Financial information on Brimore Engineering Limited Company

Introduction

This paper presents an analysis of the financial information (shareholders information, budgeted and actual costs/revenues, and income statement) of a small engineering company located in the North East of England, Brimore Engineering Limited (BE). BE is a private limited company which had been exclusively owned by the Brimore family from 1987 to 2012 when two non-family members made an invested £1,000,00 which was valued as 25% of the company’s ordinary shares. At the time of the investment, the company was in its third consecutive year of financial loss. Following the investment, the company was back to its profit-making ways in 2014. The managing director of the company is Charlie Brimore, son to the company’s founder, Bob Brimore. In this analysis, BE will be analyzed on two levels, analysis of the budget vs. actual and financial ratios analysis. A budget to practical variance analysis involves determining the variation between budgeted and actual costs/ revenues and explaining possible reasons for the differences (Kaplan & Atkinson, 2015). On the other hand, an analysis of financial ratios involves evaluating company performance based on different performance metrics such as profitability, liquidity level, debt etc. (Haskins, 2017). In this paper, an analysis of various budget variances and financial ratios of BE is conducted to determine the company’s financial standing.

Budget Variance Analysis

Budget variance analysis focuses on describing the variation between budgeted costs/revenues and the actual costs/revenues. For cost variables, a variance is favourable when the budgeted cost is high compared to the actual cost since it means the company pays less than what it had budgeted for a particular expenditure. On the other hand, revenue variances are regarded as favourable when the actual return is greater than the budgeted revenue (Kaplan & Atkinson, 2015). Some of BE’s budget variances are discussed below:

Sales Volume Variance

This variance measures the effect of the difference between the budgeted sales volume and the actual sales volume on profit. In a deep explanation, it analyses the difference between the actual sales of the company to the budgeted sales volume of the to show how the company varies its dairy profit, in essence, to evaluate profit margin and also evaluate the loss that may be drawn from the actual sales. It is calculated as:

We already have the actual and budgeted sales volumes; the standard profit per unit can be calculated as:

therefore,

Revenue variance

This is the disparity between budgeted revenue and actual revenue. If the actual revenue is higher than the budgeted revenue, the variance is favourable. In this case, there is a difference of than the budgeted; therefore, this is a favourable variance since more revenue was received than expected (Farkas, et, al. 2016). But if the actual volume in comparison to the budgeted revenue of the total sales of the company could indicate of how these sales may not favour the company and this is because the results mainly to be recorded at the end of the sales will indicate losses rather than profit margin as planned. From my analysis it is well evident that actual revenue is supposed to be higher than the budgeted revenue this is to ensure that the sales going out from the company are both favourable to their customers and also to the company.

Gross profit variance

The actual gross profit, £1,278,060, is higher than the budgeted benefit, therefore, this is a favourable variance for BE. Out of the above analysis in comparison of actual volume revenue to the estimated revenue, we see how it affects the gross profit variance. This is because from the figures we see that the company corrected a higher profit margin than planned. This was as a result of high actual revenue to the budgeted revenue, and this shows how the outcome was more favourable to the last corrected digits of their sales which shows that company recorded a higher gross profit than expected to the budgeted advantage (Kes, 2019).

Labour variance

This is the difference between the real cost of labour and the projected cost of labour. For BE in 2019, this can be calculated as:

Labour variance=actual cost of labour- Budgeted cost of labour = £478,000 – 432,000 = £46,000

The labour variance is positive; positive labour variance is unfavourable for any company since it means that more was spent than was budgeted for. But if it were recorded to be negative, then that means the total less was spent during their sales than the actual figures which had been budgeted. Out of this negativity in labour variance, the company hence records higher profit margins in correspondence to the total losses.

Overheads variance

This variance describes the difference between the actual costs and the budgeted overheads. For BE, the actual costs, £285,000 are equal to the budgeted costs; therefore, there is no effect of costs on the budget.  Therefore, costs variance was neutral for BE in 2019.

Profit variance

The actual profit (£514,260) is less than the budgeted gain (£531,000). Therefore, this is an unfavourable variance for BE. This can be attributed to increased labour costs.

Cost of goods sold variance

The actual price of products sold is higher than the budgeted cost of goods sold; therefore, this is an unfavourable variance.

Price Elasticity of demand

This refers to the change in the demanded quantities concerning its price change (Kaplan & Atkinson, 2015)

It is calculated as:

Therefore, the price elasticity of demand =

This means that with a price increase of 1%, there was a 4.80% increase in the demand for BE products.

Analysis of Financial Ratios from the Income Statement

Gross margin

This ratio represents the proportion of the company’s sales revenue that it keeps after paying for the direct costs required for production. It is calculated as:

(Haskins, 2017)

This means that in 2019, BE kept about 77% of its sales revenue after paying for all production expenditures.

In 2018, the gross margin was:

79% of the revenue was kept

While in 2017 it was:

78.6% of the revenue was kept

Operating profit margin

This is the share of profit that the company keeps after paying for all expenses. It is calculated as:

These means BE kept 30.98% of the profits generated in 2019.

In 2018, the operating profit margin was

, BE kept 35.4% of the operating profit.

While in 2017, it the

Asset turnover

This ratio represents the total revenue generated by every single pound of assets owned by the company. It is calculated as:

|

For 2019, the asset turnover was:

This means that every single pound of assets owned by the company generated £5.74 in revenue in 2019.

