The Characteristic of the Sandmoor Estate Limited - Research Paper Example

Performance Analysis of Sandmoor E Limited TABLE OF CONTENT Content Page# TERM OF REFERENCE 3 ACKNOWLEDGEMENT 4 EXECUTIVE SUMMARY 5 INTRODUCTION/ BACKGROUND OF THE ORGANIZATION 6 METHODOLOGY 6 DESCRIPTION OF THE SYSTEM 7 INTERNAL AND EXTERNAL CUSTOMERS 7 ANALYSIS OF PERFORMANCE 8 RATIOS ANALYSIS 10 SWOT ANALYSIS 16 DISCREPANCY IN THE REPORT AND ITS EFFECTS 18 RECOMMENDATION 19 Term of Reference This report has been developed to fulfill the requirements of unit 10. 'Managing Systems and People in the Accounting Environment', of the technical stage for the Association of Accounting Technician qualification. The aim of this report is to improve accounting system of a company. I would like to explore how accounting system performs and how can it be improved at SANDMOORE ESTATES LIMITED. This aim will be achieved by identifying the weaknesses of the accounting system of the organization. Acknowledgement First of all we would like to thank God for giving us courage and enough wisdom to work on such a purposeful report. Making an idea actually work could not have been possible without the grace of God, prayers of our parents and support from our friends. Due credit goes to Ms. Aliya Saleem for being such a supportive course instructor as well as a source of information whenever needed. Without her guidance and timely feedback this report could not have been materialized. We would also like to thank our teachers and associates who helped and supported us throughout. Lastly we would like to thank all those who gave their expert advises and technical support. Executive Summary The company is working well as compared to previous year. However, when an isolated ratio analysis was done, it was revealed that still financial position of the company is not appreciable. Moreover, few discrepancies also exist. Like use of multiple depreciation methods, unclear or incorrect figure of the number of shares, this leads to false ratio analysis of earning per share. Thus it is recommended that the figures should be clearly stated and discrepancies should be avoided. Auditing, though not mandatory in this case, should be done to gain confidence of the stakeholders rapidly. INTRODUCTION/ BACKGROUND OF THE ORGANIZATION This report is the performance analysis of the Sandmoor Estates Limited. The principal revenue generation activity for the company is to receive rental income from its freehold petrol stations. METHODOLOGY: The research for analyzing the accounting system at work was done in two phases. Primary Research: The primary research included the deep study of the records and statements of the company. Secondary Research: The secondary stage comprises of the discussion about the company with the seniors and the colleagues to get their perspective about the same. Internet research was also done to identify potential weaknesses and their solutions. Approach Used: The Approach used for this study is as follows: We tried to study the annual report of the firm under observation from different angles. There are different methods for studying these reports and analyzing it, like ratio analysis and horizontal analysis etc. Each of the method has its own advantages and disadvantages. For example, the horizontal method is highly affected by the previous year's performances. Moreover, the micro and macro environment may also vary from one year ot another, the industry situations may also change. To overcome this, we have used the ratio analysis method. Ratio analysis takes the ratios of the quantities of the same year, so there are no chances of the effect of changing environment on the one side of the equation. DESCRIPTION OF THE SYSTEM: The accounting year of the Sandmoor Estates Limited starts at December 1 and ends on November 30 every year. The financial statements are prepared on annual basis. These statements preparation occupies a key position in the financial arena of the organization. These statements not only serves the purpose of the accountants, but financial and another managers as well and provides a basis for decision making for the top-level management. INTERNAL AND EXTERNAL CUSTOMERS The internal users of these financial statements are the top level managers and the board of directors, who take their decisions based on these reports and statements. The externals users of this report are the shareholders who try to analyze the worth of their investments by comparing the statements of the organization where they have invested with the statement of another organization in the same industry, Likewise, stock market players who buy and sell shares in very short time, with a view to earn capital gain, also use these reports to analyze the growth of the company. To sum up, we can say that these reports and statements create the image of the company, hence they should be developed with greatest efficiency. ANALYSIS OF PERFORMANCE OF SANDMOOR ESTATES LIMITED (ON THE BASIS OF ANNUAL REPORTS): Fixed