No.

Topic

Pages

1.0

Introduction

2-8

2.0

The objective of financial ratios

9-12

3.0

Calculate the profitability, solvency and capital structure ratios Explain situation (a) by using calculated ratios Explain situation (b) by calculate appropriate ratio Conclusion

13-16

4.0

10-11

5.0

12-13

6.0

14-15

7.0

Reference

16

8.0

Coursework

17-20

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1.0 Introduction Financial Statement

A financial statement (or financial report) is a formal record of the financial activities of a business, person, or other entity. In British Englishincluding United Kingdom company lawa financial statement is often referred to as an account, although the term financial statement is also used, particularly by accountants. For a business enterprise, all the relevant financial information, presented in a structured manner and in a form easy to understand, are called the financial statements. They typically include four basic financial statements, accompanied by a management discussion and analysis:

1. Balance sheet - statement of financial position at a given point in time. 2. Income statement revenues minus expenses for a given time period ending at a specified date. 3. Statement of Changes in Equity - explains the changes of the company's equity throughout the reporting period 4. Statement of cash flows - reports on a company's cash flow activities, particularly its operating, investing and financing activities. For large corporations, these statements are often complex and may include an extensive set of notes to the financial statements and explanation of financial policies and management discussion and analysis. The notes typically describe each item on

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the balance sheet, income statement and cash flow statement in further detail. Notes to financial statements are considered an integral part of the financial statements.

Content in Balance Sheet

In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership, a corporation or other business organization, such as an LLC or an LLP. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a "snapshot of a company's financial condition". Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time of a business' calendar year. A standard company balance sheet has three parts: assets, liabilities and ownership equity. The main categories of assets are usually listed first, and typically in order of liquidity. Assets are followed by the liabilities. The difference between the assets and the liabilities is known as equity or the net assets or the net worth or capital of the company and according to the accounting equation, net worth must equal assets minus liabilities. Another way to look at the same equation is that assets equals liabilities plus owner's equity. Looking at the equation in this way shows how assets were financed: either by borrowing money (liability) or by using the owner's money (owner's equity). Balance sheets are usually presented with assets in one section and liabilities and net worth in the other section with the two sections "balancing."
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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, many businesses are not paid immediately; they build up inventories of goods and they acquire buildings and equipment. In other words: businesses have assets and so they cannot, even if they want to, immediately turn these into cash at the end of each period. Often, these 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 liabilities. Assets Broadly speaking Assets represents resources which are of some value to the firm. They have been acquired at a specific monetary value by the firm for the conduct of its operations. Assets are classified as follows under the companies act:1. 2. 3. 4. Fixed Assets Investments Current Assets Miscellaneous Expenditure

Fixed Assets: - These Assets have 2 characteristics:i. They are acquired for use over relatively long periods for carrying on the operations of the firm ii. They are ordinarily not meant for resale. Examples of Fixed Assets are Land, Buildings, Plant, Machinery, Patents and Copyrights.

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Investments: - These are financial securities owned by the firm. Some investments represent long-term commitment of funds. Other Investments are short-term in nature and may rightly be classified under current assets for managerial purposes. Current Assets: - this category consists of Cash and other resources which get converted into cash during the operating cycle of the firm. Current Assets are held for a short period of time as against fixed assets which are held for relatively longer periods. The major components of Current Assets are: Cash, Debtors, Inventories and Prepaid Expenses. Miscellaneous Expenditure: - Miscellaneous Expenditure represents certain outlays such as preliminary expenses and pre-operative expenses which have not been written off. The Share capital cannot be reduced when a loss occurs and therefore to keep the share capital intact loss is shown on the right side of the Balance Sheet. Liabilities Liabilities when defined very broadly represent what the business entity owes others. The following are classified as Liabilities 1. Share Capital 2. Reserves and Surplus 3. Secured Loans 4. Unsecured Loans Share Capital: - This is divided into two parts: i. Equity Capital ii. Preference Capital

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The first represents the contributions of the equity shareholders who are theoretically the owners of the firm. Equity Capital, being risk capital, carries no fixed rate of dividend. Preference Capital represents the contribution of preference shareholders and the dividend rate payable on it is fixed. Reserves and Surplus:- Reserves and Surplus are the profits which have been retained in the firm. There are two types of Reserves i. Revenue Reserves ii. Capital Reserves Secured Loans: - These denote borrowings of the firm against which specific securities have been provided. The important components of the secured loans are debentures, loans from financial instruments and loans from commercial banks. Unsecured Loans: - these are the borrowings of the firm against which no specific security has been provided. The major components of the secured loans are fixed deposits, loans and advances form promoters etc.

