Financial Accounting

AC201

Course work 1

Ms. Simonida Kohler

Friday 15th January, 2010

Team Relax

Yeung Sin Ting, Sonia (2E) yesi201288

Chao Tim Hong, Crystal (2F) chti230490
Haruka Kasugai (2F) kaha060989
Leung Chi Ho, Simon (2F) lech240791
Tao Shengyao, Yolanda (2F) shta011187
Contents Page

Introduction and Objectives 1

Profitability

Profit Margin 2

Operating Efficiency ratio 2

Return on Assets 3

Return on Owner’s Equity 3

Efficiency

Asset turnover ratio 4

Paid occupancy percentage 5

Financial Position analysis

Horizontal Analysis 6

Liquidity Ratios 7

Solvency Ratios 8

Statement of Cash Flow 9

Conclusion and Recommendation 11

References 12

Appendices 13
Introduction and objectives

For accounting coursework 1, readers would get the financial analysis report from

different accounting aspect of a particular company. They would know how the

financial department is performed, how the evolution of the financial position is going

on and what the state of its finance is. Students would give their recommendations or

advices to help the company to some improvements at the end as well.

It requires us to make use of the data from balance sheets, income statements,

indicators reports and competitor status reports of the same company to analyze its

profitability, efficiency, the change of financial position and cash flow statement. This

coursework would help us to strengthen our accounting knowledge. In order to

achieve it, we are asked to use our critical thinking skills to develop a creative financial

analysis and recommendations based on our own accounting knowledge which we

gain from the weekly classes. We need to insert some of the data into the accounting

formula to get the results. So, we can figure out the analysis by comparing them.

Instead of using own knowledge, we would also make use of the library and internet

resources to be our references materials. And they can guide us to the right direction

and help us to innovate ideas.

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Profitability

Profit Margin

The profit margin is an overall measure of management’s ability to generate sales and

control costs. Determined by dividing Net Income by Total Revenue. It is a key

profitability ratio.

According to the appendix 1, Year 3 profit margin of 12.32% is an increase over the

Year 2 profit margin of 4.44%. Excellent pricing and high sales volume are showed in

the high ratio. Also both the operated departmental margins and the controlling of

expense are satisfactory.

Operating Efficiency Ratio

The operating efficiency ratio is a measure of management’s ability to generate sales

and control expense. According to the appendix 2, Year 3 operating efficiency ratio

shows that over 39 of each 1 of revenue is available for fixed charges, income taxes,

and profits, which is an great increase compared with Year 2.

This result shows that the expense control is good and the management had reviewed

tax assessments, insurance policies and quotations and made good recommendations

to the owners that can affect the facility’s total profitability.

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Return on Assets

The return on assets is a ratio providing a general indicator of the profitability of a

hospitality operation by comparing net income to total investment. According to the

appendix 3, the return on assets ratio of Year 3 shows that 10.76 cents of profit were

generated for every 1 of average total assets.

As this result is quite high, older assets will require replacement in the near future is

suggested.

Return on Owners’ Equity

The return on owners’ equity is a ratio providing a general indicator of the profitability

of a hospitality operation by comparing net income to the owners’ investment, it is also

a key profitability ratio. According to the appendix 4, the Year 3 return on owners’

equity ratio shows that for every 1 of owners’ equity, 21.96 cents was earned.

As this ratio represents the end result of all management’s efforts, the management’s

ability to produce for the owner is suggested could be higher.

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Efficiency

Asset turnover ratio = Total revenue / Average total assets:

Year3:

Total revenue – $15,148,732

Average total assets

– Total assets at beginning and end of year /2

(17,122,402 + 17,569,505) / 2 = $17,345,954

Asset turnover ratio;

15,148,732 / 17,345,954 = $0.87 times

Analysis of the statistics:

The asset turnover of 0.87 times indicates that each $1 of assets generated $0.87 of

revenue in third year. It is normal to estimate a relatively low for a hospitality industry,

especially for hotel. The relatively low ratio is because of the hospitality industry’s high

dependence on property and equipment and its inability to quickly increase their

output to maximize the demand.

Moreover, it is truth that this company put much dependence on their property and

equipment, such as leisure club and shop. These facilities need lots of investment to

maximize its output in order to satisfy customer’s needs.

