Financial accounting is defined as a branch of “Accounting” that derives the financial position of a company for a specific period. The report consists of detailed financial analytics of two companies, namely, “Sustainable Clothing plc” and “Domestic Appliances Ltd”. The first question is based on evaluating the value of several ratios for the years 2021 and 2022 based on the financial data provided by “Sustainable Clothing plc”. The second question deals with a critical explanation of various risks facing “Domestic Appliances Ltd” based on the financial data provided by the company.
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Based on the financial data provided in Question 1, the values of turnover of “Sustainable Clothing” for the years 2021 and 2022 stand at £14,523000 and £9,216000 respectively. This shows that the company earned less revenue in 2022 compared to its value in 2021. The values of the “cost of sales” of the company for the years 2021 and 2022 are observed as £13,534000 and £8,853000 respectively, indicating a huge reduction in the value of the company’s cost of sales in 2022 compared to that in 2021.
Subtracting the amounts of the company’s respective cost of sales for the two mentioned years from the respective values of its turnover, the values of the company’s “gross profit” for the two mentioned years are derived as £989000 and £363000 respectively. This indicates that the company earned less amount of gross profit in 2022 than the amount it earned as gross profit in 2021. The values of the company’s “administrative expenses” for the years 2021 and 2022 are observed as £478000 and £257000 respectively, which derives that the company’s administrative expenses were reduced in 2022 compared to the expenses borne by the company in 2021. The values of the company’s “other operating expenses” for the years 2021 and 2022 are shown as £56000 and £49000 respectively. Therefore after the substraction of the total values of “Administrative expenses” and “Other Operating Expenses” for the two respective years from the respective values of the company’s gross profit, the values of the company’s “profit before interest and tax” for the two mentioned years are derived as £455000 and £57000 respectively, indicating a drastic reduction in the company’s “profit before interest and tax” in 2022 compared to that in 2021.
Comment on the company’s performance, liquidity, and solvency based on the calculations of ratios
Gross Profit Margin: “Gross profit margin” is one of the three major “profitability ratios” to evaluate the financial position of a company in a given accounting period. The value of a company’s gross profit margin is calculated after the company makes payments that include all of its direct expenses for running its business for that given accounting period (Kadim et al 2020). The values of the company’s “gross profit margin” for the years 2022 and 2021 are calculated as 4% and 7% respectively, which shows that the company had performed less efficiently in making profits after paying off its direct costs of running business operations in 2022 compared to the derived value of that in 2021. The only for the reduction of the value of the company’s gross profit margin is that the percentage of the company’s value in the “cost of goods sold” with respect to its turnover is relatively high in 2022 compared to that in 2021.
Debt-equity ratio: Debt to equity ratio is an important financial measure to find out a company’s efficiency to generate capital for running their business. The debt-to-equity ratio signifies a company’s ability to stabilize its financial position and generate extra capital in a specific financial period (Hosaka, 2019). The values of the company’s debt-to-equity ratio for the years 2022 and 2021 are calculated as 0.53 and 0.28 respectively. This value of a high debt-to-equity ratio in 2022 establishes that the company had relied on debts for financing its business growth.
III. Return on Capital Employed: Return on Capital employed is a financial tool that indicates a company’s ability to reinvest its current profit to generate more profit in the foreseeable future. The value of a company’s “return on capital employed” can be calculated by deriving its “operating profit” as a percentage of its “long-term loans” and finally adding the derived by with the value of the company’s “equity” (Husain and Sunardi, 2020). The value of the company’s “return on capital employed” for the years 2022 and 2021 are derived as 2% and 11% respectively. The lower value of ROCE in 2022 indicates that the company has performed poorly in 2022 compared to 2021 with regard to reinvestment of its current profits for generating more profit in future business operations.
Current Ratio: The value of a company’s current ratio is derived by dividing the value of its “current assets” by the value of its “current liabilities” (Awaysheh et. al. 2020). The values of the mentioned company’s current ratio for the years 2022 and 2021 are calculated as 0.96 and 2.24 respectively. The higher value of the current ratio is 2021 indicates the company’s poor performance in paying off its “short-term” obligations in 2022 compared to 2021.
Interest Cover: The value of a company’s “interest cover” is derived by dividing the value of its “earnings before interest and taxes” by the value of its “total expenses”. The values of the company’s “interest cover” for the years 2022 and 2021 are calculated as 2.04 and 22.75 respectively. The lower value of “interest cover” in 2022 establishes less financial stability for the company in 2022 compared to 2021.
