Accounting for Management Decisions and Analysis

Question: Discuss about the Accounting for Management Decisions and Analysis. Answer: Computation of financial ratios Return on Assets: It depicts how profitable the venture is in comparison to its total assets. It shows how productively an organization is using its assets to create profits. Table 1: Statement showing Computation of Return on Assets of Tom Ltd. and Jerry Ltd Particulars Tom Ltd. Jerry Ltd. Return on Assets Total Assets 410,000 310,000 Net Profit 55,000 65,000 Return on Assets = Net Profit/ Total Assets 13.41% 20.96% Return on Equity: It means the amount of return generated or available for shareholders for distribution in name of dividend. Table 2: Statement showing Computation of Return on Equity of Tom Ltd. and Jerry Ltd. Particulars Tom Ltd. Jerry Ltd. Return on equity Net Profit available for Equity Shareholders 55,000 65,000 Share Capital Reserves 330,000 230,000 Return on Equity = Net Profit available for Equity Shareholders/ Share Capital Reserves 16.66% 28.26% Profit Margin: It refers to proportion of net profit in relation to sales. In other words it reveals how much out of every dollar of sales of a company actually keeps in earning. Table 3: Statement showing Computation of Profit Margin of Tom Ltd. and Jerry Ltd Particulars Tom Ltd. Jerry Ltd. Profit Margin Total Sales 300,000 300,000 Net Profit 55,000 65,000 Profit Margin = Net Profit/ Total Sales or Revenue 18.33% 21.66% Current Ratio: It depicts the liquidity position of an organization. It shows whether the company is able to pay their short term and liabilities or not. Current ratio is proportion of Current Assets to Current Liabilities. Table 4: Statement showing Computation of Current Ratio of Tom Ltd. and Jerry Ltd. Particulars Tom Ltd. Jerry Ltd. Current Ratio Current Assets 110,000 110,000 Current Liabilities 30,000 30,000 Current Ratio: (Current Assets/ Current Liabilities) 3.66 times 3.66 times Asset Turnover Ratio: It is a financial ratio which calculates proficiency of a companys use of its assets in generating sales revenue of the company. In simple words it indicates how company has deployed its assets to generate the revenue. Table 5: Statement showing Computation of Asset Turnover Ratio of Tom Ltd. and Jerry Ltd Particulars Tom Ltd. Jerry Ltd. Asset Turnover Ratio Total Assets 410,000 310,000 Total Sales 300,000 300,000 Asset Turnover Ratio = Total Sales/ Total Assets 0.73 times 0.97 times Debt Ratio: It indicates organizations liability to pay off its liabilities with is assets. It compares total debts with total assets, which is used to gain idea as the amount of leverage being used by the company. Table 6: Statement showing Computation of Debt Ratio of Tom Ltd. and Jerry Ltd Particulars Tom Ltd. Jerry Ltd. Debt Ratio Total Assets 410,000 310,000 Total Liabilities 80,000 80,000 Debt Ratio = Total Debt/ Total Assets 19.51% 25.80% Comments on the performance of Tom Ltd. and Jerry Ltd Return on Assets: Tom Ltd. is generating 13.41% return on assets, while on the other hand, Jerry Ltd. is generating is 20.96% on assets (Helfert, 2013). Jerry Ltd has deployed its assets efficiently as compared to Tom Ltd. because this ratio indicates how a company is utilising their assets in order to create profits. Return on Equity: Return on Equity indicates how much a company is earning profits for their shareholders against their investment. Higher Ratio indicates that the company is generating a higher return for their shareholders and vice versa. Potential shareholders generally seek this ratio prior to investing money in any company (Delen, Kuzey and Uyar, 2013). Here, in this case, Tom Ltd is generating 16.66% for their shareholders. On the contrary, Jerry Ltd. is fetching 28.26% return for their shareholders. This states that Jerry Ltd. will lure potential shareholders if they are planning for a public issue. This will be the case when the investor is comparing Tom Ltd. against Jerry Ltd. Profit Margin In this analysis also Tom Ltd lacks behind Jerry Ltd. Tom Ltd fetch 18.33% on sales and on the contrary Jerry Ltd. is earning 21.66% on sales. This shows that trading efficiency of Jerry is better than Tom Ltd as they are managing their expenses effective to generate better returns for the business. Current Ratio Current ratio shows liquidity position of an organisation. It is proportionate of Current Assets and Current Liabilities. In this scenario, both the company i.e. Tom Ltd. and Jerry Ltd. has a same current ratio (Healy and Palepu, 2012). Both the company have 3.66 times of current assets in comparison of their liabilities. However, this ratio is significantly higher as it is blocking funds unnecessarily. Asset Turnover Ratio It reveals how the efficient company is using its resources in generating revenue (Lawal, 2007). Tom Ltd. has 0.73 times of sales in relation to their assets and on the other side Jerry Ltd has .97 times of sales. Debt Ratio Debt ratio shows total debts of the company in proportionate to its assets. Tom Ltd. has a debt ratio of 19.51%. It means that they have equity of 4 times as compared to their debt. On the other hand, Jerry Ltd. has 25.80% of debt in relation to its Equity. Table 7: Summary statement of financial ratios of Tom Ltd and Jerry Ltd Particulars Tom Ltd. Jerry Ltd. Return on Assets 13.41% 20.96% Return on Equity 16.66% 28.26% Profit Margin 18.33% 21.66% Current Ratio 3.66 times 3.66 times Asset Turnover Ratio 0.73 times 0.97 times Debt Ratio 19.51% 25.80% Importance of identifying accounting policy choices for inter and intra comparison Accounting policies can be termed as specific norms and procedures used by corporate entities for the preparation of financial statements of business. These are also inclusive of methods, measurement systems used for presentation of financial information in prepared statements. These policies are significant for making interpretation of financial statements. Thus, business organisations are required to state these policies for providing a better understanding to users clearly (Gibson, 2012). Further, inter and intra comparison will not be possible if accounting policies are not clearly outlined. For example, IAS 2 provides an alternative to choose between FIFO and weighted-average method. Thus, in a situation, if the policy is not disclosed properly then the basis of standard or interpretation which is applicable to the particular situation (Ehrhardt and Brigham, 2008). However, in the situation there is standard or interpretation related to transaction they specific and relevant policy should be applied to assist users in decision making by making information in a financial statement more reliable. References Ehrhardt, M. and Brigham, E., 2008. Corporate Finance: A Focused Approach. Cengage Learning. Gibson, H. C., 2012. Financial Reporting and Analysis. Cengage Learning. Helfert,E.A., 2013.Techniques of financial analysis. Homewood, IL: Irwin. Lawal, A., 2007. Interpreting financial statement for decision making. Business day. Healy, P.M. and Palepu, K.G., 2012. Business Analysis Valuation: Using Financial Statements. Cengage Learning. Delen, D., Kuzey, C. and Uyar, A., 2013. Measuring firm performance using financial ratios: A decision tree approach. Expert Systems with Applications. 40(10). Pp.3970-3983.