1

FINANCIAL STATEMENT ANALYSIS

Name of the student

Name of the institution

Name of the tutor

Date of submission
 2

Task one

Introduction

EasyJet was founded by Stelios Haji-Ioannou in the year 1995 as one of the new frills

airlines services. The company charges low fares, fewer comforts and lower operating costs

structure than other more advance legacy carriers such as British Airways. Some of the key

model to the business of EasyJet as well as other low-cost carriers, that are charging for ancillary

services such as food baggage and the priority boarding, quick turnaround times for the aircraft

and high aircraft utilization.

Explain the purpose, structure and content of published accounts

The main purpose of published reports is mostly for use by both internal and external

interested part (Gassen 2014). Government is an interested party in financial statement of the

company as they are establishing the tax that an organization is supposed to pay. Potential

investors is also interested in the financial statements as this will help them in making decision

whether to invest or not spend in the corporation. Auditors also use financial statements to

determine the compliance of business and other corporations in the world (Horngren et al. 2012).

Governments are other users of financial statements to levy a tax on the company. They are

useful for investors and the management at large. The three primary published financial

statements include a statement of financial position, income statement, and cash flow statement

(Gassen 2014).

Presentation of financial statement

The objectives of IAS 1 prescribes the basis for the presentation of general purpose

financial statements to ensure that there is comparability with other entities, and with other

previous statements (Waegenaere, Sansing, & Wielhouwer 2014). A financial statement that is
 3

considered complete comprises the following with, in brackets, the titles to be used for

accounting periods. They are

 The balance sheet (statement of financial position)

 An income statement (statement of comprehensive income

 Statement of changes in equity

 Cash flow statement (statement of cash flow) and

 Notes, comprising a summary of significant accounting policies and other explanatory

notes

The international accounting standards 1 set out some of the basic concepts and other

guidelines that should be complied with when preparing and presenting financial statement

(Horngren et al. 2012). Published financial statements content should be made in line with going

concern, accrual, consistency, and materiality. Assets, liabilities, income, and expenses, when

material should be reported separately so that users can make proper assessment of the progress

and financial position of the entity (Waegenaere, Sansing, & Wielhouwer 2014). Therefore,

assets and liabilities, and income and expenses should not be offset unless required or permitted

by an IFRS.

Structure and content of monetary statements

IAS 1 specifies the least line items disclosures on the features of or in the explanation of

the balance sheet, the income report and another report of changes in equity (Waegenaere,

Sansing, & Wielhouwer 2014). In the balance sheet, current and fixed assets, current and fixed

liabilities, are obtainable as separate classifications on the face of the financial position statement

(Beatty & Liao 2014). This distinction is very essential because the extent of the future assets
 4

and liabilities are to be realized clear implications for an assessment of the financial position and

solvency of an entity. The format for balance sheet is shown below;

Statement of financial position

Assets $ "000."
Non-Current Assets
Property, plant, and e
Property, plant & equipment
Accumulated depreciation
Goodwill
Accumulated amortization
Other intangible assets
Investments in associates
Available-for-sale investments
Current assets
Inventories
Trade receivables
Cash and cash equivalents
Total assets
Equity and liabilities
Parent company shareholders ‘equity
Share capital
Other reserves
Retained earnings
Minority interest
Total equity
Non-current liabilities
Long-term borrowings
Deferred tax
Long-term provisions
Total non-current liabilities
Current liabilities
Trade and other payables
Short-term borrowings
Current portion of long-term borrowings
Taxation
Short-term provisions
Total current liabilities
Total liabilities
Total equity and liabilities
 5

For income statement, commonly, all items of revenue and expenditure recognized during the

year should be reported in the statement of operations (Beatty & Liao 2014). There are very

limited items of revenue and expense, however, properly excluded from the income statement.

