You need to include analysis and discussion, rather than just stating the numbers if you wish to obtain above a C+
Checklist:
You need to include analysis and discussion, rather than just stating the numbers if you wish to obtain above a C+
Cover Page
Contents Page
Executive Summary
Analysis of Sustainability look at the ratios
Need to discuss:
2021 PR 12% and 2022 PR 11% compared to the industry analysis of 10% - is this good or bad?
Profit is falling or decreasing in terms of $$$ to $63, 800.
GPR 2021 is 55% and 2022 55.2% no change. To improve the ratio the owner could switch to a cheaper supplier to improve margins? Basically this would reduce the COGs
Expense Ratio; Advertising spend in 2021 was 2% of sales, 2022 was 3.2% therefore the addition spending didnt really increase the sales so not really worth it?
Financial risk in the short term is low with working capital ratio of 2.89:1 in 2021.
Poor Solvency as debt ratio is 77%
Debt to equity ratio is 242% so although safe in the short term the business owner still needs to pay off the debt.
Rent increased by 50% so closing one store would help save on rent expense and wages.
Financial stability in terms of the times interest earned ratio is 11 times.
Evaluation of Alternatives and recommendations
New Vehicle
Suggested Answers will be revealed if you complete the above.
Closing one Store and adding online sales
Taking on a new partner
Assessment type 2: Accounting Advice
Name of business: The Tank Factory
Business owner: John Flemming
Prepared by: Thomas Dutton
accountant at EY
Table of contents
Executive summary
Analysis of sustainability
Profitability
Liquidity
Solvency
Evaluation of alternatives and recommendations
Close down one store and convert to an online business
Change in ownership structure from sole trader to partnership (private company)
Conclusion
Appendix
1.0 Executive summary (100 words)
This report has been prepared for John Flemming the owner of The Tank Factory it has been prepared using the current P/L Statement, balance sheet and ratios for the years 2021 and 2022. This report will discuss the businesses profitability, liquidity, solvency and will provide recommendations for the business owner to further improve their business. Furthermore, the recommendations for the purchase of the New Delivery Vehicle will be provided, as well as a recommendation for closing one of the stores and converting to an online store. A recommendation for converting from a Sole Trader to a Partnership will be provided. Throughout the report the findings suggested that the businesses profitability is reasonably good however does need some improvements, the businesses liquidity is reasonable poor and needs to improve and the businesses solvency is reasonably good. Furthermore, I suggested that changing one store to online would be good for the business to increase profit and lower expenses. Lastly, I would recommend John to change his business from a sole trader to a partnership, this will increase the businesses security and will allow John Flemming to retire with ease.
Analysis of sustainability (700 words)
profitability (300 words)
Profitability essentially means how much profit the business is making; a good business is generating lots of profit. To help calculate businesses profitability ratios are use, some of these include the return on equity ratio, return on total assets ratio, profit margin ratio, expense ratio and the gross profit margin. For John Flemming, the business owner of The Tank Factory has a reasonably good business however, it does need some improvements. The businesses profit margin as evident in appendix 6 is 12% for 2021 and 11 % for 2022, this is a very good profit margin as the industry average is 10%. Furthermore, a good profit margin is between 7%-10%. Additionally, when talking about a businesss profitability you have to refer to the expense ratio. The expense ratio for The Tank Factory advertising expense is 2% in 2021 and 3% in 2022 as evident in appendix 7. This shows an increase in the advertising expense by 1 % from 2021 to 2022, this is not good at all. This is because John invested into more advertising, however, didnt generate more revenue as the revenue dropped from $605,000 in 2021 to $580,000 in 2022. Although this may not only be due to advertising it means the increase in the advertising expense was not necessary as it isnt generating more profit or revenue for the business. Instead, John should think about other things he can but money into for example, employing someone who looks at the businesses marketing who aims to increase the businesses sales. The rent expense ratio is 8% in 2021 and 14% in 2022 this is a huge increase in rent from 2021 to 2022, as evident in appendix 7 and 8. Due to the huge increase in rent John Flemming may need to consider new ways to reduce the rent expense.
liquidity (200 words)
Liquidity basically means how well the business manages or pays of short-term liabilities, a healthy liquidity ratio then the company has a lot of cash. For The Tank Factory two liquidity ratios were calculated, the quick acid ratio and the working capital ratio. The quick acid ratio is an indication of immediate liquidity within the 90 days, the recommended quick acid ratio is between 1: 1 2: 1. The quick acid ratio for The Tank Factory is 0.17 as evident in appendix 12, this suggest that it is way too low, when the ratio is below 1 it means the business struggles to pay off bills by the due date. John can improve his quick acid ratio by selling off inventory and potentially airing external financing.
The working capital for The Tank Factory is 2.8:8 in 2022 as evident in appendix 11, the working capital is an indication of short-term liquidity within the past year. It is recommended between 1.5:1, 2.0:1, although The Tank Factory has a higher ratio then the recommended it isnt as bad thing as if it is below 1 it means the business may experience problems meeting obligations within the next 12 months. This suggests that The Tank factory wont have any problems meeting obligations over the next 12 months. Overall, the businesses liquidity needs improvement, John can this by selling off some inventory or acquiring external financing.