Explanation of the inability of ratios to give a full picture of the financial health of a company
Financial ratios are unable to provide a full report on a company’s existing financial health since ratios do not consider the competitiveness and fluctuations in the existing market scenario. Financial ratios do not take into account any sudden financial changes related to a company’s assets or liabilities in a specific accounting period (Al-Homaidi et. al. 2021). Financial ratios are based on the historic values of a company’s financial data and do not provide any forecast of a company’s future financial performance.
Question 2: Critical explanation of the various risks that the Company might face
Domestic appliances Ltd plc is engaged in the manufacturing of “low energy kettles” and is also listed in Germany and on the UK stock exchanges. The Company might be various exposure to increased costs of imports in the future. Apart from that, there are several chances of an increase in the business program and expansion. The financial manager is equally concerned regarding the immediate impact of international financial exposure and risks. There are benefits that the Company might get with the exposure to international business such as political, foreign exchange risk and currency risks (Aldasoro et al. 2020). The International risks that have the most impact on the businesses in case of expansion overseas. The first and foremost risk that is identified in the context of international risks is the “foreign risk” which refers to the fluctuation in the value of the investment owing to the changes in the currency exchange rates. These risks also termed exchange risk that can have the maximum probability of occurring diversifications and implies a decrease in the value of the investment that relates to the participating currencies (Feyen et al. 2020).
Foreign investment risk is one of the most vital international risks that occur at the time of intervention of financial transactions that involve a currency other than that of the domestic currency. The political risk is evaluated to be the crucial determinant factor of how the entity is going to be faring in the economy. The increase in political risk has a major impact on the performance of the economy that can negatively affect the situation of the economy. In the opinion of (Chen et al. 2021), regardless of the identifiable locations of the business, they can face the maximum consequences of a financial crisis.
The increase in both the fixed and variable costs tends to highly affect the profitability margin of the business and creates major implications on their revenue (Al-Homaidi et al. 2021). Moreover, an increase in the expenses needed for the production of the goods depicts a decrease in the total gross profit. The increase in the total cost of energy by 20 % holds to create a major source of problems for the Company in the later phase. This has a huge chance of deteriorating the revenue balance of the Company. The aim of the Company is to keep its revenue at equilibrium for the upcoming year. The aim of the Company is to have a positive contribution to meeting their fixed costs that are relatively difficult for the manager to estimate (Rudebusch, 2021). The rate of profit in the current times has lowered owing to the decrease in the level of the profit and the tax rate is assumed to be 30%. The cost of borrowing is relatively high. The increase in the cost is likely going to leave a negative impact on the “break-even point” of the Company or have the chance of decreasing the profit margin that exists in the entity. Therefore, with the increase in the cost, the Company will be highly pressurized to keep the sales of the business high in order to reduce the increase in their revenue level or in order to reach the break-even point.
Debt financing refers to the total valuation of the money that is required to be repaid later. Based on the research work (Ghadge et al. 2021), debt financing is regarded to be an aggressive capital structure and it is identified to be possessing a higher level of risk to their investors. The principal amount that is included in the total amount is needed to be repaid by the lenders and interest holders. The rise of the capital structure indicates any kind of growth that the Company takes by taking out loans. Moreover, debt financing incurs no dilution of the ownership of the Company's interest in the firm. However, the manager is positive about the debt financing that has been used as the method of capital financing. The adoption of capital financing will help the Company to leverage more amount of funds in less period of time. Apart from that the rapid growth of the business rather than it is expected. Similarly, the increase in the tax rate is not applicable to the Company since the debt financing does not carry the burden of tax deduction.
Figure 2:
The price elasticity of the kettles has been identified from the above-required scenario depending on the various income and expenses. The net profit earned by the Company in the first year has been identified to be near about £ 5021100 and the “net profit margin” for that particular year is 22.17%. The proposed criteria for the NPM throughout the years have been 50%. Moreover, the Company has been able to maintain the criteria through the years of operations reflecting the price elasticity at different ranges. During the first year, the elasticity of the price was 22.17%, which kept on increasing within the given time, span of years. The price elasticity increased to 22.51% in the fifth year.
Conclusion
The entire conclusion can be drawn from the financial assumptions of the two different Companies facing two different kinds of situations. The computation of the ratio analysis for “sustainable clothing Plc” in the previous two years has identified that states that the profitability amount has decreased in the year 2022. The liquidity position of the entity has severely deteriorated in the second year owing to the increase in the liabilities and reduction of the assets. The second question relates to the various risk and advantages that might be a part of intervening for the Company trying to establish its business in the international market. The discussion related to the various kinds of risk has been mentioned in the report. The impact of the price elasticity on the business and the changes in the future scope in mentioned.
References
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Appendices:
Appendix 1: Calculation of the financial ratios for Sustainable Clothing plc
