The Role of Financial Resources – Part B

Profit and Loss Account

The profit and loss account is a very useful tool for businesses because it shows how
much has been made at the end of a financial year. Therefore, it can help a bank or
other lenders decide whether or not it is worth the risk to invest in a business. As for
the businesses themselves, they often use the projected profit and loss accounts to
help them plan their finances, thus it can actually help a lot with budget setting.

Gross Profit
Gross profit is the profit a company makes after deducting the costs associated with
making and selling its products, or the costs associated with providing its services.
Gross profit will appear on a company's income statement, and can be calculated
with this formula:
Sales/Revenue – Cost of goods sold = Gross Profit

In the case for ‘Office Works’, the gross profit for the business in 2015 and 2016 are
$2140000 and $2500000 respectively.

Net Profit
Net profit is the measure of the profitability of a business after accounting for all
expenses. Whether a business is successful or not can be decided by looking at the
net profit of the business. It can be calculated by this formula:

Gross Profit – Expense = Net Profit

In the case for ‘Office Works’, the net profit for the business in 2015 and 2016 are
$589050 and $483250 respectively.

Balance Sheet
A balance sheet reports a company’s assets, liabilities and the owner’s equity at a
specific point in time, and provides a basis for businesses to compute rates of return
and evaluating its capital structure. It is a financial statement that provides a
snapshot of what the business owns and owes.

Assets
Assets are considered as economic resources in a business. Any thing tangible that
can be owned or controlled by a business to produce value are considered assets. It
can be classifies into two types – fixed assets and current assets. Fixed assets are
assets that are owned and expected to be retained for one year or more. In ‘Office
Works’, fixtures and fittings and van are fixed assets, valued to be $345000 and
$119500 respectively in 2015. Current assets are those that can be converted into
cash more easily and are only retained for a short period of time. Stock, debtors and
cash are current assets in ‘Office Works’, valued to be $180000, $45000 and $125000
in 2015 respectively.

Liabilities
Liabilities are a business’s financial debts that arise during the course of its business
operations. It is settled over time through the transfer of economic benefits including
money, goods or services. It can be classified into two types as well – current
liabilities and long-term liabilities. Current liabilities are debts to be settled within a
financial year while long-term liabilities are those that cannot be settled in a year. In
‘Office Works’, the current liabilities are creditors and loan, valued to be $98000 and
$25000, while the long-term liability is bank loan, which is valued to be $200000 in
2015.

Equity
Equity is the value of an asset less than the total amount of all liabilities on that
asset. It can be calculated be this formula:

Assets – Liabilities = Equity

Ratio Analysis
Current Ratio in 2015 Current Ratio in 2016
350000 = 2.85 : 1 680250 = 6.80 : 1
123000 100000
Current ratio measures a business’s ability to pay its short-term debts. In 2015, the
business had a current ratio of 2.85, which indicates that every $1 of short-term debt,
they had $2.85 of current asset. This is a satisfactory result as Office Work was able to
meet its short-term debts. However, an ideal ratio would be 2:1 which is slightly lower
than the result obtained in 2015. In 2016, the current ratio increased drastically as the
result was 6.80, indicating that for every $1 of short-term debts it had $6.80 of current
asset. It is not a satisfying result because there is a huge difference between the result
and the ideal ratio. The business should be looking at investing some of its spare cash.

Acid Test in 2015 Acid Test in 2016

 350000 – 180000 = 1.38 680250 – 450000 = 2.30
123000 100000
The acid-test ratio is a strong indicator of whether a business has sufficient short-term
assets to cover its immediate liabilities. The acid test in 2015 indicates that the business
had $1.38 coming into pay each $1 of debt. As for the result of 2.30 in 2016, manning
that Office Works had $2.30 coming into pay each $1 of debt. I suggest the business to
sell its stock which may improve the acid test.

Gross Profit Margin in 2015 Gross Profit Margin in 2016

2140000 x 100 = 69% 2500000 x 100 = 68%
123000 3650000
Gross profit margin (GPM) shows us how much gross profit the business is earning from
sales revenue. In 2015, the result of 69% indicates that for every $100 of sales revenue
the business is earning $69 in the gross profit. The difference which amounts to $21 is
attributed to the cost of the goods sold. In 2016, the result decreased by 1% (68%) which
indicates that for every $100 of sales revenue, the business earns $1 less of gross profit.
Based onlooking at the sales revenue figures, it’s clear that the gross profit margin had
decreased because of a rise in costs of goods sold. I suggest that Office Works find a brew
supplier that provides goods at a cheaper price or negotiate the price of good of the raw
materials with the current supplier to reduce the cost of goods sold.

Net Profit Margin in 2015 Net Profit Margin in 2016

589050 x 100 = 19% 483250 x 100 = 13%
3100000 3650000
Net profit margin (NPM) shows us how much net profit the business is earning from sales
revenue. In 2015, a result of 19% is obtained, indicating that Office Work is earning $19 in
net profit for every $100 of sales revenue. This result decreased in 2016, as the business
was only able to earn $13 in net profit for every $100 of sales. So because sales revenue
had decreased, we can conclude that the drop in net profit margin is attributed to the
decrease in sales. The business should focus on how to boost sales or reduce the cost of
sales in this case.