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Paid occupancy percentage = paid rooms occupied / available rooms:

Year3:

Total Room sold:

4823+6373+5703+6618+7975+6286+5461+5971+5103+4291+5063+2491 = 66158

rooms

Available rooms – Rooms available per day times 365

Estimating the complimentary rooms by taking the highest room occupancy in this year

– September (95.35%)

Total Room sold /occupancy percentage /30

(6618/95.35%) /30 = 230

Assume there are two hundreds rooms are available per day

200*365 = 73000 rooms

Paid occupancy percentage;

66158 / 73000 = 90.6%

Analysis of the statistics:

It shows on the average 90 percent of rooms were sold in third year which is a very

positive figure.

According to the information provided, we can estimate that the high season of this

hotel is between July and October, January to March would be their low season in

terms of room occupancy.

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Financial Position Analysis

There are several analyses to observe financial situation of the company.

Horizontal analysis uses the calculation of absolute and relative changes of an item,

Vertical analysis is based on the percentages of single items to a total, and there are

also several ratios. Ratios show the relationships between certain items in the financial

statements (Schmidgall., Damitio, 2006). For interpreting financial position, Liquidity

Ratios and Solvency Ratios are used. In this report, we took horizontal analysis,

Current ratio, Accounting Receivable turnover, Average collection period, Dept-equity

ratio, and Number of times interest earned ratio, in order to show our company’s

financial situation.

Horizontal Analysis:

Horizontal Analysis shows the absolute changes and relative changes in two

accounting period in order to compare those changes (Schmidgall., Damitio, 2006). As

appendix 5 shows the calculation of horizontal analysis, there are three main findings

in the balance sheet.

First, in the current assets, there is no big difference in cash but in Accounts

Receivable and Inventories increased more than 50% of relative changes. It pushed

up the total current assets to 258,693 more than year 2.

Second, both Account Payable and Business tax owed in the current liabilities,

increased greatly. It is more than 600,000 in absolute changes. Compare to total

current Assets and Liabilities, we can observe that we do not have ability to pay its bills

as they come due because total current assets cannot cover the total current liabilities.
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Third, Long-term debt decreased by 3,746,484 or 40.7%. It means we paid back the

debts. Even though we increased the total current liabilities, the total Liabilities are still

lower than previous year.

Liquidity Ratios:

Liquidity Ratio can check if we have ability to pay the current debt as its due comes

(Schmidgall., Damitio, 2006). We are going to use 3 methods to see which situation

are we in now.

Current Ratio

As we shown the calculation of current ratio in the Appendix 6, in year 2, for very

1$ current liability, we had 0.83$ current assets. Moreover, in year 3, it is even worse.

We only had 0.42 $ current assets. It might makes creditor worried and unreliable to

our company because they cannot ensure that they can receive payments timely

(Schmidgall., Damitio, 2006). For coming year, we need to be aware of decreasing it

and it needs to be higher.

Account Receivable turnover / Average collection period

Compare to year 2 and 3, year 2 is 17.46 times and year 3 is 33.68 (Appendix 7),

which means every 10 days we can correct Account Receivable during year 3

(Appendix 8). It was 20 days each in year 2. Since we can change receivables to cash

quicker than year 2, we can put more trust on it. This makes current ratio and acid-test

ratio more reliable as well. Overall comparison to year 2 and 3, even the current ratio is

7
lower than year 2, we are still in the same situation in year 3 according to the Account

Receivable turnover.

Solvency Ratios:

This is mainly concerned by lenders to see that the company’s long-term

obligations can be met (Schmidgall., Damitio, 2006).

Debt-equity ratio

Debt equity ratio measures that can we stand if something happens into the

company and also whether we can meet the obligation of long-term dept. Appendix 9

shows that in year 3, for 1$ of owner’s equity, we owed creditors 0.81$. It is lower than

year 2, which is 1$: 1.32$. Lower ratio indicates that we are in safe position to pay

back debts.

Number of times interest earned Ratio

It shows that how many times we can cover the interest expense. Schmidgall and

Damitio (2006: 527) state that “The greater number of times interest is earned, the

greater the safety afforded the creditors.” According to Appendix 10, we could cover

our interest expense by over 5 times in year 3. It is said that more than four times

suggest we have plenty of earning (Schmidgall., Damitio, 2006). It was 1.83 times in

year 2, so we are in positive situation to cover the interest expense of existing debts.

