SUBJECT:

HND PEARSON EDEXCEL

UNIT NAME:

PREPARATION OF FINANCIAL STATEMENTS,

COMPLYING WITH RELEVANT LEGAL AND
REGULATORY PROVISIONS

UNIT NO:

10

UNIT CODE:

F/601/0864

WORDS COUNTS: 5624

STUDENT NAME:

HayatUllah

COLLEGE:

INSTITUTE OF BUSINESS LEADERSHIP-Islamabad

Table of contents
Sr No.

Description

Page

Task 1.1 The main users of Financial Statements

6

Task 1.1 The Information Needs of Users of Financial Statements

8

Task 1.2 (a) Legal and Regulatory influences on

9
Financial Statements

Task 1.2 (b) How Laws/Regulations are dealt with by

13
Accounting Standards

Task 2 (a) Total Purchases for the year ended 31 August 2003
14

Task 2 (b)

Profit and Loss Account

14
7

Task 3: Consolidated Financial Statements A-One Ltd

15

Task 3: Consolidated Income Statements A-One Ltd

16

Task 4 (a) Importance of Company Financial Information to

18
different Stakeholders

10

Task 4 (b) Financial Statements for the year March 31, 2012
19

11

Task 5.1 Calculating Ratios -A2Z Motors

21

12

Task 5.1 Calculating Ratios - Fashion Do-Do Ltd

22

Task 5.2 Interpreting ratios A2Z Motors

23
12

Task 5.2 Interpreting ratios - Fashion Do-Do Ltd

24

12

Task 5.2 Weaknesses and Limitations of ratio analysis:

25

ACKNOWLEDGEMENT
I would like to dedicate my work to my respectable teacher and my parents
who always helped me and supported in my studies. I also dedicate my
work to the author whose work provided me good assistance in my
assignment.

Research Method:
I have used secondary methods for collection of data taking
help from different sources like Internet, books and different
articles etc,

Task 1.1. The Main Users of Financial Statements:

The primary objective of financial statements is to provide users with adequate
information about the economic entity, information that enables each user to
make decisions in full knowledge regarding the economic entity and in relation to
the activity it performs. This objective requires that financial statements be able
to provide more comprehensive and vast information than that offered by the
balance sheet, the profits
and loss account and the changes in equity structure, together with related
explanatory notes.
Originally managers were identified as primary users of accounting information.
Thus, Edwards and Bell, in 1961, believed that the main function of accounting
was to provide management with the necessary information in the assessment of
their activities, namely (Edwards & Bell, 1961, p. 273):
a precise measurement of operating profit;
a precise measurement of accumulated earnings as a result of holding
assets
whose value has increased.
Edwards & Bell believe that the accounting information helps in evaluating
decisions, thus contributing to (Edwards & Bell, 1961, p. 4):
monitoring current events in the production process;
formulating better decisions in the future;
changing the decision-making process.
Although they believe that the tax authorities, business owners, analysts, the
general public should probably be among those that influence the type of
information produced (Edwards & Bell, 1961, p. 4), their information needs are
considered less important than those of the management, noting that the point
of view of external users of accounting information cannot exercise significant
influence in the business decisions (Edwards & Bell, 1961, p. 105).
Therefore, in Edwards and Bells view, intended users were existing and
prospective managers. Unlike Edwards and Bell, Sterling (Sterling, 1970) does
not distinguish between different types of users. He classifies users between
managers and other stakeholders, considering that they could include creditors,
owners, employees, and government institutions (Sterling, 1970, p. 132).
In the UK, the Accounting Standards Steering Committee discussion paper,
entitled The Corporate Report, London, 1975, lists users identified with a
reasonable
right to obtain information:
the group of investors including shareholders and the holders of
securities;
the group of creditors including existing and potential holders of bonds
and
loans for stocks and short-term secured and unsecured loan providers;
the group of employees including current, prospective and former
employees;
the group of advisors, analysts including financial analysts, economists,

