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Financial management carries a significant role in organizational decision-making by providing an organization with guidelines to earn maximum profits. The research study of Musah et al. (2018) represents those improved practices of financial management helps to improve the profitability and growth of this firm as well. it is stated that financial management will help Smith to improve their profitability and growth. This research paper explores the current financial condition of Smith Construction Company. Understanding of this condition could be made by attaining ratio analysis. Rising from the ground cemented by this aim, this paper sheds light on the ratio analysis task. In addition, this paper will provide an appropriate financing source and identify weak areas of internal control. After the analysis, some recommendations on the internal control will be provided to increase the company performance.
Figure 1: Profitability ratio
Ratio analysis provides organizations with an understanding of current financial results and trends over time. Moreover, ratio analysis shows whether a firm is improving or not as compared to its past year (Keerthi and Eswari, 2020). Haralayya (2021) has pointed out that this management tool helps organizations to compare the relationship between return and risk of firms of different sizes. Shedding light on Smith's current financial performance, a few ups and down could be noticed. There is no margin of net profit in the year 2018 as this company do not generate any profit. The “net profit margin” shows that it increased from 4.78%-11.13% in 2020, whereas the company experienced 0.03% decrease in 2021. A decrease in the gross profit margin could also be noticed in the same year. Since 2018, the company has experienced a positive flow in its sales activities alongside a small increase in their expenses. Therefore, the primary reason for the company's decreased net profit could be the increase in expenses after 2018. Table 2 (Refer to Appendix B) represents the ratio of liquidity of Smith Construction Company. Alongside, financial ratio, Smith has also enjoyed an increase in its quick ratio due to effective management of payables and receivables.
Figure 2: Liquidity ratio
Table 2 (Refer to Appendix B) above shows Smith’s ability to cope with all obligations related to debt as well as its safety margin. As per the comment of Ginting (2021), the short-term liabilities and current assets of firms have some components that influence the liquidity rations value of the firm. Current ratio for the year 2018 stands for 2.8 times, 2019 stands for 1.23 times, 2020 stands for 1.43 times, and 2021 stands for 1.74 times. Therefore, by doing the company’s liquidity ratio calculation, it has been noticed that the company is in a sustainable position in terms of ensuring the ability required to pay its debt obligations at a specific time. As that company is having a liquidity ratio above 1, its liquidity position is currently in a good state. This claim could also be supported by their quick ratio, which is 1.24 in 2021.
Figure 3: Efficiency ratio
The aforementioned calculation aimed to measure the ability of Smith in utilising its assets for generating income. As per the comment of Hodzic and Celebi (2017), it is the indicator that helps an organisation to generate revenue at the time of demand by using their assets. This resource mainly includes all the assets and capital of this construction firm. It is identified that payable turnover ratio for the year 2018 stands for 8 days while asset turnover ratio stands for 6.3 days. By calculating the efficiency ratio, it has been observed that there is a significant increase of 1.65% and 1.42% in 2020 from 2019 and 2021. The reason for this increase in this ratio is the demand of their suppliers for faster payment. Moreover, it has also been noticed that the turnover rate of the company’s assists will decrease by 0.13% in 2021, compared to the turnover rate in the last year. This indicates weak control of the organization’s internal operation and the company is pushed to experience such a decrease by weakening its financial performance.
By analysing all the three ratio calculation tasks, the company must focus on a few areas for investigation. The weakest areas are internal control, expenses, and turnover assets. Alongside these areas, the organisation should also extend their investigation time on areas like internal control associated with their production operations. Although the increase in expenses acts as the primary reason for this misfortune, the lack of focus of the management on internal control should be taken as the main cause of the issues, created by Smith Construction Company.
In internal control, the aim of Smith is to ensure integration in accounting and financial information through a set of rules, mechanisms, and procedures. The organisation could be at risk of fraud from the managers' ends if they fail to strengthen their control in internal operations. As per the opinion of Kneevi?, ivkovi? and Milojevi? (2021), internal control must be used as a management tool to preserve the assets of the firm that contribute to the operation of achieving business goals. Therefore, the areas Smith Construction Limited must focus on are their technical, operational, and administrative control.
