a.) The income statement, also called the profit & loss account (P & L), is used to illustrate a company’s revenues and expenses over a particular period of time. It shows the net profit and/or loss for the given period (the difference between the business’ total income and its total costs). It also allows shareholders to see the performance of the business and if it has made an acceptable profit.
An income statement is very useful when assessing the performance of John’s Furniture as it shows what changes can be made in order for the business to be more profitable in the next financial year and what immediate areas needs to be focused on in order to save on expenses.
b.) By looking at the statement, there are a few reasons for concern. The first thing I would like to point out is that even if the business is making a profit, the margin from 2011 to 2012 has decreased dramatically. The net profit is £249,200 less than previous year. A decreasing net profit means less money to spend in to the business for next year. Another cause for concern is the cost of goods sold for 2012, a cost of £793,300, compared to the gross profit of £799,000. This is concerning as the business is spending too much money on stock without barely making a profit.
Marketing expenses has decreased from £84,000 to £27,000. While this is considered as an expense for the business it is also an investment supporting the business. With the predicted product demand increase in mind, marketing should be invested in, as this will return a profit.
Another cause of concern is the amount spent on wages and salaries, an increase by £33,200 compared to previous year. The cost has risen but there is no greater outcome in terms of profit.
Looking at purchases and the cost of £861,000, deducted with the purchase of the sawing equipment of £160,000, shows a difference of £45,900 compared to purchases made 2011. Comparing this with the less closing stock, a margin of £67,000 compared to previous year shows that the business spent too much money purchasing stock without returning a profit.
a.) A balance sheet is a statement that summarizes a business’s assets, liabilities and ownerships’ equity. It can be described as a snapshot of a company’s financial condition at a specific moment in time. The balance sheet gives investors an idea about what the business owns and owes as well as money invested by the shareholders. It also gives other interested parties an idea about what the business is worth at a given moment.
The balance sheet is useful for a business like John’s Furniture as it gives a wider picture of the business, especially when looked at alongside the income statement. For example, if a business has borrowed money from the bank one financial year and also made a profit that year, the profit would only show on the income statement whilst what the business owes would be shown on the balance sheet.
b.) One big concern about the balance sheet for John’s Furniture, is the current and short term liabilities. John is close to reaching his overdraft limit of £350,000 and in the long-term this will lead to the business paying greater interest which will lead to a decrease in profit. Compared to last year, both creditors and overdraft have increased and if this continues it can lead to debts and the business will end up selling its assets in order to survive. Capital/Equity is £361,300 compared to last years’ equity of £431,800, which means that the business is valued less than previous year.
a.) A cash flow statement shows money going in and out of a business and it allows investors to understand how a business’s operations are running- where the money is coming from and how it is being spent. The cash flow statement is useful for any business as it helps to plan how much and when to borrow and how much available cash a business is likely to have at a specific time.
This statement is useful for John’s Furniture as it predicts future cash flow, and gives a bigger picture to both stakeholders and the business of money available within the business, which will also help with the company’s budgeting and planning.
b.) There are a few concerns regarding the cash flow statement. Firstly, the significantly increased overdraft will make the bank manager concerned as it will question whether the company will be able to pay the £240,000 loan back in 5 years time. Overall, this would be looked at as a negative cash flow statement as the business has spent more than it has received during 2012. The operation profit before loan is significantly lower than last year and the bank manager might question John why he has taken out drawings of £93,200 when the previous year he withdrew £67,400, bearing in mind that this years profit is far less than previous year.
My recommendations for John’s Furniture are firstly to analyse the cost of goods sold. This year, too much money has been spent on purchasing stock without returning a great profit. One idea is to discuss the possibility with retailers about bulk buying stock to keep in store. This way the business can save money on not having to store unsold stock and would know precisely how much money to spend on purchasing stock. When discussing the overdraft with the bank manager, John should mention that the new sewing equipment he purchased using the overdraft is a great investment for the business as it will improve the efficiency of the manufacturing process, increase production capacity and in return make the business more profitable.
Marketing is essential, especially with the upcoming increase in product demand. With the new sewing equipment purchased, John should invest in a good marketing campaign, as this will increase product demand even more.
John should bear in mind that when the business isn’t doing well in terms of profit, he should be careful with withdrawing money from the business. There should have been a decrease in drawings from last year, but instead there was quite a big increase. If John follows the above recommendations, 2013 will be a profitable year, which is essential for the business to pay back the loan in 5 years time.
Day, J, Eller, L, Preston, D, Watson, G (2011), An introduction to accounting and finance in business, Milton Keynes, The Open University.