journalists, statisticians, researchers and other providers of advisory

services;
the group of business partners including customers, suppliers and
competitors, those interested in mergers and acquisitions;
state authorities including the tax authorities and organisations
responsible
for oversight of industry and commerce and local authorities;
the public including tax and fee payers, political parties, companies
dealing
with customer protection.
(Fraser & Nobes, 1985, p. 146), in their 1985 study, note that managers appear
to be the decision-makers, and that management is one of the main users of
financial
statements.
(Chambers, 2006, p. 428) notes that the first forms of accounting have paid
special attention to managers- owners of businesses according to whom
management
has the right to establish accounting practices. During the nineteenth century, the
accounting objective was represented by protecting creditors, accounting
manifesting a
conservative character. In the late nineteenth century and during the twentieth
century,
as a result of the growing importance of investment in securities, accounting has
changed, especially regarding the role of managers, largely due to higher
investments in securities, the role of corporate managers having a fiduciary
character, and it was considered that financial statements were simple reports on
the managements administration. During the twentieth century, accounting was
strongly influenced by its usefulness in making management decisions. One of
the main elements of this period
was the belief that financial statements serve different types of decisions.
Connection between financial statements and usefulness in decision making was
introduced by governing bodies in the 1970s. At first, this connection was
criticized by
researchers, these considering that regulators should define the balance
between
organizational and individual needs as a basis for accounting standards, without
considering usefulness in decision making as a starting point. Gradually,
usefulness in
decision making has become accepted by the group of users of financial
statements and is encountered in almost all articles and literature.
Identifying users of financial statements requires the development of a
conceptual framework. The stages of developing a conceptual framework are
considered by some authors (Macve, 1981, p. 33) as follows:
identification of users, and the decisions they take;
for each decision, establishment of accounting information necessary to
be

known;
for each case, making a comparison between benefits obtained and costs
incurred, so methods providing the greatest net benefit are chosen.
Regarding the identification of users of financial statements, it can be said that
only those for which financial statements are useful will use these financial
statements and how they will be used will be influenced by information provided
by these financial statements. Thus, user identification depends on the general
conceptual framework of
drafting financial statements; also the development of the general conceptual
framework
depends on these users.
We find in some authors a differentiation between various types of users. Thus,
some divide users into two groups (Riahi-Belkaoui, 2004, p. 133), as follows:
direct users, consisting of:

owners and shareholders of the economic entity;

creditors and suppliers;

the management of the economic entity;

tax authorities;

employees of the economic entity;

clients.
indirect users, consisting of:

financial analysts and consultants;

stock exchanges;
lawyers;
financial press and agencies;
professional associations;
unions;
competition;
the public;
other government agencies.

The Information Needs of Users of Financial Statements

(Cyert & Ijiri, 1974, p. 29) considered that formulating accounting objectives
needs to solve the conflict of interest regarding existing information needs,
considering
that financial statements are the result of the interaction between three groups,
namely:

economic entities;

users;

accounting profession.
Economic entities are the main group directly involved in accounting. Through

financial statements, they provide a reflection of their business, consisting of

operating, financial and extraordinary activities. Economic entities are also
among those who develop accounting information.
Users are the second group, and their interests and their information needs exert
direct influence on the production of the accounting information. The accounting
profession is the third group that influences the type of accounting information
that needs to be included in financial statements.
The Framework for the Preparation and Presentation of Financial Statements,
issued by the IASC in April 1989, established that financial statements meet the
common information needs of a wide range of users (2007, p. par.6). Regarding
the identification of primary users, we note that in accordance with the
Framework for the Preparation and Presentation of Financial Statements,
paragraph 10, investors are primordial users of financial statements as the
supply of financial statements that meet their needs will satisfy most of the needs
of others users. Also paragraph 30 of the Financial Accounting Standards Board
(FASB) Statement of Financial Accounting Concepts No. 1. Objectives of
Financial Reporting by Business Enterprises (1978), stated that investors and
creditors and their advisers represent the most prominent external group using
information provided by financial reporting. In paragraph 1.11. of Chapter 1:
Objectives of Financial Statements in the Statement of Principles for Financial
Reporting issued by the Accounting Standard Board in December 1999,
investors were considered primary users, while also laying an emphasis on the
common interest that all users have in terms of an entitys financial performance
and financial position. Information useful and necessary to investors was
provided to them through financial statements, while their information not useful
to them was deemed unnecessary to be presented in financial statements. Under
Objectives of Financial Statements in the Statement of Principles for Financial
Reporting issued by the Accounting Standard Board in December 1999, the
information needs of investors are those relating to:

