Financial Analysis of Bestwish Limited Company Overview

Financial Analysis of Bestwish Limited

Company Overview

Bestwish Limited produces extensive range of quality products such as gift dressing, greetings cards, and plush merchandise of more than 50,000 stocks. The production of different categories of products involve between 2 and 15 processes. The company produces standardized products and custom designed products ordered from customers on contract basis. However, Bestwish Limited is facing challenges to control the costs because of varying production process, reliance on indirect costs and large number of stock keeping units.

Bestwish Limited has just closed the 2010 fiscal year account and the company is finalizing the 2011 budget. Bestwish intends to analyze the 2010 financial statement to present the accurate picture of the company financial performances.

Objective of this report is to analyze 2010 financial statements to assess the viability of Bestwish Limited.

Task

Attn:

Audit Committee of the Board

Finance Director

Subject: Financial statement Analysis

Date: 27 January 2013.

This report verifies the 2010 financial statement of Bestwish Limited to ensure that the financial record is accurate, is in line with exact statutory requirements, and laid down regulations for limited companies as being established by Companies Act 1985 and the list rules.

The report evaluates the viability of Bestwish Financial Statements using:

Statement of Comprehensive Income

Balance Sheet

Cash Flow Statement.

In the contemporary business environment, organizations need to set a clear direction to make their stakeholders understanding what they are seeking to achieve. Financial analysts, investors, and other external parties use financial goals to monitor the financial performances of Bestwish Limited. Thus, this financial report intends to compare the actual performance of Bestwish against the target sales growth goals. (Glynn, Perrin, Murphy, et al. 2003).

Analysis of Bestwish statement of Comprehensive Income in Exhibit 1 reveals the accounting period for the end of 2010 fiscal year. From the Statement of Comprehensive Income, Bestwish recorded the total revenue of $400 Million in 2010 fiscal year compared $395 Million that the company recorded in 2009. A difference of $5 Million between 2009 and 2010. The increase in the total revenue assisted the company to record the increase in the gross profits between 2009 and 2010. The company gross profit was $27.9 Million in 2010 compared to $25.9 Million in 2009. The company recorded the $2 Million increase in the gross profit despite the increase in the costs of sales and administrative expenses between 2009 and 2010.

Similar to the gross profit, Bestwish improved its financial performances in 2010 because the company was able to record net profits in 2010 compared to 2009 fiscal year where the company recorded a net loss. In 2009, Bestwish recorded a net loss of $33.6 Million, however, the company improved in 2010 and recorded a net profit of $7.4 Million. (Fig 1 presents the summary of the company comprehensive income statement).

Fig 1: Summary of Bestwish Comprehensive Income Statement

Balance Sheet

The report uses the balance sheet to demonstrate the financial positions of Bestwish. The Balance Sheet shows the relationships between the assets and the liabilities of a business. When the total liabilities are deducted from the company total assets, the report arrives at the company net assets. The chart in Exhibit II consists of the total assets that consist of two main elements: current assets and non-current assets. Bestwish current assets and non-current assets increased between 2009 and 2010. The current assets consist of inventories, trade receivable, cash and financial investments. The current assets were $64.9 Million in 2009 and declined to $62.7 Million in 2010. However, the company non-current was $77 million in 2010 and $60.9 Million in 2009 revealing the $16.1 Million increase between 2009 and 2010. The company total assets were $140 million in 2010 compared to $125.6 Million in 2009. Similarly, the company total liabilities increase from $94.7 Million in 2009 to $101.9 Million in 2010. The net assets are calculated by deducting the total liabilities from the total of assets. Thus, the company net assets were $38.2 Million in 2010 compared to 30.9 Million in 2009. (Table 1 and Fig 2 presents summary of the company balance sheet).

Table 1: Summary of Bestwish Balance Sheet ($000)

Summary of Bestwish Balance Sheet ($000)

2010

2009

Difference

Current Assets

62,760

64,941

Non-Current Assets

77,410

60,691

Total Assets

140,170

125,632

14,538

Current Liabilities

(90,605)

(85,153)

Non-Current Liabilities

(11,326)

(9,166)

Total Liabilities

(101,931)

(94,679)

(7,255)

Net Assets

38,239

30,953

7,286

Fig 2: Summary of Bestwish Balance Sheet ($000)

The final section of the company Balance Sheet reveals the amount of shareholders' funds. "This is the price paid by the shareholders for their initial share capital and the retained profits made by the company." (The Times 100, P4). Bestwish also increased the total equity between 2009 and 2010. The total equity was $38.2 Million in 2010 compared to total equity of $30.9 Million in 2009.

