Financial Analysis Report
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Introduction
With the rapidly changing business environment along with the prevailing share of uncertainties, there is an apparent need for firms to meet up with the ongoing operational and tactical obligations and maintain themselves as a going concern. Financial stability refers to the ability of the organisation to effectively meet the overhead and the additional expected financial costs and expenses in relation to its business associates in due course of an accounting year. Additionally, balance sheets, income statements as well as cash flow statements are appropriate statistical measures for accessing the financial stability of the firm for a stipulated timeframe. The current study deals with critically accessing and discussing the financial viability of a hypothetical project in terms of the projected income statement, cash flows statements, and balance sheet estimate, thereby estimating financial ratios based on the aforesaid estimates.
About the Project
Harold and Sons is a consumer good company explicitly dealing with the sale of consumer durables and other lifestyle products in the market. Over the years, Harold and Sons, have been planning on entering the market with its new brand of coffee Lousy Owl, in the market which is free from added preservatives, gluten, and sugar. Besides, the content of the product confines to 100% coffee and is free from chicory. In order to start the business, the company has relied upon employing personal savings and additional capital obtained from family and friends totaling to a sum of £50,000. However, considering the prevailing uncertainties as well as the additional burden of costs it is insufficient to finance the business and manufacturing and distribution of Lousy Owl with such limited finance. Therefore, as a solution, Harold and Sons are going to pitch the business idea, to ABC Holdings and DMVC Pvt. Ltd, the identified potential investors.
Determination of Cost Statement
As affirmed by Naranje, Kumar and Hussein (2014), accuracy in the process of estimating cost is one of the significant aspects associated with the survival of the organisation. Additionally, coming up with the wrong decision regarding the estimation of costs further slows down the product development phases thus, affecting the competitiveness of the firms in comparison to its rivals. Besides, effective analysis beforehand, further assist in ascertaining the feasibility of the project thereby, estimating its efficacy to fetch greater returns. As opined by Othman (2016), a cost sheet provides affluent information pertaining to the selling price of the product per unit volume of a particular product or service. Also, the cost sheet further sheds light on the manufacturing and operational costs at each stage of the product. Moreover, the formulation of a cost sheet serves a greater purpose for managerial decision-making thus, helping in cost reduction and profit maximisation. As stated by Amade and Akpan (2014), the cost is classified into four categories namely, fixed, variable, indirect, and direct cost. Fixed costs are defined as the cost that does not change irrespective of the units manufactured within an accounting year, besides organisation must cover up the fixed cost estimates irrespective of profit or loss. On the contrary, variable costs are costs incurred by an organisation based on the estimates of its production units such as labour and raw material costs. Direct costs are costs incurred by the firm that is directly associated with the cost of the objects.
The table below shows the costs associated with the manufacturing of Lousy Owl Coffee for Harold and Sons for two accounting years. Besides, it was further assumed that the total number of units manufactured by the firm would be 300,000 and 350,000 units. From the above-discussed facts, the total fixed costs for Lousy Owl in FY 2019 and 2020 are £220,000 and £310,000 respectively.
Therefore, the fixed cost per unit volume of output would be equivalent to £0.733 per unit volume and £0.885 per unit volume. Similarly, the total variable cost for FY 2019 and 2020 £185,200 and £266,100, which is the sum of the indirect costs such as selling and distribution expenses, factory overhead, and others. Henceforth, the variable cost per unit for producing Lousy Owl coffee is £0.62 cost per unit and £0.76 cost per unit.
