, creditors have to recover the amounts from the company so accounting reports helps them to make their decision that whether they should continue to supply goods to a particular company or not.
Accounting reports help the employees of the company in order to judge that whether their future is secured in a specific company or not. For example, after reading the accounting reports if the employee feels that the company is going to liquidate soon, then he might try to find a job in another company in order to secure his job in the future.
Financial institutions provide the loans to the different companies, and these institutions did not give a loan without analyzing the financial condition of the company. Accounting reports assist them greatly in order to make the decision that whether the loan should be given to a particular company or not on the basis of the evaluation of the financial condition of the company.
Accounting reports also help the taxation department in terms of calculating the actual tax payment by analyzing the profits of the company.
So it has been concluded that the accounting reports are an integral and the most important part of any company because almost all the stakeholders of the company have to make some important decisions on the basis of reading, analyzing and evaluating the accounting reports of the company.
As almost every economic decision of the stakeholder of the company is dependent on the accounting reports, so it has also been concluded that the accounting reports must have the true information and does not have any kind of misleading, inaccurate and fraudulent information which may affect the decisions of the stakeholders of the company. For that purpose, there are lots of governing bodies that ensure that the information presented by the company is free from any kind of material misrepresentation. The main purpose of these bodies is to work for the public interest and hence these institutions are not profit making institutions.
Almost every country has the regulatory bodies which govern the rules and regulations relating to the production and the publication of the accounting reports (i.e. annual reports). These legal regulations include the Securities and Exchange Commissions. The main purpose of these types of the organization is to work for the welfare of the public by establishing and implementing some rules that companies must have to follow regarding the publication of the accounting reports.
The main purpose of these rules, policies and procedures, are that the company is forced to present the reasonable and true and fair view of the accounting information by avoiding the fraudulent and inaccurate reporting to its stakeholders. As this environment is very helpful for the protection of the shareholders by providing them maximum true information about the companies.
For example, some of the rules by which the integrity of the business information of the company can be assured are that every listed company (i.e. whose shares can be traded publicly) must have to appoint independent auditors whose major responsibilities are to check that whether there are sufficient internal controls in the business and whether these internal controls providing sufficient assurance that the accounting reports which are going to publish publicly are free from material misstatements or not. After applying the proper audit procedures, independent auditors then give their overall opinion regarding the company’s accounting report. It is considered to be a source of reliability and authenticity for the shareholders of the company if the auditor’s report says that the company’s accounting reports present true and fair view of the business. The company is bound to publish the same auditor’s report in the published annual reports.
Moreover, the other body that deals with all the accounting reports matters is the Corporate Governance body. The main function of this institution is to monitor that every company has its proper appointments of the directors and the boards that ensure that each and every section of the company is clear and crystal, and the company is not involved in any type of fraudulent activities.
So after the above discussions, it has been concluded that these regulatory bodies have a significant role on the reduction of the fraudulent reporting of the financial information (i.e. accounting reports) by the company that is a great sign for the modern world. Having said that, there is still a great need of establishing some more sophisticated, so that the management of the company should not have any kind of way by which the fraudulent reporting can be done.
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