Financial Statement Analysis

Balance sheet for the year 20X5

Fixed assets                                                    2126.74

Add: Working capital

Current assets                        1000.00

Inventory                               4166.67          

Less: Current liabilities        5426.64                (259.97)


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Shareholder’s Equity                                       1866.77


Income statement for the year 20X5

Sales                                                               25000

Less: Cost of sales                                          15000

Gross profit                                                     10000

Less: Expenses                                      8805

Profit before tax                                                1195

Less: Tax                                                            500

Net Profit                                                            695

Accounting Ratios

Details                                                                                                            20X5

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Return on sales= net profit/sales=695/25000                                                   0.0278

Return on Equity= Net income/Shareholder’s Equity= 695/1866.77                0.3723

Average collection period=Days*AR/Credit sales                                           30.4167

Inventory turnover=sales/inventory=25000/4166.67                                        6

Current ratio= current assets/current liabilities=5166.67/5426.64                     0.7937

Quick ratio-current assets-inventory/current liabilities=

                        1000-4166.67/5426.64                                                          -0.5835

Debt to Equity= Total liabilities/Shareholder’s Equity

                        = 5426.64/1866.77                                                                2.9070

Fixed Asset Turnover=Net sales/Fixed assets=25000/2126.74                       11.7550

2.The reason as to why I used the above statistics in my accounting analysis is because there is a common trend on the 20X1, 20X2, 20X3 and 20X4 which helped me forecast the 20X5 statistics. For instance the constant trend of return on sales and inventory turnover for the four years running made me predict similar results for the year 20X5. For the current and quick ratio, there is a significant decrease over the years and as a result I have also reduces my 20X5 statistics. The information provided shows that there was no addition of fixed assets as the buildings had been completed in the previous year. Due to this reason I have taken the fixed asset turnover for the year 20X5 to be similar to that of 20X4.

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3.From the above financial information the business can be said to be undergoing some financial difficulties. This is because having a constant return on sales ratio, shows that the business has not been reviewing its pricing strategy for the five consecutive years which is not recommended. The reduction of the current ratio and quick ratio indicates that there is liquidity problem in the business. It shows that the business is continuously increasing its current liabilities in order to finance its daily operations. Maintenance of 30.4167 as the average collection period is not viable considering the liquidity problem that the business is going through. A review to reduce this period should be undertaken in order to improve the liquidity status of the business.

On the other hand, an increase to the return on equity shows that the business is relatively moving towards its core objective of maximizing its shareholder’s wealth. ROE is a profitability measure which shows that the business generates money with the invested money.

4.The management therefore out to streamline its operations well in order to ensure future sustainability of the business. It is advisable for them to increase the share capital of the business through an issue of additional shares to the new or existing shareholders. Such action will significantly assist in the improvement of the business liquidity. They should also adjust return on sales ratio in order to help them suit with the changing economic trends. A change on the return on sales will significantly boost them in creating an effective pricing strategy for their products.

It is advisable for them to maintain an increasing inventory turnover as it indicates the business growth potential. Maintaining the inventory turnover rate at 6 for the past 4 years shows that there is no any significant growth for that period. A viable business ought to expand with time and its production and volume of sales should also increase as time goes. So since there is no any notable growth on the inventory and sales, the management should consider strengthening the marketing department in order to improve this. In their marketing strategy, they should focus on new customers and new markets if possible. Incentives such as products promotions, issue of discounts and after sales service should be used to increase the business sales volume.

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