They include and not limited to;

 The correction of errors as stated in IAS 8,

 Revaluation surpluses IAS 16

 Certain gains and losses arising from translating the financial statement of a foreign

operation as per IAS 21

 Gains or losses on re-measuring available for resale financial assets as pet IAS 39

The income statement is as follow

Income statement – function of the expense format

Income statement for the year ended 31 December 20X5 £000

Revenue $ "000."
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Other expenses
Operating profit
Other income
Finance costs
Share of profit of associates
Profit before tax
Taxation
Profit after tax
Attributable to:
Equity holders of the parent
Minority interest
 6

Income statement – nature of the expense format

Income statement for the year ended 31 December 20X5 £000

Revenue
Raw materials and consumables used
Employee benefits expense
Depreciation and amortization expense
Impairment of property and plant and equipment
Other expenses
Operating profit
Other income
Finance costs
Share of profit of associates
Profit before tax
Taxation
Profit for the period
Attributable to:
Equity holders of the parent
Minority interest

For the statement of changes in equity, shareholders equity between the balance sheet

dates, of course, equal to the upward or decline in the net assets during that period (Harrison et

al. 2014). Cash flow statement, a company that is marking good profits, can still get difficulties if

it fails to generate adequate cash flows and manage those cash flows.

Analysis of the company performance

Ratios in financial analysis are one of the most important cross-sectional analysis tools.

The four basic ratio categories liquidity, leverage, profitability, and turnover are used for the

comparisons Waegenaere, Sansing, & Wielhouwer 2014). Initially, each company's ratio is

calculated from the financial statements and then they are compared against each other ratio

Waegenaere, Sansing, & Wielhouwer 2014). Although there are hundreds of the different ratios,

some of the other ratios are very difficult to calculate, and the general concept is similar to the

ones, which has been calculated and analyzed.

a) Current Ratio = Current Assets/Current liability
b) Quick Ratio = (Cash + Debtors)/ Current Liabilities
 7

c) Debt to Equity Ratio = Total Liability/Equity

d) Gross Profit Margin = Gross Profit/Sales
e) Sales to Asset = Sales / Total Assets
f) Return on Assets = PBT/Total Assets
g) Return on Equity = PBT/Equity
h) Inventory turnover = Cost of goods sold/ Inventory
Current ratio
Current ratio = current assets/ current liability
2013 = 1448/ 1379
= 1.05
2011 = 1738/1177
= 1.48
From the analysis, the current ratio for the year 2013 is 1.05 while that of 2011 is 1.48. From the

analysis, the company performance has declined by 0.43. This is a poor indication of the point of

company growth.

Quick Ratio = (Cash + Debtors)/ Current Liabilities

2013 = (1013 + 194) / 1379
= 0.875
2011 = (165 + 1100) / 1177
= 1.07
XX states that the higher the quick ratio the better the performance of the firm. From the

analysis, in 2011 quick ratio is 1.07 while in 2013 is 0.875. Therefore, the company performance

has declined in performance.

Debt to Equity Ratio = Total Liability/Equity
2013 = 2395 / 2017
= 1.19
2011 = 2764/1705
= 1.6
In 2011, debtor's ratio was 1.6 while in 2013 ratio went down to 1.19. This shows that the

company has improved in terms of debt management.

Gross profit Margin = Gross profit/Sales
2013 = 711 / 4258
= 16.70%
2011 = 468 / 3452
= 13.60%
The gross profit margin increased from 13.60% to 16.70%. Therefore, the performance of the

firm has been increased.

Sales to Asset = Sales / Total Assets
2013 = 4259 / 4412
 8

= 0.97
2011 = 3854 / 4469
= 0.86
The performance of the firm has improved since in 2011 it was 0.86 while in 2013 it increased to

0.97. Therefore, the company is healthy in terms of assets performance

Return on Assets = PBT/Total Assets
2013 = 711 / 4412
= 0.16
2011 = 468 /4469
= 0.105
The returns on assets also improve in the year 2013 as compared to the year 2011.
Return on Equity = PBT/Equity
2013 = 711 / 2017
= 0.35
2011= 468 / 1705
= 0.27
Advice to the investors
From the analysis, the company shows some good indication of improvement; therefore, the

investors should consider investing in the company.

