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accounting home heaters a holistic view of the financial statements case solution
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accounting home heaters a holistic view of the financial statements case solution

ABSTRACT:
In this case, two start-up companies in the same industry have identical economic transactions. Although both companies follow generally accepted accounting principles (GAAP), each manager makes different choices and estimates when applying GAAP. By preparing the financial statements, calculating ratios, and comparing and contrasting the two companies, students see how choices and estimates made by management affect the financial statements. They also see the challenge faced by users of financial information when trying to interpret the financial statements and compare companies. Students really experience an aha! moment while analyzing this case. The case refutes their commonly held assumptions that accounting always has a right answer and that financial statements represent the truth.

Ratio and Financial Statement Analysis

Abstract

Evaluation of financial statements is a skill shared by many organs. These organs includes investors, bankers, bondholders, and stockholders along with the managers a firm. Review and assessment of the financial information helps in recognizing the strengths of a company as well as its weaknesses. This leads to excellent strategies of investment as well as good financial planning. Analysis of financial statement entails the identification of various items for the financial statements of a company for a given period. The analyzers create trend lines for main items in the financial statements over various time periods to be able to establish the company s performance.

The main trend lines are usually for the debt, accounts receivable, cash, net profits, gross margin, and revenues. There are also various ratios for discerning of the relationship that exists between the various accounts size in the financial statements. For instance, one can calculate the quick ratio of a company for estimation of its ability of paying its instant liabilities. Debt to equity ratio can also be calculated to determination of whether too much debt has been taken. The given analysis is mostly between the expenses and revenues that are stated in the income statement and the equity, liabilities and assets accounts indicated in the balance sheet. Analysis of financial statement is a very powerful too for various financial statements users. Each of them has varied intentions to learn the financial circumstances of an entity.

Ratio and Financial Statement Analysis

Introduction

Analysis of financial statement entails the identification of various items for the financial statements of a company for a given period. The analyzers create trend lines for main items in the financial statements over various time periods to be able to establish the company s performance. The main trend lines are usually for the debt, accounts receivable, cash, net profits, gross margin, and revenues. There are also various ratios for discerning of the relationship that exists between the various accounts size in the financial statements. For instance, one can calculate the quick ratio of a company for estimation of its ability of paying its instant liabilities. Debt to equity ratio can also be calculated to determination of whether too much debt has been taken. The given analysis is mostly between the expenses and revenues that are stated in the income statement and the equity, liabilities and assets accounts indicated in the balance sheet. Analysis of financial statement is a very powerful too for various financial statements users. Each of them has varied intentions to learn the financial circumstances of an entity (William, et al 2010).

Financial statement analysis users

There are various users of financial statement analysis. These include the following: regulatory authorities, management, investors, and creditors

Regulatory authorities: In the event that a company is held by the public, its financial statements are scrutinized by the commission of securities and exchange. This is aimed at determining whether the statements are in conformity to the various accounting standards and the rules set by the commission.

Management: the control of a company prepares a continual analysis of the financial results of a company. This is done specifically in relation to a number of operational measures not available to the public. These measures include profit per product, cost per distribution channel, and cost per delivery among others.

Investors: Both the present and the potential investors scrutinize the financial statements to determine the ability of a company to go on with offering dividends or ability to generate cash flow or ability to grow at the normal rate in relation to the company s philosophy.

Creditors: any individual who has given a company money is eager to know the company s ability to pay back the debt, and therefore they will be focusing on various measures of cash flow.

Financial statement analysis methods

There are two main methods for analysis of financial statements. The first method involves the use of vertical and horizontal analysis. Vertical analysis entails the proportional analysis of the financial statement, whereby every item on the financial statement is stated as a percentage of a different item. On the other hand, horizontal analysis entails the comparison of financial information over a series of reporting periods. Naturally, this implies every line item in the income statement is listed as a percentage of gross sales. On the same note, every line item on the balance sheet is indicated as a percentage of the total assets. Therefore, horizontal analysis comprises of reviewing of results of several time periods but vertical analysis involves reviewing of the proportion of accounts to another one within a specified period.