financial performance;

financial position;

generation and use of cash;

financial adaptability.
The investors information need regarding financial performance comes from
the fact that this financial performance provides information about:
the managements ability to administer the economic entity, as well as past and
future financial performance of the entity;
The entitys ability to generate cash flows using the available resources, and the
effectiveness with which the entity has used its resources. The investors
information need regarding financial position is due to the following reasons:
assessment of the managements administration, and the ability of an entity
to generate future cash flows is based on information about the economic
resources controlled by the entity and uses of these resources in the past;
assessment of how future cash flows will be distributed to those who have an
interest in the entity is based on information about the financial structure;
assessment of the entitys ability to meet its obligations at maturity is based

on information about liquidity and solvency;

assessment of current performance and financial adaptability is based on
information regarding the entitys risk and its management.
The information need of users in terms of the generation and use of cash is
because this type of information is useful in understanding and reviewing
previous assessments in relation to:
liquidity and solvency;
connection between profits and cash flows achieved;
impact on future cash flows of financial performance.
Regarding financial adaptability, it tries to determine the economic entitys ability
to:
increase capital;
pay equity or debt;
obtain cash by selling assets without disrupting current operations
conduct;
increase cash inflows from current operations.
Task 1.2 (a) Legal and Regulatory influences on Financial Statements
Companies that are privately owned are not required by law to disclose detailed
financial and operating information in most instances. They enjoy wide latitude in
deciding what types of information to make available to the public. Small
businesses and other enterprises that are privately owned may shield information
from public knowledge and determine for themselves who needs to know specific
types of information. Companies that are publicly owned, on the other hand, are
subject to detailed disclosure laws about their financial condition, operating
results, management compensation, and other areas of their business. While
these disclosure obligations are primarily linked with large publicly traded
companies, many smaller companies choose to raise capital by making shares in
the company available to investors. In such instances, the small business is
subject to many of the same disclosure laws that apply to large corporations.
Disclosure laws and regulations are monitored and enforced by the U.S.
Securities and Exchange Commission (SEC).
All of the SEC's disclosure requirements have statutory authority, and these rules
and regulations are subject to changes and amendments over time. Some
changes are made as the result of new accounting rules adopted by the principal
rule-making bodies of the accounting profession. In other cases, changes in
accounting rules follow changes in SEC guidelines. For example, in 2000 the
SEC imposed new regulations to eliminate the practice of "selective disclosure,"
in which business leaders provided earnings estimates and other vital information
to analysts and large institutional shareholders before informing smaller investors
and the rest of the general public. The regulation forces companies to make
market-sensitive information available to all parties at the same time. Dramatic
and sweeping amendments were made to the SEC's disclosure rules in the

