This report looks at Chudley Construction’s profit ; loss account and balance sheet and attempts to provide advice to potential investors as to whether or not they are a suitable company to conduct business with / invest in. Ratio analysis is undertaken where possible, which helps examine the financial health and performance of the company. This review process has raised a number of questions, primarily in respect of the lack of information provided, one key example being the absence of a cash flow statement.
Alongside the profit ; loss account and balance sheet, a cash flow statement is considered “one of three essential reporting and measurement tools for assessing a company’s strength” Cash flow statements illustrate the cash flow of a company i. e. the money flow in and out of the company’s bank account in terms of income and expenditure over a specified period. Accurate forecasting of the cash flow is vitally important for planning and budgetary control. The report may also look at a range of factors which would influence whether or not Chudley Construction may be considered as a company suitable to conduct business with / invest in.
An appraisal of Chudley Construction’s profit ; loss account and balance sheet will allow one to begin to understand the financial position of the company at a certain time for when the accounts were published. Inadequacies in the information provided will be highlighted and improvements to accounting procedures will be proposed and substantiated. The profit ; loss account provided does not state when it was published, therefore I have assumed that it was published for the same period as the balance sheet i. e. “last year”.
“Last year” is unspecific as it may have been published in the last month, tax year or possibly at the beginning of the year. The earlier the accounts were published the more they will exclude recent activities and potentially provide inaccurate representation of current affairs. Clarity is key in these circumstances and the date the accounts were published should be stated, for this example I will assume they have just been published and are therefore the latest information; this also applies for the balance sheet discussed later on in this section.
After everything has been accounted for, i?? 24,000 of the gross profit is retained from the gross profit of i?? 100,000 which equates to 24%. If banks were to increase the cost of borrowing finance, the future of Chudley Construction could be put in jeopardy, assuming future business was reminiscent to that reported by the profit ; loss account provided. Dividends in the profit ; loss account are 500%, a substantial amount in today’s terms. However, as so few shares have been taken up, the dividends only accrue to i??
1,000. The more shares Chudley Construction sell, the more pressure will be on them to revise their dividend per share in order to survive. The fact Chudley Construction has only sold 200 out of 1,000,000 shares tends to indicate they are not an attractive proposition. I have carried out ratio analysis where possible for Chudley Construction to help us further understand the financial figures provided. All formulae and workings used to calculate the ratios can be found in appendix 2.
Due to insufficient information, I was not able to calculate all ratios, and some assumptions were made when calculating the ratios, these are listed at the front of appendix 2. “Ratios can be grouped into certain categories, each of which reflects a particular aspect of financial performance or position” (Atrill et al. 2001 p141). I have split the ratios into five categories; profitability, efficiency, liquidity, gearing and investment. These five different types will now be discussed in more detail.
ROSF compares profit available to the shareholders, with the shareholders’ stake in the company, which can be particularly useful for potential investors. ROCE, another measure of business performance expresses the relationship between net profit and long-term capital. Net profit margin and gross profit margins are both proportions of sales revenue. As previously stated, the model illustrated in figure 1 can be used to help decide whether a subcontractor should work for a main contractor.
A subcontractor will want to know if the main contractor is financially sound, so there is no risk of not getting paid. The subcontractor will also be interested in the main contractor’s payment method which may follow a similar route to the main contractor; “traditionally the construction client expects the contractor to carry out a month’s work which is then valued and certified and the certificate is later honoured by cheque” ( Cooke et al. 2004 p233).
With regard to technical ability, the subcontractor will want to know if the main contractor has enough skilled managers to organise and plan the project. “All construction work must be programmed to ensure that activities are sequenced in the correct order” (Vore et al. 1997 p33). The master programme will be made available to all parties, so they understand where and when they fit into the project and how long they have to complete their part of work. A subcontractor will also be interested in various other issues, such as the health and safety record of the main contractor.
Workability of the main contractor is another issue, will they help resolve issues, for example, if a subcontractor is delayed due to lack of resources, will the main contractor assist? Due to lack of further information it is impossible to complete the model in figure 1 satisfactorily; the primary data that has been provided is insufficient to confidently base a recommendation on. A supplier supplying goods to Chudley Construction will only be interested in receiving payment for the goods they supply.
The supplier will want to know that the company is financially sound, so they are guaranteed payment. Potential suppliers will also be interested in when Chudley Construction can afford to pay their debts and will therefore be interested in the average settlement period for creditors, however I was unable to calculate this due to lack of information provided. Liquidity would equally be a concern if Chudley Construction was interpreted as a risky investment; this indicates a firm’s ability to turn assets into cash which may be required if cash flow was running particularly tight.
Otherwise Chudley Construction may have to factor their debt, which means “the sale of trade debt at a discount to an agency which assumes the task of recovering the debt and accepting the credit risk. ” (Hore et al. 1997 p76) Once again based on the information provided I am not really able to offer any advice on whether or not a supplier should supply goods to the company. Financial analysis is just one of the aspects that you should consider when attempting to find out if a company is well managed.
I would advise auditors to carry out a thorough audit which assesses management styles, strategic decision, staff morale etc. The audit would have to look at all levels of hierarchy in the organisation. I personally question some decisions Chudley Construction have taken, such as having a i?? 60,000 revenue reserve whilst having loans and other debts, surely the company would be better off settling these debts, especially as they are so high. Another issue to consider is the size of the dividend which is currently 500%. Isn’t this amount a little excessive?
I suspect this decision was made by a majority shareholder who wants to be grossly rewarded. If the company was going to gain new investors you would expect the dividend to be revised and become less, to cope with potentially an increased dividend payout ratio. I have a number of suspicions with regard to the information provided – but cannot prove these and therefore have to be wary when offering advice. Yet again I am not in any position to offer advice on whether or not Chudley Construction is well managed, I have raised some issues which are not encouraging, however they could be perfectly justified.
The report interprets the information provided for Chudley Construction’s balance sheet and profit & loss account, and highlight’s the inadequacies. The information provided was insufficient to provide a confident response to the brief. I feel that the information provided was overall well appraised and interpreted. Chudley Construction has very little cash in hand and is currently being funded substantially by loans and an overdraft facility.
From the information provided, I feel Chudley Construction would be a risky investment to all businesses and investors as a lot of money is currently tied up in stock and WIP. I must state that if I was provided with further information, my interpretation of the information may change, as there may be reasons for the financial performance. There are also a host of ways of reporting accounting information, and Chudley Construction may have adjusted accounting records for income and expenditure to enhance financial reporting.
A review of the most recent management accounts i. e. the day-to-day financial accounts might throw more light on the strengths or weaknesses of this company. The acid test indicates this business is struggling for cash whilst trying to grow too quickly. This report should be treated with the utmost caution due to the limitations of information provided, and should therefore not be used to make any final decisions. It is merely an interpretation of what little information has been provided and tends to raise as many questions as answers.