Vertical analysis

This implies the proportional analysis of a financial statement. In this case all the line items on the financial statement are stated as a percentage of a different item. Characteristically, this implies that every line item in the income statement is indicated as gross sales percentage. Every line item on the balance sheet is indicated as a total assets percentage. Commonly, vertical analysis is used for financial statements for a single period of time. This helps in showing the relative proportions of the balances in accounts. In addition, vertical analysis is beneficial for analysis of timeline, whereby relative changes can be seen in the accounts for a given period. for instance, is the cost of goods sold has in past been 35% of sales, and then a new percentage of 46% will be alarming.

Horizontal analysis

This is the comparison of financial information from past records over a reporting period series or for the ratios obtained from the given financial data. It involves a simple information grouping sorted in terms of period. However, the numbers in every subsequent period can be given in percentage form of the amount in the base year. The baseline amount in this case is listed as 100%. A common limitation with the horizontal analysis is that the information aggregation in the financial statements may have varied over time. These changes may result from modifications in the accounts charts, such that liabilities, assets, expenses and revenues may change between various accounts. This seems to bring about variations when accounts balances are compared for different periods. When doing a horizontal analysis, it is advisable to do analysis for all the financial statements at the similar period. This helps in seeing the full effect of the operational results on the financial condition of a company for a given period.

Income statement s horizontal analysis is normally in a format of two years. The variance is also indicated and it gives the difference between the two years for the different line item. An alternative format is adding several years as the page can allow without indicating the variance. This helps in showing the general variations of the account for several years. Another format is including of a vertical analysis for every year in the report. This ensures that every year indicates the expenses as a percentage of the total revenue in a given year. Balance sheet horizontal analysis is normally in a format of two years. The variance also indicates the different between the years for the different line items (Wahlen, & Wieland, 2011).

Ratios

The second way for financial statements analysis is the use of various ratios. Ratios are used for calculation of the relative size of a given number in comparison to another. After calculating the relative ratio, it can then be compared with the same ratio that has been calculated for a preceding period. It can also be based on the average of industry to determine whether the company s performance meets what was anticipated. In a usual analysis of financial statement, most of the ratios will meet the expectations, with a small number flagging probable challenges that will end up attracting the reviewer s attention.

There exists various general groups of ratios; everyone is designed for examining a distinct aspect of the performance of a company. The different ratio groups are:

Liquidity ratios

This reflects the company s ability to meet the short term obligations by use of its assets that can be easily converted to cash. The assets that are convertible to cash within a short period of time are known as liquid assets, and are indicated as current assets in financial statements. The current assets are termed as working capital since the assets indicate the resources that are required daily activities for the long term and capital investments of a company. The current assets are used for satisfaction of current liabilities or short-term obligations. The amount by which current assets surpass the current liabilities is termed as the net working capital.

Liquidity measurement

Liquidity ratios offer a measure of the ability of the company for generation of cash for meeting of the instantaneous needs. The three commonly used liquidity ratios are:

Quick ratio: it is the ratio of quick assets (in general current assets less inventory) to current liabilities. It shows the ability of a company to satisfy the current liabilities with the company s most liquid assets.

Current ratio: it is the ratio of current assets to current liabilities; it shows the ability of a company to satisfy the current liabilities with the current assets.

Networking capital to sales ratio: it is the ratio of networking capital (current assets less current liabilities) to sales. It shows the liquid assets of a company (following meeting the short term obligations) in relation to its need for liquidity shown by sales.

In general, if these ratios are large, it is advantageous to the company in satisfaction of its immediate obligations (Irina, & Inta, 2012).

Profitability ratios

The profitability ratios also known as profit margin ratio compare income components with ratio. They provide an idea of what makes up the income of a company and are normally conveyed as a portion of every sales dollar. The profit margin ratios discussed here vary just by the numerator. It is in the numerator that there is reflection and hence evaluate the performance for varied business aspects:

Gross profit margin: it is the ratio of gross income or profit to sales. It shows the amount of each dollar for the sales is left following the cost of goods sold.