summer of 2002 with the passage of the Sarbanes-Oxley Act, often referred to
simply as Sarbanes-Oxley, Sarbanes, or SOX.
The Sarbanes-Oxley Act
The Sarbanes-Oxley Act came about because of the stunning and unexpected
bankruptcy filed by Enron, an enormous energy-trading company in late 2001.
This bankruptcy filing was the largest to date in 2001, it cost investors billions
and employees lost far more than their jobs, many lost their life savings. The
Enron debacle would have been prevented if audits of the company had detected
accounting irregularities or if the company would have been required to disclose
transactions not directly reflected on its balance sheet. To a large extent, Enron's
failure was the result of corrupt practices. Concern quickly grew about how easily
these practices had been carried out and hidden from investors and employees
alike.
Sarbanes-Oxley was principally a reaction to this failure. However, during this
same period, the equally dramatic actual or pending bankruptcies of WorldCom,
a long-distance telecommunications company, and Tyco, a diversified equipment
manufacturer, influenced the content of the legislation. SOX thus deals with 1)
reform of auditing and accounting procedures, including internal controls, 2) the
oversight responsibilities of corporate directors and officers and regulation of
conflicts of interest, insider dealings, and the disclosure of special compensation
and bonuses, 3) conflicts of interest by stock analysts, 4) earlier and more
complete disclosure of information on anything that directly and indirectly
influences or might influence financial results, 5) criminalization of fraudulent
handling of documents, interference with investigations, and violation of
disclosure rules, and 6) requiring chief executives to certify financial results
personally and to sign federal income tax documents. The provisions of SOX
have significantly changed SEC disclosure requirements.
In a very real sense, SOX has changed the very regulatory authority upon which
the SEC operates. For a detailed discussion of the provisions of Sarbanes-Oxley,
refer to the essay by the same name in this volume.
SEC DISCLOSURE OBLIGATIONS
SEC regulations require publicly owned companies to disclose certain types of
business and financial data on a regular basis to the SEC and to the company's
stockholders. The SEC also requires disclosure of relevant business and
financial information to potential investors when new securities, such as stocks
and bonds, are issued to the public, although exceptions are made for small
issues and private placements. The current system of mandatory corporate
disclosure is known as the integrated disclosure system. By amending some of
its regulations, the SEC has attempted to make this system less burdensome on
corporations by standardizing various forms and eliminating some differences in

reporting requirements to the SEC and to shareholders.

Publicly owned companies prepare two annual reports, one for the SEC and one
for their shareholders. Form 10-K is the annual report made to the SEC, and its
content and form are strictly governed by federal statutes. It contains detailed
financial and operating information, as well as a management response to
specific questions about the company's operations.
Historically, companies have had more leeway in what they include in their
annual reports to stockholders. Over the years, however, the SEC has gained
more influence over the content of such annual reports, primarily through
amending its rules on proxy statements. Since most companies mail annual
reports along with their proxy statements, they must make their annual
stockholder reports comply with SEC requirements.
SEC regulations require that annual reports to stockholders contain certified
financial statements and other specific items. The certified financial statement
must include a two-year audited balance sheet and a three-year audited
statement of income and cash flows. In addition, annual reports must contain five
years of selected financial data, including net sales or operating revenues,
income or loss from continuing operations, total assets, long-term obligations and
redeemable preferred stock, and cash dividends declared per common share.
Annual reports to stockholders must also contain management's discussion and
analysis of the firm's financial condition and results of operations. Information
contained therein includes discussions of the firm's liquidity, capital resources,
results of operations, any favorable or unfavorable trends in the industry, and any
significant events or uncertainties. Other information to be included in annual
reports to stockholders includes a brief description of the business covering such
matters as main products and services, sources of materials, and status of new
products. Directors and officers of the corporation must be identified. Specific
market data on common stock must also be supplied.
Registration of New Securities
Private companies that wish to become publicly owned must comply with the
registration requirements of the SEC. In addition, companies floating new
securities must follow similar disclosure requirements. The required disclosures
are made in a two-part registration statement that consists of a prospectus as
one part and a second section containing additional information. The prospectus
contains all of the information that is to be presented to potential investors. It
should be noted that SEC rules and regulations governing registration
statements are subject to change.
In order to meet the disclosure requirements of new issue registration,
companies prepare a basic information package similar to that used by publicly

