Section 2.4 Explain the impact of finance on financial statements
What is the effect on the balance sheet and the profit and loss account if an organization receives a huge investment from a share issue?
In this case, the term huge investment will refer to oversubscription of issued shares, for clarity purposes. Therefore, there are three treatments that can be carried out with regard to an oversubscription. First, the excess amount may be returned to the investor that wished to acquire the shares. In such a move, it means that some of the investors will not be allocated any shares; therefore, they will not become part of the owners of the business. Second, the firm accepts part of the investors’ cash and returns the excess. In this case, the investors will not be allocated the amount of shares applied for but will be allocated an amount of shares based on pro rata basis to ensure the investors get a portion of the shares applied. The excess amount is returned to the investors. Finally, if the company articles of association allow the firm to keep the shares as a calls-in-advance, the excess amount is retained as calls in advance upon the applicant approval (Pendlebury and Groves, 2004). However, the company is liable to pay some interest on the call in advance. As such, this is not prudent thus option two will be adopted.
Considering the share capital effect on the balance sheet, using the accounting equation concept, assets of a firm are equal to the shareholders’ claim and liabilities. Shareholders claim consist of paid up capital and any reserves that the company has. Paid up capital will have a line on the balance sheet. In this case, it is assumed the shares are issued at par. As such, the huge investment will increase the value of paid up capital in the shareholder claim section of the balance sheet. In order to view other effects on the balance sheet of the capital from the balance sheet, one will need to examine how the capital was used up. However, in principle, this value will affect the asset section. Therefore, it should be expected that the increase in the value of capital will result in a similar increase in the value of the firm’s assets (Fridson and Alvarez, 2011).
Considering the effect on the statement of financial performance, the effect will be primarily observable if the capital was used to acquire assets that are depreciable. The value of depreciation of the assets will be captured in the operational expenses in the statement of financial performance. Also, an additional impact will be observed when examining the trading and manufacturing sections of the financial performance statement. As such, a high capital will lead to an increase in operations, therefore, the cost of goods will increase as a result of increased variable costs and variable overheads since the capital will be used to scale up the operations (Fridson and Alvarez, 2011).
Section 3.2 Explain the calculation of unit costs and make pricing decisions using relevant information
Determining the price to sell a product is one of most challenging decisions that managers make. The reason is because they have to consider many factors that are beyond their control such as response by competitors and acceptance of the product by the consumers at a given price. However, in order to explore the price, the managers need to consider the unit cost of production. First, the managers will need to identify the costs and classify these costs into variable, fixed and mixed costs. The mixed costs are further apportioned to either variable or fixed costs using a predetermined approach. Variable costs refer to the costs that will change as a result of a change in the level of production while fixed costs refer to the that are insensitive to the level of production thus will remain unchanged regardless of the level of production (Hansen and Mowen, 2003). Having allocated the costs, variable costs are added to unit fixed costs of the product to obtain the value of the unit cost of producing the product.
After computing the unit cost of production, the managers will explore several factors such as the prevailing market condition, capability of the firm to handle a price war as a result of competitors response to the product entry to the market, ability to sustain the product in the market even in period of severe economic times without changing the price and profitability margin acceptable to the firm. Having considered these factors, the firm’s managers will set the price based on the model they want to pursue.
Setting the price, the managers will wish to understand how long the firm will take to sustain itself, the point the firm cash flows will match the firm’s costs. Therefore, the firm will need to carry out a cost volume profit analysis in order to determine the breakeven point (Hansen and Mowen, 2003).
Assume SHE Ltd produces (only) ribbed flavored edible condoms (3 per packet). Each packet has £0.02 of materials, £0.10 of labor and £0.05 of variable costs. The fixed costs are £10,000 with each packet selling for £1, the following calculation will show the firm’s breakeven point
The break-even in units will be obtained by dividing fixed costs by the contribution margin while the breakeven point in value is obtained by the product of breakeven point in units and the price of the product (Cafferkey and Wentworth, 2010). The interpretation here is that` the firm will start making profits the moment it exceeds 12,048.19 units sales or £12,048.19 sales. In order to examine the sales needed to make a given profit, the value of profit is added to fixed costs to obtain the required level of sales to make that profit.
References
Cafferkey, M. E. and Wentworth, J. 2010. Breakeven analysis: The definitive guide to cost-volume-profit analysis. New York: Business Expert Press.
Fridson, M. S. and Alvarez, F. 2011. Financial statement analysis: A practitioner's guide. Hoboken, NJ: Wiley.
Hansen, D. R and Mowen, M. M. 2003. Cost management: Accounting and control. Mason, OH: Thomson/South-Western.
Pendlebury, M. and Groves, R. 2004. Company accounts: Analysis, interpretation and understanding. London: Thomson.