Alternatively, the contribution per unit volume of Lousy Owl coffee would be the difference between the selling price per unit and the variable cost per unit. Contribution per unit for FY 2019 and 2020 are £1.84 per unit and £2.52 per unit respectively. In addition, towards the end of the cost sheet, the addition and subtraction of direct and indirect costs further help in the determination of the projected sales value, therefore the selling price per unit of the expected volume for FY 2019 and 2020 are £2.46 and £3.28 respectively. Likewise, the profit per unit for the product for the two accounting year stands at £0.41 per unit and £0.55 per unit for 2019 and 2020 respectively.
| FY 2019 | FY 2020 | |||
| Particulars | Amount (£) | Amount (£) | Amount (£) | Amount (£) |
| Direct Materials Consumed | 12,000 | 14,000 | ||
| Opening Stock of Raw Materials | 150,000 | 165,000 | ||
| Add: Purchases | 200,000 | 400,000 | ||
| Less: Closing Stock of Raw Materials | 6,000 | 356,000 | 8,500 | 570,500 |
| Direct Wages | 60,000 | 80,000 | ||
| Direct Expenses | 25,000 | 30,000 | ||
| Prime Cost | 441,000 | 680,500 | ||
| Factory Overhead (100% of Direct Wages) | 60000 | 80,000 | ||
| Works Cost | 501,000 | 760,500 | ||
| Office and Administrative Overhead (20% of Works Cost) | 100,200 | 152,100 | ||
| Total Cost of Production | 601,200 | 912,600 | ||
| Add: Opening Stock of Finished Goods | 15,000 | 23,000 | ||
| Cost of Goods available for sale | 616,200 | 935,600 | ||
| Less: Closing Stock of Finished Goods | 24,000 | 13,000 | ||
| Cost of Goods Sold | 592,200 | 922,600 | ||
| Selling and Distribution Overhead | 25,000 | 34,000 | ||
| Cost of Sales | 617,200 | 956600 | ||
| Profit on Cost (expected to be 20%) | 123,440 | 191,320 | ||
| Sales | 740,640 | 1,147,920 | ||
Table: Projected Cost Statement for Lousy Owl Coffee for two accounting years
Calculation for Break-even and Margin of Safety
Break-even analysis in cost accounting deals with the assessment of profits and losses in order to effectively determine the price point of the project thus, assisting in investment decision-making. As opined by Saywell et al. (1995), the break-even point in economics is a point at which total cost and total revenue are equal. Additionally, one of the major use of break-even point analysis is to ascertain the number of units of revenue required to cover off the total costs for the particular financial year. The formula for the calculation of break-even is provided below:
Break-Even Point (Sales) = Total Fixed Costs / Contribution to Sales Ratio
Break-Even Point (Sales) for FY 2019 = £220,000 /£1.85/2.46 * 1.85
= £306,077.23
Break-Even Point (Sales) for FY 2019 = £310,000/ £2.52/3.28 *2.52
= £600,190.24
On the other hand,
Break-Even Point (Units) = Total Fixed Costs / Contribution per Unit
Break-Even Point (Units) for FY 2019 = £220,000 / £1.85 *£1.85
= 220,000 units
Break-even Point (Units) for FY 2020 = £310,000/ £2.52 *£2.52
= 310,000 units
The margin of Safety has defined the difference between the amount of expected profitability of the firm from its operational activities and the estimated break-even sales level. As affirmed by Calandro (2011), the estimation of margin of sales and output figure further helps in ascertaining the level of risk within a business concern thereby, curtailing the share of its operational and strategic losses. Therefore, based on the aforementioned facts it can be deciphered that there exists a direct interconnection between the margin of safety and profitability. Moreover, the formula for the estimation of Margin of Safety (MOS) is provided below:
Margin of Safety (Sales Value) = Current Level of Sales – Break-Even Sales
OR
