The Income Statement
The income statement presents a report on the financial performance of an entity in a given accounting period. It is done by analysing how a business realises revenues and expenses through operating and non-operating activities of an entity. Income statement reflects the financial information of a given period as opposed to a report such as a balance sheet that represents the data of a single moment in time. The income statement is therefore very useful to both investors and creditors as it can be used to determine the financial performance of an entity in the past as well as project the future performance. This report is therefore critical and key for businesses like Better Homes Limited. It will be highly useful, especially when the time to sell comes since the potential buyers will use it to decide as to whether it is a performing business or not.
The Balance Sheet
The balance sheet, also known as the statement of financial position, is one of the key reports in a business entity. It provides an overview net worth of a business at a given point in time (Hail 2011). It shows the total assets an entity owns, what it owes to lenders as well as the amount of equity. It gives a clear picture of the liquidity status of a business which is very useful information, especially when selling a business. The buyers will want to know if it is a going concern or not. The balance sheet will also show how well a business is managing its assets, hence gives an idea of the financial efficiency of the business for a given period.
Statement of Cash Flow
Statement of cash flow is the report that is used to show the net amount of cash and cash equivalents that flows in and out of business in a reporting period. An entity's ability to create value for the shareholder is highly determined by its ability to generate positive cash flows. This report helps in giving clear information on the movement of cash in an entity. Used by relevant accounting personnel in making an original forecast of a company's financial performance (Goddard and Onali 2012). This report will be of help to businesses like Better Homes Limited in determining its liquidity and solvency status as it is a prerequisite for the long-term success of a company.
Areas of Concern in the Income Statement
Some of the areas of concern from an overview of the income statement provided by Better Homes Limited is the rise in operating expenses from 19,215 euros in 2016 to 21,627 euros in 2017. This reduced the substantial profit before tax from 30,003 euros in 2016 to 29,885 euros in 2017. This eventually translated into a small drop in the profits after tax from 24,002 euros (2016) to 23,908 euros (2017). A considerable increment in operating costs, especially those that recur translates to decline in profits for the business.
Financial Health of Better Homes Limited
Financial health, which can be defined as a means of measuring the overall financial standing of an entity, including the total amount of assets owned and income that must be generated to cover regular and other expenses fully. In measuring the liquidity status of a company, we use the current ratio as a test. The current ratio of Better Homes Limited is 0.63 having taken its current assets divided by current liabilities. This ratio indicates a sign of danger since it shows the current liabilities exceed the current assets, hence could quickly run a company into financial difficulty. We use the debt to equity ratio to test the solvency of an entity that is, the ability of a company to fully meet its debt obligations on an ongoing basis. The debt to equity ratio of Better Homes Limited is 0.16; this is somewhat a good sign that most of its financing comes from shareholders as opposed to creditors (Trewavas, Botica Redmayne and Laswad 2012). This is a plus since shareholders do not charge interest when financing an entity. The profitability status of Better Homes Limited is tested using the profit net margin method. The profit net margin is 0.3; this is relatively low hence indicates the company is not well placed to commit its capital to growth and expansion.
Statement of Cash Flow Analysis
The statement of cash flow reflects a definite amount of cash from operating activities of 1,244 euros which is slightly lower than 1278 euros reported in 2016. The company should be on the lookout not only to maintain the cash flow from operating activities as a positive figure but to also have it on an increasing trend (Kim and Im 2017). The firm should also monitor the gap between its reported earnings and the operating cash flow to prevent an incidence where its growth cannot be translated into cash as it would eventually lead to liquidity problems.
Comparison of Performance between 2016 and 2017
In this context, the company performed better in 2016 than in 2017. Its debt to equity ratio in 2016 was at 0.2 which is close to 0.16 (2017); this means the company has been comfortably getting its finances from shareholders mostly as opposed to creditors. The current ratio for 2016 was 4.96 as opposed to 0.63 for 2017. It indicates that the firm's current assets exceeded the current liability hence a good signal that the company can fully contain its obligations. The company also realized a higher profit before tax since its operating expenses were lower as compared to those incurred in 2017.
Recommendations for Better Homes Limited
Bill Rancini can ensure that most financing of the company remains from shareholders for the debt to equity ratio to stay low. There should be a small increase in operating expenses especially those of a repetitive nature such as salaries and office administration expenses to achieve substantially huge profits before tax. The company should invest in research and development to be in a position to produce goods that meet the customer needs hence improve their revenues by selling more.
References
Goddard, J. and Onali, E. (2012). Self-affinity in financial asset returns. International Review of Financial Analysis, 24, pp.1-11.
Hail, L. (2011). Discussion of consequences and institutional determinants of unregulated corporate financial statements: Evidence from embedded value reporting. Journal of Accounting Research, 49(2), pp.573-594.
Kim, J. and Im, C. (2017). Reported profits and effective tax rate following accounting standards changes analysis of consolidated financial statements and separate financial statements. Journal of Applied Business Research (JABR), 33(6), p.1171.
Trewavas, K., Redmayne, B. N. and Laswad, F. (2012). The impact of IFRS adoption on public
sector financial statements. Australian Accounting Review, 22(1), pp.86-102.