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Statement of Cash-Flow

“Cash flow refers to the money coming into a business from selling its products and

the money it spends on all aspects of production” (bized.co.uk, 2009). And a cash flow

statement is the financial document that shows what the business plan means in term

of money. It is same as a budget. It can be used for internal planning and estimates

how much money will flow into and out of a business in a fix period of time (Pinson.L

and Jinnett.J, 2006). It summaries where the cash came from and how it was spent

(Mott.G, 2005). The functions of making cash flow statement is that it identifies when

cash is expected to be received and when it must be spent to pay bills and debts,

allows the manager to identify where the necessary cash will come from (Pinson.L and

Jinnett.J, 2006) and identifies how cash is generated and applied in a single

accounting period (Australian Bureau of Statistics, 1996). The business owner can

gain a huge benefit from using the cash flow statement. He can know how the financial

performance of his business is, hence he can create a new financial plan precisely for

further developing his business.

From the statement of cash flow by using indirect method, the overall net cash flow

figure of Team relax (the Orange Simulation Company) is positive. It reflects that the

cash inflow of operating is increased. It means there is a gain in net income from the

operating activities. Also, after the reduction of depreciation in investment, we find that

there is a raise of cash outflow of investment activities which means the numbers of

property or equipment is increasing by purchase. And 3746484 debts are retired and
9
there is no additional funds are borrowed as a long-term basis. (Please refer to

appendix figure 11).

On one hand, there is an increase in the cash outflows of investment activities to

change or buy new equipments in order to maintain its high service quality and

reputation. On the other hand, the increase of its operating activities is sufficient

enough to provide cash inflows to cover the outflows for financing and investment

activities. Because of this, it shows that the operation cash flow is healthy. Since the

company has enough ability to increase the gain from operating activities and settle

down its huge debt from the creditors, its financial performance is excellent and

positive generally. From the accounting point of view, it is not a starting-up, enlarging

or bankrupt company. It is because it does not have an obvious great gain or loss on

the operating, investment and financing aspect. On the contrary, it is a well-developed

and earning company on a maturity stage because it can generate money to cover the

debt when it is necessary. The generation is large and stable and it can keep its room

occupancy rate above 70% throughout the year.

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Conclusion

The year 3 efficiency of RELAX is considerable based on its reliable room occupancy

rate and healthy F&B revenue. The management of property and inventory should be

improved but it is a profitable year in general. Liquidity ratios show that the financial

performance of this company is relatively positive comparing to year 2, but the

company needs to be aware of the balance of current Assets and Liabilities according

to the Current Ratio. As well as Solvency ratios, they prove that the company is able to

pay all the long-term debts when the due come in year 3.

From the statement of cash flow we can see that, it is positive in overall situation. Due

to the healthy operation, there are new equipments were brought, as well as no

increase of long-term debt.

Recommendation

Base on the hotel operation performance, there is a possibility to borrow more debts in

order to further develop and enlarge the hotel. In this way, it can enhance the

customers’ experience and its competitiveness. Since the result of cash flow statement

of the hotel is healthy, the statement can be a strong evidence to prove that the hotel

has enough ability to ask for a huge loan with on time payment afterwards. It is not

risky to borrow a large loan. It is good point to convince a bank for supporting the

enlargement of the hotel from the financial side. However, there is a risk because of

the increasing in account receivable. It is better to try to ask for the money back as

soon as possible in case it may influence either the operation or emergency fund of the

hotel.
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References

1. Schmidgall, R., and Damitio, J. (2006) Hospitality Industry Financial Accounting.

3rd edition. U.S.A., EDUCATIONAL INSTITUTE of American Hotel & Lodging
Association.
2. Pinson,L., and Jinnett,J. (2004) Steps to small business start-up: everything you
need to know to turn your idea into a successful business. 6th edition. UK, Kaplan
Publishing.

3. Mott,G. (2005) Accounting for non-accountants: a manual for managers and

students. 6th edition. UK, Kaplan Publishing.

4. Australian Bureau of Statistics. (1996) Year book Australia, Issue 70. Australia,
Bureau of Statistics.

5. Bized.co.uk. (2009) what is a cash flow [online]. Available at: <

http://www.bized.co.uk/educators/level2/finance/activity/cashflow11.htm>. [Last
accessed on 16.12.2009].

