unit 2 p5 p7 m3 d2 RESUB

UNIT 2 P5

Businesses who work on a daily basis, must ensure they check up on their financial statements so that they can judge how well their doing financially. Financial statements allow Johnsons Hardware store to measure their financial resources and stability. PLC (public limited companies) must publish their accounts so that investors can see how the business is doing. The 2 main final statements are; profit and loss, balance sheet. A profit and loss sheet shows you how much Johnsons Hardware stores has made at the end of a financial year. This is useful for e.g. if you wanted to lend money from the bank, the bank will look at this and determine whether or not it’s worth the investment and if yours good at making profit and not spending too much or going overdraft. Smaller businesses e.g. sole traders, LTDS find it useful when they want to see how much profit they have made at the end of the year and this helps them plan finances and budget settings. A profit and loss has a lot of features that are included within it and they have purposes. A sale is the amount of money which is generated by selling a product/service. This allows the manager of Johnsons Hardware Store to understand and see where the money is coming from and how well the business is performing. The cost of sales is the cost of marketing the goods or buying them. Its purpose on the profit and loss sheet is so that you can see where the money is coming in or out of the business and to understand how the business is performing. Next is usually gross profit which is the sales revenue minused by the cost of goods sold. The purpose of gross profit is so you can see how much profit has been made after all the costs are deducted and it indicates how a product is performing. Net profit is the gross profit minused by the expenses. Examples of this is rent, advertising etc. this is to see the final profit when all costs have been deducted and to also see how successful a profit is. Expenses is another feature on the sheet which is the overheads and expenses which are basically necessity costs, examples of this is wages, staff, advertising, salaries etc. This is shown on the sheet to see how Johnsons Hardware store is operating and if it is efficient or working in the best possible way. 

On a balance sheet, it has a separate set of features which are different to the features on a profit and loss sheet. A balance sheet gives Johnsons Hardware store a snippet of the businesses assets, abilities and equity. By producing a balance sheet it is important because it shows Johnsons stores finance and where they are getting their money from. It also shows investors how much Johnsons Hardware store is worth based on their assets. The first feature is fixed asset, which are assets that are owned or expected t be kept by the business for 1 year or more and this is on the sheet to see where money is being invested. They are to see what the business has invested Johnson’s money into. Secondly, current assets can be converted into cash more quickly and are only kept for a short period of time, usually under a year. An example of a current asset is stock which is used up under a year an then you rebut more stock. Its purpose is to show where finances are available. Current liabilities are amounts due to be paid to creditors within twelve months and it shows where expenses are. Liabilities mean responsibilities that a business has. Johnsons must make sure their extremely responsible for their current liabilities or they could be forced into going bankrupt. Moreover, long term liabilities are liabilities with a future benefit over a year and they are shown on the balance sheet representing the sources of funds. An example of a long term liability that Johnsons Hardware Store own, is their mortgage. Share capital is the amount of money invested into a company by shareholders and its purpose is to show how much capital was raised or invested in Johnsons Hardware store. Lastly, reserves are the profits that have been kept for a particular purpose which is shown on a balance sheet to see the purchase of fixed assets, legal settlements, and pay bonuses. It is back-up money incase something in the business goes wrong it is there to use in an emergency.

P7 and M3

A ratio analysis is an explanation of financial information to satisfy the needs of various interested parties. Stakeholders in the business, internally and externally seek information to find out the fundamental questions. There are different categories of a ratio analysis to help us understand more about financial accounts. One of them is liquidity/solvency which is the ability of Johnsons Hardware store to pay its way. Another one is profitability which is how effective the business is at generating profits given sales and or its capital assets. Also, financial/performance is the rate at which a Johnsons sells its stock and the efficiency with which it uses it assets. 

Liquidity/solvency ratios show the cash levels of Johnsons Hardware store and the ability to turn other assets into cash to pay off liabilities and other current obligations. Liquidity is not only a measure of how much cash Johnsons Hardware store has but it is also measured of how easy it will be for a business to raise enough cash or convert assets into cash. The ratios that are included are current ratios and acid test ratios. Current rates are worked out by dividing the current assets from the current liabilities and this will work out the liquidity and efficient ratio that measures Johnsons ability to pay off its short term liabilities with its current assets. If this rate is too high then this means a business has too much stock and if the ratio is too low this means the business is not able to pay it back. Acid test ratios are worked out by minusing the stock from current assets then dividing that by the current liabilities. By doing this you will get the liquidity rate that measures the ability of Johnsons Hardware store to pay its current liabilities when they become due with only quick assets. Quick assets are current assets that can be converted into cash within 90 days or in a short period of time.

