EBF 1033 BASIC ACCOUNTING

1.0 INTRODUCTION

There were a few explanations were given to make people understand

about an importantly of the financial statement analysis or financial ratios.

Commonly, managers, officer and internal auditor used financial statement

analysis to help these users for making a better business decision. Moreover, the

purpose of the financial analysis is to provide meaningful information in improving

the company performance especially to make the company more efficiency and

effectives in providing products and services. (Ratios analysis,

[Link])

Information’s that provide at the financial statement were used to calculate

most of financial ratios. If someone want to make the compare ration between

one’s companies financial to the other company in the industry, financial ratios

are used as an indicators of company’s performance to predict future bankruptcy.

(Financial Ratios, [Link])

Ratio analysis is process of the determining and evaluating financial ratios

that were often used by the managers in assessing the significance of various

financial data. A relationship between company’s activities can be indicates with

a financial ratio as the ratio between the company’s current assets and current

liabilities or between its accounts receivable and its annual sales.(Financial

Ratios, [Link]

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1.1 Purpose and scope

The purpose of this essay is to practice the standard financial ratios and

to evaluate the performance of Falcon Company using the information that were

given at the Falcon Company financial statement and it is hope that with the

financial ratios, the Falcon Company can improve its performance.

The study of this essay focused on the adapted financial statement for the

year ended Dec 31, 2000 & 2001. It was concerned only with the comparisons

between current and prior periods and industry average using financial ratios to

help make decision to predict future bankruptcy.

2.0 ESSAY REFERENCE

2.1 Financial statement source

The financial statement of the Falcon Company and the industry averages

was retrieved from web site and it was adapted become more useful for archived

the purpose and scope of the essay. The full information about the financial

statements was showed at appendices pages.

3.0 EVIDENCE OF SIGNIFICANT RESEARCH

N.A Manley (1999) in Financial Ratios mentioned that there are 4 main financial

ratios categories that usually use in interpreting financial statement which is

liquidity, profitability, leverage and activity or efficiency.

3.1 Standard Financial Ratios of Falcon Company

3.1.1 Liquidity Ratios

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This ratio is generally used to analyze about the ability of Falcon Company

to meet its short –term obligations. This is for measures Falcon Company can

survive.

The industry average is 2.0 times.

• Current ratio= Total current asset / total current liabilities

2001} 6300 / 2700 = 2.3 times 2000} 3600 / 2400 = 1.5 times

Falcon Company is going to have more ability to meet it current liability out

its current assets at 2001 with 2.3 times than 2000 with is look like Falcon

Company have a problem to pay current debts rather than the industry average.

It’s also not too good for have a higher ratio because the company should not

invest too much in current asset, is not an efficient.

‘While high liquidity means that the company will not default on its short-

term obligations, one should keep in mind that by retaining assets as

cash, valuable investment opportunities may be lost. Obviously, cash by

itself does not generate any return. Only if it is invested will we get future

return.’

H.B. Lermack (2003) Financial Ratio Analysis

3.1.2 Profitability

This ratios is useful for analyze the ability of company management to

control the expenses and earn of profits or income.

Industry average is 15%

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• Gross profit margin= sales – cost of good sales / sales

2001} 11,500 – 9,430 / 11,500 = 0.18 x 100 = 18%

2000} 7,650 – 5,800 / 7,650 = 0.24 x 100 = 24%

Profitability of a Falcon Company sales were decrease for year 2001 after

the cost of sales has been deducted. These conditions were not too good for the

company because the company unable to control the expenses of cost of sales

to gain more profit in the future. However Falcon Company still in control rather

than industry average which only have 15% profitability.

‘According to Gibson (1997), "Analysis of profit is of vital concern to

stockholders since they derive revenue in the form of dividends. Further,

increased profits can cause a rise in market price, leading to capital gains.

Profits are also important to creditors because profits are one source of

funds for debt coverage. Management uses profit as a performance

measure.’

N.A Manley (1999), Financial Ratios.

3.1.3 Asset Management (efficiency)

Asset management ratio is to help the company analyze about how

quickly it resources can be convert to cash or turn it into sales.

Industry average is 5.0 times

• Inventory turnover = Cost of good sold / inventory

2001} 9,430 / 2,450 = 3.84 times 2000} 5,800 / 1,500 = 3.87 times

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During 2 years operating time period Falcon Company can not fight the industry

average which is have 5.0 times to convert into cash or sales more quickly.

While, the company is decrease their ability to produce and sold.