Assets: The fixed assets in the beginning of the accounting period were 62,161 $, in the end they were of 60,564 $. There is 2.57% decrease in the total balance of fixed assets. This decrease can be well attributed to the depreciation. Current Assets: The current assets in the beginning of the accounting period were 27612 $, then it rose to 33082 $. So we can say that the current assets have increased by 19.81%. There can be multiple reasons for it, but the most possible reason may be greater cash inflows than outflows. Total Assets: The overall effect of increase in current assets and decrease in fixed asset reveals that on the whole the total capital increase by 4.31%. Current Liabilities: The current liabilities in the beginning of the accounting period were 32871 $, then it fell to 27471$. Thus, the current liabilities have been declined by 16.42% that is a good signal for the company. Share Capital: The share capital remains the same during the period, which is 55$. Profit and Loss Account: The profit for the firm in the beginning of the accounting period were 29,235 $, then it rose to 33,038$. Thus the profit for the firm in the given period increased by 13.01% Share Holder's Equity: The overall impact of constant share capital and almost 13% increase of profit on the shareholder's equity is increase of 12.98 % Revenue: The revenue for the period remained the same as the previous one (7500$). Having the same revenue as previous year, yet decrease in current liability and the increase in current assets shows a good sign for the company and its performance. Profit on ordinary activities before taxation: The profit on ordinary activities before taxation in the beginning of the accounting period was 3858 $, then it decreased to 3803$. Thus there is decreased by 1.3%. The same is retained profit for the period of 1 Dec 2004 to 30 November 2005. An Analysis of Horizontal Analysis: The horizontal comparison reveals that the company, in most of the aspects, working better than the previous year. Its current assets have been increased; consequently, the total assets have also been increased. Another good signal for the Sandmoor Estate Limited is the declining current liability. This means that with the same revenue, the company has not only increased their current assets but also decreased their liability, which is remarkable and which play a significant role in improving their current ratio that is the firm's ability to meet the current demand of its creditors with the current assets. However, the horizontal analysis is not the only thing that can be done. Since it is just comparison with the past performance of the company. If the past performance of the company is pathetic due to any unforeseen circumstances, lets saysome natural disaster in the company, even if the next year's performance is just a mediocre one, the company will yet be shown as a market champion, if we rely totally on horizontal analysis. RATIOS ANALYSIS: To overcome the challenge with the horizontal analysis we can use another method, that is the ratio analysis. One of the primary objectives of annual reports is identification of major changes in trends, and relationships and the investigation of the reasons underlying those changes. The judgment process can be improved by experience and the use of analytical tools. The financial ratios are one of those tools that can be used to predict the change in trends and to predict the productivity of the company. The advantage of the ratio analysis over the horizontal analysis is that the picture presented by the horizontal analysis is greatly dependent on the the previous years performance and the business environment as well as macro environment can vary form one year to another year within the same economy. But since ratio analysis uses both the quantities of the same year, so it is less prone to the varying business environments at micro and macro level. Liquidity Ratios: It measures a firm's ability to meet its current obligations. Current asset ratio tells that how much a form can pay for its current obligations out of its current assets, the greater the value, the better for the firm. The lesser the value, the lesser encouragement for the creditors to lend credit to the firm. Current Ratio = Current Assets Current Liabilities Current Ratio for this period is 0.54. This means that for 1 dollar of liability, the current assets of the company can pay up to 0.54 dollars. Thus, from this perspective, company's position of current assets is not appreciable. Net Working Capital: Net Working Capital = Current Assets - Current Liabilities Net working capital is also negative for this period. We can interpret it as , since the networking capital is negative, it means that the firm has more to pay to meet its current obligations than it has the current assets at hand. Again, this is not a pleasing scenario for the firm. Analyzing these two ratios we are able to say that in the eyes of creditors the firm's financial position is not strong, keeping