Margin of Safety (in units) = Current Sales Units – Break-Even Units
OR
Margin of Safety (%) = Current Sales level – Break-Even Sales / Current Level Sales X 100
Therefore, in order to calculate the margin of safety,
| Particulars | FY 2019 | FY 2020 |
| Break-Even Sales | 306,077 | 600,190 |
| Break-Even Units | 220,000 | 310,000 |
| Actual Sales Value | 740,640 | 1,147,920 |
| Actual Sales Unit | 300,000 | 350,000 |
Table: Estimates for Expected Break-even and Actual Sales of Lousy Coffee for two accounting years
Margin of Safety in units,
For 2019 = 300,000- 220,000 = 80,000 units
For 2020 = 350,000 – 310,000 = 40,000 units
Margin of Safety in Percentage,
For 2019 = 34,563/ 740,640 *100 = 58%
For 2020 = 547,730/ 1147920 *100 = 47%
Margin of Safety (in Sales value)
For 2019 = 740,640 – 306,077 = 434,563
For 2020 = 1,147,920 – 600,190 = 547,730
| Particulars | Jan | Feb | Mar | April | May | June | July | Aug | Sept | Oct | Nov | Dec |
| Beginning Cash Balance | 80000 | 125587 | 169724 | 205361 | 242798 | 289735 | 338842 | 382679 | 429766 | 477073 | 529410 | 529410 |
| Cash Sales | 61720 | 61720 | 61720 | 61720 | 61720 | 61720 | 61720 | 61720 | 61720 | 61720 | 61720 | 61720 |
| Accounts Receivables Collected | 12000 | 6000 | 500 | 500 | 4500 | 850 | 4500 | 850 | 520 | 10000 | 520 | 500 |
| Including recognised in Curent month | 1500 | 1000 | 200 | 600 | 6000 | 7850 | 8500 | 6000 | 7500 | 5400 | 9500 | 10000 |
| Recognised in Last Month | 750 | 6000 | 4000 | 5500 | 5400 | 9520 | 0 | 8500 | 7850 | 5400 | 4500 | 450 |
| Recognised in month before last | 500 | 300 | 100 | 200 | 50 | 0 | 900 | 600 | 700 | 800 | 600 | |
| Direct Materials | -1000 | -1000 | -1000 | -1000 | -1000 | -1000 | -1000 | -1000 | -1000 | -1000 | -1000 | -1000 |
| Direct Labour | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 |
| Manufacting Overheads | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 |
| Administrative expenses | -8350 | -8350 | -8350 | -8350 | -8350 | -8350 | -8350 | -8350 | -8350 | -8350 | -8350 | -8350 |
| Selling expenses | -2083 | -2083 | -2083 | -2083 | -2083 | -2083 | -2083 | -2083 | -2083 | -2083 | -2083 | -2083 |
| Interest Paid | -4450 | -4450 | -4450 | -4450 | -4450 | -4450 | -4450 | -4450 | -4450 | -4450 | -4450 | -4450 |
| Dividend Paid | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 |
| Cash Surplus/Deficit | 45587 | 44137 | 35637 | 37437 | 46937 | 49107 | 43837 | 47087 | 47307 | 52337 | 46157 | 42387 |
| Ending Cash Balance | 125,587 | 169,724 | 205,361 | 242,798 | 289735 | 338,842 | 382,679 | 429,766 | 477,073 | 529,410 | 575,567 | 571,797 |
Estimated Monthly Cash Budget
Table: Projected Monthly Estimates of Cash Budget for the manufacturing of Lousy Owl Coffee in FY 2019
| Particulars | Jan | Feb | Mar | April | May | June | July | Aug | Sept | Oct | Nov | Dec |
| Beginning Cash Balance | 571797 | 656601 | 741905 | 827209 | 912513 | 997817 | 1083121 | 1166825 | 1247879 | 1328933 | 1409979 | 1491021 |
| Cash Sales | 95660 | 95660 | 95660 | 95660 | 95660 | 95660 | 95660 | 95660 | 95660 | 95660 | 95660 | 95660 |
| Accounts Receivables Collected | 12000 | 12000 | 12000 | 12000 | 12000 | 12000 | 12000 | 12000 | 12000 | 12000 | 12000 | 12000 |
| Including recognised in Curent month | 5400 | 5400 | 5400 | 5400 | 5400 | 5400 | 5400 | 5400 | 5400 | 5400 | 5400 | 5400 |
| Recognised in Last Month | 4500 | 5000 | 5000 | 5000 | 5000 | 5000 | 3400 | 7000 | 7000 | 7000 | 7000 | 3400 |
| Recognised in month before last | 6700 | 6700 | 6700 | 6700 | 6700 | 6700 | 6700 | 450 | 450 | 450 | 450 | 450 |
| Direct Materials | -1166 | -1166 | -1166 | -1166 | -1166 | -1166 | -1166 | -1166 | -1166 | -1166 | -1174 | -1166 |
| Direct Labour | -6666 | -6666 | -6666 | -6666 | -6666 | -6666 | -6666 | -6666 | -6666 | -6674 | -6666 | -6666 |