owned companies for their annual reporting. The prospectus, which contains all
information to be presented to potential investors, must include such items as
audited financial statements, a summary of selected financial data, and
management's description of the company's business and financial condition.
The statement should also include a summary of the company's material
business contracts and list all forms of cash and noncash compensation given to
the chief executive officer (CEO) and the top five officers. Compensation paid to
all officers and directors as a group must also be disclosed. In essence, a
company seeking to go public must disclose its entire business plan.
Securities Industry Regulations
Additional disclosure laws apply to the securities industry and to the ownership of
securities. Officers, directors, and principal stockholders (defined as holding 10
percent or more of the company's stock) of publicly owned companies must
submit two reports to the SEC. These are Form 3 and Form 4. Form 3 is a
personal statement of beneficial ownership of securities of their company. Form 4
records changes in such ownership. These reporting requirements also apply to
the immediate families of the company's officers, directors, and principal
stockholders. Individuals who acquire 5 percent or more of the voting stock of a
SEC-registered company, meanwhile, must also submit notification of that fact to
the SEC.
Securities broker-dealers must provide their customers with a confirmation form
as soon as possible after the execution of an order. These forms provide
customers with minimum basic information required for every trade. Brokerdealers are also responsible for presenting the prospectus to each customer for
new securities issues. Finally, members of the securities industry are subject to
reporting requirements of their own self-regulating organizations. These
organizations include the New York Stock Exchange (for listed securities
transactions) and the National Association of Securities Dealers (for over-thecounter traded securities).
DISCLOSURE RULES OF THE ACCOUNTING PROFESSION
Generally accepted accounting principles (GAAP) and specific rules of the
accounting profession require that certain types of information be disclosed in a
business's audited financial statements. As noted above, these rules and
principles do not have the same force of law as SEC rules and regulations. Once
adopted, however, they are widely accepted and followed by the accounting
profession. Indeed, in some instances, disclosures required by the rules and
regulations of the accounting profession may exceed those required by the SEC.
It is a generally accepted accounting principle that financial statements must
disclose all significant information that would be of interest to a concerned
investor, creditor, or buyer. Among the types of information that must be

disclosed are financial records, accounting policies employed, litigation in

progress, lease information, and details of pension plan funding. Generally, full
disclosure is required when alternative accounting policies are available, as with
inventory valuation, depreciation, and long-term contract accounting. In addition,
accounting practices applicable to a particular industry and other unusual
applications of accounting principles are usually disclosed.
Certified financial statements contain a statement of opinion from an auditor, in
which the auditor states that it is his or her opinion that the financial statements
were prepared in accordance with GAAP and that no material information was
left undisclosed. If the auditor has any doubts, then a qualified or adverse opinion
statement is written.
Task 1.2 (b) How Laws/Regulations are dealt with by Accounting Standards
Accounting systems deal with the monetary structures of countries, which are
derived from local laws, socio-economic conditions, cultural standards and
traditions. Accommodations to cultural, legal, and socio-economic factors give
accounting systems unique structures. In spite of the common framework of
principles, countries integrate specific aspects of culture, socioeconomic
framework and legal structure into unique sets of Generally Accepted Accounting
Principles or GAAPs.
Accounting standards and practices reflect the influence of legal, cultural, political
and economic factors. Because these factors vary by country, the underlying
goals and philosophy of national accounting systems vary dramatically (Griffin,
2009).
In common law countries like the United States and United Kingdom, accounting
procedures evolve from decisions of independent standard-setting boards.
Accountants in common law countries follow generally accepted accounting
principles (GAAP) that provide a "true and fair" value of a firm's performance
based on standards promulgated by standard-setting boards. Operating within
the boundaries of GAAP, accountants can exercise professional discretion in
reporting a "true and fair" depiction of a firm's performance (Griffin, 2009).
In countries which rely on code law, national accounting practices are likely to be
codified rather than based on the collective wisdom of professional accounting
groups. In France, for example, firms must adhere to a national chart of
accounts. This accounting system dates back to the seventeenth century and
reflects a long tradition of strong government control over the economy (Griffin,
2009).
In countries where accounting practices are determined by national laws, the
government plays the major role in monitoring accounting practices. Common
law countries rely to a greater extent on private litigation to enforce the accuracy
and honesty of accounting practices.

A country's accounting system may also reflect its cultural background. Large
companies in France must publish a "social balance sheet" detailing
compensation of their workforces. Strong anti-inflation biases are embedded in
German accounting practices as a reaction to the hyperinflation of the early
1920s (Griffin, 2009).
Accounting system structure is heavily influenced by economic and political
systems also. In centrally planned economies, accounting systems are designed
to provide information which shows how state funds are used and whether statemandated production quotas are being met.

