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Overview of the Income Statement

M/s Schutz Building Services

INCOME STATEMENT

For the current period

Revenues:

Building services provided

       550,000.00

Total Revenues

       550,000.00

Costs & Expenses:

Building supplies used

       310,000.00

Electricity & Telephone expenses

           4,000.00

Motor vehicle expenses

           5,600.00

Wages owed to employees

           3,500.00

Wages paid

       150,000.00

Total Costs & Expenses

       473,100.00

Net Income

         76,900.00

The principal revenue generating activity of M/s Schutz Building Services  is providing building and construction services. And hence, the revenues generated from the provision of such service are considered as the primary source of income of the firm.

In the question, no information is given about the building supplies held by the firm at the beginning of the period. Hence, it is assumed that there was no opening stock of building materials with the firm. Building supplies and materials would form a part of the cost of rendering the building service, hence, recorded as an expense.

Wages owed to the employees shall also be included as an expense in the income statement as the financial statements of a firm are prepared on an accrual basis of accounting. This emphasizes that all the incomes and expenses pertaining to a particular period should be recorded and accounted for in that period only, immaterial of the fact that the actual receipt or payment is made or not during that period.

 Motor vehicle expenses are the expenses incurred for the running and maintenance of motor car. It is presumed that the motor car is used for the provision of the primary service of the firm.

Balance sheet, often referred to as the statement of position of the firm reflects the financial status of the firm’s assets, liabilities and equity. The balance sheet of M/s Schutz Building Services is prepared below:

M/s Schutz Building Services

BALANCE SHEET

For the year end

Assets:

Non-current assets:

Equipment

         68,000.00

Motor vehicle

         32,000.00

Current assets:

Building supplies in hand

         18,000.00

Cash in the shoe box

                  500.00

Cash in bank account

           3,800.00

Sundry receivables

         80,000.00

Total assets

       202,300.00

Noncurrent liabilities:

Opening capital

                          97,600.00

Add:

                           76,900.00

Less:

                             5,700.00

       168,800.00

Current Liabilities:

Sundry payables

         30,000.00

Wages outstanding

           3,500.00

       202,300.00

Non-current assets are the assets which are not current in nature, i.e. they have a maturity period of more than 12 months/ 36 months, as the case may be. Non-current assets help the firm in carrying out its business operations. They aid in the generation of income and revenues. Therefore, equipment and motor vehicle are characterized as non-current in nature.

Building supplies in hand is equivalent to the closing stock in hand. This means the materials purchased this year but not used in providing the building service. These shall be advantageous in future as it will be used in the future years to come.

Sundry receivables refer to those sums of money, the service for which has been provided and the moneys are yet to be received from the customers. This is an income generated this year which would be settled off in the next year.

Similarly, sundry receivables refer to those sums of money, the materials for which has been purchased but are yet to be settled off in the next year.

As per the accrual concept of accounting, wages whether actually paid or not, pertaining to a particular period shall be attributable to the income statement. So, wages payable to the employees constitute a liability on the part of the firm, and non-current in nature.

Also, the opening balance of the firm’s opening capital is not given separately in the question. So, the balancing figure in the balance sheet is considered as opening capital and calculations and analysis are carried out accordingly.

Answer (B): The basic objective of every financial statement is to provide information about the financial position, performance and changes in financial position. This information, in turn helps the users in making both financial and economic business decisions. Also, these financial statements lay down a grade of the effectiveness and efficiency with which operations are managed by the firm.

Notes to the Income Statement

 So, the financial statements produced for M/s Schutz Building Services, more particularly, the Income statement and the Balance sheet will help the supplier of building materials decide whether to trade or not to trade with Johan. The supplier shall be able to assess the credit worthiness of the firm with the help of these financial statements and there will be an elimination of the risk element in the payment for the supplies by Johan. Every supplier wishes to get paid for the goods and materials supplied on time, so that he is able to discharge his financial liabilities too. Hence, a careful assessment of the financial statements is required to ensure that the firm would be able to settle its accounts with the creditors in the desired period of time. Such an assessment basically requires an in depth examination of the firm’s current assets and current liabilities. Also, the supplier should determine whether the firm has taken any loans or the amounts owed by the firm to its creditors, Government, employees and loan providers are large as compared to the assets owned. The supplier should ensure that the firm’s current financial position is such that the firm is more likely to discharge off all its current and non- current liabilities with the assets the firm possesses. It can be done by clearly assessing all the assets and liabilities like cash in hand, cash receivables, cash payables, balance in bank accounts, annual revenue, annual income, etc. And all such elements can be easily assessed with the help of financial statements. So the financial statements produced will be very effective for the supplier of building materials. Also, the supplier of building materials should keep a check on the credit repayment history of the firm. A study of the past loan and creditors repayment method would help to judge the firm’s policies better and help to secure the supplier of timely payment. For analyzing this, ratio analysis, which is a major tool for analyzing the financial statements, can be used by the supplier. More particularly, the supplier can track the firm’s creditor’s turnover ratio and the calculated average payment period and cycles, which shall bring a sense of safety and security in the mind of the supplier that he would soon be repaid. The supplier should also evaluate by assessing the past two years financial statements whether the firm has taken any loans since its establishment and if taken, has the loan been repaid on a timely basis. This would help the supplier to judge the firm’s commitment and policies to discharge off its debts on time. The financial statements prepared in “Part A” covers various aspects which can act as POSITIVE INDICATORS for trading with the firm. Some of such positive indicators are discussed below:

The supplier may be very well convinced that the firm has a very favorable debt equity ratio as the firm has no outstanding loans or borrowings which is to be repaid or any finance charges to be paid for the same by Johan. So, in such a case, the supplier shall get an advantage and shall be repaid his debts at utmost priority.