| Manufacting Overheads | -6666 | -6666 | -6666 | -6666 | -6666 | -6666 | -6666 | -6666 | -6666 | -6666 | -6666 | -6674 |
| Administrative expenses | -12675 | -12675 | -12675 | -12675 | -12675 | -12675 | -12675 | -12675 | -12675 | -12675 | -12675 | -12675 |
| Selling expenses | -2833 | -2833 | -2833 | -2833 | -2833 | -2833 | -2833 | -2833 | -2833 | -2833 | -2837 | -2833 |
| Interest Paid | -4450 | -4450 | -4450 | -4450 | -4450 | -4450 | -4450 | -4450 | -4450 | -4450 | -4450 | -4450 |
| Dividend Paid | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 | -5000 |
| Cash Surplus/Deficit | 84804 | 85304 | 85304 | 85304 | 85304 | 85304 | 83704 | 81054 | 81054 | 81046 | 81042 | 77446 |
| Ending Cash Balance | 656,601 | 741,905 | 827,209 | 912,513 | 997,817 | 1,083,121 | 1,166,825 | 1,247,879 | 1,328,933 | 1,409,979 | 1,491,021 | 1,568,467 |
Table: Projected Monthly Cash Budget estimates for the Production of Lousy Coffee in FY 2020
Projected Income Statement
| Particulars | 2019 | 2020 |
| Revenue | 740,640 | 1,147,920 |
| Cost of Goods Sold | 592,200 | 922,600 |
| Gross Profit | 148,440 | 225,320 |
| Operating Expenses | ||
| Selling and Distribution Expenses | 25,000 | 34,000 |
| Administrative Expenses | 100,200 | 152,100 |
| Depreciation and Amortisation Expenses | 10,000 | 20,000 |
| Total Operating Expenses | 135,200 | 206,100 |
| Operating Income | 13,240 | 19,220 |
| Other Income and Expenses | ||
| Interest Revenue | 150,000 | 200,000 |
| Interest Expenses | 53,400 | 53,400 |
| Dividend Paid | 60,000 | 60,000 |
| Income before Tax | 49,840 | 105,820 |
| Less: Income Tax @ 5% | 2,492 | 5,291 |
| Net Income | 47,348 | 100,529 |
Table: Projected Income Statement for Lousy Coffee for two accounting years
Projected Balance Sheet
| Particulars | FY2019 | FY2020 |
| 1. ASSETS | ||
| Non-Current Assets | ||
| Fixed Assets | ||
| Tangible Assets | 12,000 | 14,000 |
| In-tangible Assets | 3,500 | 5,000 |
| Non-Current Investments | 850 | 1,050 |
| Deferred Tax Assets | 0 | 0 |
| Long-term loans and Advances | 0 | 3,400 |
| Other Non-Current Assets | 0 | 0 |
| Total Non-Current Assets | 16,350 | 23,450 |
| Current Assets | ||
| Current Investments | 400 | 600 |
| Inventories | 356,000 | 570,500 |
| Trade Receivables | 1,000 | 5,000 |
| Cash and Cash Equivalents | 571,797 | 1,568,467 |
| Short-term Loans and Advances | 0 | 0 |
| Other Current Assets | 0 | 0 |
| Total Assets | 945,547 | 2,168,017 |
| 2. EQUITIES AND LIABILITIES | ||
| Shareholder’s Funds | ||
| Share Capital | 50,000 | 180,000 |
| Reserves and Surplus | 184,000 | 250,000 |
| Non-Current Liabilities | ||
| Long-term Borrowings | 300,000 | 250,000 |
| Other long Term Liabilities | 10,000 | 90,000 |
| Long term Provisions | 5,000 | 10,000 |
| Current Liabilities | ||
| Short-term Borowings | 340,000 | 850,000 |
| Trade Payables | 46,000 | 52,000 |
| Other Current Liabilities | 9,750 | 420,000 |
| Short-term Provisions | 797 | 66,017 |
| Total Equities and Liabilities | 945,547 | 2,168,017 |
Table: Projected Balance Sheet Estimates for Lousy Coffee in the FY 2019 and 2020
Ratio Analysis
Ratio analysis is an effective management tool that helps in the precise analysis of financial metrics and trends over a stipulated timeframe determining the organisational effectiveness. As affirmed by Dalnial, Kamaluddin, Sanusi and Khairuddin (2014), analysing financial ratios is of greater use to both managers and investors to categorically pinpoint the strengths and weaknesses on which strategies and initiatives can be undertaken. Besides, the assessments of financial ratios are further divided into four categories liquidity, leverage or funding ratios, operational, and profitability.