‘This ratio shows how quickly the inventory is being turned over (or sold)

to generate sales. A higher ratio implies the firm is more efficient in

managing inventories by minimizing the investment in [Link] a

ratio of 12 would mean that the inventory turns over 12 times, or the

average inventory is sold in a month.’

H.B. Lermack (2003) Financial Ratio Analysis

• Accounts Receivable Turnover = sales / account receivable

Industry average is 6.08 times

2001} 11,500 / 3,800 = 3.02 times 2000} 7,650 /1,200 = 6.38 times

The industry average of accounts receivable turnover ratio is 6.08. For the

year 2000 Falcon Company can collect its accounts receivable within 6.38 times

which is quicker than the industry average but in 2001 the Falcon Company

ability to collect their accounts receivable were down to 3.02 times only. This ratio

showed that Falcon Company was not effective anymore in collecting accounts

receivable.

• Average collection period = (account receivable / annual sales) x 365

Industry average is 60 days

2001} (3,800 / 11,500) x 365 = 120 days

2000} (1,200 / 7,650) x 365 = 57 days

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This ratio show that during year 2001 operating period Falcon Company

were not effective in collecting it receivable because they take 120 days which is

two times than industry average collection period. Actually 120 days for make a

collecting is not valuable for the company, it can reduce the liquidity of the

receivable. And the average collection period ratio for year 2000 operating period

is very reasonable and effectively.

‘Ratio accounts receivable turnover and average collection period

show the company efficiency in collecting cash from its credit sales. While

a low ratio is good, it could also mean that the firm is being very strict in its

credit policy, which may not attract customers.’

H.B. Lermack (2003) Financial Ratio Analysis

• Total asset turnover = sales / average total asset

Industry average is 0.56 times

2001} 11,500 / 17,650 = 0.65 times

2000} 7,650 / 13,650 = 0.56 times

This ratio shows that Falcon Company generates 0.65 times of sales for

every Ringgit of investment in asset for year 2001 of operating period. Actually

the higher the ratio is, the better the company performance. So, these ratios also

show the company effective in uses its total resources to generate sales.

‘A high ratio suggests greater efficiency in using its assets to generate

sales, and a low ratio suggests less efficiency in using its assets to

generate sales.’

Ratios Analysis, [Link]

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3.1.4 Debt management (leverage)

The debt management ratio will show the limitation for the company to

continue the company operation by using or via debt and the relation of the

revenue with debt.

• Debt ratio = total debt / total asset

Industry average is 25%

2001} 6,050 / 17,650 = 34.3% 2000} 2,750 / 13,650 = 20.15%

Debt ratio of Falcon Company during year 2001 show that company were

more of the asset at the company were financed by debt. The Falcon Company

seems find it is difficult to attract additional financing for the company purpose.

‘High debt to total assets ratio means more of the firm's assets are

financed by debt relative to owners' funds and it is requires the

commitment of more funds to pay interest and repay principal amount.

Generally, lower is better Low debt ratio means that the firm is using more

of owner’s capital and retained earnings to finance its assets. It means

less risk to creditors. Company can borrow additional funds with relative

ease.’

Ratios Analysis, [Link]

3.1.5 Profit Margin Ratio (Net Profit Margin)

One of the most important in financial statement analysis is to know

weather the company’s performance can generate producing profits.

Industry average is 11%

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• Profit margin Ratio = net income / sales

2001} 1,000 / 11,500 = 8.7% 2000} 1,050 / 7,650 = 13.73%

The ratio show that Falcon Company were not effective in producing profit

during the 2001 operating period, on the other hand in 2000 operating period

Falcon Company were successes because it can generate profit higher than

industry average.

‘Generally, higher is better it suggests that expenses as a percentage of

sales are under control indicating operational efficiency. A low ratio may

suggest that expenses as a percentage of sales are high.’

Ratios Analysis, [Link]

4.0 CONCLUSIONS

Falcon Company financial ratios above give the overview about company’s

financial health and also can vary significantly among companies and same

industries. Since the Falcon Company financial statements were compared with

industry averages, ratios result can help the Falcon Company managers to

analyze their company's performance to generate more profits. The ratios were

calculated should be use in evaluating a company operating position such as

making comparisons with the previous years or industry average like what had

show in this essay before.

Furthermore, Falcon Company also can make the horizontal analysis or

vertical analysis to compare its own ratio within the years operating or with other

years of operating period. With this analysis company still can evaluate the

company development for the certain operating time periods.

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