in view this financial statement. Profitability Ratio: Profitability ratios measure management's ability to control expenses and to earn a return on the resources committed to the business. Return on asset is calculated by dividing the net income in that accounting period with the average of total assets. Average of total assets is take by summing the amount of total assets and then dividing by two. Return on Assets = Net Income Avg. Total Assets ROA = 3803/91709.5 = 0.0414 This shows that one dollar of investment in the capital yields 0.0414$ of net income. Return on Equity is calculated by dividing the net income in that accounting period with the average of total shareholder's equity. Average of total assets is taken by summing the amount of total assets and then dividing by two. Return on Equity = Net Income Avg. Stockholder's Equity ROE = 3803/31191.5 = 0.122 This shows that one dollar raised from the share yield 0.0414$ of net income. Profit Margin: Profit margin is the share of profit in the sales. Higher the margin, higher the profit with lesser sales and thus better for the firm. It is calculated by dividing the net income with sales. Net Income Profit Margin = ---------------------- Sales Profit Margin = 3803/7500 = 0.5071 This shows that the profit margin is 50%. The amount of profit is half that of sales. Earning per share shows how much a single share is getting. It is calculated by dividing the net income with the no. of outstanding shares. Earning per Share = Net income / No. of shares outstanding = 3803/2 (Refer to footnote 7) = 1901.5$ Activity Turnover Ratio: Efficiency, activity or turnover ratios provide information about management's ability to control expenses and to earn a return on the resources committed to the business. Asset turnover ratio is calculated by dividing the sales in that accounting period with the average of total assets. Average of total assets is take by summing the amount of total assets and then dividing by two. Asset Turnover Ratio = Sales / Average Total Assets = 7500 / 91709.5 = 0.081 This shows that 1 $ of asset yield 0.081$ of Sales. Summary of Ratio Analysis: The abovementioned ratios reveal that financial position of the company is not appreciable, although better than previous year. It is not better in different aspects. In the eyes of creditor, the company has already more to pay than it already has at its disposal. The company can pay only half of its current liabilities from its current assets. Which means the company must either borrow or sale its fixed assets to pay off the remaining current liabilities. So this is not a pleasing scenario for the creditors. From the productivity point of view, one dollar of the assets can yield only 0.14$ of the income, means the assets of the firm are not that much productive. This can be due to several reasons like, obsolete machines, wastage of raw-material, less-productive production technique and so-on. So the assets are not productive enough. When we look at the income generated by raisin 1 dollar of capital, the situation is again deplorable. With 1 dollar of share capital only 0.122$ 's income is generated, which will ahgain not be acceptable for the investor. The profit margin on sales is 50%. This figues cant be commented, unless we know the average of industry. However, since it is more like a service firm, 50% margin is not too much. Because no merchandise is involved. This also shows that company is not performing well. Earning per share is under a lot of criticism in this report, on account of false reporting of the no. of shares. The reporting is not only false, but also there is huge difference between the claimed value and the reality. Using the true figure (55 shares) will drop the amount significantly. Using false values has simply created the mistrust among the stakeholders. It is also illogical that every ratio is giving a negative perception but earning per share give a very pleasing ratio. Assets turnover ratio also shows that one dollar of the assets can produce sales of only 0.081 dollar, which is very low. SWOT ANALYSIS: Strength: The company is performing better than the previous year. This can be said because horizontal analysis is presenting a very bright picture that with slight declines in fixed assets and profit, the company managed to rise their current assets and reduce current liabilities and it is done within the same revenue, this shows that the organization has increased its productivity as compared to the past year and this led to the reduction of the cost, and reduced cost meant greater profit margin and greater profit margin enabled to reduce current liabilites and increasing the current assets within the same revenue. Weakness: If looked in isolation, the company's position is not attractive. If we see the ratio analysis, the bright picture becomes gloomy. This is so because the ratio analysis is not giving results in the favour of the firm. The probably had very bad performance last year, that led to create the