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TACC602 Accounting for Business Assignment Sample

Below is the summary information from the financial statements of two companies competing in the same industry:

Income Statement for the year ended 30 June 2022

Assignment Tasks

(1) Perform a vertical (common-size) analysis of the income statements and balance sheets for both companies. (Note: beginning balances are not necessary).

(2) Calculate and compare the following financial ratios/amounts for both companies for assignment help (two decimal places for all ratios EXCEPT dollar amounts and number of days with no decimal place):

(a) Liquidity

• Working capital
• Current ratio
• Quick/acid-test ratio

(b) Solvency

• Debt ratio
• Debt-to-equity ratio
• Times interest earned

(c) Efficiency

• Accounts (and notes) receivable turnover
• Days’ sales in receivables (average collection period)
• Inventory turnover
• Days’ sales in inventory
• Total asset turnover

(d) Profitability

• Gross profit margin
• Net profit margin
• Return on total assets
• Return on equity

(e) Market perspective

• Price-earnings (P/E) ratio
• Dividend yield

(3) Based on the ratio analysis in (2) above, evaluate the financial health of both companies in respect of their liquidity, solvency, efficiency, profitability, and market perspective.

(4) Based on your evaluation in (3) above, identify which company’s shares you would recommend as the better investment. Provide explanations.

Solution

1. Vertical Analysis

Common Size Balance Sheet of Bayside Company and Gamba Company as at 30th June 2022

Common Size Income Statement of Bayside Company and Gamba Company for the year ended 30th June 2022

2. Calculation of Ratios

a. Liquidity Ratios

b. Solvency Ratio


c. Efficiency Ratios


d. Profitability Ratios


e. Market perspective

3. Ratio Analysis

Liquidity Analysis

Liquidity ratio indicates the ability of the business to meet its short-term obligations. To measure the liquidity of Bayside and Gamba Company, working capital, current ratio, and Quick or Acid-test ratios have been calculated.

As can be seen from the calculations above, both the company have sufficient working capital to meet their obligations. However, compared to Gamba company, the working capital of Bayside company is higher by $36,00,000. This means that Bayside has a higher ability to meet its obligations.

The current ratio of the company also measures the ability of the company to pay its debts due within a year. A higher current ratio is always considered desirable as it represents that the company has good short-term liquidity (Lalithchandra, 2021). Therefore, investors generally look for a current ratio of 2 or 3. If a current ratio is less than 1, it is a sign that the company will either be unable to or will have difficulties in paying its short-term liabilities. According to the evaluation of the current ratio of Bayside and Gamba company, we can see that both companies have a ratio of more than 2. This indicates that the companies are sufficiently liquid and unlikely to face any issues with the payment of their obligations. If the results of both companies are to be compared, Bayside again shows a better performance than Gamba; however, the difference is only by a slight margin.

The Quick or Acid-Test ratio for both companies is also calculated to determine the availability of the most liquid assets in the company that can be used to meet its current obligations. According to the calculation, it is seen that both companies have the same Acid-test ratio of 1.20. Since a quick ratio that is higher than one usually indicates a healthy business, the ability of both companies to deploy their quick assets is similar.

Overall, both Bayside and Gamba are highly liquid, and they do not indicate any difficulty in the payment of their current debts. However, the working capital and current ratio indicate that Bayside has a better liquidity performance that Gamba, while the quick ratio indicates a similar performance in terms of liquidity.

Solvency Analysis

Solvency ratios help to understand the financial health of any business. It helps to measure the company's capability to repay its non-current liabilities. The solvency position of Bayside and Gamba Company is measured using the Debt ratio, Debt to Equity ratio, and Times Interest Earned Ratio.

The Debt Ratio of Bayside is 0.24, while that of Gamba is 0.20. Both companies have a debt ratio of lower than 0.5, which indicates that both companies are wisely managing their debts. They will be able to pay off their liabilities on time (Wijaya and Muljo, 2022). On comparing the two companies, Gamba company has an even lower debt ratio than Bayside Company. Therefore it would be safer for investors to consider Gamba Company stocks.

The debt-to-equity ratio of both companies is lower than 0.50, which means they are using more equity than debt to finance their operations. The ratio of Bayside Company is higher than Gamba Company. Thus, indicating a risky financial position. It is safer to invest in Gamba Company as the margin of safety is higher for long-term lenders.

The Times Interest Earned ratio calculates the amount of profit available to the company to pay interest obligations. Both companies have a high Times Interest Earned ratio. This means that the company can increase its borrowing. In comparison, Bayside has a higher Times Interest Earned Ratio. So for debenture holders and long-term lenders, Bayside company would be better.

Efficiency Analysis

The efficiency ratio indicates how well the assets of a company are managed. It also helps to compare the performance of multiple companies operating in the same industry. Therefore, to compare the performance of Bayside and Gamba, several efficiency ratios have been calculated. These include accounts receivable turnover, average collection period, inventory turnover, days' sales in inventory, and total asset turnover.