Profitability ratios compare income statement accounts and categories to show Johnsons Hardware stores ability to generate profits form its operating actions. It focuses mainly on a businesses return on investment in inventory and other assets. These ratios basically show how well Johnsons can achieve profits from their operations. Profitability ratios include; gross profit margin, net profit margin and return on capital employed and these are all percentages. Gross profit margin is worked out from dividing the gross profit by the sales revenue then timesing this number by 100 to get a percentage. This percentage will help Johnsons Hardware store to understand how much profit they are making from buying and selling goods. The higher the percentage the better because the business can assess the impact of its sales and how much it costs to generate. Net profit margin is worked out by dividing the net profit from sales revenue then timesing this by 100 which provides a much more accurate reading of how much profit Johnsons has made as its takes away all of the costs and not just those we had in the buying and selling of out goods. Lastly return on capital employed is worked out by dividing the operating profit (which can be found in the profit and loss sheet) from the capital employed (which is found on the balance sheet)then timesing this number by 100 which gives you a percentage that looks at how much money you have invested in the business. Once again the higher percentage, the better!! Operating profit only covers the gross profit minus direct expenses for the business while net profit includes all gains and loses by the business including tax payments.

Financial ratios look at how Johnsons Hardware store is performing financially. It is usually relationships determined from businesses financial information and used for comparison purposes. Financial ratios include gross profit margin, net profit margin and return on capital employed. To work out the asset turnover you divide the sales by the net assets then times that number by 100 to get a ratio. This rain measures the businesses ability to generate sales from its assets by comparing net sales with average total assets. The ratio shows how efficiently a business can use its assets to generate sales. To work out the stock turnover you would divide the cost of sales by the stock then times this by 100 to get a ratio also. The stock turnover tells you the rate at which Johnson’s stock has turned over. Lastly, debtors collection period is worked out by dividing the debtors by the credit sale then timesing this by 100 and this tells us how long it takes the business to recover its debts. This can be skewed by the degree of credit facility a firm offers, therefore the shorter the number the better it is.

In my opinion I personally feel that you, the branch manager of the bank should make the loan to Johnsons Hardware store as it is a reliable business and it checks its profit and loss account as well as their balance sheet to see the stability of their business and the measures the ability of the business and Johnsons ensure that they sort out what they need to do if the business is decreasing in sales or have any other problems.

We use ratios within a business so that they can see the financial result in the business. Johnsons Hardware Store use them so that they can evaluate the financial stability of their business and then estimate their performance and see what they can do to change and improve it. There are 3 different categories of accounting ratios which are; solvency ratios, efficiency ratios and profitability ratios.

Solvency Ratio’s

	EQUATION	WOKRING	RATIO	EXPLANATION
Current ratio	Current assets Current liabilities	32836 32451	1.01:1	This measures Johnsons Hardware store’s ability to pay off short term liabilities using current assets.
Acid test ratio	Current assets-stocks Current liabilities	32836-1354 32451	0.97:1	This measures Johnsons ability to pay off its current liabilities with only quick assets

Explanation of current ratio- Because the current ratio is 1.01.1, this means that the business it not able to pay the money back because the ratio is too low. They need to increase this ratio yet, if the ratio is too high then this will mean the business has too much stock.

Explanation of acid test ratio- This ratio is 0.97.1 which means that the business are not good at paying back their current liabilities when they become due with only quick assets as the ratio is extremely low.

Efficiency Ratio’s

	EQUATION	WORKING	RATIO
Gross profit margin	Gross profit Sales revenue x 100	256250 290000 x 100	88.36%
Net profit margin	Net profit (before tax) Sales x 100	207874 290000 x 100	71.68%
Return on capital employed	Operation profit Capital employed x 100	207874 112735 x 100	184.39%

Explanation of gross profit margin- This means the business is performing well and are earning enough money which they are making a profit on. They are not 100% which is what they should be aiming for however, at 88.36% that is a high percentage meaning the business can assess the impact of its sales and how much it costs to generate these sales.