Task 2 (a) Total Purchases for the year ended 31 August 2003
Creditors for Purchases 1-Sep 2002
Bank Payments during year
Creditors for Purchases 31-Aug 2002
Total Purchases

(7, 400)
101,500
8,900
_______
10,3000

Task 2 (b) Profit and Loss Account for the year ended 31 August 2003
Sales (100%)
Cost of Sales(67%)
Opening Inv
Purchases
Closing Inv

171493
8600
103000
(16800)

(94800)

Gross Profit (33%)

56593

Rent Expense
Electricity
Delivery Cost
Casual Labour

(5040)
(1390)
(3000)
(6620)

Net Profit

40543

Task 3: Consolidated Financial Statements

A-One ltd Consolidated Statement of Financial Statement
For the year ended 30 September 1997
(in
millions)
Noncurrent assets:
Tangible Fixed Assets (1280+440)

1,720

Current assets
Stocks (300+250)

550

Debtors (280+150-100)

330

Cash and Bank (40+10)

50

Total assets
2650
Equity & Liabilities:
Trade Creditors (80+160)

240

Other Creditors (160+70)

230

Provisions for Liabilities and charges

480

(460+20)

Proposed Dividends

270

Ordinary share capital $1 (A-One ltd only)

900
Group Retained earnings (W5)
Non-controlling interest (W4)

Total equity and liabilities

2650

502
28

Consolidated Income Statement

For the year ended 30 September 1997
(in
millions)
Revenue (1700+450)

2150

Cost of sales (920+75)

(995)

Gross profit

1155

Operating expenses (300+175)

(475)

Profit before taxation

680

Tax (30+20)

(50)

Profit for the year

630

Attributable to:
Non-controlling interest (30 x 20%)
6
Group (630-6)

W1) Group Structure

A-One Ltd

80%

B- One Ltd

624

W 2) Net assets of B-One Ltd (Values in 000)

@ acquisition

@ reporting

date
Share capital
400,000

400,000

Retained Earnings
100,000

40
400,040

500,000

W3) Good Will

Parent holding (investment)at fair value
400,000
NCI value at acquisition (20% 400,040 (W2))

8,000

Less:
Fair value of net assets at acquisition (W2)
(400,040)
Goodwill on acquisition

7960

W4) NCI
NCI value at acquisition (as in W3)

8000

NCI share of post acquisition reserves (20% x (500,000-400,040)(W2))

19,992
27992
W5) Group Retained Earnings
A-One Ltd (100%)
430,000
80% of B-one Ltd post acquisition retained earnings

79,968
(80% x (500,000-400,040)(W2))
Good Will (w3)

(7,960)
502,008

Task 4 (a) Importance of Company Financial Information to different

Stakeholders
The objective of financial statements is to provide information about the financial
position, performance and changes in financial position of an enterprise that is
useful to a wide range of users in making economic decisions (IASB Framework).
Financial Statements provide useful information to a wide range of users:
Managers require Financial Statements to manage the affairs of the company by
assessing its financial performance and position and taking important business
decisions.
Shareholders use Financial Statements to assess the risk and return of their
investment in the company and take investment decisions based on their
analysis.
Prospective Investors need Financial Statements to assess the viability of
investing in a company. Investors may predict future dividends based on the
profits disclosed in the Financial Statements. Furthermore, risks associated with
the investment may be gauged from the Financial Statements. For instance,
fluctuating profits indicate higher risk. Therefore, Financial Statements provide a
basis for the investment decisions of potential investors.
Financial Institutions (e.g. banks) use Financial Statements to decide whether
to grant a loan or credit to a business. Financial institutions assess the financial
health of a business to determine the probability of a bad loan. Any decision to
lend must be supported by a sufficient asset base and liquidity.
Suppliers need Financial Statements to assess the credit worthiness of a
business and ascertain whether to supply goods on credit. Suppliers need to
know if they will be repaid. Terms of credit are set according to the assessment of
their customers' financial health.
Customers use Financial Statements to assess whether a supplier has the
resources to ensure the steady supply of goods in the future. This is especially
vital where a customer is dependent on a supplier for a specialized component.
Employees use Financial Statements for assessing the company's profitability
and its consequence on their future remuneration and job security.
Competitors compare their performance with rival companies to learn and
develop strategies to improve their competitiveness.
General Public may be interested in the effects of a company on the economy,
environment and the local community.
Governments require Financial Statements to determine the correctness of tax
declared in the tax returns. Government also keeps track of economic progress
through analysis of Financial Statements of businesses from different sectors of
the economy.