Bestwish's Cash Flow Statement

Cash flows statement is used to analyze the financial viability of Bestwish Limited and the cash flow statements sets out the incoming and outgoing cash within a fiscal year. "Cash flow is very important to the company because cash enables the business to pay its bills, pay dividends to its shareholders and, in addition, to make acquisitions." (The Times 100, P5). As being revealed in Table 2, Bestwish generated $19 Million of the cash flow from operating activities in 2010 compared to $22 Million that the company generated in 2009. However, the company cash flow from investing activities increased from $11.6 Million in 2009 to $18.8 Million in 2010. On the other hand, cash flow from financing activities was $6.5 Million in 2009 and declined to $2 Million in 2010.

Table 2: Bestwish's Cash Flow Statement ($000)

Bestwish's Cash Flow Statement ($000)

2010

2009

Cash flow from Operating Activities

19,036

22,205

Cash from Investing Activities

18,867

11,620

Cash flow from Financing Activities

2,000

6,552

Fig 3: Bestwish's Cash Flow Statement ($000)

In 2010, Bestwish Limited focused more on investing activities because the company intended to achieve:

higher sales growth increase its operating profit margins higher free cash flow.

Through efficient financial management, Bestwish implemented efficient credit control and administration efficiency which made the company to raise credit notes of $2 Million in 2010 compared to $1.7 Million credit noted raised in 2009.

Task 2

Attn:

Chief Executive Officer

Finance Director

Subject: Ratio Analysis

Date: 27 January 2013

The ratio analysis is an aspect of the company financial statements that assists in making a quick indication of company financial performances. The data in the financial statements are used to calculate the financial ratios and the ratios could be used to form trend analysis to identify the key areas where firms have improved or deteriorated.

Profitability Ratios

Profitability ratios are the quantitative tools to analyze business ability to generate earning and the ratios show the company's ability to convert revenue into profit. Operating profit is one of the company profitability ratios to determine profit generated from $1 sales. The formula used to calculate operating profit is as follows:

Bestwish operating profits for 2010 and 2009 fiscal year are calculated as follows:

Operating profit 2010=14,776,000 / 400,042,000 x100

=3.69%

Operating profit 2009=27,293,000 / 395,120,000 x100

=6.91%

Gross margin is another profitability ratio that measures the profits that a company generates from sales. Gross margin is calculated by deducting the costs of goods sold from the total revenue. The gross margin represents the percentages of profits that a company retains after removing the cost of sales such as direct costs associated from the sales of the company's goods and services.

Formula to calculate the Gross Margin is as follows:

Bestwish Gross Margin for 2010 and 2009 fiscal years are calculated as follows:

Gross Margin 2010= 400,042,000-372,142,000 / 400,042,000 x100

=27,900,000 / 400,042,000 x 100

=6.97%

Gross Margin 2009=395,120,000-369,255,000 / 395,120,000 x100

=25,865,000/395,120,000 x100

=6.55%

The company gross margin for 2010 fiscal year was 6.97% and 2009 gross margin was 6.55%, representing a slight 0.42% increase.

Table 3: Bestwish Ratio Analysis

Profitability Ratios

2010

2009

Operating profit

3.69%

6.91%

Gross Margin

6.97%

6.55%

Liquidity Ratio

Current ratios

0.69

0.75

Operation Cash Flow Ratio

0.28

0.30

Efficiency Ratio

Inventory Turnover Ratio

10.07

Asset Turnover

3.01

Liquidity Ratios

Current ratio is analytical tool to determine whether Bestwish Limited has more liquid assets to settle its short-term obligation. Formula to calculate the current ratio is as follows:

Bestwish Current ratios for 2010 and 2009 fiscal year are calculated as follows:

Current ratios 2010=62,760,000 / 90,605,000

=0.69

Current ratios 2009=64,941,000 / 85,513,000

=0.75

Operation Cash Flow

Operation cash flow ratio is the cash generated from operating activities, which is the percentage of current liabilities in a given period. The formula to calculate the operation cash flow ratio is as follows:

Operation Cash Flow Ratio= Operating Cash Flow / Current Liabilities

2010: 25,251/90,605

=0.28

2009: 25,735/85,513

=0.30

Operating cash flow ratio measures the liquidity of Bestwish Limited, and the company operation cash flow ratio is less than one revealing that the company generated less cash to settle its current liabilities in 2010 and 2009.

Efficiency Ratio

Efficiency ratio measures how effectively Bestwish limited utilized its assets and the extent the company managed its liabilities. The paper uses the inventory turnover ratio and total asset turnover to evaluate the efficiency ratio of Bestwish Limited.

