Analyse the ratios and additional information to outline business risks that com
ID: 2814717 • Letter: A
Question
Analyse the ratios and additional information to outline business risks that company faces.
Additional information:
Two years ago, the company devoted significant time and resources to the development and implementation of a new IT system. All teething problems associated with the implementation phase have now been resolved, and the financial controller is satisfied that the automated controls in place are assisting in producing accurate and complete accounting records. The management accountant also looks after the IT function as the position is not regarded by management as being a full-time job. Once application programs have been tested, strict password control exists over access to the programs. Passwords are not required for access to databases.
To assist in the planning for the current year's audit engagement, you extracted the following information from a review of the systems notes in the permanent file and a perusal of the new internal control manual:
There are three section managers, one each for grape production, wine production and beef production. Each can order supplies for their respective operations up to a limit of $10,000 for each order. Orders between $10,000 and $30,000 must be approved by the management accountant. Orders over $30,000 must be approved by the CEO. Orders over $50,000 must be approved by the Board.
-Orders must be made through the computer ordering system which has direct links to the approved suppliers.
-Supplier information is contained in a supplier master file. Each supplier has a unique supplier code. If a section manager orders from an unapproved supplier, the order is rejected and sent to the management accountant for approval.
-The supplier information file is maintained by the accounts clerk. Changes to the file are approved manually by the management accountant.
-When supplies are received at the winery, the storeman checks the supplies received to the online copy of the order and the delivery docket provided by the supplier. Any discrepancies are noted on the online copy of the order.
-The delivery docket is filed by the storeman in a folder that is kept at the winery.
-The invoice is received electronically from the supplier and matched to the order by the accounts clerk. If the order and the invoice match the invoice is included in a payments file.
-The payments file is approved online by the management accountant once a week and used to generate an ABA file which is then uploaded to the bank by the management accountant.
-When the payments file is approved by the management accountant, the invoice is automatically recorded as being paid in the accounting system.
-When services such as repairs are ordered for the winery by the wine production manager, a service order is generated within the computer system and automatically sent to the service provider.
-When the service has been delivered, the wine production manager or the storeman signs the service delivery docket on the service man’s tablet.
-The invoice from the service company, with a copy of the signed service delivery docket, is received online by the accounts clerk.
-The accounts clerk checks the signed service delivery docket to the invoice and the order and adds the invoice to the payments file for final approval by the management accountant.
-In the case of discrepancies, the accounts clerk contacts the supplier and the wine production manager to resolve the issue. Payments are not made until the issue has been resolved.
Ratios
Ratio
2018 (Unaudited)
2017 (Audited)
2016 (Audited)
Return on equity %
10.80
17.5
15.2
Return on beef production assets %
1.67
-0.82
-3.45
Return on grape and wine production assets %
12.2
14.5
16.2
Gross margin %
24.5
30.00
31.76
Net profit margin %
14.38
20.27
17.85
Marketing expense % of total S & A expenses
23.67
17.89
15.2
Times interest earned
6.67
7.51
8.10
Days in inventory - wine
367
423
460
Days in accounts receivable - wine
50.2
60.65
53.24
Days in accounts receivable - beef
57
36
24
Current ratio:1
2.80
2.54
2.66
Quick asset ratio:1
1.18
1.15
1.20
Debt to equity ratio:1
0.54
0.63
0.67
Ratios
Ratio
2018 (Unaudited)
2017 (Audited)
2016 (Audited)
Return on equity %
10.80
17.5
15.2
Return on beef production assets %
1.67
-0.82
-3.45
Return on grape and wine production assets %
12.2
14.5
16.2
Gross margin %
24.5
30.00
31.76
Net profit margin %
14.38
20.27
17.85
Marketing expense % of total S & A expenses
23.67
17.89
15.2
Times interest earned
6.67
7.51
8.10
Days in inventory - wine
367
423
460
Days in accounts receivable - wine
50.2
60.65
53.24
Days in accounts receivable - beef
57
36
24
Current ratio:1
2.80
2.54
2.66
Quick asset ratio:1
1.18
1.15
1.20
Debt to equity ratio:1
0.54
0.63
0.67
Explanation / Answer
Risks that the company faces are as follows:
1) One of the base risk that the company faces is not having a full time employee for performing the IT Function. As most of the companies activities of generating invoice or placing orders or retrieving information or placing service orders are all done through systems and any system failure in future can cause major hindarance in performing day to day tasks of the company.
2) As access to databases donot require any password , it can be accessed by any third party or outsider for their advantage and company might also loose on some confidential information.
3) As supplies of larger quantity require board approval which is time consuming there might be an Hindrance on production due to delay in supplies and long procedure followed for the management of supplies and service orders.
4) Increase in expenses not leading to subsequent increase in profits is a major risk for the company as it might cause major financial crisis.
5) Declining ROE indicates that the shareholders capital is not optimally utilised generating lesser profits which causes Dissatisfaction amoung the shareholders leading to withdrawal or decline in capital which might lead to Business Closure.
6) A declining Times interest earned ratio is not favourable as risk to creditors or investors increases interms of solvency leading to default and bankruptcy.
7) Receivable collection in case of beef is very high during 2018 indicating lot of sales during that year is made on credit which if not collected in lesser time might lead to bad debt.
8) As current ratio is much high that is more than 2 it indicates that company may not be using its current assets or its short-term financing facilities efficiently which is a risk as it might loose on income.
9) Interest to creditors is tax deductable so a good proportion of debt to equity of about 1 can help company save on expenses which is a risk in this case as company is not borrowing money through creditors.
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