DEPT OF

Management Division
Name : ____________________

Date : ______________

FIN : ____________________

Intake : _______________

IBM20500: ACCOUNTING FOR BUSINESS DECISION

MAKING

Assignment 1
There are 2 pages including this page. You must answer ALL questions.
Soft copy of report to be submitted to your lecturer by 6 January
2014

EXAM RESULTS
TOTAL: _______/100

The statement of financial position and other information below relate to Lowland
Limited and Highland Limited.
Statement of Financial Position
as at 30 June 2013
Lowland Ltd
($)

Highland Ltd
($)

Current Assets
Bank
Trade Receivables (Net)
Stocks
Others
Total Current Assets

18,000
86,400
72,900
1,800
179,100

20,160
89,460
71,820
3780
185,220

Fixed Assets
Property, Plant and Equipment

297,900

351,540

Total assets

477,000

536,760

Current Liabilities
Trade Payables
Total Current Liabilities

72,000
72,000

75,600
75,600

Non-Current Liabilities
Long Term Borrowings

108,000

126,000

Total Liabilities

180,000

201,600

Shareholders Funds
Share Capital
Retained Profits

180,000
117,000

180,000
155,160

Total Shareholders Funds

477,000

536,760

Lowland Ltd
($)

Highland Ltd
($)

650,000
435,400
46,980

673,920
448,580
39,780

Income statement
for the year ended 30 June 2013

Sales Revenue
Cost of Sales
Gross Profit

QUESTIONS
1. Comment on the performance of the two companies?
2. Which company do you think is a better investment? Why?
3. Which company do you think is the better short-term credit risk? Why?
Answer:
The balance sheet, also known as the statement of financial condition, offers a snapshot of a
company's health. It tells you how much a company owns (its assets), and how much it owes
(its liabilities). The difference between what it owns and what it owes is its equity, also
commonly called "net assets" or "shareholders equity".
The balance sheet tells investors a lot about a company's fundamentals: how much debt the
company has, how much it needs to collect from customers (and how fast it does so), how
much cash and equivalents it possesses and what kinds of funds the company has generated
over time.
Assets, liability and equity are the three main components of the balance sheet. Carefully
analysed, they can tell investors a lot about a company's fundamentals.
1. Comment on the performance of the two companies?
Current Ratio
Current ratio is an indication of a company's ability to meet short-term debt obligations; the
higher the ratio, the more liquid the company is. Current ratio is equal to current assets
divided by current liabilities. If the current assets of a company are more than twice the
current liabilities, then that company is generally considered to have good short-term
financial strength. If current liabilities exceed current assets, then the company may have
problems meeting its short-term obligations.
Highland Ltd. current ratio = $185,220 / $75,600 = 2.45
Lowland Ltd.s current ratio = $179,100 / $72,000 = 2.49.
Lowland Ltd. would be in relatively better short-term financial standing.
Fixed-asset turnover ratio
A financial ratio of net sales to fixed assets. The fixed-asset turnover ratio measures a
company's ability to generate net sales from fixed-asset investments - specifically property,
plant and equipment (PP&E) - net of depreciation. A higher fixed-asset turnover ratio shows
that the company has been more effective in using the investment in fixed assets to generate
revenues.
The fixed-asset turnover ratio = Net sales / (PP&E)

This ratio is often used as a measure in manufacturing industries, where major purchases are
made for PP&E to help increase output. When companies make these large purchases,
prudent investors watch this ratio in following years to see how effective the investment in
the fixed assets was.
Highland Ltd. fixed-asset turnover ratio = 673,920 / 351,540 = 1.92
Lowland Ltd. fixed-asset turnover ratio = 650,000 / 297,900 = 2.19
Lowland Ltd.s fixed-asset turnover ratio is higher than that of Highland Ltd, which means
that Lowland Ltd is doing a good job of generating revenue from its investment in fixed
assets, compared to Highland Ltd.
2. Which company do you think is a better investment? Why?
Return on Equity
Widely used by investors, the ROE ratio is an important measure of a company's earnings
performance. The ROE tells common shareholders how effectively their money is being
employed. Peer companies, industry and overall market comparisons are appropriate;
however, it should be recognized that there are variations in ROEs among some types of
businesses. In general, financial analysts consider return on equity ratios in the 15-20% range
as representing attractive levels of investment quality.
While highly regarded as a profitability indicator, the ROE metric does have a recognized
weakness. Investors need to be aware that a disproportionate amount of debt in a company's
capital structure would translate into a smaller equity base. Thus, a small amount of net
income (the numerator) could still produce a high ROE off a modest equity base (the
denominator).
Return on Equity = Net income / Shareholders Equity
Highland Ltd return on equity = 673,920 / (180,000 + 155,160) = 2.01
Lowland Ltd return on equity = 650,000 / (180,000 + 117,000) = 2.18
Lowland Ltd return on equity is higher than that of Highland Ltd, which means that Lowland
Ltd.s earnings performance is higher than that of Highland Ltd., and a better investment as
well.
Gross Profit Margin
A company's cost of sales, or cost of goods sold, represents the expense related to labour, raw
materials and manufacturing overhead involved in its production process. This expense is
deducted from the company's net sales/revenue, which results in a company's first level of
profit, or gross profit. The gross profit margin is used to analyse how efficiently a company is
using its raw materials, labour and manufacturing-related fixed assets to generate profits. A
higher margin percentage is a favourable profit indicator.
Industry characteristics of raw material costs, particularly as these relate to the stability or
lack thereof, have a major effect on a company's gross margin. Generally, management cannot
exercise complete control over such costs. Companies without a production process dont

