These financial statements are designed according to the UK GAAP (Appendix 1)
- RATIOS ANALYSIS
Ratios investigation will allow me to compare and interpret Tulip accounting information against those of cafe 88, thus have a clear understanding of how well the business has done and how well Tulip has used its resources. Finally, I will be able to evaluate the financial health of this falling canteen. There are hundreds of recognisable ratios, but for the purpose of this assignment, I will investigate three main headings ratios.
- Profitability
- Efficiency
- Liquidity
Nevertheless, ratio analysis on its own is not enough to translate business accounts, other elements have to be taken in account such as:
- Cash flow statement
- Recent acquisition or disposals of subsidiary by the company
- The age and nature of the canteen assets
PROFITABILITY RATIOS
Profitability ratios gauge how well a business is performing by evaluating how profit was earned relative to sales, total assets and net worth. I have used four ratios in order to evaluate Tulip Refractory performance and compare it to its sister canteen Café 88. These are the following:
ROCE which stands for return on capital employed. It represents the capital earned by a business in relation to the investment; it “measures the percentage returns on the total investment of fund in the business”. The ROCE is express in percentage and appear in the form of the following equation:
Tulip Refractory ratio: = (250) % Café 88 ratio is: = 29.41%
The findings clearly show that Cafe 88 has a positive and higher ROCE than Tulip Refractory; therefore Café 88 is in a much better position than its sister canteen. The higher the ROCE, the better the company is performing; Tulip has a high negative ROCE meaning is making losses. These results show that café 88 earns 29.5 pence on each £ spent for the business, meaning that the activity of this canteen is profitable with its resources fairly utilised whereas the opposite is shown with Tulip that looses £2.50 for every £ spent for its activity.
PROFIT MARGIN: This ratio gives what analysts term the profit on sale; it is the percentage of profit earned on sales. It weights out the Tulip refractory business by measuring how much out of every £ of sales the canteen keeps in earnings. This ratio is important because businesses need to make profit to survive in a long run. This ratio is expressed in percentage terms and is as follow:
Tulip Refractory Canteen is: = (12.5) % Café 88 is: = 25%
This ratio is useful in this case since it will establish comparison between the two canteens; the results show that café 88 has a higher profit margin (25%) than Tulip Refractory (-12.5%). This indicates that Café 88 is more profitable and has a better control over its costs compare to its sister company Tulip. Café 88 has a net income of 25p for each £ of sales whereas Tulip is loosing 12.5p for each £ of sales, this may be due to factors such as the degree of competition, the variety of products and number of employees influencing its profit margin.
GROS PROFIT
This ratio of profitability provides and measures how much profit a company is able to generate from its sales before other deductions such as admininistration costs etc... The formula is as follow:
Tulip ratio: 50% Cafe 88 ratio: 87.5%
The outcome of this calculation shows that café 88 is earning a good return on its merchandise sale compare to Tulip. Margin earned on sales and fees is not equal to Tulips sister organisation, café 88 and is the cause of any favourable profit.
LIQUIDITY RATIOS
According to Collis & Hussey (2007), ‘liquidity ratios are used to evaluate the solvency of and financial stability of a business and to assess how effectively it has managed its working capital’. These ratios express the ability for a company to repay short term creditors accordingly to its total cash. It should be defined as ‘ratios derived from balance sheet that measures how easily a firm can pay its debts’ MWE, Glautier & B, Underdown (2001). For this financial investigation and according to information available, I chose the following:
CURRENT RATIOS
This is a part of liquidity ratios that measures the potentiality of a company to meet its short term debts obligations. According to Holmes & Sugolen (1997), the current ratio is sometimes called the working capital ratio and is a broad indicator of a company short term financial position and appears in form of the equation:
Tulip Refractory ratio: Cafe 88 ratio:
“If the current asset of a company is more than twice the current liability, then that company is generally considered to have a good short term financial strength”. The figure should always be above 1 or the firm does not have enough assets to meet its liabilities and become technically insolvent. Tulip current ratio seems to be to the edge of the acceptable (1.5) which means although the canteen encounters losses; it is still possible to overturn the current situation. On the opposite, Café 88 has a current ratio of 4, which is above acceptable limit of the business and should consider investing some for a longer period to earn it more. Café 88 has an asset of £4 for every £ the business owes.
