Accounting for Decision Makers
KT partners, a Hong Kong-based small private equity firm, are considering investing in JL Foods plc. However, in light of recent global socio-political developments, the firm is concerned about the investment's suitability and has solicited your services as an advisor. Your opinion needs to be provided in the form of a report, limited to 1000 words, and addressed to Ben Burns, the CEO of KT partners. It should analyze the above financial statements using the various ratios introduced in the module and other necessary research. The proportions need to be presented as a table, as part of the appendices and do not count toward the word limit. (60 marks)
Your colleague is very dismissive of your analysis and argues that profits/losses are nothing more than the construction of an accountant. They are based on what the accountant can and chooses to measure and should not, therefore, be the basis for judging a company. Write a note in no more than 500 words critically evaluating the assertion. (40 marks)
[TOTAL 100 marks]
Abstract
Analysis
ratios are crucial in determining the financial health of a company. In the
present paper, analysis ratios, namely liquidity and profitability ratios, were
used to assess the financial status of JL Foods Plc, which operates a
restaurant in Ireland and the UK. These analysis ratios utilized the
profit/loss and balance sheet of JL Foods Plc from 2018 to March 2022. Parts
one and two of the paper focused on (a) analysis ratios and (b) evaluation of
the analysis based on the profit/loss statement. It was established that the
investment in JL Foods Plc is not profitable. As a result, KT Partners should
not consider investing in the company. Investing in the company is risky
because the future performance of the company is uncertain. Again, it was
established that it is not true that accountants make independent decisions
when developing profit/loss statements. However, they work as a team and
closely with the management, making it impossible for them to use their own
decisions to make a profit/losses statement, resulting in a profit/losses
statement that reflects the company's financial performance.
Introduction
It
is a fundamental approach for investors to determine the financial position of
any firm before they invest in it. As a result, the investors need a practical
approach that provides financial insights concerning the company, where ratio
analysis comes in. Ratio analysis describes a quantitative technique of
understanding the company's profitability, liquidity, solvency, and operational
efficiency by examining the firm's financial statements, such as income
statements and balance sheets (Janatyan & Shahin, 2021). For this reason,
ratio analysis is significant for fundamental equity analysis. It shows how a
specific company performs within a particular market segment for a given period.
Furthermore,
ratio analysis provides the company's historical and current performance, which
is crucial for investors (Janatyan & Shahin, 2021). Therefore, the ratio
analysis of JL Foods Plc offered vital information for KT partners to examine
their decision to invest in JL Foods Plc. As a result, the consultancy firm
used four financial ratios, namely liquidity and profitability ratios, to help
KT partners determine whether their interest in investing in JL Foods Plc is
worth it. The analysis utilized the profit or loss statement of JL Foods Plc
for five years, starting from 2018 to March 2022. Additionally, the analysis
used JL Foods Plc’s financial statement between 2018 and March 2022. To better
understand the ratio analysis concept in determining firm financial health, the
paper is divided into two sections (a) ratio analysis for JL Foods Plc to give
investing insights for KT partners, and (b) the evaluation of the
analysis-based profit/losses statement.
(a) Ratio analysis of JL Foods Plc
As
mentioned before, liquidity and profitability ratios were used to determine the
financial health of JL Foods Plc.
Liquidity
ratios
These
ratios determine the capability of a firm to pay off its short-term debts as
its payment periods approach. There are different forms of liquidity ratios (Anureet
et al., 2022). Furthermore, they are the working capital ratio or current
ration and quick ratio.
Current
ratio or Working capital ratio
The
current ratio measures the liquidity of the company. It reveals the company's
ability to settle its short-term debts. The current ratio is calculated by
comparing the company's current assets and present liabilities (Anureet et al.,
2022). Table 1 provides a current ratio of JL Foods Plc from 2018 and March
2022 based on the provided JL Foods Plc’s financial statement. Equation 1 gives
the ratio between present assists and present liabilities of the company (JL
Foods Plc). In Equation 1, CR signifies the current ratio; CA denotes the
current asset, while CL refers to current liability.
CR= CA/CL Equation 1
According
to CR calculations, between 2018 and 2022, JL Food Plc struggled to pay its
current liabilities. The CR for JL Foods Plc’s financial statement shows that
it was only in 2020 that the company was 0.85 times
below meeting its current obligations. The company was less than 0.5 times
below paying its current liabilities for the rest of the years.
Quick ratio
The quick ratio determines the company's capability to rapidly
change its liquid assets into money to settle its short-term debts. Typically,
the quick ratio assists investors in determining whether they should invest in
the company or provide a loan for it (Anureet et al.,
2022). Equation 2 determines the quick ratio, in
which the QR represents the quick ratio, QA denotes quick assets, and CL
signifies current liabilities. Furthermore, Equation 3 demonstrates how to
obtain the quick asset. In Equation 3, QA signifies quick assets, and CR
denotes the current assets. On the other hand, PE represents prepaid expenses.
