There are three important types of financial
statements which all have an important part in helping assess the financial
status of any business. These are the income statement, balance sheet and the
cash flow statement.
Income statement identifies a company’s revenues,
gains, expenses and sometimes losses. On the statement, expenses explain the
costs which are associated with earning the revenue1. Capital gain or loss is shown on the income
statement when a business sells one of its assets.
The main purpose of a cash flow statement is to show
the amount of cash within a company and how it has changed over time.
A cash flow statement includes the operating
activities which shows how much cash is coming in and out of the company. The
statement also has the investing activities which shows the purchases of
non-current assets, and even the disposal of these assets. If the company has
made repayments of any loans or payments to shareholders this will be shown in the financing
activities of the statement. 2
A balance sheet gives a simple picture of a business’
finance, including the basic accounting formula of Assets = Liabilities +
Shareholder. This equation provides the structure for the statement. First
listed are the assets which the business has, then the long-term investments
such as fixed assets, for example any property owned.3 To determine the value of
a company at that specific moment in time the balance sheet is important to
investors as it lists all liabilities in order of maturity.
It is vital to assess all three of the finance
statements in order to gain a better understanding of Clare’s company and the
financial status of the business. From analysing the income statement, one of
the main concerns in the financial performance of Home Range Ltd. is the
decrease in the gross margin. Although sales for Home Range Ltd has increased
by £18,396k, the gross profit has still decreased by 10.2%.
equation ‘Gross Profit / Sales x 100%’ the gross margin has decreased from
55.3% in 2016, to 45.1% in 2017. This could be due to factors such as
wholesalers increasing their prices, as the purchases made by Home Range Ltd. increased
To look at the
financial health of Home Range Ltd, both the income statement and the balance
sheet need to be taken into consideration. Doing this means that the inventory
turnover is able to be calculated to gain to clearer understanding of how long
the inventory is held in stock for. The average number of days’ inventories
were held in stock for went from 58 days in 2016, and decreased to 55 days in
2017. This means that Home Range Ltd where able to speed up the process of
distributing the items to their customers. This is highlighted by the change in
expenses on distribution and postage costs. There was a 4.6% rise in amount of
money spent on distribution, which may seem like a negative impact on the
company, but could also show that Home Range Ltd is getting their stock
distributed quicker to their customers.
the operating profits of Home Range Ltd, it is clear there has been a 9.5%
decrease of profits (before the deduction of taxes). In the year ending 31
December 2016 the operating profits where at 35%, whereas in 2017 it had
decreased to 25.5%. No matter how large or minimal the downward change in probability,
this is still an issue which needs to be investigated by Home Range Ltd. The
reasons for the decrease in operating profits needs to be identified and
addressed as this decrease repeated over a number of years would damage Clare’s
The receivable collection period is the time it takes
for customers to pay Home Range Ltd for their goods. This is calculated by
using the equation (receivables/sales) x 365 to work out the average number of
days it takes for customers to pay Clare the money for products. Using the
equation it is clear that this period has doubled from one year to the next. In
the year ending 31st December 2016, the average time it took for
customers to pay Home Range Ltd was 7 days, whereas at the end of 2017 the
average had risen to 14 days. These figures could be seen as concerning as
unless the reason is identified, this number could keep rising significantly over
the next few years. There could be a number of reasons for this increase, from
the customers being slow to repay bills as they are poorly organised or have
cash restraints of their own. However, a more detailed statement (monthly)
would provide more detailed information for accountants to investigate and give
a more significant reason for this rise in collection period.
Assess the value of Clare Lombardo’s
parent’s recent concern that ‘the company has not spent its significant cash
resources wisely in the past year’ (the year to 31 December 2017). What
practical steps should Clare Lombardo now undertake in order to help to maximise
the value of the business for resale in about 3 years? (20 marks)
Clare now wants to invest more
in the company to continue to make it grow in profitability for the next 3
years so she can maximise its value for the planned sale. On the 1st January
2017 the business took out a further bank loan of £1.2 million to expand the
business with as little risk as possible. In the last year, Clare has relied
mainly on advice of the company financial director to invest particularly in
buying goods with a higher profit margin and to spend more on marketing. Her
parents have recently challenged the views of the financial director and
advised Clare that the company has not spent its significant cash resources
wisely in the past year.
Clare Lombardo wants to sell her
business within the next three years. Her parents who own shares of her company,
have offered their advice that in order to maximise the value of the business
Clare needs to consider how she is spending the company’s cash resources. After
assessing the financial statements provided, there are a couple of areas which
show the cash could have been spent more effectively.
One of these would be the money spent
on computers and equipment. The money spent has raised by £84k in the space of
one year. This money could be spent on distribution and packaging, ensuring
customers receive their items quicker. This in effect, could reduce the receivable
collection period and further increase their sales over the next three years.
Although there has been excess money
spent where is may not be necessarily needed, Clare has increased her
expenditure on marketing and advertisement. In 2016, there was £864k spent on
this, whereas in 2017 there was £1,137k spent. Although from initially looking
at the Income Statement the £273k increase in expenditure on marketing and
advertisement could be seen as alarming, in the long term it would be highly
beneficial to Clare’s company. With improving the company’s website, it has
proven to be a profitable investment as the sales have increased by 17.2% over
the space of 12 months.
1 Staff, I. (2018). Income
Statement. online Investopedia. Available at:
https://www.investopedia.com/terms/i/incomestatement.asp Accessed 5 Jan.
2 AccountingCoach.com. (n.d.). Cash Flow Statement | Explanation | AccountingCoach. online
Available at: https://www.accountingcoach.com/cash-flow-statement/explanation
Accessed 20 Nov. 2017.
3 The Open
University Module book – Block 3 Accounting and Business Finance.