ACID TEST
Acid Test is defined by Bob Ryan (2004) as a “famous ratio which is a severest test of a company’s liquidity and its ability to pay its short term liabilities, excluding debt which more than one year” This ratio gives an early warning of financial problems within a business; if the acid test is lower than 1, the company will not be able to meet its debt obligations. With a figure above 1, the company will be able to meet their liabilities without having to sell any of its stock.
Tulip ratio: Café 88:
Cafe 88 has a high liquidity level (3.5), meaning that it has enough liquid to pay short term loans. Tulip is just able to meet its financial liabilities but has to be cautious in the near future especially while introducing new products and equipments to improve their services, soaring cash will lead to monetary difficulty.
EFFICIENCY RATIOS
STOCK TURNOVER
Collis & Hussey (2007) define stock turn over as “an efficiency ratio that measures the average number of times stock has been sold and replaced during the year”. This gives the inventory of the canteens stocks as well as measuring the efficiency with which the goods are dispatched. This ratio is worked out by dividing stock by cost of sales times 365 days.
Tulip ratio: Café 88:
Tulip is holding its stock for an average time of 14 days (massive storage and money tied up), whereas Café 88 takes 10 days to move its stock: Café 88 is holding a lower stock turnover and is maybe working in a just in time system, reducing significantly costs in terms of holding and financing the stock and cost of tying money up in unproductive assets.
ASSET TURNOVER
This element of profitability can be defined as the amount of sales generated for every £’s worth of assets. Asset Turnover will be measuring company effectiveness at using its assets in generating sales revenue; the higher the number, the better. It also tends to indicate pricing strategy; companies with low profit margin have a high asset turn over. ATO formula is:
Tulip Refractory ratio is: = 20 Cafe 88 ratio is: = 1.17
This shows that Tulip has the potential to better utilise its fixed assets in order to increase its sale whereas café 88 is generating £1.17 of revenue for every 1£ worth of fixed assets.
DEBTORS TURNOVER
This equation indicates the relation between trade debtors and sales; it “measures the number of times receivable during the year” Dyson, T, R (1997). The higher debt turnover, the better becomes the shorter time between sales and cash collection. This formula will allow both canteens to gauge the efficiency with which the organisations manage their own resources.
Tulip Refractory : Café 88 :
It will take Tulip 11 days to collect debts owed by its customers however, I assume that Café 88 does not allow its customers to take on debts, enabling the cash to circulate by rapidly and effectively, and increasing liquidity level.
CREDITORS TURNOVER
This ratio indicates the credit period enjoyed by a firm from its suppliers and measures how many times a business payable turn over during a year. A low payables turnover may indicate the shortage of cash. A high credit turnover indicates a short time between payment and settlement, meaning that the business is not benefiting fully for its credit period. The formula is as follow:
Tulip Refractory: 27.03days Cafe 88: = 139.04days
Tulip payable turnover is less than a month, meaning that Tulip does not have enough cash to play with; these results are worrying especially when we know that small businesses need about 40 days to pay their accounts; the management has to review their supplier policies.
- LIMITATIONS OF RATIO ANALYSIS
Although ratio analysis has been useful, by comparing the two canteens, it also provides indications their performance and financial position at a certain time. Meanwhile, it is important to underline that ratios are not definitive measures to conduct financial analysis; analysts should be aware of problems and make adjustments when necessary. This leads us to consider some limitation s of ratios which are:
- There are no agreed definitions of the terms used
- Outdated information in financial statements: Figures in the set of accounts are out of date and are not giving a proper indication of the financial position of the canteens.
- In case of high inflation, financial statements might be misleading.
- On their own, ratios cannot show whether the performance of these two canteens is god or bad, they are only comparing the results.
- Summarised financial statements information: Ratios are forged on financial statements, which are condensed of the accounting records. Important information is usually left out during the process of summarization, leading to end information that may not be the accurate reflection of the overall picture of the business situation.
- Ratio interpretation: It is complicated to determine whether a ratio is good or bad; for instance a current ratio might indicate a strong liquidity position which is good or excessive cash which is bad.
