Accounting Ratio Analysis and Memo For Peyton Approved
One of the measures of success in any business is profitability. All successful managers and business owners must have an understanding of how to assess the
profitability of a company. This is done through the use of accounting.
By working through the accounting cycle, you will understand how money flows through a company and what other components are included in the assessment
of profitability and financial stability. Using this information can also help you determine whether or not the organization can afford to stay open employing
current practices. The accounting information helps you determine what types of changes might need to be made to allow the organization to become profitable
if it is currently struggling financially. This process also helps you understand the level of commitment to attention to detail that is required in a successful
business venture.
In the ratio analysis and memo, you will use course-provided information to 1) demonstrate the purpose and importance of the ratios used, and 2) communicate
the results of operations to stakeholders and/or interested parties.
This assessment addresses the following course outcomes:
? Apply the accounting cycle to business transactions for communicating financial data
? Interpret financial statements for informing business decisions
? Analyze the importance of industry standards and regulations in the implementation of the accounting cycle in supporting responsible
Introduction
Financial ratios in company analysis reflect the financial position or the state of a company’s financial status at a particular time or for a specified period of time. These ratios reveal the profitability of the firm, liquidity position, debt or gearing ratio. Ratio analysis provides a diagnostic tool that assists to identify the problematic areas as well as the areas that the company can exploit and the opportunities involved. This information is critical to investors who are mostly interested in earning profits from their investments (Harrison & Hongren, 2001).
The following are the ratios of Peyton;
| Peyton Approved | 2014 | |
| Current Ratio | Total Current Assets/Total current liabilities | 2.74 |
| Quick Ratio | TT C/ Assets – inventories /TT/ C Liabilities | 2.68 |
| Receivable turnover | Annual credit sales/average receivables | |
| Inventory Turnover | Cost of goods sold/Average inventory | 63.81 |
| Asset turnover | Sales/Average total assets | 2.12 |
| Dividend yield | Div per Share / Current Share price | 0.03 |
| Dividend cover | EPS/ Dividend per Share | 4.55 |
| Net assets turnover | Net assets / total sales | 0.31 |
| Times interest earned | EBIT/Annual Interest Expense | 58.05 |
| Debt to total Asset | Debt/Assets | 0.17 |
| Book value per share | Value of shares/div paid | 1.58 |
| Interest cover | EBIT/Annual Interest Expense | 58.05 |
| Profit margin on sale | GP/sales | 0.40 |
| R.R return on assets | EAT/Total Assets | 0.57 |
| R.R com stock equity | Profit after taxes/Shareholders equity | 0.86 |
| Earnings per share | Profit after taxes-pref div)/No. of comm O/S | 1.54 |
| Payout Ratio | cash dividends/income | 0.27 |
| ROE | Return On Equity (ROE) | 0.86 |
| ROA | Return on average Assets | 0.57 |
Liquidity ratios
These ratios stem from assets that can be quickly converted into liquid cash and they provide short term financial relief for the company in cases of emergency cash needs. Higher ratios indicate better and greater liquidity for the company. The rule of thumb in most cases require a ratio of at least 2:1 for the current ratios while for quick ratio should be 1:1. These ratios indicate that the current assets should be higher than the current liabilities in the case of the current ratio while the assets and the liabilities should be similar or the same incase of quick ratio. The current ratio for Peyton Approved is 2.74:1. These mean that the current assets are 2.74 times more than the current liabilities. The current assets are adequate to honor any commitments or obligations that may arise because of the current liabilities (Hermanson, Edwards & Invacevich, 2011).
Peyton Approved quick ratio is 2.68:1. The current assets are more than the current liabilities by 2.68 to 1. The quick ratio is very favorable and the liquidity position of Peyton approved is very stable. Instead of the standard 1:1 its 2.68:1.
Analyzing debt or Leverage ratios
The debt ratios indicate how much or to what extent a company is relying on debt to fund its business operations and also investments. A company that cannot manage its debt portfolio effectively may find itself with a lot of debts that may lead to bankruptcy in case of insolvency. However, planned use of debt can be beneficial to the company as it may provide tax incentives and benefits.
Peyton Approved debt to asset ratio is 0.17:1 that’s the ratio of debt to total assets is 17%. The long term debts of Peyton Approved are only 17% of the total assets. The ratio shows a positive picture for the company.
The interest coverage ratio for Peyton Approved is 58.05 that’s the net earnings of the company can payback the interest for the company’s debts 58.05 times. The company has enough ability to pay all the fixed interest expenses that may accrue to the company because of the debt.
Analyzing Profitability ratios
It’s not easy to quantify the amount of profit that may be considered as relatively better than the others but it can only be compared to the industry’s average. The net profit margin for Peyton Approved is 3.72 the Return On Assets and the Return On Equity are 0.57 and 0.86 respectively.