One of the key integral areas of internal control is the technical areas of the organisation. By analysing the case study, it has been that the company does not possess any integrated framework for its technical control. This directly led them to experience severe weakness in their internal control.
Lack of following up on policies and procedures of the organisation from the managers' end resulted in severe weaknesses in the operational areas of Smith. The two most important people for this failure for Smith were Freda and Ted who were responsible for setting rules and regulations for the company. On the other hand, it has also been noticed that the company lacks in following well-established rules and regulations while operating the business.
The most important role of the administrative areas in Smith is to show the organisation their optimal way of business operations. With this aim, operational areas of Smith deal with the practical information for creating ways to conduct day-to-day activities of the organisation. The main aspect making Smith’s administrative areas weak is the lack of establishing security control for this area. This gives rise to the chance of administrative corruption. Administrative corruption is a major cause for the collapse of an organisation (Taboli, Samie'e Darooneh and Ehsani, 2019). The amount of money spent by Ted in recent days implicitly indicates that there might be some fraud done by him through utilising this advantage created by a lack of security control.
Assessment of risks is the important area of internal control as it helps to assess risks within a company and provide ways for mitigating such risks. In the context of Smith Company, Ted done a few frauds in the business in recent years and due to this reason, different risks can be faced by this company. In this regard, it can be stated that there is a need for risk assessment. it will help Smith company to identify potential risks of their company can mitigate it although this company does not have any security control. It might be another area for taking care by Smith company for further progress.
By considering the performance of Smith in controlling its various control areas such as operational, technical, and administrative areas, it is suggested the company focus on the current way of operating their business internally. As claimed by Turedi and Celayir (2018), the structure of the internal control within the business aims to protect the assets of the business. Thus, one of the most important tasks that Smith must undertake is establishing a framework for their technical control areas for better capture of Fraud. In order to decrease the possibility of corruption either in the administrative areas or in other areas within the business, proper security control must be implemented. There is a high possibility of the organisation in terms of occurrence of any risks to their business operations. Therefore, Smith should also focus on enhancing their operational control by the implementation of strict rules and policies for both higher-tier and lower-tier employees.
The directors of the organisation are unable to make a decision for choosing appropriate sources of finance, as the board wants to invest £250,000. In order to meet the aim of securing tier competitiveness, it is necessary to identify the cost effective financing sources. However, below are some financing sources that the organisation might consider choosing to secure adequate investment:
Bank loans are among the external financing sources that organisations can easily take to invest in business projects. However, the criteria to be met for availing this source of finance include capacity, character, condition, capital, and collateral (Saidi, Uchennaand Ayodele, 2019). Meeting all of these criteria, the advantages that Smith would unlock include cost-effectiveness, tax benefits, flexibility, and profit-retention. However, the organisation must also acknowledge disadvantages like the lengthy process of application, long eligibility criteria, and risk occurrence. On the other hand, avoiding all of these disadvantages, Smith could get flexibility in paying the amount back with long-term instalment policies. SMEs can find bank loans as the most important external sources of financing due to easy availability (Veiga and McCahery, 2019). Moreover, the cost-effectiveness benefit will also help the company to enjoy the low interest at the payback time. Considering all these benefits, the directors are suggested to consider using bank loans as their primary source of finance for the upcoming project. Through this discussion, it can be stated that this company might face issues with the implementation of such process for generating loan as it is cost-effective and this company does not have much amount as their revenue. However, as this company has increased sales and net profit therefore, it can be stated that bank loan will be more profitable than other financing sources.
As an important source of internal finance, investor loans will help the company to have most of the advantages that they may experience if they use bank loans. As per the claim of Pierrakis (2019), an investor gives organisations unsecured loans without seeking any intermediation of banks. Therefore, one of the major pros that the organisation would get from using investors' loans in the project is no payment. This means that Smith will not have to repay the amount after taking the investment. However, there might be some clauses and conditions that the organisation has to abide by to secure this loan from their investors. In the form of payback, investors demand some profit gained by the organisation from the invested project (Chishti and Puschmann, 2018). This is called share of profit that could cause problems for the organisation, in case they fail to gain adequate profit from the project. Moreover, investors charge a higher rate of interest than that of banks for giving the money. Therefore, it can be stated that Smith company might face issues with high rate of interest. Moreover, this company will be responsible to provide a portion of their profot which might not be profitable for them.