Inventory Turnover Ratio= Cost of Sales / Average Inventory

2010=372,142, 000 / (37,653,000+36,217,000)2)

=372,142, 000/36,935,000

=10.07

The result reveals that Bestwish Limited replenished its inventory 10.07 times between 2009 and 2010.

Total Asset Turnover= Revenue/Average Total Assets

2010: 400,042,000 / (140,170,000+ 125,632,000)/2)

=400,042,000/132,901,000

=3.01

The results reveal that for every dollar that Bestwish invests, the company generates $3.01 of revenue.

Recommendation

Analysis of the company comprehensive income statement reveals that the company cost of sales increase yearly between 2009 and 2010. Moreover, company administrative expenses increase yearly making the operating profits to decline from $27.2 Million in 2009 to $14.7 in 2010. Bestwish needs to redefine its business portfolio and find appropriate strategies to cut costs. The company should outsource some of its non-core business to reduce costs of sales and administrative costs. In the present competitive business environment, outsourcing has become a strategy tool that organizations use to cut costs to offer cheap and high quality products to generate higher revenue.

Task 3

Attn:

Division Controller

Division's Management Accountant

Subject: Performance of the Division.

Date: 27 January 2013

(a). The variance analysis is use to evaluate the master budget to compare the actual expenditure and the income of the budget. At the end of the 2010 fiscal year, it is revealed that Bestwish was not able to realize its actual budget objective for the Birthday Card Division. The actual budget for the Sales and Production units were 30,000, while the actual budget for the Sales and Production units were 27,000 leading to Variance of (3000). The company was not able to realize its budget for the production units because the company experienced several machine breakdowns during the year. Moreover, some of the orders could not be delivered at specified time. The machine breakdown also made the company to incur additional spending in repairs under variable production overhead. As being revealed in Table 4, the budget for direct labor was 10,000 and the company was able to realize 9,500 actual direct labor hours leaving variance of (500) hours. Similarly, the company recorded the variance of (15,000) hours for machine hours.

Inability to meet the required sales and production units made the company to record lower sales than the sales budgeted for the 2010 fiscal year. The budget for the Birthday Card's total sales for the 2010 fiscal year was $1.2 Million, however, the actual sales that the company realized was $1.06 Million revealing the variance of $140,000.

Table 4: Budget and Actual Information for Birthday Card

2010

2010

Budget

Actual

Variance

Sales and Production Units

30,000

27,000

(3,000)

Direct labor Hours

10,000

9,500

(500)

Machine hours

300,000

285,000

(15,000)

Similarly, the company was not able to meet the target required for the materials needed for the production of the birthday card in 2010. Moreover, the budget of the production costs was higher than the actual costs of production. The variance for variable with machine overhead was (8,000) and variance for fixed selling overhead was (2,000). The effect of the variance in the costs of production made the company to record an unfavorable variance of (64,000).The profits budgeted for the Birthday Card division was $100,000 and the actual profits realized were $36,000. Typically, the company recorded 177% unfavorable variance in profits for the Birthday Card division.

(B). The budget monitoring objectives are:

To identify significant variances for Birthday Card Division.

To identify unusual spending patterns in the Birthday Card Division.

To identify potential risks that arisen from unfavourable variance. (Oxfordshire County Council, 2011).

Analysis of the company position showed Bestwish embarked on the fixed budget and this type of budget requires effective monitoring to ensure that the company meets its budget objectives. However, Divisional Controller lacked the knowledge of accounting. Using the fixed budget technique, the company may not be able to adjust favorably to the cost of materials during the period of inflation. The flexible budget technique might be advantageous for the Birthday Card Division so that the company will be able to adjust the cost of materials in case of inflation to meet the target budget.

Another limitation of fixed budget is that variance could be arisen when the company is embarking on investing activities. When a company is spending on investing activities, there is a likely that the company will not be able to realize the target budget. Thus, variance may not be realistic in this case. Analysis of the Bestwish financial position reveals that the company cash flow from investing activities increased significantly from $11.6 Million to 18.8 million, which was more than 62% increase. Thus, if the company uses the same budget technique of the precedent years for the 2010, the company may not be able achieve its budget objectives because of its investing activities.

C. Costing system in the pricing strategy is very critical to fix a right price for a product. Costing strategy assists a company to fix the right price for a product thereby sells the good for more than the costs incurred for the production of the goods. Accurate calculation of the costs is the first step in cost pricing strategy. The costs pricing strategy will assist the company to allocate different pricing for different products. Moreover, cost-pricing strategy will assist the company to accurately bid for the cost of materials that would be used for the production of goods. Thus, the pricing strategy will allow a company to keep the costs low as much as possible.