Content in Income Statement

1. Net Sales: - Net Sales appearing in the Income Statement is the sum of the Invoice price of the goods sold and services rendered during the period. Sales Inward represents the invoice value of the goods rendered by the customers. Excise duty refers to the amount paid to the government. 2. Cost of Goods Sold:- Cost of Goods sold is the sum of the costs incurred for manufacturing and procuring the goods sold during the accounting period. It consists
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of direct material cost, direct labor cost, and factory overheads. It should be distinguished from cost of production. The latter represents the cost of the goods produced in the accounting year. 3. Gross Profit: - is the difference between net sales and the cost of the goods sold. 4. Operating Expenses: - Operating Expenses is the difference between gross profit and the operating expenses and depreciation. 5. Operating Profit: - Operating Profit is the difference between gross profit and operating expenses. As a measure of profit it reflects operating performance and is not affected by non-operating gains/losses, financial leverage and the tax factor. 6. Non Operating Surplus: - Non Operating Surplus represents gains arising from sources other than normal operations of the business. Its major components are incomes from investments and gains from disposal of assets. 7. Earnings before Interest and Taxes (EBIT): - EBIT is the sum of operating profit and non-operating surplus/deficit. Referred to also as earnings before Interest and Taxes, this represents a measure of profits which is not influenced by financial leverage and the tax factor. Hence, it is pre-eminently suited for inter-firm comparison. 8. Interest: is the expense incurred on borrowed funds such as term loans, debentures, public deposits and working capital advances. 9. Profit before tax: - This is obtained by deducting interest from profits before Interest and Taxes. Tax means income tax expense for the year. 10. Profit after Tax: - This is the difference between Profit before Tax and the Tax for the year.

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11. Dividends: -This represents the amount earmarked for distribution to shareholders 12. Retained Earnings: -This represents the difference between profit after tax and dividends

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2.0 The objective of financial ratios

What they mean? In assessing the significance of various financial data, managers often use ratio analysis, the process of determining and evaluating financial ratios. A financial ratio indicates a relationship between a company's activities, for example, the ratio between the company's current assets and current liabilities or between its accounts receivable and its annual sales. The basic source for these ratios is the company's financial statements that contain figures on assets, liabilities, profits, and losses. Ratios are only meaningful when compared with other information. Since they are often compared with industry data, ratios help managers understand their company's performance relative to that of competitors and are often used to trace performance over time. Ratio analysis can reveal much about a company and its operations. However, there are several points to keep in mind about ratios. First, a ratio is just one number divided by another. Financial ratios are only "flags" indicating areas of strength or weakness. One or even several ratios might be misleading, but when combined with other knowledge of a company's management and economic circumstances, ratio analysis can tell much about a corporation. Second, there is no single correct value for a ratio. The observation that the value of a particular ratio is too high, too low, or just right depends on the perspective of the analyst and on the company's competitive strategy.

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Third, a financial ratio is meaningful only when it is compared with some standard, such as an industry trend, ratio trend, a ratio trend for the specific company being analyzed, or a stated management objective. The objective of ratio analysis is to judge the earning capacity, financial soundness and operating efficiency of a business organization. The use of ratio in accounting and financial management analysis helps the management to know the profitability, financial position and operating efficiency of an enterprise. 1. Liquidity position: With the help of Ratio analysis conclusion can be drawn regarding the liquidity position of a firm. The liquidity position of a firm would be satisfactory if it is able to meet its current obligation when they become due. A firm can be said to have the ability to meet its short-term liabilities if it has sufficient liquid funds to pay the interest on its short maturing debt usually within a year as well as to repay the principal. This ability is reflected in the liquidity ratio of a firm. The liquidity ratios are particularly useful in credit analysis by bank & other suppliers of short term loans. 2. Long-term Solvency: Ratio analysis is equally useful for assessing the long-term financial viability of a firm. This respect of the financial position of a borrower is of concern to the longterm creditors, security analyst and the present and potential owners of a business. The long-term solvency is measured by the leverage/capital structure and profitability ratio. Ratio analysis that focus on earning power and operating efficiency.
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Ratio analysis reveals the strength and weakness of a firm in this respect. The leverage ratios, for instance, will indicate whether a firm has a reasonable proportion of various sources of finance or if it is heavily loaded with debt in which case its solvency is exposed to serious strain. Similarly the various profitability ratios would reveal whether or not the firm is able to offer adequate return to its owners consistent with the risk involved. 3. Operating Efficiency Yet another dimension of the useful of the ratio analysis relevant from the viewpoint of management, is that it throws light on the degree of efficiency in management and utilization of its assets. The various activity ratios measure this kind of operational efficiency. In fact, the solvency of a firm is, in the ultimate analysis, dependent upon the sales revenues generated by the use of its assets- total as well as its components. 4. Overall profitability Unlike the outside parties, which are interested in one aspect of the financial position of a firm, the management is constantly concerned about overall profitability of the enterprise. That is, they are concerned about the ability of the firm to meet its short term as well as long term obligations to its creditors, to ensure a reasonable return to its owners and secure optimum utilization of the assets of the firm. This is possible if an integrated view is taken and all the ratios are considered together. 5. Inter firm comparison Ratio analysis not only throws light on the financial position of firm but also serves as a stepping-stone to remedial measures. This is made possible due to inter firm comparison and comparison with the industry averages. A single figure of a

