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.

Financial Analysis

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

Amade, B. and Akpan, E., 2014. Project Cost Estimation: Issues and the Possible Solutions. International Journal of Engineering and Technical Research (IJETR), [online] 2(5). Available at: <https://www.researchgate.net/publication/280805190_Project_Cost_Estimation_Issues_and_the_Possible_Solutions> [Accessed 11 December 2020].

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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