Overview of the Balance Sheet

It is not only sufficient for a firm to carry on its business. What determines the existence and growth of the firm is the income or the profits the firm earns during its business period. It is favorable in this case because the firm has a positive net income for the given period. This implies that the revenues generated by the firm during the course of period are more than the expenses and costs borne by the firm.

Assets turnover ratio indicates the proportion of the assets to the total turnover of the firm. It is mathematically calculated by dividing the total firm’s assets by the gross revenues generated. In the given case, the firm has a good assets turnover ratio, which is equal to (2, 02, 300 / 5, 50, 000) *100 = 37%.

In the given question, the opening balance of the capital is calculated at the balancing figure in the balance sheet. As per the financial statements prepared above, the firm is able to earn good return on the invested capital. The firm here earns a positive return of $ 76, 900 on an invested capital of $ 97, 600, which amounts for 79% profits on capital, which is excessively favorable for the supplier to rely upon.

Current ratio is a proportion of the firm’s current assets over the firm’s current liabilities. This ratio determines the ability and sufficiency of the currents assets of the firm to discharge and pay off all its liabilities. For the given firm, the current assets as reflected in the financial statements amount to $ 1, 02, 300 and the current liabilities amount to $ 33, 500, which equals 3.05, which is a very favorable benchmark for the firm.

The supplier can also assess the firm’s liquidity position, i.e. the firm’s current position to pay off current debts. Liquid assets refer to the assets which are either cash or cash equivalents or do not take any time for such conversion into cash or cash equivalents. Generally, liquid assets do not include closing stock and prepaid expenses, as they are not readily convertible into cash. The liquid ratio of the firm is also favorable in the given case, as reflected by the financial statements.

Just like the favorable factors, there are certain NEGATIVE FACTORS, reflected in the financial statements prepared in “Part A”, which the supplier must pay proper attention to before providing building materials on credit:

Expenses are an important part of financial statements. Is the proportion of expenses borne by the firm is more than the desired percentage of revenues generated, then, it can be harmful for a business. In the given case, expenses constitute a very high proportion of the gross revenues generated by the firm, which is quite unfavorable. This is depicted by high expenses turnover ratio and which is not a good sign of a healthy business. Expenses ratio is given by total expenses in a business divided by net turnover of a business, which is - 473100 / 550000 = 86%, which is much higher.

Every business continues to earn profits and adequate profits ensure the stability and growth of a business firm. The stability of a firm in the long run can be determined by calculating the net profit ratio, which is the very essence of financial statements. Net profit ratio is given by net profit divided by net sales in percentage. In the given case, since the expenses hold a very high proportion as stated above, net profit ratio is much lower and so it adds to negative remarks of credit worthiness. Here, the net profit ratio given by $ 76, 900 / $ 5, 50, 000 = 14%, which can be improved by cutting down expenses.

Cash in shoe box is extremely lower and so it does not assure whether Johan will be able to pay on a timely basis. With annual cash of rupees 500no enterprise can repay their debts.

Cash in bank account is also not satisfactory and so adds to the concern for the supplier whether to trade or not. Adequate cash and bank balance adds to the reliability of the firm while discharging its liabilities. A les balance might create concerns in the mind of the supplier of building materials.

Wages to turnover, which is given by percentage of total wages by net sales and this ratio, is even more than net profit ratio, which is almost 28%. ($ 1, 53, 500/ $5, 50, 000). Here total wages, i.e., wages paid and outstanding wages is $ 1, 53,500.

References

Lee, T. (1997) The editorial gatekeepers of the accounting academy. Account- in, Auditing & Accountability Journal 10 (1).

Felltham, G. A., Olson, J. A. (1995) Valuation and clean surplus accountin0067 for operating and ?nancial activities: Contemporary Accounting Research 11 (2).

Financial Accounting Standards Board of the financial accounting foundation (2007) Statement of financial accounting standards no. 141,Norwalk: Financial accounting foundation.

Kimmel, Paul D. , Jerry J. Weygandt and Donald E. Kieso (2011). Financial Accounting : Tools for Business Decision Making’,  6th ed. Hoboken.

Deegan, C. M. (2007) Financial Accounting Theory (2nd ed.). Australia: McGraw-Hill.

Gray, R., Owen, D., & Maunders, K. (1987) Corporate social reporting: Accounting and accountability, London: Prentice-Hall.

Connor, Brian O’ “The importance of cash flow statement”.

Beyersdorff, M. (2014) International GAAP 2014: Generally accepted accounting principles under international financial reporting standards. 9th edn. United States: John Wiley & Sons.

Dagwell, R., G. and Lambert, C. (2012) Corporate accounting in Australia. Australia: Pearson Australia.

Cormier, D. and Gordon, I. (2001) An examination. Accounting, auditing & Accountability journal.

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