Business Accounting Assignment 1: Business Report on Accounting Practices and Financial Standing of Crafty Limited
Introduction
Final Accounts are prepared at the accounting cycle in order to determine the financial state of a business during a designated period. Preparation of final accounts include Manufacturing and Trading account statements, Profit and Loss Account sheets and the Balance Sheet. In order to calculate the amount of profit or loss a business entity has generated within a specified period, the Trading, Profit and Loss Account is prepared; since the Balance Sheet provides a snapshot of the assets and liabilities of a business, its interpretation reveals how financially viable the business is currently; while the most important function of the Manufacturing Account is to ascertain how much it cost the business to produce the goods as well as the expenses incurred to sell off the products manufactured in a specific period .
The method of preparing these and other accounts varies depending on whether Financial or Management Accounting is being used. Financial Accounting techniques are used when financial statements are being prepared for the consumption of the external stakeholders of a business that include its stockholders, the Board of Directors, other financial institutions such as banks and even potential investors. Financial Accounting Reports provide an overview of a company’s past performance, and for publicly traded companies, making these reports after they have been audited available to the general public is mandatory.
Management Accounting on the other hand is for the benefit of managers. Here, the focus is less on past performance and more on the current financial position of the company and expected costs in the future. Therefore, it is not as accurate as financial accounting, since a lot more projections are made .
The following calculations for Crafty Limited for instance, as they are based on costs that have already been incurred, utilize financial accounting principles.
With fixed costs (that will be incurred regardless of the number of units produced) of £1200 and raw material costs of £0.5 per unit, if Crafty Limited manufactures 400 such units, then the total cost incurred will be 1200+(0.5x400) = £1400.
If fixed costs are £1000, raw material costs incurred are £1.5 per unit and Crafty sets the selling price at £2.5 per unit and decides to manufacture 500 such units, then:
Sales income will be 500x2.5= £1250
Total costs incurred in the manufacturing are 1000+ (1.5x500) = £1750.
As the calculations above indicate, the sales revenue generated is insufficient to cover the fixed and variable costs of production in manufacturing 500 of such units by Crafty Limited. This implies that despite the sales, the company is not netting a profit.
This scenario will become clearer by performing a break-even analysis for Crafty Limited. The breakeven point (which can be calculated either in dollar amounts or in terms of units sold), is the amount of revenue that a business needs to earn during a specific period, in order to cover both its fixed and variable expenses.
The break-even point in the graph is at the intersection of the total revenues (red) and total costs (green) lines, which is approximately 560 units. This means that in order for the sales income to cover the business’ expenses, Crafty Limited will have to sell almost 560 units. The formula used here is Total Fixed Costs/ Contribution Margin per unit. The contribution margin calculation is relatively simple; all variable costs incurred to produce one unit are subtracted from the sales price set per unit.
The assumption in the breakeven analysis is that an organization’s expenses are directly tied in to the number of units that it sells. This is a major limitation of this analysis because a business might not be able to breakeven in actuality simply by selling more units. The increase in expenses may be due to factors other than the costs of selling more, there may be multiple product lines with varying levels of profitability or a company could simply be operating in different countries, where the profit margins or overhead costs vary. Therefore, Crafty Limited should not rely entirely on the breakeven analysis to determine a profitable volume of business.
Budgetary Controls
Budgets are official statements that allocate organizational resources to specific activities during a specified time period. Preparing budgets ensures that a business coordinates its activities and the inputs and outputs are closely measured. Budgets also help in setting up a check and balance system that ensures that tasks are prioritized so that a business always has the required amount of funds for the most important tasks. Setting a budget at the start of every year also ensures that managers are aware of the level of financing that will be required to keep the business afloat .
Budgetary controls are business processes that are put in place to compare a business’ actual performance with the budgeted forecasts, and appointing individuals who are responsible for this variance. It is important that the people assigned responsibility also have the authority to revise budgets or take actions to revise individual and departmental performance.
Broadly, there are four types of budgetary controls that are used commonly. First are the revenue centers; these are the departments where the focus is on the value/volume of output, without comparing them with input costs. Second are the investment centers where the focus is on measuring how efficiently output is being generated, by determining the ROI involved. Third are expense centers that only focus on the costs being incurred with no monitoring of outputs. Lastly, the profit centers compare inputs with outputs to determine if the department/business is netting a profit.
Cash Flows
The opening bank balance for Crafty for all the months between April-September was in the debit, and this immediately put the company on the back foot from the start. What made the situation worse in July was the 10,000 additional payment for Equipment that had to be made, that put the company’s closing balance at 5,000 in the red. The first cash surplus for Crafty Limited happened in the month of August when the company’s closing bank balance was one thousand pound sterling.
Business Stakeholders and Profitability Ratios
In addition to the stockholders who have a vested financial interest in the performance of a business, there are several other stakeholders that make up the business environment. The suppliers and distributors of a company (when outsourced) are at risk of losing a sizeable chunk of their business when a company faces cash flow or profitability issues. Similarly, since an important source of revenue for the government is via taxation of businesses, increased frequency of bankruptcies pose a major threat to their income. Lending institutions who are creditors of the business always keep a close eye on the balance sheets and cash flow statements as repayment of loans may become a question for cash-strapped businesses .
Gross profit for Crafty is calculated by subtracting the cost of sales (4000) from the revenue (11500), and comes out to be 7500, while the net profit is calculated by first adding all the costs (3500+1000+2000+450+400) and then subtracting it from 7500 (gross profit); the net profit is therefore 150.
For 2013, the cost of sales is (revenues- gross profit) which equals 1198, while the expenses (gross profit-net profit) are 912. For 2014, the gross profit is 1369 (2833-1464), while the net profit is 165 (1369-1204). The net profit registered a decrease from 535 to 165, despite an increase in the sales figure mainly because the expenses increased from 912 to 1204.
The GPM for Avon is calculated by GP/Sales (2290/3590) which equals 63.79% while the NPM is determined by Net Income/Sales Revenue (140/3590) which equals 3.9%. The return on capital for Crafty is calculated by dividing Net Income by the capital invested which equals (140/10000) = 1.4%. To improve its profitability ratios, Avon needs to bring down its expense figure while reducing the cost of goods sold as well.
For Stosur, since current assets and current liabilities are equal, the value for stock is 1700-1600=100. Therefore, the total assets are (2700+100+900+550+1600) 5850 and the net current assets are -100 (1600-1700).
The net working capital ratio is net assets/total assets (-100/5850) = -0.017 while the acid test ratio is (quick assets/Current liabilities) 1600-1400/1700 = 0.12.
Bourne can improve its trading position by reducing its trade credit or Accounts Payable figure, as well as by paying off its loan.
References
Atrill, P., 2014. Accounting and Finance for Non-Specialists. 9th Edition ed. New York: Pearson.