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particular ratio is meaningless unless it is related to some standard or norm. One of the popular techniques is to compare the ratios of a firm with the industry average. It should be reasonably expected that the performance of a firm should be in broad conformity with that one of the industry to which it belongs. An inter firm comparison would demonstrate the firms position vice-versa its competitors. If the results are at variance either with the industry average or with those of the competitors, the firm can seek to identify the probable reasons and in light, take remedial measures.

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3.0 How much is enough and the cost of maintaining sufficient stock levels
The director of KK Ltd appointed a new sales manager towards the end of 2010. This manager advised a plan to increase revenue and profit by means of a reduction in selling price and extended credit term to customers. This involved considerable investment in new machinery early in 2011 in order to meet the demand which the change in sales policy has created. The financial statement for the years ended 31 December 2010 and 2011 are shown next page. The sales manager has argued that the new policy has been a resounding success because revenue and, more importantly, profits have increase dramatically. You are required: (a) Explain whether you believed that the performance for the year ended 31 December 2011 and the financial position at that date have improve as a result of the new policies adopt by the company. You should support your answer with appropriate ratios. (b) All of KK Ltd sales on credit. The finance director has asked you to calculate the immediate financial impact of reducing the credit period offered to customers. Calculate the amount of cash which would be released if company could impose a collection period of 45 days.

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Income Statement 2011 RM000 Revenue Cost of sales Gross profit Selling expenses Bad debt Depreciation Interest Net profit 2800 (1680) 1120 (270) (140) (208) (192) 310 2010 RM000 900 (3600) 540 (150) (18) (58) (12) 302

Note: the balance on the retained profits reserve at the end of 2010 was RM 327000. Balance Sheet 2011 RM000 Non-current assets Factory Machinery 441 1791 2232 Current assets Inventory Account Receivable Bank 238 583 30 83 12
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2010 RM000 RM000 RM000

821 Total assets 3053

125 1065

Current liabilities Account Payable Bank 175 11 186 Non-current liabilities 36 36

Borrowing

1600 (1786) 1267

100 (136) 929

Equity Share capital Retain profits 328 393 1267

Gross Profit margin = Net Profit margin = Return on Capital Employed (ROCE) = Current Ratio =
( )

300 629 929

Acid test or Quick ratio =

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Profitability ratio Gross profit : revenue Net profit : revenue ROCE

2010 60% 34% 31%

2011 40% 11% 18%

Solvency Current ratio Acid test ratio 3.47 : 1 2.64 ;: 1 4.41 : 1 3.13 : 1

Capital Structure Capital gearing 10% 56%

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4.0 Explain situation (a) by using calculated ratios

Profitability ratio decreases. Gross and net profit margin also decreases. The likely reason is price reduction or changes in cost. It should not decline after the implementation of the new system. ROCE fell from 31% to 18%, because the companies increase their investment, but not so fast to see results and effects. The increase in market demand or the prices of goods can obtain higher rate of return. Capital gearing represents the company's funds in the debt component, the company is likely to lend money in the future.