impression this year of a glowing performance, when we compared it with the past, but when studied in isolation, the picture stopped to glow. Opportunities: Since company is improving, especially significant increase in current asset and profit gives a hope that the company will improve. Though the results of the ratio analysis contradicts the pleasing result of horizontal analysis, yet there is better point to cheer up, that is, the position of the firm is improving. So this is a good hope for existing shareholders. So far as the investors are concerned, they can also realize that since the firm has just started to grow, its shares would be comparatively cheaper at the moment so it they buy the shares at the moment, the firm has greater potential to grow and grow faster. The firm can encash this point and attract the customers. Threat: The report is un-audited thus it may bear some discrepancies. Usually people, especially those who are going to invest their money in the firm, are suspicious, when it comes to the matter of finance. They are hardly going to believe an un-audited report. Avoiding audit, if the firm was fair, just saved few bucks. However, the opportunity cost is yet higher, that is avoidance of investors. The mistrust created due to un-audited report costs the firm more than the amount saved. There are also some issues with the report, which may be classified either as the deliberate attempt of fraud or the errors, however, having such a terrible errors in annual report of a firm seems illogical, even if it is error, yet it shows negligence of the director. DISCREPANCY IN THE REPORT (FRAUD) AND ITS EFFECTS: The word discrepancy is used here because fraud usually means a deliberate attempt, whereas, we can not be sure, whether these errors are deliberate or error, so its better to use the word discrepancy. In the footnote 7, the par value of share capital is 1$ per share. But for 55$ of allotted/paid up capital/equity, there are only two share holders. Ideally, it should be 55. If it also contains amount of something else, it should also be mentioned, otherwise ratio analysis will give false value. The error/fraud has a very major impact. Since it is directly related with the profitability ratios and return on equity etc. Moreover, the difference is also huge, that is almost 53 shares. This, even if it is an error, is not acceptable for any stakeholder rof the company and will only bear the mistrust among the stakeholders. When we consider two shareholders, the earning per share is 1901.5$, if there are 55 shares issued, the earning per share will be 69.15$. Thus there is a vast difference between the two values and most of the internal and external users look at earning per share to analyze the strengths of the company, which is misleading Another potential problem is un-audited report, though the law allows but still, audited report gains confidence among its users easily. Think of two soft drinks, one Pepsi while other is some un-branded, usually people will be willing to pay more and get Pepsi, instead of that un-branded soft-drink. This is so, because people think that if something is endorsed or trusted, though initially it costs more, yet in the long run, they are never cheated, the trust that they are given compels them to pay even more to get the Pepsi. Same is the case with the annual reports, audited reports gains better acceptability in the financial sectors of the market. If a report is un-audited and an error is found, it is directly attributed as fraud. Last but not the least, the two fixed assets use two different methods of depreciation, that may probe in estimations etc. Ideally it is the company's discretion to use any of the method, but it is recommended that it should be consistent in that regard. Using two different methods, again, on one hand creates doubt, on the other hand confuses the customer / stake holders. It also opens the chances for technical errors. Above all, if you want to make estimations regarding total assets / total fixed assets, it is really difficult to do so when you have separate mechanisms for separate assets. RECOMMENDATION Thus it is highly recommended that company should clearly and truly state the correct figures. Reputation is something that is tough to be made and easy to be shattered. Incorrect figures in the report can do nothing but harm the reputation of the company. Moreover, now a days auditing is not only a formality, rather a marketing tactic to attract investors as well. The grade of the auditor you have hired, his experience his clientele, all this creates the impression of the company hiring that auditor, thus it is strongly recommended that the company should present the audited report. The company should use a single method for depreciation to avoid confusion. Although company may use different methods for annual reporting and the tax filing but not two methods within the same report, this is problem for all the stakeholders, the investors, auditors, accountants etc. Read More