Limitation of ratios
Since ratio analysis is based on his historical cost that can easily lead to distortions in

measuring performance hence is a big limitation of ration analysis. Price level changes affect the

utility ratio analysis, and this is disadvantageous since ratios are being compared over a period

(Beatty & Liao 2014). Ratios lack adequate or accepted standards or rule of thumb that can be

used hence might result in wrong comparison.

Task two
Different business structures and ownership
The most common business structure and ownership includes;

 Sole Proprietorship

 Partnership

 Limited partnership

 Limited Liability Company (LLC)

 Corporation (for-profit)
 9

 Nonprofit Corporation (not-for-profit)

 Cooperative

A sole proprietorship is one-person business that is not registered with the government of

a limited liability company or the corporation (Beatty & Liao 2014). One person owns it and in

most cases small in size. Legally, it is inseparable from its owner. The advantages, of the sole

trader, are that it is easy to start, and the owner takes all profit by his or her own. The demerits

are that, the owner incurs all losses of him or her own. Two or twenty people, on the other hand,

own partnership (Deegan & Ward 2013). The partners pay tax on their profit. Advantages of

partnership are that members can easily raise more capital compared to a partnership. The

demerits are that members share profit, unlike a sole proprietorship (Beatty & Liao 2014).
Limited companies are registered by the state, and its shares are limited liabilities.

Limited partnerships are usually created by one person or company (the "general partner"), who

will solicit investments from others (the "limited partners"). They have access to a large source

of capital compared to sole and partnership kind of business. The demerits are that it is difficult

to form, and decision-making process is tedious (Beatty & Liao 2014). Corporations are set as

part from other types of enterprises is that a company is a self-governing legal and tax entities,

part of the individuals who own, manage it. Because of this separate status, the owners of a

corporation do not use their individual tax income to pay tax on business profits. Non-profit

organization, on the other hand, does not make a profit and in most cases are not businesses

oriented (Deegan & Ward 2013).

Agent theory
The agency theory explains the association between the principals that is the shareholders

and the agents who are the managers. In this kind of relationship, the principals do delegate or

hire the agents that are managers to work for t the benefits of the shareholder (Gassen 2014).

The duty of decision-making is being delegated, and authority to lead is given to managers and
 10

the principal’s full losses. This can lead to loss of efficiency and consequently result in the cost

increase (Beatty & Liao 2014). .

There are three main agency problems. They include risk aversion, divided retention and

horizon disparity. The risk aversion is an agency problem that results due to the relationship

between risk and the return (Waegenaere, Sansing & Wielhouwer 2014). As per the

shareholders, it is accepted that the higher the risk, the higher the potential of return. The second

problem is from dividend retention, which is the ability of managers to pay out less of the

company to shareholders and retain more so that they can reinvest in the company growth which

could benefit the company n long term. This is a source of conflict in the agency problem

(Waegenaere, Sansing & Wielhouwer 2014). Lastly, the horizon disparity is another problem

that arises as a result of agency principal relationship. It can link to the long term bonus

incentives in order to overcome this problem. This problem is where the managers expect to stay

with the company for a short period and is concerned with the performance of the company

while manager it (Beatty & Liao 2014). To solve this problem, the shareholders should ensure

that a manager takes a longer term in the companies that they manage.

Task three

a. Projected income statement

(i) Share Capital

$ (000) $ (000) $ (000)

Profit before tax 10

Reduction OE 6

PBT 16

Tax 30% (4.8)

 11

PAT 11.2

Dividends (4)

Net profit 7.2

(ii) Capital

Loan

$ (000) $ (000) $ (000)

Profit before tax 10

Reduction OE 6

Less loan interest (3)

PBT 13

Tax 30% (3.9)

PAT 9.1

Dividends (4)

Income 5.1

b. Find out the level of gearing as at the end of Year 10, for both schemes

Gearing ratio is a term that describes financial ratio that compares some form of owner's equity
to borrowed funds. It includes equity ratio and time interest earned.