Despite having these benefits, no repayment and non-existence of the requirement for showing eligibility are the two benefits that Smith can unlock using this internal source of finance.
Although both sources could assist the organisation in securing adequate funds for their upcoming project, a lack of eligibility would not allow the organisation to take loans from banks. On the other hand, taking loans from investors will help them to precede the project with the reduced concern of paying back an equal amount to investors at the end of the project. As per the comment of Mullins (2017), investor loans allow organizations to secure funds by showing their profit-making criteria in the project. This is the key aspect that the organization can utilize well to impress their investors for the amount.
In conclusion, this assignment aimed to evaluate the financial performance of Smith by calculating and analysing financial ratios. Analysis of the financial performance of Smith using ratio analysis makes it obvious that the organisation has the ability of paying debt on time. However, they lack in ensuring the capability to generate profits with promise.
The root causes for such weakness are the lack of internal control. This company has several weak areas in internal control such as weak technical control, weak security control, and weak operational and administrative control. Therefore, the management of Smith must consider restricting their internal business functions.
In order to secure fund for the upcoming project, the company can seek help from its investors to enjoy the no payment benefit. Additionally, there is no need to provide any finance history. However, this company will be liable to provide a share of profit to the investors in case they take finance from them. This paper recommends to take loan from investors as bank loan will not be appropriate for them.
Chishti, S. and Puschmann, T., 2018. The Wealthtech Book: The FinTech Handbook for Investors, Entrepreneurs and Finance Visionaries. Hoboken, United States: John Wiley & Sons.
Ginting, E.S., 2021. Ratio-Based Financial Performance Analysis of PT. Mustika Ratu, Tbk. Enrichment: Journal of Management, 11(2), pp.456-462.
Haralayya, B., 2021. Ratio Analysis at NSSK, Bidar. Iconic Research And Engineering Journals, 4(12), pp.170-182.
Hodzic, S. and Celebi, H., 2017. Value-added tax and its efficiency: EU-28 and Turkey. UTMS Journal of Economics, 8(2), pp.79-90.
Keerthi, K. and Eswari, S., 2020. A Study on Financial Performance Using Ratio Analysis of Kumbakonam Central Co-operative Bank. ICTACT Journal on Management Studies, 6(3), pp.1273-1275.
Kneevi?, S., ivkovi?, A. and Milojevi?, S., 2021. The role and importance of internal control and internal audit in the prevention and identification of fraudulent actions in banks. Bankarstvo, 50(1), pp.66-89.
Mullins, J., 2017. The New Business Road Test: What entrepreneurs and investors should do before launching a lean start-up. United Kingdom: Pearson UK.
Musah, A., Gakpetor, E.D. and Pomaa, P., 2018. Financial management practices, firm growth and profitability of small and medium scale enterprises (SMEs). Information management and business review, 10(3), pp.25-37.
Pierrakis, Y., 2019. Peer-to-peer lending to businesses: Investors’ characteristics, investment criteria and motivation. The International Journal of Entrepreneurship and Innovation, 20(4), pp.239-251.
Saidi, A.A., Uchenna, E.B. and Ayodele, M.S., 2019. Bank loans and small medium enterprises’(SMES) performance in Lagos, Nigeria. Ilorin Journal of Human Resource Management, 3(1), pp.52-61.
Taboli, H.R., Samie'e Darooneh, M. and Ehsani, A., 2019. Administrative Corruption: Why and How?. International Journal of Advanced Studies in Humanities and Social Science, 8(3), pp.282-288. Turedi, H. and Celayir, D., 2018. Role of effective internal control structure in achievement of targeted success in businesses. European Scientific Journal, 14(1), pp.1-18.
Veiga, M.G. and McCahery, J.A., 2019. The financing of small and medium-sized enterprises: an analysis of the financing gap in Brazil. European Business Organization Law Review, 20(4), pp.633-664. Available at: https://link.springer.com/article/10.1007/s40804-019-00167-7 [Accessed 12 November 2021]
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