It means that for every dollar invested in the company as equity the company pays back 0.86 dollars while the amount invested in the company as assets the company pays back 0.57. The payout ratio for Peyton Approved is cash dividends divided by the net income = 9500/34830 = 0.27.
| $ | $ | ||
| Peyton Approved | $ | TT Assets- Inventories | 55192 |
| GP | 52198 | Interest Expense | 600 |
| Net Profit | 34830 | Average Receivables | 1395 |
| EAT | 34830 | Current Assets | 56413 |
| Share holders Equity | 40330 | Current Liabilities | 20625 |
| Total Assets | 60955 | Average total assets | 60955 |
| Total Liabilities | 20625 | Receivables | 1395 |
| Inventories | 1221.05 | Outstanding shares | 15000 |
| Cost of Goods | 77914 | Payables | 525 |
| Average inventory | 1221.05 | Dividend per share | 0.63333 |
| Debt | 10600 | Earnings per share | 2.322 |
| EBIT | 34830 | Net assets | 40330 |
| Sales | 129500 | Net assets turnover | 0.31143 |
| Total Dividend Paid | 9500 | Net profit margin | 3.71806 |
Analyzing Efficiency
The inventory turnover reflects how fast a company’s inventory is actually being produced and the rate of sales. A higher ratio indicates more efficiency i.e. the rate of inventory turn-over to make or generate sales. The inventory turnover for Peyton Approved is 63.81 times in six months. The assets turnover for the company is equal to total sales divided by total assets = 129500/60955 = 2.13. The sales cover the assets 2.13 times more which means the company’s performance is good.
Memo
To: The Bank Manager 26th April 2015
From: Peyton Approved Accountant
Re: Peyton Approved Financial Status
Ratio analysis provides a diagnostic tool that assists to identify the problematic areas as well as the areas that the company can exploit and the opportunities involved. This information is critical to investors who are mostly interested in earning profits from their investments. The investors use these information to decide whether to invest in a company or not depending on its profitability, leverage or liquidity position.
The accounting system that Peyton Approved Company uses is based on accrual system where the revenues are recognized when the sales have been made and not when cash has been received. For example when sales have been made on credit and the invoices have been raised then the records reflect that the sales have taken place and when cash is received then the debtors are credited with the amounts paid while the cash account is debited with the cash received. These strategies have been selected to ensure that the accounting records comply with the provisions of the company law that provide for accurate, fair and true representations of financial statements.
The general accounting process commences with the subsidiary books that are known as the journals and the day books. These are the journal proper, the sales day book, the purchases day book, the purchases and the sales return day books. These books record the first transactions before they are posted to the ledgers. The ledgers are made of the real, personal and the nominal accounts. The general entry method is to debit the accounts that have received money goods or services and to credit the accounts that have given money, goods or services.
The invoices are raised every time there is a credit transaction and the statements are sent to the debtors at the end of the month. All the cash sales are banked the following day after the receipt books have been reconciled. The receipts and the invoices are reviewed every day to control and prevent any errors or omissions that may be committed or to unearth any fraud that may have taken place.
The major internal controls that have been instituted to ensure that proper controls are followed while handling cash are 1). All cash receipted immediately it has been received on receipts that have been pre-numbered. 2). All the dates are also written clearly together with the quantities of the sales involved. 3). The receipts are then added up and the stock sold is reconciled with the balance available in the stores on daily basis. 4). Ones every year external accountants have to audit all the books of accounts including all the bank records, banking and bank statements.
Control procedures have been adopted to ensure compliance to the GAAP as well as the adoption of the major accounting concepts that deal with accounting prudence, valuation and continuity concepts.
The major results of the operations are the sales that have been made and the purchases that have to be made to restock the inventory. The Gross profit margin is very favorable which currently stands at 40% of the turnover.
The income statement shows a gross profit of $52,198 which is about 40% of the total turnover of Peyton Approved. The net profit for the company amounted to $34830 and a net profit margin of 3.72. The profitability of the company is in positive and favorable. The company’s performance is encouraging and it may attract a lot of investors.
The balance also shows that debts are minimal and manageable. More debt would enable the company to expand and also to grow. The company statements reveal that the company‘s liquidity is very stable and the profitability margins are also favorably high. The financial strength of the company stems from its strong financial base. The weaknesses of the company are mostly the low closing stocks that may cause some interruptions in business activities when apparently the stocks may run out unexpectedly.
The changes would be to increase the minimum stock levels to be about three thousand dollars in value so as to provide a comfortable lead time in cases of stock shortages or other unforeseen circumstances.
The company’s financial weaknesses are its inability to take advantage of the debt portfolio to expand and enlarge its business operations. The debt ratio for the company is very low. Peyton Approved debt to asset ratio is 0.17:1 that’s the ratio of debt to total assets is 17%. The long term debts of Peyton Approved are only 17% of the total assets. The ratio shows a positive picture for the company but the company is actually loosing the opportunity to expand using the debt portfolio that also has some tax benefits to the company.
The interest coverage ratio for Peyton Approved is 58.05 that are the net earnings of the company can payback the interest for the company’s debts 58.05 times. The company has enough ability to pay all the fixed interest expenses that may accrue to the company because of the debt (Vance, 2003).
The company can take advantage of its low debt portfolio to seek financing from the banks in order to finance its investments. Its stable profitability and leverage status are also part of its strength. The significance of a stable liquidity can only be useful if the banks can advance you loans based on the strength of its financial statements.
The company can explore its expansion strategy to expand its operations to foreign markets as well adopt aggressive marketing strategies to increase its sales and expand to foreign markets.
References
Hermanson, R.H., Edwards, J.D., & Invacevich, S.D. (2011) Accounting Principles: A Business Perspective. First Global Text Edition, Volume 2 Managerial Accounting, 37-73.
Harrison, W.T. & Hongren, C.T. (2001) Financial accounting (4th Ed). Englewood
Cliffs, NJ: Prentice Hall.
Vance, D. (2003) Financial analysis and decision making: tools and techniques to solve
financial problems and make effective business decisions. New York: McGraw-Hill.