Explanation of net profit margin- This means the business is performing in the right areas; however they should find ways to increase their profit because the percentage 71.68% is not as high as it should be.

Explanation for return on capital employed- This means that the business has invested a lot of money in the business because the percentage is 184.39% because the higher the percentage the better.

Efficiency Ratio’s

	EQUATION	WORKING	RATIO
Asset turnover	Revenue Net assets	290,000 145186 x 100	199.74%
Stock turnover	Cost of sales Average stock held	33750 2155 x 100	1566.1%
Debtors collection period	Trade debtors Revenue x 365	2123 256250 x 365	3.02 days

Explanation of asset turnover- This means that for every £1 of assets, the business generates £2 in sales. The percentage is 199.74% which implies the business is very good at using assets to generate sales and they have made a lot of sales.

Explanation of stock turnover- Johnsons Hardware store’s inventory turns over 23.3 times a year. This means that the business inventory turns over 15.661 times a year. The percentage is extremely high being 1566.1% which is maybe because the goods that Johnson’s sell are expensive which will make the percentage high.

Explanation of debtor’s collection period- This denotes to us that it Johnsons Hardware store 3.02 days, so 3 days to collect debts. This means that their credit terms are too strict and the customers may want suppliers who are less harsh or have different options of payments.

D2

In this assignment I will be evaluating the adequacy of accounting ratios as a means of monitoring the state of Johnson's Hardware store, using my ratios in P7 and M3. I will clearly explain each ratios strengths and weaknesses when it comes to monitoring Johnson's financial status. Financial ratios have three main purposes, one is so that you can predict the businesses future, another is so they can compare their financial status with businesses and lastly, Johnsons can compare their financial status with competitors who are in the same industry as them. They are also good because it allows lenders to see how the business is doing. For example, if a business want to borrow money then the lenders would look into the businesses ratios and evaluate their financial stability and determine whether or not they are going to lend the money. It allows lenders to decide whether or not the business is a safe investment and whether or not the business would be able to repay their debts with interests.

Financial ratios can be useful and helpful to Johnson's Hardware store because they clearly show Johnsons financial status which is the important information the staff need to know in order to change and improve the business frequently. An example is if the staff look at the financial ratios and notice that the sales are decreasing and the price of stock is increasing. By looking at the ratios we will be able to tell that the business need to potentially replace their wholesaler for a cheaper one or they could reduce the amount of stock they by. There are plenty of other options a business could do in order to improve the business by looking at the ratios.

They can help Johnsons to predict the future for the entire business. For example the cost trends can be found out by looking at the financial ratios. This is good to analyse as it will show you previous years trends and the business will be able to see what the business makes the most profit on etc. By doing this, Johnson's can plan future years business activities however, they may change as it is is just a predicting and assumptions.

Another way in which financial ratios are useful is when you want to compare Johnson's Hardware store to other competitors and see their financial status. By comparing businesses, it will give a good representation of what Johnson's is doing well and what the competitors are doing well in and what both businesses are lacking in. Therefore, you can come to a conclusion and work out a plan in order to improve the businesses financial statement. This is helpful for the management team in the business because it easily allows them to compare how efficient they are working in comparison to other businesses and their competitors.

On the other hand, by using financial rations to judge Johnsons financial status can be inaccurate and wrong in some cases because there are a vairety of different factors that need to be considered such as; environmental, external, economic, internal etc. By comparing a business to Johnsons, could be misleading because for e.g. A business sells only Halloween equipment and therefore they are only going to make the majority of their profit around Halloween time whereas a store e.g. Bakery which sells cakes and different foods all year round will have a consistent income which is why comparing businesses financial statements using financial ratios can be extremely incorrect and false.

Financial ratios can be used to help lenders decide whether or not they should lend money to the business. This can be especially unfair and wrong in some cases. An example of this is if a businesses financial statement has a really bad month because that was the month they spent a lot of money on stock for a festive holiday yet they only do that once a year which doesn't give a wide count on the financial statement of Johnsons. This will then affect the lenders decision and will not be willing to lend Johnsons money because they think they won't be able to pay back their debts with interest therefore they won't be able to lend money which is unfair for the business.