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5.0 Explain situation (b) by calculate appropriate ratio

Description: Some people find that the accounts receivable turnover figure is easier to understand if it is expressed in terms of the average number of days that accounts receivable are outstanding, which is the collection period. This format is particularly useful when it is compared to the standard number of days of credit granted to customers. For example, if the average collection period is sixty days and the standard days of credit is thirty, then customers are taking twice as long as they should to pay their invoices. A sign of good performance is when the average receivable collection period is only a few days longer than the standard days of credit. An excellent way to use this measurement is to track it on a trend line, to spot any sudden worsening of the collection period. Formula: To calculate the collection period, divide annual credit sales by 365 days, and divide the result into average accounts receivable. The formula is as follows: Average Accounts Receivable Annual Sales/365 days Overview of Accounts Receivable Accounts receivable are the amounts owed to a business by its customers, and are comprised of a potentially large number of invoiced amounts. Accounts receivable constitute the primary source of incoming cash flow for most businesses, so you should be able to analyze these invoices in aggregate to ascertain the health of the underlying cash flows. Several accounts receivable analysis techniques are noted below.
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Accounts Receivable Analysis One of the easiest methods for analyzing the state of a company's accounts receivable is to print an accounts receivable aging report, which is a standard report in any accounting software package. This report divides the age of the accounts receivable into various buckets, which you can sometimes alter within the accounting software to match your billing terms. The most common time buckets are from 0-30 days old, 31-60 days old, 61-90 days old, and older than 90 days. Any invoices falling into the time buckets representing periods greater than 30 days are cause for an increasing sense of alarm, especially if they drop into the oldest time bucket. There are several issues to be aware of when you analyze based on an aging report, which are:

Individual credit terms. Management may have authorized unusually long credit terms to specific customers, or perhaps only for particular invoices. If so, these items may appear to be severely overdue for payment when they are, in fact, not yet due for payment at all.

Distance from billing date. In many companies, the majority of all invoices are billed at the end of the month. If you run the aging report a few days later, it will likely still show outstanding accounts receivable from one month ago for which payment is about to arrive, as well as the full amount of all the receivables that were just billed. In total, it appears that receivables are in a bad state. However, if you were to run the report just prior to the month-end billing activities, there would be

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far fewer accounts receivable in the report, and there may appear to be very little cash coming from uncollected receivables. Time bucket size. You should approximately match the duration of the time buckets in the report to the company's credit terms. For example, if credit terms are just ten days and the first time bucket spans 30 days, nearly all invoices will appear to be current.

Another accounts receivable analysis tool is the trend line. You can plot the outstanding accounts receivable balance at the end of each month for the past year, and use it to predict the amount of receivables that should be outstanding in the near future. This is a particularly valuable tool when sales are seasonal, since you can apply seasonal variability to estimates of future sales levels. Trend line analysis is also useful for comparing the percentage of bad debts to sales over a period of time. If there is a strong recurring trend in this percentage, management may want to take action. For example, if the percentage of bad debt is increasing, management may want to authorize tighter credit terms to customers. Conversely, if the bad debt percentage is extremely low, management may elect to loosen credit in order to expand sales to somewhat more risky customers. This is a particularly useful tool when you run the bad debt percentage analysis for individual customers, since it can spotlight problems that may indicate the imminent bankruptcy of a customer. There are several issues to be aware of when you use trend line analysis, which are:

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Change in credit policy. If management has authorized a change in the credit policy, this can lead to sudden changes in accounts receivable or bad debt levels.

Change in products or business lines. If a company adds to or deletes from its mix of products or business lines, this may cause profound changes in the trend of accounts receivable.

A third type of accounts receivable analysis is ratio analysis. The most commonly used ratio is the accounts receivable collection period, which reveals the number of days that an average customer invoice remains outstanding before it is paid. The formula is: Average accounts receivable Annual sales/365 Days

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6.0 Conclusion
Analysis and interpretation of financial statements help in determining the liquidity position, long term solvency, financial viability and profitability of a firm. Ratio analysis shows whether the company is improving or deteriorating in past years. Moreover, Comparison of different aspects of all the firms can be done effectively with this. It helps the clients to decide in which firm the risk is less or in which one they should invest so that maximum benefit can be earned. Financial statements are the product of the financial accounting process. They are the means of communicating economic information about the entity to individuals who want to make decisions and informed judgments about the entitys financial position, results of operations, and cash flows. Although each of the four principal financial statements has a unique purpose, they are inter related, and all must be considered in order to get a complete financial picture of the reporting entity. Users cannot make meaningful interpretations of financial statement data without understanding the concepts and principles that relate to the entire financial accounting process. It is also important for users to understand that these concepts and principles are broad in nature; they do not constitute an inflexible set of rules, but instead serve as guidelines for the development of sound financial reporting practices. In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership,

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a corporation or other business organization, such as an LLC or an LLP. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a "snapshot of a company's financial condition". Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time of a business' calendar year.