The marginal costing is the costing technique that includes variable costing in the units and fixed costs are treated as period costs. In the marginal costing, only the variables costs are relevant in decision-making. On the other hand, absorption costing treats both variable and fixed costs as product costs. It is believed that products could not be produced without resources allocated to the fixed manufacturing overhead. Contrarily, marginal costing treats variable costs as product costs and fixed costs are treated as period costs. It is believed that fixed manufacturing overhead will be incurred whether there is a production or not. Fundamental similarities between marginal costing and absorption costing is that both costing systems consider direct material, direct labor, and costs of goods sold to calculate the cost of finished goods. Table 5 illustrates the similarities and differences between absorption costing and marginal costing.

Table 5: Absorption Costing vs. Marginal Costing

Absorption Costing

Marginal Costing

Sales

X

Sales

X

Less: Cost of Goods sold

X

Less: Variable (Cost of Goods Sold)

X

Gross Profit

X

Production Contribution Margin

X

Less Expenses

Less (Variable Manufacturing Expenses)

Selling Expenses

X

Variable Selling Expenses

X

Admin Expenses

X

Variable Admin Expenses

X

Other Expenses

X

Other Variable Expenses

X

Total Contribution Expenses

X

Less Expenses

Fixed Selling Expenses

X

Fixed Admin Expenses

X

Other Fixed Expenses

X

Net Profit

X

Net Profit

X

Based on the analysis of absorption costing and marginal costing, marginal costing is relevant for decision-making and is used to avoid profit manipulation. Since marginal costing does not use the fixed cost to set the selling price, it is more appropriate for the break-even analysis.

(D). "A cost object is any given item for which costs are measured and assigned" (McConomy, 2004 P. 5) and this include products, customers, and product lines. The cost objects are assigned as either direct or indirect. At Birthday Card Division, the best costing system that would be appropriate for the company will be as follows:

(i) The best classification of cost object should be by product. The strategy will allow the company to make decision about the pricing, volume and production of product-by-product basis relative to the profitability of each product. The job costing would be ideal for Bestwish because it would allow the company to understand the costs to be allotted on a product-by-product basis.

(ii) The company could make decision-based n the costs behavior because the company will be able to implement the tight control on the costs, which will assist the company to optimize efficient allocation of resource. The "Opportunity cost is the benefit given up or sacrificed when one alternative is chosen over another" (McConomy, 2004 P. 4). Decision based on the alternatives will have the cost and benefits. Thus, choosing opportunity costs to support decision might involve too much of speculative, which might not pay off in the long run if the company makes wrong decision between the alternatives. (Drury, 2009).

(iii) Bestwish Limited should implement the job costing to record the company costs. Job costing is best suited for the production of goods and services of customer's order. The job costing assists the company to deliver the product based on customer's specification. In the job costing, the company could easily trace material and labor to each job as well as logically follow the cost assignment. Thus, the company would be able to make decision on a product-by-product basis as well as implementing flexibility in the marketplace. Moreover, the variance analysis will allow the company to analyze costs as well as comparing budget against the past performances. The variance analysis will also allow the company to understand how the business changes in each fiscal year with respect to pricing and market potentials.

E. Some organizations face frustration in utilization of traditional costing, the activity-based costing (ABC) divides production according to its core activities and allocate costs based on the consumption of those activities. Major benefits of activity-based costing are that it attempts to overcome the deficiencies found in the traditional costing and aligning activities closely to products. This means that product will only be charged with the costs associated with the manufacturing activities.

"With ABC a product is only charged with the cost of capacity utilized. Idle capacity is isolated and not charged to a product or service. Under traditional approaches, some idle capacity may be incorporated into the overhead allocation rates, thereby potentially distorting the cost of specific output. This may limit the ability of managers to truly understand and identify the best business decisions about product pricing and targeted production levels." (Walther, 2010 P. 28).

The report uses the data in the Exhibit VI to compute the activity based-costing in order to evaluate potential merit and limitation of ABC.

Activities

Overhead Costs

Activity Rate

BC12

BC38

Machine Running Costs

$5,000

Labor Related

8.30

9.00

Production set up costs

$10,000

Order Processing

$11,000

(F). Bestwish should emphasize on the profit centers. The profit centers are the section of the company that is responsible for the profit maximization for the company. Profit center manager should be responsible for both revenue and expenses. Within the company, management should be able to drive up sales revenue and this would make the section to be more challenging than cost center. Moreover, the company should focus on the costs responsibility within each business division and each division should be able to motivate managers to control the costs. Typically, management of overall division should use costs in combination with revenue to design the cost centers. The company could begin by understanding the product costs based on the activity-based costing and this should be adjusted with the market conditions.

