UNDERSTANDING FINANCIAL STATEMENTS

Table of Contents
Executive Summary.........................................................................................................................1
Question 1. Features of Melmotte’s financial statements................................................................1
Question 2: Interpreting Melmotte’s Statement of Profit or Loss...................................................2
Question 3 – Interpreting Melmotte’s Statement of Financial Position..........................................5
Question 4 – Interpreting Melmotte’s Statement of Cash Flows....................................................6
 Executive Summary
Yes, that would be a good Grosvenor investment. As Melmotte's business is an growing company with
numerous verticals. The two new industry divisions opened up in 2018, namely the online shop and
the hotel chain, which are the most generating segments of revenues. Grosvenor is interested in
investing in Melmotte's shares.

Question 1. Features of Melmotte’s financial statements

Answer (a) (i) The description is related to Statement of financial statements.

Answer (a) (ii) As there is long term debt funding and these kind of decisions are related to assets and
liabilities which falls under statement of financial statements.
Answer (b) Purpose of the Primary financial statements:
1. Statement of Financial position
The ultimate aim of the Financial Position Statement is to announce the financial condition of the
corporation in a given time span. The statement indicates what an company owns, what it ows, and
how much it retains in the business.

2. Statement of Profit and Loss

The objective of the profit and loss statement is to analyze whether company makes profit or loss
over a given time span. In most other words, profit and loss accounts reflect the amount that an
company invests or pays to raise revenue, which reflects the pays of conducting out business.

3. Statement of Cash Flow

The aim of the cash flow statement is to demonstrate where cash is created by businesses and where
their cash is allocated for a period of time. The liquidity and long-term solvency of a corporation is
essential for the business to evaluate.

 The Statement of Financial position is used by Companies to show their assets and liabilities.
 The Statement of profit and loss is used by business in three ways, first it may be a part of
financial statements, may be act as pro forma or may be projected document for an application of
startup of business loan.
 Statement of cash flow is also used as financial statements or used by external users to know the
liquidity and solvency position of the organization for investing purpose.

The Grosvenor’s investment management team is looking for the Statement of financial position, i.e
to identify its financial securities whether is he liable to pay the loan amount or its asset values are
able to pay that amount.

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Answer (c) (i) The inventory as per IAS 2, should be recorded at cost or net realizable value (NRV),
whichever is lower.

Answer (c) (ii) This includes the most types of stocks, but the main measure is the lower cost or net
realizable value. This includes approaches such as unique recognition, FIFO and weighted average
processes.

Answer (c) (iii) If their value is diminished, the inventory will be written down. In such a scenario,
the cost of the products sold in the Profit & Loss Statement would be debited and credit to the
Expired account funds, which will be the replacement for the stock line item.

Question 2: Interpreting Melmotte’s Statement of Profit or Loss

(a) Revenue

Answer (i) Percentage change in total revenue

Revenue for the year 2017 is 5,550

Revenue for the year 2018 is 9,000

Percentage change = Revenue of this year – Revenue of last year

Revenue of last year

= 9,000 – 5,550
5,550

= 3,450
5,550
= 62.162%

Answer (ii) The contribution of revenue made by the different deparrments

= Amount of revenue by each department

Total revenue

The contribution of revenue made by the Retail operations:

= 6,006 / 9000 *100

= 66.733%
The contribution of revenue made by the Online store:
= 1,644 / 9000 * 100
= 18.267%

The contribution of revenue made by the Hotel Contract:

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 = 1,350 / 9000 * 100
= 15%

Answer (iii) Percentage change in revenue between the total revenue and retail operation
revenue:
= Change in revenue / Revenue from retail operation
= 9,000 – 5,550 / 6,006
= 3,450 / 6,006
= 57.442%

Answer (iv) This additional data would give Grosvenor an estimation of the vertical variance in
the company from which they earn profits. This means that they do not depend on one source.
Before investing, it is important to know that the source of income is better and will continue to
increase investment in the region.
(b) Gross Profit

Answer (i) Big profit shows how many profits make a profit. The gross profit must be
recognized because it indicates the management performance in the process of production using
labor and supplies.
Answer (ii) Gross profit margin ratio = Gross profit / Net sales *100

Retail operation:
= 1800 / 6006 * 100
= 29.970%

Online store:
= 494 / 1644 * 100
= 30.048%

Hotel Contract:
= 581 / 1350 * 100
= 43.037%

Answer (iii) Thanks to the hotel branding, they are able to charge their goods a higher price as
against the online store and discount stores as price ranges are set. That is why the deal for hotels
is considerably higher than two other industry segments.