Calculation of Financial Ratios
Concerning the above-mentioned facts and projects in order to access the viability of the investment, the following ratios are calculated:
- Current Ratio
| Particulars | FY 2019 | FY 2020 |
| Current Assets (A) | 929,197 | 2,144,567 |
| Curent Liabilities (B) | 396,547 | 623,017 |
| Current Ratio (A/B) | 2.34 | 3.44 |
Table: Estimation of Current Ratio for Lousy Coffee for two accounting years
- Net Profit Ratio
| Particulars | FY 2019 | FY 2020 |
| Net Profit (A) | 47,348 | 100,529 |
| Sales or Revenue (B) | 740,640 | 1,147,920 |
| Net Profit Margin (A/B*100) | 6.39 | 8.76 |
Table: Estimation of Net Profit Margin of Lousy Coffee for two accounting years
- Debt-Equity Ratio
| Particulars | FY 2019 | FY 2020 |
| Total Libalities (A) | 711,547 | 1,738,017 |
| Total Shareholder’s Equity (B) | 234,000 | 430,000 |
| Debt-Equity Ratio (A/B) | 3.04 | 4.04 |
Table: Estimation of Debt-Equity Ratio for Lousy Coffee for two accounting years
- Assets Turnover Ratio
| Particulars | FY 2019 | FY 2020 |
| Net Sales (A) | 740,640 | 1,147,920 |
| Average Total Assets (B) | 872,774 | 1,556,782 |
| Assets Turnover Ratio (A/B) | 0.85 | 0.74 |
Table: Estimation of Assets Turnover Ratio for Lousy Coffee for two accounting years
Interpretation of Ratios and Relevance
The afore-mentioned are entirely based on the projected estimates in the year-end financial statements provided and discussed in the former sections of the study.
Current Ratio
Based on the above calculation it can be deciphered that the current ratio is the effect estimate of the liquidity stance of an organisation, besides the current ratio estimate of an organisation must be less than 1. In the present case, the estimate of the current ratio for Harold and Sons stands at 2.34 and 3.44 for 2019 and 2020 respectively. The higher estimate of current ratios further hints at the inability of the organisation to meet its short-term obligations. Besides, the lack of funds within the organisation would further bar the management as well as operational heads to effectively fuel the day-to-day business operations.
Net Profit Margin
On the other hand, the Net Profit margin is the measure of the organisation’s liquidity, signifying the estimate of income generated equivalent to the percentage of revenue of the company for the particular accounting year. The net profit margin estimates for Harold and Sons in 2019 and 2020 stand at 6.39% and 8.76% respectively. From the above table, it can be deciphered that there is an increasing trend of net profit margin thereby, hinting to the recurrence of high volumes of profit from the manufacturing of Lousy Owl coffee. In addition, a high net profit margin indicates that Harold and Sons have been effectively managing its costs as well as engaged in the practice of providing its product at higher than its operational costs.