- CONCLUSIONS
Despite its constraints, ratio analysis is broadly used as a means of evaluating the performance and forecasting the future successes or failures of organisations. It can be of great importance in financial planning and decision making process especially in this case where Tulip canteen is encountering losses over the last 5 years. Financial analysis became the tool helping the head office to decide whether to inject further loans or have the canteen under a new sub-contracting management. Financial ratios provide information in establishing standards, controlling performance and offer operational information which are essential to realise certain changes for the betterment of Tulip refractory canteen which aims to repay its loan and realise profit. Meanwhile, ratios were not sufficient providers of information about Tulip. Information of a non financial nature is required before a meaningful analysis is plausible.
Reasons for my findings
The main reason of conducting financial analysis was to help the Finance director to better leverage information collected within the current operation system of the two canteens and help him make decision while presenting the proposal dossier (loan or sub-contract?) to the main board.
Implications for Tulip and Recommendations
By conducting financial analysis on Tulip and contrasting the results with its sister company that is realising surplus, I was able to measure the well being of the company and its ability to generate sufficient funds to meet its ongoing obligations. The implication is that I was able to calculate and interpret an insight of some element s of Tulip canteen, from accounts to receivable, to the level of liabilities the canteen currently has to continue its operations. In order to move on towards success, a code of conduct and self policing may be recommended to ensure a good management of the canteen as well as a better communication between employees and their manager. It is also important to review the way stock manage as well as conducting a market research on the products and services offered.
BIBLIOGRAPHY
Bob, Ryan. (2004), Finance and Accounting for Business, London, International Thomson Press.
Dyson, J R. (1997), Accounting for Non- Accounting Students, 4th Edn. London, Pitman.
G, Holmes & A, Sogolen. (1997), Interpreting Company Reports & Accounts, Cornwall, GB, Prentice Hall Europe.
J, Collis & R, Hussey. (2007) Business Accounting, Basingstike, UK, Palgrave MacMillan.
Tyran, M (1992) Business & Financial Ratios, Woodhead-Faulkner,
Lewis, R & Pendrill, D. (2000) Advanced Financial Accounting, Prentice Hall
MWE, Glautier & B, Underdown. (2001). AccountingTheory and Practice, 7th Edn. Essex, Pearson Education Ltd.
APPENDICES
APPENDIX 1: UK GAAP
The Generally Accepted Accounting Principles in the UK, or UK GAAP, are the overall body of regulation establishing how company accounts must be prepared in the . This includes not only accounting standards, but also UK company law.
Accounting standards derive from a number of sources. The chief standard-setter is the (ASB), which issues standards called Financial Reporting Standards (FRSs). The ASB is part of the ,an independent regulator funded by a levy on listed companies, and it replaced the Accounting Standards Committee (ASC), which was disbanded in 1990 following a number of criticisms of its work. To the extent that the ASC's pronouncements, known as Statements of Standard Accounting Practice (SSAPs), have not been replaced by FRSs, they remain in force.
APPENDIX 2:
PROFIT & LOSS ACCOUNTS/ BALANCESHEET STATEMENT OF BOTH TULIP & CAFÉ 88
Profit also has an important role in allocating resources (land, labour, capital and enterprise). Put simply, falling profits (as in a business coming to an end eg black-and-white TVs) signal that resources should be taken out of that business and put into another one; rising profits signal that resources should be moved into this business. Without these signals we are left to guess as to what is the best use of society’s scarce resources.
People sometimes say that government should decide (or at least decide more often) how much of this or that to make, but the evidence is that governments usually do a bad job of this e.g. the Dome.
In , a balance sheet or statement of financial position is a summary of a person's or organization's , and on a specific date, such as the end of its . A balance sheet is often described as a snapshot of a company's financial condition. Of the four basic , the balance sheet is the only statement which applies to a single point in time.
A company balance sheet has three parts: assets, liabilities and . The main categories of assets are usually listed first and are followed by the liabilities. The difference between the assets and the liabilities is known as the or the of the company. According to the , net worth must equal assets minus liabilities.
Records of the values of each or line in the balance sheet are usually maintained using a system of accounting known as the .
A business operating entirely in cash can measure its profits by withdrawing the entire bank balance at the end of the period, plus any cash in hand. However, real businesses are not paid immediately; they build up inventories of goods and they acquire buildings and equipment. In other words: businesses have and so they can not, even if they want to, immediately turn these into cash at the end of each period. Real businesses owe money to suppliers and to tax authorities, and the proprietors do not withdraw all their original capital and profits at the end of each period. In other words businesses also have