Task 4 (b)

Sales
Cost of Sales
Opening Inv
Purchases
Closing Inv

Profit and Loss Account

For the year 31 March 2012
1,606,086
290,114
810,613
(317,426)

(783,301)

Gross Profit
Expenses:
Depreciation- Building
Equipment
Carriage inwards
Carriage outwards
Salaries
Office Expenses
Sundry Expenses
Directors remuneration
Business rates
Net Profit

822785
(40000)
(48000)
(2,390)
(13,410)
(384,500)
(9,100)
(2,360)
(119,200)
(14,800)

(633760)
189025

Balance Sheet
For the year 31 March 2012
Non Current Assets:
Cost
Building
800000
680,000
Equipment 320000
176,000

Accumulated Depreciation
(80000+40000)
(96000+48000)

Current Assets:
Inventory
Receivables
Bank

317,426
321,219
8,100

NBV

646,745
TOTAL ASSETS
1,502,745

Equity:
Issued Share Capital
800,000
Retained Earnings (136204+189025-28354)
Transfers to reserves
196,875
General Reserve (120000+70000)
190,000
Foreign Exchange Reserve (20000+30000)
50,000

296,875
(100,000)

1,236,875
Liabilities:
Accounts payable
Dividends Payable

237,516
28,354

265870
Total Equity & Liabilities
1,502,745

Task 5.1: Calculation Ratios to measure performance

A2Z Motors:

2009
2010

ROCE = PBIT/ Capital Employed

25/260 = 9.6%

30/205 = 14%

Return on Equity = PAT/ Ordinary Share capital+ Reserves 23/145 = 16%

15/160 = 9.3%
Gross Profit margin = Gross Income / Sales
51%
255/610 = 42%

255/500 =

Net Profit margin = Operating Income / Sales

4.6%
15/610= 2.4%

23/500 =

Interest Cover = OPBIT/ Debt Interest

times
25/10 = 2.5 times

30/7 = 4.2

Current Ratio= Current assets / current liabilities

55/20 = 2.8

80/25 = 3.2

Quick ratio = current assets-inventory / current liabilities

(5)/20= 0.2

30/25 = 1.2

Fashion Do-Do Ltd

2009
2010

ROCE = PBIT/ Capital Employed

30/202 = 14.8%

25/225 = 11.1%

Return on Equity = PAT/ Ordinary Share capital+ Reserves

12%
27/177 = 15%

18/150 =

Gross Profit margin = Gross Income / Sales

51%
230/460 = 50%

215/425 =

Net Profit margin = Operating Income / Sales

4.2%
23/460 = 5%

18/425 =

Interest Cover = OPBIT/ Debt Interest

times
30/3 = 10 times

25/7 = 3.5

Current Ratio= Current assets / current liabilities

77/50 = 1.5

40/35 = 1.1

Quick ratio = current assets-inventory / current liabilities

55/50 = 1.1

13/35 = 0.3

Task 5.2: Interpreting Ratios - A2Z Motors:

ROCE: The companys ROCE has decreased in 2010 ie for every $100 of capital
invested the company earned $9.6 compared with $14 earned in 2009.
ROE: The Companys has fallen from 16 to 9.3%. This suggests that the
company is failing to make the most of shareholders investments.
Gross Profit: The gross profit margin has decreased from 51 to 42% which is
not a good sign for the business but Increase in sales may suggest that the
company might have decreased the selling prices to increase sales.
Net Profit: The net profit margin has also decreased from 4.6 to 2.4% which is in
line with the gross profit margin. Again it might suggest the decrease in selling
prices or increase in cost of sales for buying a quality materials.
Interest Cover: The Interest cover ratio has also fallen as compared to previous
year but still the company is in a strong position as regards the payment of
interest. The profit would have to drop considerably before any problem of paying
the interest arose.
Current ratio: Companys current ratio has decreased to 2.8 compared to the
previous years ratio of 3.2 but still it is better and shows how well the company is
able to pay its debts as they fall due.
Quick ratio: Quick ratio has decreased considerably from 1.2 to 0.2 in 2010. It
indicates the company is unable to pay its debts as they fall due at once although
in previous year it was to an acceptable level.

Interpreting Ratios - Fashion Do-Do Ltd:

ROCE: The companys ROCE has increased in 2010 i.e. for every $100 of
capital invested the company earned $14.8 compared with $11.1 earned in 2009
which indicates a good performance for the company.
ROE: The Companys has increased from 12 to 15%. This suggests that the
company is succeeding to make the most of shareholders investments.
Gross Profit: The gross profit margin has slightly increased from 50 to 51%
which indicates that company has managed to earn a constant profit margin over
the year.
Net Profit: The net profit margin has also increased slightly from 4.2 to 5% which
is in line with gross profit margin. It also indicates that companys operating
expenses have been consistent with the previous year.
Interest Cover: The Interest cover ratio shows a huge increase to 10 times as
compared to 3.5 times the previous year indicating that the company is in a
strong position as regards the payment of interest. The profit would have to drop
considerably before any problem of paying the interest arose.
Current ratio: Companys current ratio has increased to 1.5 compared to the
previous years ratio of 1.1 but still it is better and shows how well the company is
able to pay its debts as they fall due.
Quick ratio: Quick ratio has increased considerably from 0.3 to 1.1 in 2010. It
indicates the companys ability to pay its debts as they fall due at once and the
company has improved well as compared to the previous year. Weaknesses

and Limitations of ratio analysis:

Weaknesses
Not all financial ratios can be compared. There are several points that analyst must
take into account. When two companies' financial data is compared, the ratios must
reflect comparable price levels and these values must be evaluated using same
accounting methods and valuation bases. Also, such comparisons should be limited
to companies engaged in similar business activities. If the financial policies differ, this
must be recognized while evaluating of comparative reports. For example one
company leases its properties while the other purchases such items; one company
finances its business using long-term borrowing while the other provide its fund by
shareholders and reserves. In these cases, ratios can not be compared.
Comparing ratios with past data of the same company (trend analysis) can indicate
the performance over years and highlight points that need for action, however it will
not be enough to tell much about the companys status among competitors. For more
informative analysis, ratios should be compared with two or more companies in

similar line of business (cross-sectional analysis). More reasonable method would be

comparing ratios to industry averages, which are developed by statistical services
and trade associations.
There is no single or correct value for a ratio. The value may be too low or to high
against to reference value. Ratios may mislead when they are not combined with
companys management and economic circumstances. Analyst must consider
companys products, competitors and also the companys vision for the future.
In the trend analysis although 2 years comparison can give the idea about the
performance of the company, it is best to use three to five years of ratios to have
broader view of performance. Seasonal variations also must be looked at attentively
in trend analysis.
Another point about ratios is that they could be evaluated with different methods and
they are dependent on the perspective of the analyst. Therefore it is not always
possible to define good and bad for the values.

Limitations
Despite usefulness, financial ratio analysis has some disadvantages. Some key demerits of
financial ratio analysis are:
1.

Different companies operate in different industries each having different environmental

conditions such as regulation, market structure, etc. Such factors are so significant that a
comparison of two companies from different industries might be misleading.

2.

Financial accounting information is affected by estimates and assumptions. Accounting

standards allow different accounting policies, which impairs comparability and hence ratio
analysis is less useful in such situations.

3.

Ratio analysis explains relationships between past information while users are more
concerned about current and future information.