Equity ratio = equity/ assets

= 83/ 119

=0.69

IE = EBIT/ total interest

 12

16/1

= 16

Plan (ii) 16/3

= 5.33

c. Which scheme would you advice the business adopt? Give reasons and state what additional

information you would require

From the above analysis, the first scheme is better than the second scheme since there will be no

interest to be paid back to shareholders as compared to loan interest that will lower the profit.

d. Briefly explain to shareholders of ABC1 the relative advantages and disadvantages to a

company of issuing debt and equity finance.

Debt capital increases company expenses hence lowering company profitability as compared to

equity capital that does not attract such interest (Beatty & Liao 2014). On the other hand, equity

capital diluted ownership of the company hence shareholders dividends are smaller as compared to

debt capital.

The advantage of debt capital is that it does not dilute ownership of the company while advantage

of equity capital is that it does not attract interest.

Task four

Loss that the company makes when it administer its debts

Total credit sales = $ 4,500,000

Time period = 50 days

Loss from bad debts = 0.4% of total sales

 13

Cost of using factor

Annual fees 1% of credit sales

$ 35,000 (saved)

Collection period 30 days

0.4% (saved)

Annual interest 11%

Overdraft cost 10%

a. From the analysis the total cost that the company would save if they employed factor is

higher compared to the loss they incurred if they collected debts on their own. These

include 0.4% of bad debts that could be eliminated and $ 35,000 annually which

translates to 0.7% of annual sales. This shows that the company would save 0.1% of their

annual revenue. Hence, the factor should be used in collecting debts. The debtors holding

factor would also be reduced by 20 days while the advance in given by a factor is less

than the finance cost by 1%.

b. There are several methods to control stock of which all are designed to provide an

efficient system for deciding what and when to use the stock. One method is Just in Time

(JIT) this aims to reduce costs by cutting stock to a minimum (Waegenaere, Sansing &

Wielhouwer 2014). Items are being delivered when they are required and used

immediately. Another method is Re-order lead time that allows for time between placing

order and times to receive an order (Harrison et al. 2014). Economic order quantity is

another method that can be used as it helps in balancing between holding too much or too
 14

little. Batch control that can help in managing the production of goods in batches and

lastly, first in first out stock control method.

Some of the ways through which company might control their debtors include first,

putting system in place on how often one checks the debtors and when to check them.

Secondly, stick to number of days, which is debtors lead time (Waegenaere, Sansing &

Wielhouwer 2014). Outsource debtor management to your accounts and lastly review

terms and condition regarding debtors.

Task five

a. Actual budget

Items Number of units Cost per unit Total cost

Direct labour 1780 hrs 2hrs @ $ 5.25 $ 4672.5

Direct materials 2410 14 33,740

Fixed overhead 800 27 28.67

Total cost $ 38,441.19

Prepared budget

Direct labor (1780 hours) 9,665

Direct materials (2,410kg) 33,258

Fixed overheads 21,365

64,288

Difference in budget = 38,441.19 – 64,288

Budget flexed = $ (25,846.19)

b. From the information given, the total units prepared were 850 units

The sales price per unit = $ 110, therefore, sales of the month will be 850 % 110
 15

= 93,500

Cost of direct labor

Hours used = 1780 while cost 2 hrs @ 5.25

= $ 4,672.5

Cost of material 2410 kgs @ 14 per kg

= $ 33,740

Fixed cost 28.67

Income statement as per May

$ $ $

Sales 93,500
Cogs
Direct labour $ 4,672.5
Direct material $ 33,740
Total Cogs (38,412.5)
Gross profit 55,087.5
Fixed overhead (28.67)
Net profit 55,058.83