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Appendices
(Appendix 1: Profit Margin)
Profit Margin = __Net Income__
Total Revenue

Year 2 = __348480__
7851372

= 4.44%

Year 3 = __1866138__
15148732

= 12.32%

(Appendix 2: Operating Efficiency Ratio)

Operating Efficiency Ratio = Gross Operating Profit
Total Revenue

Year 2 = __1863983__
7851372

= 23.74%

Year 3 = __5986305__
15148732

= 39.52%

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(Appendix 3: Return on Assets)
Return on Assets = __Net Income__
Average Total Assets

Year 3 = __1866138__
17345953.5

= 10.76%

*Average Total Assets = Total Assets at Beginning

____and End of Year____
2

= __17569505 + 17122402__
2

= 17345953.5

(Appendix 4: Return on Owner’s Equity)

Return on Owner’s Equity = _____Net Income_____
Average Owners' Equity

Year 3 = __1866138__
8497172

= 21.96%

*Average Owners' Equity = Owners' Equity at Beginning

____and End of Year____
2

= ___7564103 + 9430241___
2
= 8497172

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(Appendix 5: Balance sheet and Horizontal analysis)
Team- Relax Year 2 Year 3 Absolute Relative
CURRENT ASSETS
Cash at bank 285,569 316,974 31,405 11.0%
A/R 354,279 545,063 190,784 53.9%
Inventories 42,562 79,066 36,504 85.8%
TOTAL CURRENT ASSETS 682,410 941,103 258,693 37.9%

PROPERTY AND
EQUIPMENT
Net Property and Equipment 16,887,095 16,181,299 (705,796) -4.2%
TOTAL ASSETS 17,569,505 17,122,402 (447,103) -2.5%

CURRENT LIABILITIES
A/P 791,226 1,452,168 660,942 83.5%
Business Tax Owed 27,472 799,773 772,301 2811.2%
TOTAL CURRENT
LIABILITIES 818,698 2,251,941 1,433,243 175.1%

LONG-
LONG-TERM LIABILITIES
Long term dept 9,186,704 5,440,220 (3,746,484) -40.8%

OWNERS' EQUITY
Share Capital 7,500,000 7,500,000 0 0.0%
Retained Earnings 64,103 1,930,241 1,866,138 2911.2%

TOTAL OWNERS' EQUITY 7,564,103 9,430,241 1,866,138 24.7%

TOTAL LIABILITIES & O.E 17,569,505 17,122,402 (447,103) -2.5%

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(Appendix 6: Current Ratio)
Current Ratio = Current Asset / Current Liability
Year 3 = 941,103 / 2,251,941 = 0.42 to 1
Year 2 = 682,410 / 818,698 = 0.83 to 1

(Appendix 7: Account Receivable turnover)

Account Receivable turnover = Total Rev. / Average A/R
Year 3 = 15,148,732 / (545,063+354,279)*0.5 = 33.68 times
Year 2 = 7,851,372 / 449671 = 17.46 times

(Appendix 8: Average collection period)

Average collection period = 365 / A/R turnover
Year 3 = 365 / 33.68 = 10.83 days
Year 2 = 365 / 17.46 = 20.9 days

(Appendix 9: Dept-equity Ratio)

Dept-equity Ratio = Total Liabilities / Total O.E
Year 3 = 7,692,161 / 9,430,241 = 0.81 to 1
Year 2 = 10,005,402 / 7,564,103 = 1.32 to 1

(Appendix 10: Number of times interest earned Ratio)

Number of times interest earned Ratio = EBIT* / Interest expense
*EBITU Earning Before Interest and Tax
Year 3 = (2,665,911+550,341) / 550,341 = 5.84 times
Year 2 = (325,952+449,948) / 449,948 = 1.83 times

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(Appendix 11: Statement of Cash Flow)

Net operating cash flow

=Cash at bank of year 3 – Cash at bank of year 2
=316974- 285569
= 31405

Net operating Cash-flow indirect method Year 3

CFO
Net income 1866138
Depreciation 828296
Increase in accounts receivable -190784
Increase in inventories -36504

Increase in accounts payable 660942

Increase in business tax owed 772301
3900389

CFI
Cash from investment activities
*purchase of property and equipment -122500
3777889

CFF
Cash from financing activities
cash to repay debt -3746484
Net Cash Flow 31405

*Net Property and Equipment of BS year3 – (Net Property and Equipment of BS year
2 – depreciation of departmental income statement year 3)
= 16181299 - (16887095 – 828296)
=16181299 – 16058799
= 122500

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