Debt-Equity Ratio
The debt-equity ratio is the measure of a firm’s financial leverage, suggesting the degree to which the company is financing its operations via debts or wholly owed funds. In the case of Harold and Sons, the gearing ratio stands at 3.04 and 4.04 for 2019 and 2020 respectively. Additionally, an effective gearing ratio estimates ranges between 1.5 and 2.0. The high estimates of the D/E ratio further indicate that the stock of Harold and Sons are at a higher risk to the investors.
Assets Turnover Ratio
Assets Turnover ratio signifies the ability of the organisation to employ its assets in order to generate net sales. The assets turnover ratio for Harold and Sons is extremely low hinting that the company is unable to allocate its acquired assets to generate revenue. Besides, one of the most expected factors for the recurrence of deviation is its excessive production capacity along with the use of incompetent collection methods.
Limitations of Ratio Analysis
Despite the ability of ratio analysis to effectively decipher financial metrics and simplify investment decision-making for oragisational intermediaries, it is associated with the below-mentioned discrepancies:
- The facts and figures used in the analysis of respective metrics is based on the real past figures released by the company therefore, ratio analysis do not necessarily represent the future performance and effectiveness of the oragisation
- The sources of ratio analysis rely upon effectively decoding the financial statements released by the organisation periodically, thus such figures defy the impact of inflation which can tend to alter the estimated values
Pitching to Potential Investors
Strengths and Weaknesses
| Strengths | Weaknesses |
| 1. Affluent business idea relying on the creation of a niche customer segment
2. Precise idea about gathering sources of funds 3. Sequenced Process outlay |
1. Lack of Liquidity within the company
2. Chances of Wastage of stock 3. High debt figures and risk potential |
Conclusion
It can be concluded from the above analysis that Harold and Sons, Lousy Owl Coffee emphasizes the determination of a separate niche by targeting customers based on the specific psychographic and demographic traits. On the other hand, based on the decoded strengths and weaknesses of the project, it is highly recommended that both ABC Holdings and DMVC Pvt. Ltd should invest in the company, besides the high net profit margin along with the debt to equity estimates further backs the aforementioned claim of profitability and organisational well being of the company in the future.
References
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Calandro, J., 2011. The margin of safety principle and corporate strategy. Strategy and Leadership, [online] 39(5). Available at: <https://www.emerald.com/insight/content/doi/10.1108/10878571111161516/full/html?skipTracking=true> [Accessed 11 December 2020].
Naranje, V., Kumar, S. and Hussein, H., 2014. A Knowledge Based System for Cost Estimation of Deep Drawn Parts. Procedia Engineering, [online] 97, pp.2313-2322. Available at: <https://www.researchgate.net/publication/267025919_A_Knowledge_Based_System_for_Cost_Estimation_of_Deep_Drawn_Parts> [Accessed 11 December 2020].
Othman, M., 2016. Cost Estimation. [online] Available at: <https://www.researchgate.net/publication/290306081_Cost_Estimation> [Accessed 11 December 2020].
Saywell, R., Cordell, W., Nyhuis, A., Giles, B., Culler, S., Woods, J., Chu, D., McKinzie, J. and Rodman, G., 1995. The Use of a Break-even Analysis: Financial Analysis of a Fast-track Program. Academic Emergency Medicine, [online] 2(8), pp.739-745. Available at: <https://www.researchgate.net/publication/280805190_Project_Cost_Estimation_Issues_and_the_Possible_Solutions> [Accessed 11 December 2020].
Dalnial, H., Kamaluddin, A., Sanusi, Z. and Khairuddin, K., 2014. Accountability in Financial Reporting: Detecting Fraudulent Firms. Procedia – Social and Behavioral Sciences, [online] 145, pp.61-69. Available at: <https://www.researchgate.net/publication/315806217_ScienceDirect_Accountability_in_financial_reporting_detecting_fraudulent_firms> [Accessed 14 December 2020].
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