Operating profit margin: it is the ratio of operating profit that is income before interest and taxes and the operation income, to sales. This ratio normally shows the amount of each dollar is left over after deducting of the operating expenses.

Net profit margin: it is the ratio of net income that is, net profit, to the sales and it shows the amount of every dollar of the sakes left over after deducting all the expenses.

Break even point: it shows the level of sales at which a company strictly breaks even. The value is essential for a various operational decisions. It determines the extra capacity of production present after manufacturing of break even sales. This tells the management of the amount of profit that can be generated theoretically at minimum levels of capacity. It is also useful for determination of changes in the point of break even which results from decision for addition of fixed costs.

Contribution margin ratio: it is the percentage of the contribution of a firm to the sales. The contribution margin is the price of a product, less its variable cost, which result in the incremental profit earned for every sold unit. The overall contribution an entity contributes indicates the total earnings available for paying of fixed expenses and for generation of profits (Cenap, 2012).

Activity ratios

Activity ratios entail the measures of efficiency in use of assets. The activity ratio that mostly turnover ratios can be used for evaluation of the benefits produced by particular assets, line accounts receivable or inventory. In addition thy can be used for evaluation of the benefits produced by all the assets of a company in general. The measures help in gauging the efficiency of a company in putting of its investment into practice. Companies normally invest on assets; for instance, equipment, plant or an inventory. The company then uses the assets for generation of revenues. A company with a greater turnover will be more effective in production of a benefit from its assets investment.

The commonly used turnover ratios include the following:

Inventory turnover: this implies the cost of goods sold to inventory. It shows the number of times inventory is created and sold in a certain period.

Accounts receivable turnover: it is the ratio of net credit sales to the accounts receivable. The ratio shows the number times in the period the credit sales have been created and collected.

Total asset turnover: it is the ratio of sales to the total assets. The ratio shows the level that the investment in total assets leads to sales.

Fixed asset turnover: it is the ratio of sales to the fixed assets. The ratio shows the company management s ability to put the fixed assets to work for generation of sales.

Working capital turnover ratio: it measures the ability of a company to generate sales from a certain base of working capital.

Sales to working capital ratio: it shows the amount of working capital need for supporting of a specific sales amount.

Leverage ratios: a company may finance its assets either with equity or debt. Financing through debt entails risk legally debt compels the company to pay. Dividends are paid following the decision or will of the board of directors. Always there is some business risk in any business operating segment. However, the way a company chooses to fund its operations, the specific debt and equity mix may be a contributor to financial risk in addition to the business risk. A financial risk implies the degree to which debt financing is used relative to equity.

Financial leverage ratios are used for assessing the level of financial risk taken by a company. Some of the common equity ratios include:

Debt to equity ratio: this indicates the level by which management shows willingness of funding operations with debt instead of an equity (Claiborne, et al 2011).

Financial statements analysis

Though financial analysis is an excellent accounting tool, there exist various issues can interfere with ones results analysis interpretation. One of the challenges is compatibility between periods. The company preparing the financial statement may have altered the accounts where it stores the financial information. This makes the results to vary from time to time. Second, is the comparability between companies. There is usually comparison of financial ratios for different companies. Nonetheless, different companies may aggregate differently the financial information, so that the results of their ratios can not be compared with ease. This can result to drawing of wrong conclusions in regard to the company s results. Finally, financial analysis just reviews the financial information of a company, rather than the operational information. This makes it hard to identify varied key indicators of future performance, like changes in warranty claims and changes in warranty claims. Therefore, the financial analysis just shows the overall picture partly.
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i am looking for accounting home heaters: a holistic view of the financial statements case solution please, as soon as possible!! thank you SmileSmile Smile
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Looking for solutions to the "Home Heaters: A Holistic View of the Financial Statements"
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