According to the calculations above, we see that the accounts (and notes) receivable turnover ratio of both companies indicates an almost similar performance. The accounts receivable turnover ratio determines the efficiency of the business in collecting its debts. Therefore, a higher turnover ratio is usually considered because it shows that the collection of debts is being done promptly (Quaranta, Tartufoli and Zifaro, 2018). It further indicates that the company has a higher chance to invest the money for the benefit of the business. Although the receivables turnover ratio of both companies is similar, Bayside company shows a better performance. This can also be confirmed by analyzing the days' sales in receivables which indicates the average time in days that a company takes to collect its receivables. While Gamba takes 84 days on average, Bayside takes only 75 days to convert its receivables into readily liquid assets. This again shows the higher efficiency of Bayside company.

The inventory turnover ratio measures how judiciously the inventory in the business has been used to generate sales. A good inventory turnover ratio means that the company has sufficient working capital, and it also helps the businesses in earning reasonable profits. Generally, a ratio in the range of 5 to 10 is considered optimum, but the evaluation shows that Bayside has an inventory turnover ratio of 3.03 times. This value indicates that sales are weak in Bayside. On the other hand, Gamba's evaluation shows a high stock turnover value which points to strong sales of the company's products. The results can again next confirmed through the evaluation of days sales of inventory that calculates the number of days on average taken by the businesses to sell or use up their inventories. While a higher number indicates inefficient management of stock, a lower value indicates efficient management. As per the calculation above, Bayside takes 121 days to use its inventory, while Gamba takes only 62 days. This means that compared to Bayside, Gamba is more efficient in managing its inventory and has a better sales performance.
The calculation of the total assets turnover ratio shows that Gamba has a higher ratio compared to Bayside. Since a higher asset turnover shows the efficiency of the company in generating income from the available assets, a high ratio is usually considered better. Therefore, in this aspect as well, Gamba company shows a better result than Bayside.

The overall analysis of the efficiency ratios for both companies depicts better performance by the Gamba company. Although the company takes comparatively longer to collect its receivables from the debtors, it shows its efficiency with better management of the inventory. The difference in generating sales through inventory and assets for both companies has significant difference. However, Gamba excels in this domain.

Profitability Analysis

Profitability ratios are an important measure of a company's efficiency. A higher ratio means the company has generated enough funds. These funds can be reinvested in the business for diversification or expansion (Miransyah and Dempo, 2021). The Gross Profit Margin Ratio, Net Profit Margin Ratio, Return on Total Assets Ratio, and Return on Equity Ratio have been calculated for Bayside and Gamba to understand their profitability.

The Gross Profit Ratio of Gamba Company is higher than Bayside, indicating better performance. A higher Gross Profit Ratio is always desirable as it shows the efficiently of the company's trading activities.

The Net Profit Ratio of Gamba Company is also higher than Bayside. A higher Net Profit ratio indicates efficient operational activities of the company. A high Net Profit ratio also indicates overall business efficiency. A lower ratio indicates the opposite. At the same time, both companies are profitable. The profits of Gamba company are higher than Bayside Company.

The Return to Total Assets shows how well the company uses its assets to generate profits. A higher ratio means the company is wisely using its assets to their full potential. In contrast, a lower return on equity indicates the opposite. In the given situation, Gamba Company os having a higher Return on Total Assets than Gamba Company. Therefore, Gamba is better utilizing its assets to generate profits.

A high Return on Equity indicates that the company is efficient in utilizing finance raised through Equity to generate Net Income. The Return on Equity for Gamba Company is higher than Bayside. This indicates that Gamba Company can provide better returns to its investors than Bayside.

Market Perspective Analysis

Market Perspective Ratios are used by investors to forecast income and a company's performance in the future. The Price Earnings Ratio and Dividend Yield Ratio of
Bayside and Gamba Company are analyzed.

A high PE ratio can indicate that the company's stocks are either overvalued or the company can have rapid growth in the future. The stocks with higher PE ratios are riskier. On the other hand, a low PE ratio stock indicates that less risk is involved in the company's stock (Baraja and Yosya, 2019). The PE ratio of Bayside is very high in comparison to Gamba Company. Thus, if the investor is a risk taker, he should invest in Bayside, and if the investor is risk averse, he should invest in Gamba Company.

The ideal dividend yield ratio is 2-6%. Both companies have a dividend yield ratio of 6%. Therefore, both stocks are a good source of income for investors.

4. Recommendation on Investment Decision

According to the evaluations and analysis made above, it is recommended that Gamba is a better investment.
Although Bayside shows great performance in terms of liquidity, solvency, and it's the ability to meet short-term obligations, the investment decision cannot be solely based on these criteria. The efficiency and profitability ratio indicates that Gamba is comparative more efficient in managing its assets and inventories, that further enables the company to generate higher sales. Since the dividend to be received by the investors primarily depends on the revenue generation capability of the company, it is suggested that the investment decision considers this aspect. The market perspective analysis also shows that investment in Bayside may be suitable for a risk-taking investor. However, for the safety of investments, investment in Gamba's shares will be a better choice. Therefore, the analysis of all the aspects leads to the suggesting of the investment in Gamba company.
 

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