G: Table: 2011 Budget for Birthday Card

2010

2010

Budget

Actual

Variance

Sales and Production Units

30,000

27,000

(3,000)

Direct labor Hours

10,000

9,500

(500)

Machine hours

300,000

285,000

(15,000)

G. This section prepares a more reliable 2011 budget for the Division.

Table: 2011 Fiscal Year Budget for the Division

2011

Sales and Production Units

27,500

Direct labor Hours

9,500

Machine hours

290,000

Sales

1,100,000

Direct Materials

275,000

Direct Labor

380,000

Production Overhead:

Variable with Machine Hour

55,000

Fixed

145,000

Variable selling Overhead

145,000

Fixed Selling Overhead

40,000

Total Costs

1,040,000

Profit

60,000

G i. The forecasting technique for the sale and volume division is to use the historical data. The report uses the series analysis to calculate the sales volume of the division, and based on the forecast, the report uses the average of all series from 2001 and 2010 to determine sales volume of the division. Based on the findings, the sales volume of the division is 28,846. (Harris, and Sollis, 2003).

Year

Sales Volume

Selling Overhead

Series Analysis

2001

19,671

$28,942

1.47

2002

20,841

$32,120

1.54

2003

22,846

$35,741

1.56

2004

24,210

$39,510

1.63

2005

23,854

$38,640

1.62

2006

24,120

$38,560

1.59

2007

26,184

$40,900

1.56

2008

26,043

$40,840

1.57

2009

26,570

$41,300

1.55

2010

27,000

$42,000

1.55

2011

28,846

$45,000

1.56

(Gii). The appropriate budgetary target for the Division is to earn appropriate $60,000 as the profit. The division is to realize approximate $1.1 Million from the total revenue of the company. In 2010, Bestwish realized the revenue of $400 Million. Thus, the budgetary target for the 2011 income will be used for the Division. The justification for choosing the 27,500 for the Sales and Production Units is that the Division was not able to reach its target of 30,000 for Sales and Production Units in 2010 budget. The Division was only able to record actual 27,000 for Sales and Production Units. Moreover, the report chooses 9,500 for Direct Labor Units and 290,000 for Machine hours of because the company was not able to meet the budget target for both Direct Labor Units and Machine Hours because the Division was only able to achieve the actual of 9,500 for Direct Labor hours and 285,000 for Machine hours. To avoid variance that that occurred in 2010 budget, the report chooses 9,500 direct labor and 290,000 for Machine hours, which was very close 2010 budget for the division.

More importantly, the 275,000 was chosen for Direct Materials and 380,000 for Direct Labor to avoid wide variance that occurred in 2010 budget. Based on the overall estimation, $60,000 was calculated as net profits

G ii. Budgetary Targets for the 2011 Income Statement of the Division

2011

Sales and Production Units

27,500

Direct labor Hours

9,500

Machine hours

290,000

Revenue

$1,100,000

$1,100,000

Direct Materials

275,000

Direct Labor

380,000

Cost of Sales

655,000

Gross Profits

445,000

Production Overhead:

Variable with Machine Hour

55,000

Fixed

145,000

Variable selling Overhead

145,000

Fixed Selling Overhead

40,000

Total Production Overhead

385,000

Total Costs

1,040,000

Net Profit

$60,000

(Giii): The budget assumption is that the 2011 budget for the Division will meet the Sales Volume of 28,846. Moreover the Division will maintain $45,000 for the selling overhead. The total revenue will be $1,100,000 while the total costs will be approximately $1,040,000. The assumption is that the Division will realize approximately $60,000 net profit for 2011 budget.

Master Budgeted income statement for the Division

2011

Sales and Production Units

28,846

Direct labor Hours

9,500

Machine hours

290,000

Revenue

$1,100,000

$1,100,000

Direct Materials

275,000

Direct Labor

380,000

Cost of Sales

655,000

Gross Profits

445,000

Production Overhead:

Variable with Machine Hour

55,000

Fixed

145,000

Variable selling Overhead

145,000

Fixed Selling Overhead

45,000

Total Production Overhead

390,000

Total Costs

1,040,000

Net Profit

$60,000

Task 4

Attn: Audit Committee of the Board.

Finance Director

Subject: Post-Audit Appraisal Review

Date: 27 January 2013.

This report performs a post-audit appraisal review on the automation investment. The automation of the production facilities is equivalent to $16 Million, which started at the beginning of 2010. The analysis is post-audit appraisal review and the report decides whether the investment is good or not. The table below provides the net present value calculation to decide on viability of the investment.