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(c) Other SPL Costs
Answer (i) The expenses allocated to cost of sales is a direct expense. Expenditure refers to the
expenses incurred in a business that is a regular event or directly related to growth.
The overheads are indirect expenses which are not out rightly allocable to specific cost centre.
These are Office and admin expenses.

Answer (ii) There is an uptrend in the Distribution and transportation cost, as it is 534 in the year
2017 and 996 in the year 2018. There is a growth of 462 as compared to last year.
Answer (iii) Because we use brand hotel name to sell our products and in exchange we had to
pay luxury royalty for using their name.
In online store, we have to deliver the goods to the customer’s doorstep that’s why our
distribution cost has been increased.

(d) Operating Profit

Answer (i) Based on the exclusion of all external variables from the calculation it suggests a
highly accurate measure for company profitability.
Answer (ii) Operating profit margin ratio
= Operating profit / net sales *100
Retail operation
= 544 / 6006 * 100
= 9.057%

Online store
= 206 / 1644 * 100
= 12.530%

Hotel Contract
= 123 / 1350 * 100
= 9.111%

Answer (iii) Operating profit margin ratio is high in online store which means that the company
makes more profit after paying the variable cost of the production such as wages. As there is less
expenditure on the infrastructure.

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 Question 3 – Interpreting Melmotte’s Statement of Financial Position

(a) Non-current asset

Answer (i) We will use it as costs because of the difficulty in calculating the expense for
potential advantages. It is listed in the Financial Position Statement as research and development
costs.
Property, plant and equipment (PPE) are considered as fixed asset for the company.

Answer (ii) Due to our long-lasting properties, we owe depreciation at a considerable cost and
are only used for a limited period of years.
It reduces the value of the PPE as a result of tear, tear and loss of useful life the value of the asset
decreases over time.
Answer (iii) Development costs are viewed as an asset in accordance with the regulatory system,
as the law describes anything with potential economic benefits as an asset. It is also clear that
technology would bring benefits for the future, which is why it is considered an advantage.
The study expense is difficult to predict, so it is difficult to define potential benefits so assets
associated with them. That's why it's costly to us.

(b) Grosvenor’s proposed investment

Answer (i) If company pays bank overdraft from the cash received by issuing shares of their
company then bank overdraft, cash account and bank balance will be affected.
The new figures will be, the bank overdraft of 102 will be completely finished. Cash and cash
equivalent will be increased after deducting bank overdraft i.e 648.
Answer (ii) Interest cover ratio
This ratio calculates how much your debt will gain from your operating income. The interest
coverage rate in our estimate is improved from the previous year, which ensures that the
company will pay its remaining debts on the interest.
Gearing ratio
Our gearing ratio will also rise during the last year which means the company has a larger
proportion of debt versus equity.
Answer (iii) Revised gearing ratio
= Debt / Debt + equity
= 618 / 618 + 843
= 618 / 1461

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 = 42.299%

Answer (iv) This investment will be less risky as firstly it will eliminate the bank overdraft. The
investment amount will be used to investing it further. This will also improve our financial
ratios.

Question 4 – Interpreting Melmotte’s Statement of Cash Flows

Answer (a) The reason of less outflow of cash in cash flow statement:
 Lower inventory turnover ratio
 Decline in day payable outstanding
 Increase in expenses more than increase in net income

Answer (b) Decrease in the sum of the day to pay could be because the company provides more
days for the trade to give its profits. From the perspective of the client, this may be appropriate.
This would impact the interest coverage ratio by rising interest spending. It is due to the
company having received more debt with higher interest expenses.