In 2018, the asset turnover was calculated as below:

, in 2018, every single pound of assets owned by the company generated £5.68 in revenue

Return on capital employed (ROCE)

This ratio describes the company’s efficiency in making a profit from the available capital. The

For 2019, the ROCE is calculated as:

This means that in 2019, the company was able to make a 1.05% profit on every unit of capital employed

Current ratio

This ratio describes a firm’s ability to meet its short-term (up to a year) obligations. The formula is:

For BE, the current ratios for the three years are:

2019

2018

2017

From the calculations above, it is clear that BE’s current ratio has been dropping over the past three years; 1.76 – 1.74 – 1.65.

Cause and Effect of Company Results

Sales volume variance

The actual units sold were higher than the budgeted units indicating that the sales volume variance favourable for BE. This can be attributed to increased demand for products.

Gross profit variance

The total profit variance was favourable; this is probably due to increased demand and a consequent increase in sales volume

Revenue variance

The revenue variance was favourable; this is perhaps due to improved demand and a resultant increase in sales volume. Other variations are affected by the order and increased sales volume in the same way.

The unit cost of sales

As demonstrated in the cost of goods sold variance, the actual unit cost of sales was higher than the budgeted unit cost. This can be explained using the calculations of the price elasticity of demand where the proportional change in the market is computed and found to be 11.56%. Therefore, the increase in the unit cost of goods can be attributed to the rise in demand.

            Most important ratio

From the ratio analysis conducted, the most crucial rate for evaluating the performance of BE would be the current ratio especially considering that the company has been investing on new assets after reducing its workforce by 20%. This is because the current ratio measures the liquidity ratio (the ability of the company to meet current liabilities by invoking its assets) and, therefore, since BE decided to rely more on technological assets than human resources, the current ratio becomes very important to BE as it describes the company’s position in terms of liquidity (Santolamazza, et, al. 2017).

   Other relevant information

While the financial results of BE Limited cannot be considered as impressive, the company’s performance can be better measured by comparing its performance with that of similar industries in the industry. In the current analysis, we have only looked at the financial information of BE Limited without comparing the company to its peers in the industry. However, with the available information on the budgets and actual expenditures/revenues as well as income statements of similar companies in the industry, we would be better placed to make comparisons that would help us determine precisely how BE is performing in the industry. This is because while BE has its failures and successes in various aspects, we do not know the specific factors in the industry that may be causing the successes/failures (Laitinen, 2018). Therefore, having information about BE’s competitors would put us in a better place to understand the company’s performance.

Solutions to the Company Problems

From the analysis conducted, BE’s biggest problem is the trend in the company’s current ratio (and profit margin) which has been declining towards 1 for the past three years.  A current rate of less than one would mean that the company is not in a position to pay its current obligations using its assets, and could, therefore, be liquidated. The solutions that BE could implement to prevent this include (Tonchia, 2018):

1. Increasing short term loans – this helps by increasing the amount of liquid cash
2. Optimizing spending of money to ensure that more cash remains within the company and that spent cash results in the value

Limitations to the solutions

While the solutions suggested above could go a long way in helping arrest the situation at BE, each of them comes with some restrictions. These are:

1. Increasing short-term loans

• While short terms can help improve cash flow in the company, they come at a high cost as their interest rates are usually much higher than long term loans
• The adequate availability of short term loans may make a company a regular borrower hence ending up paying more interest rates

1. Optimizing spending of cash

• Optimizing spending of money is a complex process that needs careful consideration of the most critical needs, in case of mistakes, it leads to financial losses

Conclusion

The current paper focused on evaluating BE’s budget variances and financial ratios. Overall, most of BE’s budget variances were favourable. However, there were two variances, labour cost variance and profit variance that were unfavourable for BE in 2019. The unfavourable labour cost variance can be attributed to increased demand which logically leads to increased production hence an increase in demand for labour. The unfavourable profit variance is attributed to the decreased price per unit. The most important financial ratio for BE was determined to be the current ratio as it describes the risk for liquidation, and in the past three years, BE’s current rate has been dropping.

References

Haskins, M. E. (2017). Ratios Tell a Story—2011. Darden Business Publishing Cases.

Kaplan, R. S., & Atkinson, A. A. (2015). Advanced management accounting. PHI Learning.

Laitinen, E. K. (2018). Financial Reporting: Long-Term Change of Financial Ratios.)

Farkas, M., Kersting, L., & Stephens, W. (2016). Modern Watch Company: An instructional resource for presenting and learning actual, healthy, and standard costing systems, and variable and fixed overhead variance analysis. Journal of Accounting Education, 35, 56-68.

Kes, Z., & Kuźmiński, Ł. (2019). Application of extreme value analysis in the assessment of budget variance risk. Econometrica, 23(2), 80-98.

Santolamazza, A., Introna, V., & Cesarotti, V. (2017). Energy budget control in manufacturing systems with on-site energy generation: An advanced methodology for analyzing specific cost variations. In Summer School “Francesco Turco”–Industrial Systems Engineering, 22. (pp. 404-410). AIDI.

Tonchia, S. (2018). Project Cost Management and Finance. In Industrial Project Management (pp. 153-170). Springer, Berlin, Heidelberg.