QR= QA/CR Equation
2
QA=CR- I- PE Equation
3
A
quick ratio analysis of JL Foods Plc demonstrates that the firm did not have
enough assets to be quickly liquidated to settle its current liabilities. As in
the case of the current ratio, QR for JL Foods Plc was below standard QR( QR of
1), indicating the company needed to be in a better position to pay its current
liabilities. However, in 2020, the company was 0.77 times below paying its
present liabilities. As a result, for the remaining four years, JL Foods Plc
was below 0.5 times that of settling its current liabilities.
Profitability
ratios
The
profitability ratio indicates the firm's position to make profits from its
activities. These ratios encompass gross margin ratio, net profit margin, return
on equity, return on capital invested, and return on assets.
Gross
margin ratio (GMR)
GMR
compares gross revenues from sales of services or products with the cost of
production of such services and products called 'COGS" (Nugroho, 2022).
Usually, the GMR does not incorporate any expense associated with delivering a
service or processing a product (Nugroho, 2022). Equation 4 indicates how GMR
is obtained. In Equation 4, TL is the total revenue, and COGS signifies the
cost of processing a product or supplying a service.
GMR=
(TL-COGS)/TL Equation 4
JL
Foods Plc had a low GMR from 2018 to 2022, implying the company was spending
more on production expenses. Based on the calculation, the gross margin ratio
decreased from 2018 to 2022. For instance, in 2018, the company registered the
highest GMR compared to 2019, 2020, 2021, and 2022. In 2020, the company
registered the lowest GMR, indicating that more money was used in settling
production expenses. The analysis shows that JL Foods Plc is not a profitable
venture.
Net profit margin
The
net profit margin determines all the expenses associated with the company
(Nugroho, 2022). Equation 5 describes how net profit margin is calculated, in
which NPM represents net profit margin, and TL signifies total revenues. TE is
the total expenses.
NPM
= (TL-TE)/TL Equation
5
JL
Foods Plc experienced a low net profit margin from 2018 to 2022. In 2022, the
company registered the lowest profit margin for than remaining four years. In
2021, JL Foods Plc recorded the highest profit margin (22.4%), showing that for
every 1 Euro sale, JL Foods Plc makes a profit of 22.4%. However, the profit
margin trend for JL Foods Plc kePT fluctuated and was not constant.
Return on Equity (ROE)
ROE
provides information on the profitability of the company and how the firm’s
effectiveness in generating more revenues (profit) (Nugroho, 2022). Equation 6
illustrates the calculation of ROE. In Equation 6, NE is the net income, while
ASE represents the average shareholder's equity.
ROE
= NE/ASE Equation
6
JL
Foods Plc had higher ROE (54.012%) in 2021, showing that the firm generated
more revenues from its equity financing than the rest of the four years. In
2022, the company generated less revenue from its equity financing. Nevertheless,
the trend of ROE from 2018 to 2021 indicates a consistent increase in ROE,
showing steady revenue generation for its equity financing.
Return
on Asset (ROA)
ROA
shows the company's profitability based on its assets. As a result, it gives
insight into how firms utilize their assets to generate revenues (Nugroho,
2022). Equation 7 shows how ROA is calculated. NI signifies net income, while
TA is the total assets.
ROA = NI/TA Equation 7
Based
on the analysis, JL Foods Plc has a low ROA, indicating that the company did
not use its assets effectively to generate more revenues. On the other hand, in
2021, JL Foods Plc registered the highest ROA in the remaining four years,
demonstrating that the company effectively used its assets to generate more
money. However, the trend of ROA from 2018 to 2022 needed to be more
consistent. Thus, it is difficult to predict the company's future
profitability.
Return
on Invested Capital (ROIC)
ROIC
examines the firm's efficiency in putting its revenues into a profitable
investment. It reveals how the firm utilizes its capital to generate revenues
(Nugroho, 2022). Equation 8 describes the calculations of ROIC. NI is the net
income, while D represents dividends. On the other hand, DE is the debt, and E
is the equity.
ROIC = (NI-D)/ (DE + E)
Equation
8
JL
Foods had low ROIC values from 2018 to 2022, implying that the company has an
inappropriate business model. Only in 2021 the company had the highest ROIC
(11.97%) than the remaining four years, which registered ROIC below 10%. In 2022,
JL Foods Plc recorded the lowest ROIC (1.283%).
(b)Evaluation of the analysis
A
profit/loss statement is a vital tool for any company. However, even though
accountants are responsible for making it, it is not true that it is not
essential for determining the company's performance (Spitsin et al., 2021).
Accountants must develop reliable and accurate income statements that reflect
the true picture of the company. Therefore, they refrain from using their
personal opinions in creating income statements, but the company's financial
performance.