Refer to appendix 12 and 11
solvency (200 words)
Solvency is the businesss ability to pay off debt and is the possession of assets in comparison to liabilities. Some solvency ratios consist of the debt-to-equity ratio which is an indication of the businesses gearing. It also shows how much of the business has been financed through debt compared to internal equity finance. The debt to equity for The Tank Factory is 20.3% as evident in appendix 5, this is a reasonably good as anything under 100% indicates lower levels of gearing therefore, lower risk and ratios over 100% indicates the business is highly geared and therefore, has been financed mainly through debt. The debt to equity can be improved by using more equity as a source of finance. The times interest earned ratio shows the businesses ability to pay off its interest obligations on debts-based om its current income. The Tank Factory is 11.7% for 2021 and 11.1% for 2022 as evident in appendix 10. This is not a very good ratio for times interest earned as a high ratio indicates a strong ability to cover interest on debt. John can improve this ratio by achieving lower interest rate on debt.
refer to appendix 5 and 10
Evaluation of alternatives and recommendations (600 words)
Closing the store and going online (300 words)
John Flemming is considering shutting down one of his stores and going online as an alternative. This is an extremely good idea for Johns business as he is paying a lot of rent and it only continues to increase. In 2021 the rent expense was $46,200 per year and increased to $83,000 per year in 2022, thats increased by almost double. Additionally, if you refer to the expense ratio of rent it was 8% in 2021 and 14% in 2022. This suggests that in 2021 only 8% of the businesses expenses however in 2022 has increased to 14% of the businesss expenses. Therefore, if the rent expense was to be eliminated it would reduce the businesses expenses by 14% ($83,000). This would be extremely beneficial to the business as it will increase the companys profit assuming sales stay the same. This will also allow the compony to potentially spend the money they are saving through going online on a potential new product or service to appeal to a greater audience. A potential new service could be that the business hires someone who goes out at all customers who purchased a tank and install it for them. Furthermore, from going online it saves customers from having to come into to the store, meaning they can purchase products at all times, and it saves the customer the hassle of having to go into the store, saving them time.
Figure 1: Showing an income statement I prepared
Figure 1 is showing an income statement I prepared to show the changes after converting the store to online. The changes which have occurred is the selling and distribution expenses have dropped dramatically from $143,700 to $39,500, that is a $104,200 decrease from John no longer needing to employ the salesperson. Then the administrative expense has dropped from $106,200 to $18,000 a $88,200 difference due to John no longer needing to pay rent. This has caused the profit in 2022 to change from $63,800 to $256,200, a $192,400 increase in profit. Overall I highly recommend John to convert to online as it has many benefits, lower expenses, therefore, more profit as evident in figure 1.
Taking on a new partner (300 words)
John Flemming is considering changing his business structure from a sole trader to a partnership. His potential new business partner will be his son Magnus Flemming, this will be a good idea as it will take the pressure off John and give him a chance to retire in the near future. sole trader this is a simple business structure that gives the owner all the decision-making power. Business losses can be written off your PAYG tax from another job. You can also hire staff if you want to. partnership this is when between 2 and 20 people go into business together. Partnerships can be either general or limited, depending on the liability of the partners.
Table SEQ Table * ARABIC1: Positives and Negatives about some of the ownership structures
Positives Negatives
Sole Trader You are your own boss
You get all the profit Your responsible for all debts and decisions
Partnership Different opinions
The debt is shared The money made has to be divided
Private compony Lower tax rate (gets taxed at 30%)
Limited liability There are additional legal obligations (it costs more)
Unlike a sole trader business structure where you are solely responsible for all aspect of the business including debts, losses and day-to-day business decisions, a company is a separate legal entity. This means the company has the same rights as a natural person and can incur debt, sue and be sued. This takes the liability off you as a company owner, but a company is more expensive to register and more complicated to run, so make sure it's the best structure for your needs. Overall, I think it would be the right option for John Flemming to change his business to a private company as it has lower tax rates and will suit Johns situations.
Conclusion/ summary of recommendations (100 words)
In conclusion, John Flemmings business The Tank Factory is a reasonably good business which makes good money. However, he can improve his business with a few minor changes. Some of these include, shutting down one store and converting to online and bringing his son Magnus Flemming into the business making it a partnership. All these adjustments will make the business more profitable as well as more secure.
5.0 Appendix
Gross Profit Margin = Gross ProfitRevenue x 100% =
2021 2022
332,750605,000=0.55=55%320,000580,000=0.55=55%Improve gross profit find cheaper tanks or increase the price
Net Profit Margin = ProfitRevenue x 100% =
2021 2022
72,600605,000=0.12=12%63,800580,000=0.12=12%COGS to turnover = COGSNet sales x 100% =
2021 2022
272,250605,000=0.45=45% 122,600580,000=0.2=20%Quick Asset ratio = Cash+Recievables Current Liablilties =
2021 2022
6,30086,500=0.07Debt to equity = LiabilitiesOwner's Eqity x 100%
2021 2022
86,500425,750=0.203=20.3%Profit margin = profitrevenue
2021 2022
72,600605,000=0.12=12%63,800580,000=0.11=11%Industry average is 10%...... compare to our results
Return on equity = profitOwner's equity
2021 2022
72,600425,750=0.1763,800489,550=0.13Expense ratio = individual expencesrevenue =
Advertising expense
2021 2022
12,000605,000=0.02=2% 19,000580,000=0.03=3% Advertising expense increased and profit decreased
Rent expense
2021 2022
46,200605,000=0.08=8%83,000580,000=0.14=14%Times interest earned profit +intrest expense intrest expense2021 2022
72,600+6,8006,800=11.7=11.7%63,800+6,3006,300=11.1=11.1%Working capital current assetscurrent liabilities2021 2022
33,10011,500=2.88Quick ratio (acid test) cash asset-receivables current liablities2021 2022
4,100-2,20011,500=0.17