have a cost of sales exactly. In these instances, the expense is recorded as a "cost of
merchandise" and a "cost of services", respectively. With this type of company, the gross
profit margin does not carry the same weight as a producer-type company.
The gross profit margin = Gross profit / Net sales (revenue)
Highland Ltd gross profit margin = 39,780 / 673,920 = 0.059
Lowland Ltd gross profit margin = 46,980 / 650,000 = 0.072
Therefore the profitability of Lowland Ltd is higher than that of Highland Ltd, which means
that Lowland Ltd.s profitability is higher than that of Highland Ltd., and also a better
investment.
3. Which company do you think is the better short-term credit risk? Why?
The higher is the perceived credit risk, the higher the rate of interest those investors will
demand for lending their capital. Credit risks are calculated based on the borrowers' overall
ability to repay. This calculation includes the borrowers' assets and revenue-generating ability.
Working Capital
Working Capital is an indicator of whether the company will be able to meet its current
obligations (pay its bills, meet its payroll, make a loan payment, etc.) If a company has
current assets exactly equal to current liabilities, it has no working capital. The greater the
amount of working capital the more likely it will be able to make its payments on time. It is
also a measure of cash flow and should always be a positive number. It measures the amount
of capital invested in resources that are subject to quick turnover. Lenders often use this
number to evaluate your ability to weather hard times. Many lenders will require that a certain
level of working capital be maintained.
Working Capital = Current Assets Current Liabilities
Highland Ltd working capital = 179,100 72,000 = 107,100
Lowland Ltd working capital = 185,220 75,600 = 109,620
Lowland Ltd working capital is slightly more than Highland Ltd working capital. Therefore
the credit risk of lowland Ltd is slightly better than that of Highland Ltd.
Quick Ratio
Quick ratio is measure of a company's liquidity and ability to meet its obligations. Quick
ratio, often referred to as acid-test ratio, is obtained by subtracting inventories from current
assets and then dividing by current liabilities. Quick ratio is viewed as a sign of company's
financial strength or weakness (higher number means stronger, lower number means weaker).
The Quick Ratio is a way to evaluate a company financial health by determining if it has
enough cash or other current assets to cover its current liabilities. Effectively the Quick Ratio
determines if a company can afford to pay its bills due within the next year without having to
sell off inventory or other assets.
The Quick Ratio is a more conservative evaluation metric than the current ratio, which takes
into account all current assets including inventory. Quick Ratio does not factor in inventories,
or other assets which could not potentially be converted into cash quickly.

Quick Ratio = (Current assets - Stock) / Current liabilities

Highland Ltd Quick Ratio = ($185,220 - 71,820) / $75,600 = 1.5
Lowland Ltd Quick Ratio = ($179,100 - 72,900) / $72,000 = 1.475
Quick ratio of Highland Ltd is higher than that of Lowland Ltd, which means that Highland
Ltd has higher affordability to pay its bills due within the next year without having to sell off
inventory or other assets, compared to Lowland Ltd.
Reference
1. Quick Ratio: http://www.begintoinvest.com/definitions/quick-ratio/
2. Fixed assets turnover: http://www.investopedia.com/terms/f/fixed-asset-turnover.asp
3. Working capital: http://en.wikipedia.org/wiki/Working_capital
4. How To Evaluate A Company's Balance Sheet:
http://www.investopedia.com/articles/basics/06/capitalstructure.asp
5. Financial Ratio Analysis: http://www.demonstratingvalue.org/resources/financial-ratioanalysis