financial acc.hom ass ind

8/8/2019 Financial Acc.hom Ass Ind

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Financial AccountingHome Assignment Option 1

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Krisztina Toth

11/23/2010


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Introduction

This report will assess the financial performance and financial position of Colorbox Ltd as

requested by the Directors. The assessment will be conducted through the analysis and

interpretation of the financial statements of 2008 and 2009, which have been provided by the

requestors along with some additional information. Important indicators, such as financial ratios will

be calculated and percentage changes between annual figures will be observed; and a conclusion will

be added together with recommendations on possible strategic decisions and solutions.

Analysis

Based on the information that has been shared by Colorbox Ltds representative, the

company recently implemented a marketing campaign. The goal of this campaign was to put

Colorbox Ltd into the position of the cheapest supplier on the market. Significant amounts of funds

were spent on this campaign and the goal was achieved. As provided: a major contract was signed

with one of the biggest beverages companies. The contract was won through very competitive

bidding, and it changed the overall operation of the corporation.

Sales more than doubled from 2008 to 2009. Although the prices of raw material did not change as

provided by the representative the Gross Profit achieved decreased by 10%. For the first look, it

could be assumed that it is a result of inefficiency, however further analysis indicated that profits are

lost due to the price cuts that Colorbox Ltd had to carry out to win the bidding. Cost of Sales took up

circa 60% of Sales in 2008, but this figure increased to almost 85% in 2009. If all other things stayed

the same, then it meant a 25% cut in the companys sales prices. The 2009 Gross Profit decrease

could be attributed to the changes that had to be made to extend the production capacity; it is what

comes after it that gives reason for some worrying. The 50,000 Gross Profit is quickly washed out

the Operating Expenses that grew by 125%. However the Profit before Interest and Tax is still

positive. It is the Interest Expense that makes all remaining profits disappear and makes the company

end up with a loss of 200.,000; which means almost half a million pounds less money staying with

the company than a year before.

The Balance Sheet was in a better shape in 2008 than in 2009 as well. When Fixed Assets are

analyzed they seem perfectly normal. They increased by 30% in 2009, which can be attributed to the

new production equipments that were needed to extend the production capacity, and the 90,000 of

the marketing campaign that was capitalized as Research and Development.


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Current Assets and Current Liabilities are more worrisome. The increase of inventories kept in the

companys warehouse is normal: more production requires more raw materials on stock. The

amount that the Trade Debtors owe to the company more than tripled in one year. This could be the

sign of heated business activity; however it is known that it is the result of extended payment terms

that were negotiated by the beverage company. It seems to cause serious liquidity problems to thecompany. This statement is proven by the huge Trade Creditors figure - that represents the inability

of Colorbox Ltd to pay its suppliers , the cash level that is down at zero, and the 300,000 of Bank

Overdraft 50,000 over the limit that was probably used to finance short term operations in the

absence of cash coming in. Trade Creditors increased to a bigger extent than Trade Debtors which

indicates that if the payment terms stay this way than the discrepancy will be even bigger, and the

liquidity problem even deeper. As a matter of fact, Colobox Ltd is insolvent and if things do not get

changed soon, then it will be out of business.

We shall see whether financial ratios support our analysis:

Liquidity ratios measure the companys ability to pay its short-term obligations. Current ratio shows

the ability to pay back short term debt and payables with the short term assets such as cash,

inventory and receivables. Acid Test Ratio measures the same, but it only includes the most liquid

assets, and it does not include inventory as an asset that can be liquidated. As we can see the Current

Ratio decreased significantly, showing the decreased ability to pay the short term obligations. If we

considered cash only the liquidity ratio would be zero.

Profitability ratios are tools that are used to assess a businesss ability to generate earning as

compared to expenses within a specific period of time. Return on Equity measures the firms

profitability by calculating how much profit it generates with the money the shareholders invested.

Liquidity Ratios

2009 2008

Current Ratio = Current Assets / Current Liabilities 0,968992 2,37037

Acid Test Ratio = (Current Assets - Stock) / Current Liabilities 0,813953 1,851852

Profitability Ratios

Return on Equity = Net Income / Stockholders' Equity -22% 33%

Profit Margin = Net Income / Sales -6% 20%

Turnover Ratios

Stock Turnover Ratio = COGS / Stocks 14,00 6,79

Stock Turnover (in days) = Average Stocks / (COGS/365) 26,07 53,79


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Profit Margin explains what percentage of every dollar of sales is kept by the company as earnings.In

2008, Colorbox Ltd made 33 cents on every dollars invested by the investors; while in 2009 it lost 22

cents for the shareholders every dollar. That is a very significant 55% drop well shown by the ratios.

The profit margin in 2008 showed that the firm made 20 cents on every dollar of sales, while by the

end of 2009 it lost 6 cents on the same amount of sales. The more it sells, the more money it loses atcurrent levels.

Turnover Ratio measures how many times the companys inventory is replaced within a given period

of time. A high turnover ratio is a sign that the firm is selling its inventory quickly. If the turnover is

expressed in days, then it actually tells how many days are needed to replace the companys total

inventory. The lower the number of days is, the more intense the business activity is. We can

determine that the production approximately tripled based on the Turnover Ratios. ( 42% more stock

sold 2.06 times more)

Conclusion

Although business activity tripled, Colorbox Ltd made a loss in 2009 and by signing a contract

on very unfavorable payment terms and sales prices it drifted into a liquidity crisis. If operations stay

this way it will be out of business very shortly. It experiences cash flow problems; because Trade

Debtors are given too much time to pay their obligations. Suppliers cannot be paid, which means

very high interest rates to be paid on these outstanding amounts. The Bank Overdraft limit is already

exceeded, so significant and quick intervention is needed.

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Proposal

Liquidity is needed at all costs. It is crucial to find a financial institution or an investor who

could push some cash in the company. As a second step, the contract terms with the beverage

company need to be renegotiated. There is no use of the cash injection if operations stay the way

they are now, since the company will continue to make losses. Communicating the problems towards

the suppliers is very important too, some extension on payment terms might be achieved there. It is

recommended to change the strategy of being tha cheapest on the market to something else. It is

clear now, thet business cannot be continued with prices that are this low.

financial acc.hom ass ind

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