The
profit/losses offer insights into the company's operations, efficiency, and
management. The income statement also reveals a firm's performance in a
specific market segment. Profit/losses statements work in tandem with other
financial statements, such as cash flow statements and balance sheets, to show
financial performance for a specific period (Spitsin et al., 2021). For
instance, in the case of JL Foods Plc, the profit/losses statement describes
the company's performance between 2018 and 2019, giving a clear picture of the
financial performance of the company. Hence, using the income statement,
investors decide whether their investment in the company (JL Foods Plc) is
profitable. However, as revealed in the analyses, investing in JL Foods Plc is
not profitable.
The
profitability of JL Foods Plc was apparent because of the information available
profit/losses statement and balance sheet. Hence, the argument that profit/loss
statements are used in predicting a company's performance is unfounded. On the
contrary, profit/losses are a core facet of the company's financial
performance. For example, a balance sheet offers a picture of the finances of a
company for a specific date, profit/losses give profit/losses statement
provides the financial performance of a firm throughout a particular period.
The
account's decision does not define information in the profit/losses statement.
Accountants perform their duties but hardly influence the valuable information
in the profit/loss statement. For instance, if accountants use their decisions
to make profit/losses statements, the company's operations can unearth such
behaviors because there is no correlation between the company's operations and
information in the profit/losses statement. Another scenario that makes such an
allegation unfounded is when an accountant gives false information in the
profit/losses statement that lures investors to put money in the company.
Unfortunately, after operations for a duration, the company fails to register any
improvement in its performance. In such situations, the accountant should
explain the reasons behind such failures.
Furthermore,
accountants have ethical guidelines, allowing them to use their independent
opinions on the profit/losses statement rather than the collaborative decision
of the team of accountants, management, and relevant stakeholders. Therefore,
work ethics regarding accountants refute the allegation. As a result, the
profit/losses statement is a fundamental document that assists the management
and stakeholders in determining the company's performance (Spitsin et al.,
2021). Additionally, investors must determine whether investing in the company
is profitable. In a nutshell, the allegation is not valid. Accountants do not
work in isolation. Furthermore, work ethics relating to accounting guide their
practices and prevent them from giving independent opinions that influence the
creation of profit/losses statements. Moreover, since the management depends on
the profit/losses for making a decision, it is difficult for accountants to use
their independent decisions to represent the company's financial status,
rendering the allegation unfounded.
Conclusion
Generally, based on these analyses (liquidity and profitability ratios), JL Foods is not worth the investment. The growth pattern of the company is unpredictable. As a result, it is likely to make it in the future. As observed from all the analysis ratios, in early 2022, the company performed dismally. Therefore, the profitability of the company's future is uncertain. Additionally, it is not true that the profit/losses statement should be used to determine the company's performance. Accountants work as a team among themselves and the management, creating dependable and accurate profit/loss statements representing the company's true picture.
References
Anureet, V. S.,
Rastogi, S., Gupte, R., & Bhimavarapu, V. M. (2022). Impact of Liquidity
Coverage Ratio on Performance of Select Indian Banks. Journal of Risk and
Financial Management, 15(5), 226. https://doi.org/10.3390/jrfm15050226
Janatyan, N.,
& Shahin, A. (2021). Product value analysis: a developed cost-benefit
analysis ratio based on the Kano and PAF models. [Product value analysis] TQM
Journal, 33(1), 163-181. https://doi.org/10.1108/TQM-02-2020-0028
Nugroho, L.
(2022). The Relationship between Maqasid Sharia and Profitability Ratio in
Islamic Banking Industries Performance. [İslâmi Bankacılık Sektörünün
Performansında Şeriat Hedefleri ve Kârlılık Oranı İlişkisi] Sosyoekonomi, 30(53),
243-259. https://doi.org/10.17233/sosyoekonomi.2022.03.13
Spitsin, V., Vukovic, D., Anokhin, S., & Spitsina, L. (2021). Company performance and optimal capital structure: evidence of transition economy (Russia). [Company performance and optimal capital structure] Journal of Economic Studies, 48(2), 313-332. https://doi.org/10.1108/JES-09-2019-0444
Appendices
Table
1: Analysis ratios (liquidity and profitability ratios) of JL Foods Plc between
2018 and 2022
|
Analysis Ratios |
2022 |
2021 |
2020 |
2019 |
2018 |
|
Liquidity
ratio |
|||||
|
Current
ratio |
0.334294 |
0.331667 |
0.849779 |
0.284231 |
0.365694 |
|
Quick
asset |
0.242499 |
0.231244 |
0.765884 |
0.20812 |
0.287889 |
|
|
|||||
|
Profitability
ratio |
|||||
|
Gross
margin ratio |
5.761% |
6.88% |
4.121% |
9.864% |
10.42% |
|
Profit
margin |
1.107% |
22.4% |
7.682% |
4.001% |
3.338% |
|
Return
on Equity (ROE) |
6.79% |
54.012% |
25.36% |
20.67%
|
22.1 |
|
Return
on Asset (ROA) |
1.28% |
11.97% |
5.94% |
5.05% |
4.83% |
|
Return
on Invested Capital (ROIC) |
1.283% |
11.97% |
5.43% |
4.17% |
3.91% |
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