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7.0 Reference
1. Eg. Text book (Business Accounting and Financial Statement Edition 4, 1997, Robin Hood & Jack Rose) 2. 3. 4. 5. 6.
http://agbssem1.webs.com/accounting/financial%20ratio%20analysis%20i.pdf http://library.stritch.edu/research/subjects/business/businessGuides/financialRatios.asp http://en.wikipedia.org/wiki/Financial_statement http://www.quickmba.com/accounting/fin/statements/ http://www.transtutors.com/accounting-homework/basics-of-accounting/contents-ofbalance-sheet.aspx

7. 8.

http://en.wikipedia.org/wiki/Balance_sheet#Assets http://www.transtutors.com/accounting-homework/basics-of-accounting/contents-ofincome-statement.aspx

9.

http://www.studymode.com/essays/Analysis-Of-Financial-Statements-4-633792.html

10. http://www.scribd.com/doc/32533320/Project-Report-on-Financial-Analysis-of-RelianceIndustry-Limited

11. http://www.webopedia.com/TERM/O/operational_efficiency.html 12. http://www.caledonia.org.uk/socialland/social.htm 13. http://en.wikipedia.org/wiki/Social_accounting 14. http://www.tutorsonnet.com/homework_help/macro_economics/introduction_and_natio

nal_income/national_income_accounting_assignment_help_online_tutoring.htm

15. http://www.accountingtools.com/receivables-collection-period 16. http://www.accountingtools.com/accounts-receivable-analysis 17. http://ethesis.nitrkl.ac.in/1953/1/10605038.pdf

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18. http://highered.mcgraw-hill.com/sites/dl/free/0073527068/792292/sample_chapter2.pdf

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8.0 Coursework
NAME: Cheang Sue Ning NRIC: 930902-07-5046 H/P: +60164674307 1. Social accounting can be divided into FIVE general areas. Explain carefully. Answer: Social accounting (also known as social and environmental accounting, corporate social reporting, corporate social responsibility reporting, non-financial reporting, or sustainability accounting) is the process of communicating the social and environmental effects of organizations' economic actions to particular interest groups within society and to society at large. Social accounting is commonly used in the context of business, or corporate social responsibility (CSR), although any organization, including NGOs, charities, and government agencies may engage in social accounting. Social accounting emphasizes the notion of corporate accountability. D. Crowther defines social accounting in this sense as "an approach to reporting a firms activities which stresses the need for the identification of socially relevant behavior, the determination of those to whom the company is accountable for its social performance and the development of appropriate measures and reporting techniques." Social accounting is often used as an umbrella term to describe a broad field of research and practice. The use of more narrow terms to express a specific interest is thus not uncommon.
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Environmental accounting may e.g. specifically refer to the research or practice of accounting for an organization's impact on the natural environment. Sustainability accounting is often used to express the measuring and the quantitative analysis of social and economic sustainability.

(a) Social auditing

Social auditing is a process that enables an organization to assess and demonstrate its social, economic, and environmental benefits and limitations. It is a way of measuring the extent to which an organization lives up to the shared values and objectives it has committed itself to.

Social auditing provides an assessment of the impact of an organization's non-financial objectives through systematically and regularly monitoring its performance and the views of its stakeholders.

Social auditing requires the involvement of stakeholders. This may include employees, clients, volunteers, funders, contractors, suppliers and local residents interested in the organization. Stakeholders are defined as those persons or organizations who have an interest in, or who have invested resources in, the organization.

Social audits are generated by the organization themselves and those directly involved. A person or panel of people external to the organization undertakes verification of the social audit's accuracy and objectivity.

(b) National social income accounting Cooper has defined as Social Accounting is concerned with the statistical classification of

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the activities of human beings and human institutions in ways which help us to understand the operation of the economy as a whole. The field of study summed up by the words social accounting embraces, however, not only the classification of economic activity, but also the application of the information thus assembled to the investigation of the operation of the economic system. (c) Financial social accounting in profit-oriented organizations

(d) Managerial social accounting in profit-oriented organizations

(e) Financial and/or managerial social accounting for non-profit organizations

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