ROCE in 2015 ROCE in 2016

589050 x 100 = 85% 483250 x 100 = 47%
 691500 1020250
ROCE (Return on Capital Employed) measures how good the managers / owner are at
turning their capital employed into net profit. A result of 85% in 2015 means that for every
$100 capital employed, the business was able to generate $85 worth of net profit without
any other result. There is a huge drop in ROCE in 2016, with a result of 47%. Comparing to
the previous year, it is considered very low. A suggestion for Office Works is that the
manager or owner of the shop may need to work even harder and efficiently to improve
the ratio.

Debtors collection period in 2015 Debtors collection period in 2016

45000 x 365 = 10.95 30250 x 365 = 12.3
1500000. = 11 days 900000. = 13 days
The debtors collection period is used to determine how successful a business is in
collecting money from its debtors. In 2015, Office Works’s debtors collection period was 11
days. In 2016, the business average collection period had increased slightly to 13 days. It’s
is a bad thing because the number increased, meaning that it took more time to get the
money from its debtors than the previous year. I suggest the business to make some
policies such as giving discounts to make the debtors willing to pay earlier.

Stock turnover in 2015 Stock turnover in 2016

960000 = 3.84. 365 = 95 1150000 = 3.65. 365 = 100
250000. 3.84 315000. 3.65
Stock turnover is a ratio showing how many times a company’s inventory is sold and
replaces over a period of time. The stock turnover in 2015 of Office Works is 95 while the
result in 2016 is 100. It means that the stock turnover in 2015 is 95 days per year and 100
days per year in 2016. The increase in stock turnover means that stocks are sold slightly
slower than the previous year.

Asset Turnover in 2015 Asset turnover in 2016

3100000 = 4.48 : 1 3650000 = 3.58 : 1
691500 1020250
Asset turnover measures how well the assets are being used in the business to generate
the sales. The result obtained in 2015 is 4.48, meaning that $4.48 worth of sales are being
generated by each $1 invested. As in 2016, a result of 3.58 is obtained, meaning that $3.58
worth of sales are being generated by each $1 invested. There is a decrease of asset
turnover, meaning that less asset are used to generate sales. The owner now knows that
assets are not being uses efficient enough and so they should think of ways instead to used
them wisely.

Task 2.6
Cost and Budgets
Why do businesses like Office Works keep a budget?
A carefully constructed budgets allows a business to continually track where they are
financially. This allows for strategic, long-term planning for everything from current
operating costs to potential expansion. Knowing where the budget stands opens up the
ability to hire new staffers, invest in new product lines and set earning goals in line
with the organizations’ corporate financial objectives. It also prevents the business
from overspending most importantly, to keep an eye on the business’s economic
status.

What kind of information does it show?

A budget for a business shows an estimation of revenue and expenses over a specified
future period of time, it is compiled and re-evaluated on a periodic basis.

Table of the Actual Amount Spent

Jul Ag Sep Oct Nov Dec
Stock 150000 150000 150000 80000 80000 80000
Wages 38000 38000 38000 23000 23000 23000
Rents and Rates 125000 125000 125000 125000 125000 125000
Light and Heat 3000 3000 3000 2000 2000 2000
Advertising 6500 - - 6500 - -
Insurances 15000 - - - - -
Interest on loans 2000 2000 2000 2000 2000 2000
Bank charges - 250 250 - - -
Depreciation 2000 2000 2000 2000 2000 2000
Transportation 360 360 360 240 240 240
Variance Analysis (Budgeted amount – Actual Amount Spent)
Jul Aug Sep Oct Nov Dec
Stock -50000 -50000 -50000 -15000 -15000 -15000
Wages -3000 -3000 -3000 -3000 -3000 -3000
Rents and Rates 0 0 0 0 0 0
Light and Heat 0 0 0 0 0 0
Advertising -1500 - - -1500 - -
Insurances 0 - - - - -
Interest on loans -1000 -1000 -1000 -1000 -1000 -1000
Bank charges - -250 -25- - - -
Depreciation 0 0 0 0 0 0
Transportation -60 -60 -60 -40 -40 -40

Office Works’s spending in stock, wages, advertising, interest on loans, bank charges
and transportation. There may be a difference between the budget and the actual
amount spent for interest rate because the business might have borrowed extra bank
loan or the government might have raised the interest rate. As for stock, it may be
because the prices for stock had increased suddenly and so there is a difference. I
suggest that Office Works make improvements for expenditure of rent by finding a
different place or negotiate with the land lords.

Why costs need to be controlled to budget?

In general, companies have limited resources and need to prioritize and
optimize how they invest those resources over time to reach milestones, evolve
and grow. A well run budget process helps management teams work together
to sets clear goals and expectations around revenue and cost results over time.
This process also helps tee up management discussions and decisions on
strategic choices. If costs are controlled to budget, it can make the business
achieve their goals quicker.