Prepared income statement

Selling price 92,930

Direct labor (1780 hours) 9,665

Direct materials (2,410kg) 33,258

Fixed overheads 21,365

Operating profit 28,642

Difference
 16

= 55,058.83 - 28,642

= 26,416.83

Task six

a. Adjustment of the income statement

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

£000 £000 £000 £000 £000 £000

Sales 450 470 470 470 470

Materials 126 132 132 132 132

Labour 90 94 94 94 94

Overheads 75 77 77 77 77

Depreciation 120 120 120 120 120

Working capital 180

Cost of capital 21.6

Interest on working capital 27 27 27 27 27

Cost Equipment 600

Write -off development costs 30 30 30

Total costs 180 468 450 450 420 420

Profit (Loss) (801.6) -18 -10 -10 20 20

Workings

Cost of machines;

Since the Book value machine is $ 100,000 and scrap value is zero. Therefore, we will record the
book value, and it will be deducted as an expense.

New equipment will cost $ 500,000

 17

Total cost of equipment = 500,000 +100,000

= $ 600,000

Development cost, $ 90,000

Recurrent expenditure $ 30,000

Capital cost 12% * 180,000

=$ 21,600

b. The project’s payback period = initial investment/ cash inflow per period

Project 2 Year 1 Year2 Year 2 Year 4 Year 5 Year 6

Cash flow 180 -18 -10 -10 20 20

Acc. Cash -18 -28 -38 -18 2

flow

(180 – 2)

178

Project present value

NPV = FV/ (1+r) ^n

= -18/ (1+ 0.25)1 + -10/ (1+ 0.25)2 + -10 / (1+ 0.25) 3 + 20 / (1+ 0.25)4 +20/ (1+ 0.25)5

= $ 43.30

IRR

-18/ (1+ 0.25)1 + -10/ (1+ 0.25)2 + -10 / (1+ 0.25) 3 + 20 / (1+ 0.25)4 +20/ (1+ 0.25)5

= $ 43.30
 18

-18/ (1+ 0.20)1 + -10/ (1+ 0.20)2 + -10 / (1+ 0.20) 3 + 20 / (1+ 0.20)4 +20/ (1+ 0.20)5

= $ 31.60

= 31.60/43.30

= 0.73

=73%

Analysis Project

Payback 4

NPV 43.30

IRR 5%

c. Compare and contrast IRR and ARR as two methods for appraising investment projects

Accounting Rate of Return (ARR) is capital investment analysis methods profit comparability of

the concerned project to the amount of initial capital investment that would be required for the

project (Deegan & Ward 2013). It is not discounted capital investment appraisal technique since

it does not consider the time value of money. Internal rate of return (IRR) on the other hand is a

capital investment appraisal technique that defines that gives a value of zero to NPV or net

present value. It mostly measures efficiency rather than technique. These techniques normally

considered time value of money as while IRR does not consider the time value of money

(Deegan & Ward 2013). It is superior to ARR in measuring company performance.

d. Explain why cash flow forecasts are used rather than profit forecasts to assess the viability of
proposed
 19

Capital expenditure projects

Profit forecast contains some elements like depreciation which does not involve real

money transfer in the business and the same does not exist in the cash flow forecast. Cash flow

forecast comprises of real movement of cash in the business hence the reason of its use in the

capital expenditure as opposed to the profit forecast statement

 20

Bibliography

Beatty, A., & Liao, S. (2014). Financial accounting in the banking industry: A review of the

empirical literature. Journal of Accounting and Economics, 58(2), 339-383.

Deegan, C., & Ward, A. M. (2013). Financial Accounting and Reporting: An International

Approach.

Gassen, J. 2014. Causal inference in empirical archival financial accounting research.

Accounting, Organizations and Society, 39(7), 535-544.

Harrison Jr, W. T., Horngren, C. T., Thomas, C. W., Berberich, G., & Seguin, C. (2014).

Financial accounting. Pearson Education Canada.

Horngren, C., Harrison, W., Oliver, S., Best, P., Fraser, D., & Tan, R. 2012. Financial

Accounting. Pearson Higher Education AU.

Waegenaere, A., Sansing, R., & Wielhouwer, J. L. (2014). Financial accounting effects of tax

aggressiveness: Contracting and measurement. Contemporary Accounting Research.