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Financial Performance Of Eagle Ltd Add in library

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Question:

Analyse the financial performance of Eagle Ltd?
 
 

Answer:

Introduction

The main aim of the report is to analyse the financial performance of Eagle Ltd. in the year 2013. It is noted that there is vast different between the actual and budgeted figures due to which variance analysis and ratio anazlysis have been conducted. This huge variance can be attributed to the fact that the budget is only prepared by the company accountant in isolation and further not reviewed till the year end when the actual figures are available. Clearly this practice of budgeting may be defeating the innate purpose of budgeting and thus may need to be modified which would also be the focus of the current report.

Description and Justification

The various to be used in this analysis are briefly described below (Brealey, Myers & Allen, 2008).

Gross Profit Margin = Gross Profit/Sales

This ratio is imperative in the given case so as to analyse the impact of variation of figures on the gross profitability.

Operating profit Margin = Operating Profit/Sales

This ratio is imperative in the given case so as to analyse the impact of variation of figures on the operating profitability.

Return on Assets = Operating Income/Total assets

This ratio would highlight the variation in the efficiency of the usage of the assets for generation of income.

Current Ratio = Current Asset/Current Liabilities

This ratio would highlight the variation in the short term liquidity of the company which would help in understanding whether the company would face any short term crisis.

 

Ratio Calculation

The calculation of the various relevant ratios based on the actual and budgeted figures for 2013 for Eagle Ltd. is shown below (Damodaran, 2008).

Gross Profit Margin

Actual = (12690/25000)*100 = 50.76%

Budgeted = (16540/29670)*100 = 55.75%

Operating Profit Margin

Actual = (8650/25000)*100 = 34.6%

Budgeted = (9970/29670)*100 = 33.6%

Return on Assets (ROA)

Total Assets (Actual) = 10800 + 4020 = 14,820

Total Assets (Budgeted) = 15950 + 2080 = 18030

Actual ROA = (8650/14820) * 100 = 58.37%

Budgeted ROA = (9970/18030) * 100 = 55.3%

Current Ratio

Actual = 4020/1580 = 2.54

Budgeted = 5800/2080 = 2.79

 

Variance Calculation

The variance calculation for the income statement is captured in the table shown below (Brealey, Myers & Allen, 2008).

Particulars

Actual (£000)

Budgeted  (£000)

Variance  (£000)

% Variance

Sales

25,000

29,670

-4,670

-15.74%

Cost of Sales

       

Opening Inventories

1,870

2,060

-190

-9.22%

Purchases

12,500

13,960

-1,460

-10.46%

(-)Closing Inventories

2,060

2,890

-830

-28.72%

Total cost of sales

12,310

13,130

-820

-6.25%

Gross Profit

12,690

16,540

-3,850

-23.28%

(-) Expenses

4,040

6,570

-2,530

-38.51%

Operating Profit

8,650

9,970

-1,320

-13.24%


The variance calculation for the financial position statement is captured in the table shown below (Damodaran, 2008).

Particulars

Actual (£000)

Budgeted  (£000)

Variance  (£000)

% Variance

Fixed Assets

       

PP&E

10800

15950

-5150

-32.29%

Current Assets

       

Inventories

2060

2890

-830

-28.72%

Trade Receivables

1500

2870

-1370

-47.74%

Bank

460

40

420

1050.00%

Total current assets

4020

5800

-1780

-30.69%

Current Liabilities

1580

2080

-500

-24.04%


The variance calculation for the ratios calculated is captured in the table shown below.

Ratio

Actual

Budgeted

% Variance

Gross Profit Margin (%)

50.76

55.75

-8.95%

Operating Profit Margin (%)

34.6

33.6

2.98%

Return on Assets (%)

58.37

55.3

5.55%

Current Ratio

2.54

2.79

-8.96%


Findings

From the above ratio analysis and variance analysis it is apparent, that on a gross profitability level the actual performance of the company is inferior to the expected performance. This is primarily on account of lower actual sales by almost 16% than the budgeted sales. However the decline in the cost of sales could not decline by the same percentage, hence eroding the gross profit margin. The actual operating profit margin is better than the corresponding budgeted figure since the actual expenses are nearly 39% lower than the budgeted expenses.

Further the actual return on assets is around 5.5% better than the budgeted return on asset primarily because the actual total assets are significantly lower than the budgeted total assets thus enhancing the actual ROA even though actual operating income is less than the budgeted operating income. Moreover the actual current ratio which is indicative of the short term liquidity is around 9% worse than the budgeted current ratio primarily on account of negative deviation to the tune of 31% in the current while which to some extent was balanced by the negative deviation to the tune of 24% in the current liabilities. Additionally it is apparent that there is significant variation in the actual and budgeted amounts for all the items in either the income statement or the financial position which is reflective of the fact that budget making process needs immediate revision so to as lower the variance and thus be able to present a better estimation of the company’s financial performance.

 

Limitations

Although ratio analysis and variance analysis can help us analyse the positive and negative variances for the company in the year 2013 but they do not reflect on the underlying reasons for these variances which would present a complete picture and thus would be possible to present an in-depth analysis of the company performance and the implications of the variances and their underlying causes in the long term. It is quite possible that the ratio variances are wrongly interpreted. For instance even though the actual operating profit margin is 100 basis points better than the budgeted operating profit margin, the actual operating profit is lower than budgeted figure which the company needs to analyse besides the falling sales which is 16% lower than expected. Hence variance and ratio analysis must be deployed as complementary tool along with other detailed qualitative analysis focusing on underlying causes (Ross, Westerfield & Jordan, 2013).

 

Conclusion

From the above discussion, it may be concluded that the current budgetary practice is not appropriate and hence it is imperative that the budget at the first place should be prepared by the management accountant along with the help of various departments heads so as to gain there inputs before making estimates thus lending them credibility. Further it is also needed that there should be an half yearly review of the budgetary estimates along with the actual number of the half year which could be used for making relevant changes in the budgetary estimates and thus the company can be better prepared for any contingency. With regards to performance, the reasons for the above deviations must be looked at closely along wth the given analysis so as to reach holistic conclusion in this regard.

 

References

Brealey, R, Myers, S & Allen, F 2008, Principles of Corporate Finance, 9th edition, McGraw Hill Publications, New YorkDamodaran, A 2008, Corporate Finance, 3rd edition, Wiley Publications Pvt. Ltd, London
 
Ross, S., Westerfield, R. & Jordan, B. 2013. Essentials Corporate Finance, 8th edition, McGraw-Hill/Irwin Publications, New York
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